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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended June 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number (1-14588)
Northeast Bancorp
(Exact name of registrant as specified in its charter)
Maine 01-0425066
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
232 Center Street, Auburn, Maine 04210
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (207) 777-6411
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
Common Stock, $1.00 par value American Stock Exchange
2
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant, as of September 14, 1998, was $23,072,595 based on the last
reported sales price of the Company's common stock on the American Stock
Exchange as of the close of business on such date. Although directors and
executive officers of the registrant and its subsidiaries were assumed to be
"affiliates" of the registrant for the purposes of this calculation, this
classification is not to be interpreted as an admission of such status. There
were 2,614,285 shares of the registrant's common stock issued and outstanding
as of September 14, 1998.
DOCUMENTS INCORPORATED
BY REFERENCE
The following documents, in whole or in part, are specifically incorporated
by reference in the indicated Part of this Annual Report on Form 10-K:
Form 10-K Part into Which the Document is
Document Incorporated
-------- -----------------------------------------
Proxy Statement for the III
1998 Annual Meeting of
Shareholders
PART I
Item 1. Business
________
General
- -------
Northeast Bancorp, a Maine corporation chartered in April 1987, is a unitary
savings and loan holding company whose primary subsidiary and principal asset
is Northeast Bank, F.S.B. (the "Bank"). Prior to 1996, the Company operated
under the name Bethel Bancorp. The Company, through its ownership of the Bank,
is engaged principally in the business of originating and purchasing
residential and commercial real estate loans in the State of Maine and its
primary source of earnings is derived from the income generated by the Bank.
Although historically the Bank has been primarily a residential real estate
lender, it also generates other loans and provides other services and products
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traditionally furnished to customers by full service banks. The overall
strategy of the Company is to increase the core earnings of the Bank by
developing strong interest margins, non-interest fee income, and increasing
volume by expanding its market area. As of June 30, 1998, the Company, on a
consolidated basis, had total assets of approximately $323 million, total
deposits of approximately $184 million, and stockholders' equity of
approximately $25 million. Unless the context otherwise requires, references
herein to the Company include the Company and the Bank on a consolidated basis.
The Bank (which was formerly known as Bethel Savings Bank F.S.B. ("Bethel"))
is a federally-chartered savings bank which was originally organized in 1872 as
a Maine-chartered mutual savings bank. The Bank received its federal charter
in 1984. In 1987, Bethel converted to a stock form of ownership and in
subsequent years has engaged in a strategy of both geographic and product
expansion. In October 1997, the Company completed its merger of Cushnoc Bank &
Trust, a commercial bank located in Augusta, Maine ("Cushnoc"), with and into
the Bank. As a result of the merger, the Bank added two branches which have
expanded its market area to include Maine's capital city and surrounding
communities, an area that management believes offers significant growth
opportunities. With the addition of the two Augusta area branches, the Bank
now has a total of eleven banking branches.
From its eleven retail banking branches located throughout western, central,
and the mid-coastal regions of the State of Maine, and through the Bank's
subsidiaries and other affiliations, the Bank offers its customers access to a
broad range of real estate, commercial, and consumer financial products,
including, but not limited to loans, deposit and investment services, trust
services, credit cards, ATM access, debit cards, electronic transfer services,
leasing, and other services. The Bank believes that the local character of its
business and its "community bank" management philosophy allows it to compete
effectively in its market area. The Bank has branch locations in Auburn,
Augusta, Bethel, Brunswick, Buckfield, Harrison, Lisbon Falls, Richmond, and
South Paris, Maine.
In connection with its conversion into a federal savings bank in 1984, the
Bank retained its then-authorized powers as a Maine-chartered mutual savings
bank. Under applicable regulations, except as otherwise determined by the
Office of Thrift Supervision ("OTS"), the Bank retains the authority that it
was permitted to exercise as a mutual savings bank under the state law existing
at the time of the conversion. Historically, Maine-chartered savings banks
have had certain lending, investment, and other powers that have only recently
been granted to federal savings institutions, including commercial lending
authority and the ability to offer personal checking and negotiable order of
withdrawal ("NOW") accounts. Accordingly, the Bank has had broad powers to
engage in non-residential lending activities. In addition, the unitary savings
and loan holding company charter is widely recognized for the broad range of
powers that is provided thereunder.
The Bank's corporate philosophy is to offer a wide array of financial
products and services with an emphasis on a high level of personalized service,
thereby enhancing its ability to generate significant income diversity. In the
past, the Bank has been primarily a residential mortgage lender. As a result,
the Bank's business has historically consisted of attracting deposits from the
general public through its retail banking offices and applying those funds
primarily to the origination, retention, servicing, investing in and selling
first mortgage loans on single and multi-family residential real estate.
During the past few years, the Bank has placed additional emphasis on consumer
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lending and small business, home equity, and commercial loans. The Bank also
lends funds to retail banking customers by means of home equity and installment
loans, and originates loans secured by commercial property and multi-family
dwellings. The Bank also has developed the ability to generate indirect dealer
consumer loans used for the purchase of mobile homes and automobiles.
Management's community banking strategy emphasizes the development of full
banking relationships with the Bank's customers by providing consistent, high
quality service. With the goal of providing a full range of banking services
to its customers and in an effort to develop strong primary banking
relationships with businesses and individuals, the Bank has expanded its
commercial banking operations by selectively making commercial loans to small
and medium sized companies. In this regard, the Bank's business development
efforts have been directed towards full service credit packages and financial
services, as well as competitively priced mortgage packages. At June 30, 1998,
the Bank's loan portfolio consisted of 61% residential real estate mortgages,
17% commercial real estate mortgages, 10% commercial loans, and 12% consumer
loans. At June 30, 1998, the Bank's lending limit was approximately $3.77
million. To the extent that customers credit needs exceed the bank's lending
limits, the Bank may seek participations in such loans with other banks. In
addition, the Bank invests in certain U.S. government and agency obligations
and other investments permitted by applicable law and regulations.
Consistent with its goal of providing a full range of banking services, the
Bank also offers to its customers financial planning, trust, and employee
benefit services, and, through its subsidiary, Northeast Financial Services
Corporation, it offers investment services and access to any and all lines of
insurance products. Northeast Financial Services Corporation, which is located
at the Company's headquarters in Auburn, Maine, offers the Bank's customers
access to investment and annuity products. In order to make these services
available, Northeast Financial Services Corporation has affiliated with
Commonwealth Equity Services, Inc., a fully licensed New York securities firm,
which licenses the brokers who sell such products and services.
Trust services and products are provided to Bank customers through Northeast
Trust, a division of the Bank. First New England Benefits, which is a part of
the Bank's trust division, designs and administers qualified retirement plans,
such as profit sharing, pension, and 401(k) plans. Northeast Trust, working
with its First New England Benefits division, has made a significant investment
in the development of a "turn key" employee benefit product which is designed
to provide a high level of service and education to its participants at a
competitive price. In view of the nationwide popularity of employment
retirement programs, management anticipates growth in the revenues generated
from this product.
The Bank is subject to examination and comprehensive regulation by the OTS
and its deposits are insured by the Federal Deposit Insurance Corporation (the
"FDIC") to the extent permitted by law. The Bank also is a member of the
Federal Home Loan Bank ("FHLB") of Boston. Although the Bank's deposits are
primarily insured through the Bank Insurance Fund, deposits at the Brunswick
branch, which represent approximately 27% of the Bank's total deposits, are
insured through the Savings Association Insurance Fund.
The principal executive offices of Northeast Bancorp and the Bank are
located at 232 Center Street, Auburn, Maine, 04210, and their telephone number
is (207) 777-6411.
Recent Developments
5
- -------------------
On October 24, 1997, in accordance with the terms of an Agreement and Plan
of Merger, dated as of May 9, 1997 (the "Merger Agreement"), by and among the
Company, the Bank, and Cushnoc, the Company consummated its acquisition of
Cushnoc and merged it with and into the Bank. Pursuant to the merger,
stockholders of Cushnoc received 2.089 shares of the Company's common stock
("Common Stock") in exchange for each share of Cushnoc common stock
held by them. In lieu of the issuance of fractional common stock, cash was
paid for each such fraction. As a result of the merger, 187,940 shares of
Common Stock were issued to former Cushnoc stockholders. The merger was
accounted for under the pooling-of-interests method of accounting.
On December 15, 1997, the Company paid a 50% stock dividend on all
outstanding shares of Common Stock held of record as of November 26, 1997. As
a result of the stock dividend, the number of shares of outstanding Common
Stock increased from 1,481,734 shares to 2,222,541 shares. In addition, the
conversion rate at which Series A and Series B Preferred Stock may be converted
into Common Stock and all outstanding options and warrants pursuant to which
Common Stock could be purchased upon their exercise, also were automatically
adjusted in accordance with their terms to eliminate any dilutive effects of
the stock dividend.
Market Area and Competition
___________________________
The Bank is headquartered in Auburn, Maine with full service branches in
Augusta, Bethel, Harrison, South Paris, Buckfield, Mechanic Falls, Brunswick,
Richmond and Lisbon Falls, Maine. The Bank's market area is characterized by a
diversified economy and a strong emphasis on the tourist industry.
The banking business in the Bank's market areas has become increasingly
competitive over the past several years. The Bank encounters strong
competition both in making loans and in attracting deposits. In one or more
aspect of its business, the Bank competes with other savings banks, commercial
banks, credit unions, finance companies, brokerage and investment banking
firms, asset-based nonbank lenders, and governmental organizations that offer
subsidized financing at lower rates than those offered by the Bank. Many of
the Banks' competitors are larger in size and possess greater resources
(financial and other) and have higher lending levels.
The principal factors in competing for deposits are convenient office
locations, flexible hours, interest rates and services, while those relating to
loans are interest rates, the range of lending services offered and lending
fees. Additionally, the Bank believes that the local character of its business
and its "community bank" management philosophy will enhance its ability to
compete successfully in its market areas. Further, the Bank now offers a wide
range of financial services to its customers, including not only basic loan and
deposit services, but also investment services, trust services, and insurance
products. Management believes that the availability of such a wide range of
financial services through a community bank oriented financial institution
which knows and caters to its clients will prove to be an attractive
alternative to consumers in its market area.
Regional Economic Environment
____________________________
6
The state of Maine's economy in which the Company operates, including the
south central and mid-coast region of Cumberland, Androscoggin, and Sagadahoc
counties, has experienced moderate growth.
Subsidiaries
____________
The Company acquired a wholly-owned subsidiary, ASI Data Services, Inc.
("ASI") through two stock purchases during 1993-1994. ASI initially provided
data processing services to the Company and its subsidiaries. The Company's
board of directors voted to transfer the assets and operations of ASI to the
Bank as of July 1, 1996. ASI, the Company's only subsidiary other than the
Bank, continues to exist as a separate legal entity, but is now inactive.
The Bank itself has one wholly-owned subsidiary, Northeast Financial
Services Corporation, which was organized in 1982. Through Northeast Financial
Services Corporation, the Bank has participated in certain real estate
development projects. Any proposed development project is examined for its
profit potential and its ability to enhance the communities served by the Bank.
There are no definitive plans for additional real estate development projects
at the present time. At June 30, 1998, investment in and loans to its
subsidiary constituted 0.14% of the Company's total assets. This service
corporation also supports the Bank's non-banking financial services through its
relationship with Commonwealth Financial Services, Inc., ("Commonwealth") a
fully licensed New York securities firm. The service corporation receives
rental fee income, from Commonwealth, derived from the sales activity of local
in-house security sales people. The service corporation has not invested in any
assets in its business relationship with Commonwealth.
In 1994, Northeast Financial Services Corporation invested $375,000 of
capital and became the majority owner of First New England Benefits, Inc., a
New Hampshire corporation which specialized in the design and administration of
qualified retirement plans (such as profit sharing, pension, and 401(k) plans).
In fiscal 1997, Northeast Financial Services purchased the remaining 37.5% of
outstanding shares of First New England Benefits and merged it with and into
the Bank. It currently operates as part of the Bank's trust division.
Northeast Trust, working with its New England Benefits division, has made a
significant investment in the development of a "turn key" employee benefit
product which it offers to its business clients.
Employees
_________
As of June 30, 1998, the Company and the Bank together employed 126 full-
time and 26 part-time employees. The Company's employees are not represented
by any collective bargaining unit. The Company believes that its relations
with its employees are good.
Supervision and Regulation
__________________________
General
_______
The banking industry is extensively regulated under both federal and state
law, and is undergoing significant change. These laws and regulations are
7
intended primarily to protect depositors and the federal deposit insurance
funds, and not for the protection of shareholders. The following discussion
summarizes certain aspects of the banking laws and regulations that affect the
Company or the Bank. Proposals to change the laws and regulations governing
the banking industry are frequently raised in Congress, in state legislatures,
and before various banking agencies. Although such proposals are actively
being considered and discussed by such legislative bodies, the likelihood and
timing of any changes, and the impact that such changes might have on the
Company or the Bank, are impossible to predict with any certainty. A change in
the applicable laws or regulations, or in the way such laws or regulations
are interpreted by regulatory agencies or the courts, may have a material
impact on the business or prospects of the Company and the Bank.
To the extent that the following information describes statutory and
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions.
The Company is an unitary savings and loan holding company, subject to
regulation, examination, supervision, and reporting requirements of the OTS
and the State of Maine Department of Banking (the "Department"). The Bank is a
federally chartered savings and loan association under the Home Owners Loan
Act, as amended ("HOLA"), and is a member of the FHLB system, subject to
examination and supervision of the FDIC, and subject to the regulations of the
Federal Reserve Board governing reserve requirements. As a Maine financial
institution, the Company is registered with the Maine Superintendent of
Banking (the "Superintendent").
Recent Developments in Savings Institution Regulation
_____________________________________________________
On May 13, 1998, the House of Representatives passed the Financial Services
Act of 1997, H.R. 10, originally introduced in early 1997 by Representative Jim
Leach, Chairman of the Banking Committee of the United States House of
Representatives. The Act as approved by the House on May 13, 1998, will be
considered by the United States Senate. Unlike prior versions of H.R. 10, the
Act that was passed does not eliminate the thrift charter and the unitary
thrift holding company. Instead, the Act provides a "grandfather" provision
under which companies which are unitary thrift holding companies as of March
31, 1998 (or have an application to establish a federal savings association
before such date) may continue to engage in all activities which were permitted
prior to the Act. To be eligible for the "grandfather" provision, the Act
requires that the Bank comply with any lending restrictions which were imposed
on it as a savings and loan association, and that the Bank continue to meet the
qualified thrift lending test. See "--- Savings Institution Regulation ---
Qualified Thrift Lender Requirement." The Act also provides for the creation
of financial holding companies, which under certain circumstances may engage in
a broad variety of financial services activities not permitted for banking
holding companies under the current law. The Act provides for broader
insurance and securities powers for financial institutions, subject to the
implementation of regulations. The Act also instructs the Secretary of the
Treasury to formulate plans for consolidating the OTS with the Office of the
Comptroller of the Currency within two years after enactment.
On September 30, 1996, the President signed into law the Omnibus
Consolidated Appropriations Act which included, among other provisions, the
Deposit Insurance Funds Act of 1996 (the "DIFA"). The principal purpose of the
DIFA was to recapitalize the Savings Associate Insurance Fund (the "SAIF") so
8
that over time its deposit insurance assessments could be reduced to parity
with those of the Bank Insurance Fund (the "BIF"), and to provide for the
eventual merger of the SAIF and the BIF and the adoption of a single standard
federal charter. Specifically, the DIFA requires, in pertinent part: (i) a
one-time special assessment on all financial institutions holding SAIF deposits
on March 31, 1995, calculated at 65.7 basis points, to recapitalize the SAIF;
(ii) full pro rata sharing by BIF and SAIF members of the debt service
obligations of the Financing Corp. ("FICO") beginning no later than January 1,
2000, and non-pro rata sharing (with adjustable, semi-annual premiums of
approximately 6.44 basis points for SAIF members and 1.29 basis points for BIF
members) until that date; and (iii) a merger of the BIF and the SAIF into a new
Deposit Insurance Fund (the "DIF") on January 1, 1999, if bank and savings
association charters have been combined by that date. Commencing on January 1,
2000 and continuing through 2017, banks will be assessed a flat fee of 2.43
basis points on deposits.
The legislation mandates a Treasury Department study to develop a common
depository institution charter. It also contains environmental liability
provisions indicating that lenders who do not participate in the management of
environmentally contaminated property or who do not cause the contamination are
not liable for environmental clean-up costs. In addition, the legislation
contains over 40 regulatory burden relief provisions in various areas,
including truth in lending and other regulatory reform measures designed to
reduce the burden and costs imposed on financial institutions to comply with
consumer protection provisions.
The Small Business Job Protection Act of 1996 contained provisions requiring
the thrift industry to recapture tax deductions taken pursuant to the reserve
method for accounting for bad debts of savings institutions. Based upon the 14
provisions, bad debt reserves taken prior to January 1, 1988 would not be
recaptured, and bad debt reserves taken after January 1, 1988 would be
recaptured over a six-year period beginning with the 1996 tax year.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") allows bank holding companies to acquire existing
banks across state lines, regardless of state statutes. Further, under the
Interstate Banking Act, effective June 1, 1997, a bank holding company may
consolidate interstate bank subsidiaries into branches, and a bank may merge
with an unaffiliated bank across state lines to the extent that the applicable
states have not "opted out" of interstate branching prior to such effective
date. States were permitted to elect to allow interstate mergers prior to June
1, 1997. The Interstate Banking Act also permits de novo branching to the
extent that a particular state "opts into" the de novo branching provisions.
The Interstate Banking Act generally prohibits an interstate acquisition (other
than an initial entry into a state by a bank holding company), which would
result in either the control of more than (i) 10 percent of the total amount of
insured deposits in the United States, or (ii) 30 percent of the total insured
deposits in the home state of the target bank unless such 30 percent limitation
is waived by the home state on a basis which does not discriminate against out
of state institutions.
Federal Savings and Loan Holding Company Regulation
___________________________________________________
General.
________
As the owner of all of the outstanding capital stock of the Bank, the
9
Company is a savings and loan holding company subject to regulation by the OTS
under HOLA. As a unitary savings and loan holding company owning only one
savings institution, the Company generally is allowed to engage and invest in a
broad range of business activities not permitted to commercial bank holding
companies or savings and loan holding companies owning multiple savings
institutions (a "multiple savings and loan holding company"); provided, that,
the Bank continues to continue to qualify as a "qualified thrift lender".
See "---Savings Institution Regulation---Qualified Thrift Lender Requirements."
In the event of any acquisition by the Company of another savings association
subsidiary, except for a supervisory acquisition, the Company would become a
multiple savings and loan holding company and would be subject to limitations
on the types of business activities in which it could engage.
The HOLA prohibits a savings and loan holding company such as the Company,
directly or indirectly, or through one or more subsidiaries, from (i) acquiring
control of, or acquiring by merger with or purchase of the assets of, another
savings institution or a savings and loan holding company without the prior
written approval from the OTS; (ii) acquiring more than 5% of the issued and
outstanding shares of voting stock of another savings institution or savings
and loan holding company, except as part of an acquisition of control approved
by the OTS, as part of an acquisition of stock issued by an undercapitalized
savings institution or its holding company approved by the OTS or except under
certain specified conditions (such as an acquisition of stock in a fiduciary
capacity) which negate a finding of control; or (iii) acquiring or retaining
control of a financial institution that does not have SAIF or BIF insurance of
accounts. Control of a savings institution or a savings and loan holding
company is conclusively presumed to exist if, among other things, a person
acquires more than 25% or any class of voting stock of the institution or
holding company or controls in any manner the election of a majority of the
directors or the insured institution or the holding company. Control is
rebuttably presumed to exist if, among other things, a person acquires 10% or
more of any class of voting stock (or 25% of any class of stock) and is subject
to any of certain specified "control factors."
The HOLA also allows the OTS to approve transactions resulting in the
creation of multiple savings and loan holding companies controlling savings
institutions located in more than one state in both supervisory and
nonsupervisory transactions, subject to the requirement that, in nonsupervisory
transactions, the law of the state in which the savings institution to be
acquired is located must specifically authorize the proposed acquisition, by
language to that effect and not merely by implication. As a result, the
Company may, with the prior approval of the OTS, acquire control of a savings
institution located in a state other than Maine if the acquisition is expressly
permitted by the laws of the state in which the savings institution to be
acquired is located. No director, officer, or controlling shareholder of the
Company may, except with the prior approval of the OTS, acquire control of any
savings institution which is not a subsidiary of the Company. Restrictions
relating to service as an officer or director of an unaffiliated holding
company or savings institution are applicable to the directors and officers of
the Company and its savings institution subsidiaries under the Depository
Institution Management Interlocks Act.
Restrictions with Affiliates
____________________________
Pursuant to the HOLA, transactions engaged in by a savings association or
one of its subsidiaries with affiliates of the savings association generally
10
are subject to the affiliate transaction restrictions contained in Sections 23A
and 23B of the Federal Reserve Act in the same manner and to the same extent as
such restrictions now apply to transactions engaged in by a member bank or one
of its subsidiaries with affiliates of the member bank. Section 23A of the
Federal Reserve Act imposes both quantitative and qualitative restrictions on
transactions engaged in by a member bank or one of its subsidiaries with an
affiliate, while Section 23B of the Federal Reserve Act requires, among other
things, that all transactions with affiliates be on terms substantially the
same, and at least as favorable to the member bank or its subsidiary, as the
terms that would apply to, or would be offered in, a comparable transaction
with an unaffiliated party. Exemptions from, and waivers, of, the provisions
of Sections 23A and 23B of the Federal Reserve Act may be granted only by the
Federal Reserve Board, but the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRRE Act"), authorizes the OTS to impose additional
restrictions on transactions with affiliates if the Director determines such
restrictions are necessary to ensure the safety and soundness of any savings
institution.
Restrictions on Activities of Savings and Loan Holding Companies
________________________________________________________________
Under applicable federal regulations, savings and loan holding companies and
their noninsured subsidiaries are prohibited from engaging in any activities
other than (i) furnishing or providing management services for the savings
association; (ii) conducting an insurance agency or escrow business; (iii)
holding, managing or liquidating assets owned or acquired from the savings
association; (iv) holding or managing properties used or occupied by the
savings association; (v) acting as trustee under deeds of trust; (vi) engaging
in any other activity in which savings and loan holding companies were
authorized by regulation to engage as of March 5, 1987; and (vii) engaging in
any activity which the Board of Governors of the Federal Reserve System has
permitted for bank holding companies under its regulations (unless the OTS, by
regulation, prohibits or limits any such activity for savings and loan holding
companies). The activities in which savings and loan holding companies were
authorized by regulation to engage as of March 5, 1987 consist of activities
similar to those permitted for service corporations of federally chartered
savings institutions and include, among other things, various types of lending
activities, furnishing or performing clerical, accounting and internal audit
services primarily for affiliates, certain real estate development and leasing
activities, underwriting credit life or credit health and accident insurance in
connection with extension of credit by savings institutions or their affiliates
and the performance of a range of other services primarily for their
affiliates, their savings association subsidiaries and service corporation
subsidiaries thereof. The activities which the Board of Governors of the
Federal Reserve System by regulation has permitted for bank holding companies
generally consist of those activities that the Board of Governors of the
Federal Reserve System has found to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto, and include,
among other things, various lending activities, certain real and personal
property leasing activities, certain securities brokerage activities, acting as
an investment or financial advisor subject to certain conditions, and providing
management consulting to depository institutions, subject to certain
conditions. OTS regulations do not limit the extent to which savings and loan
holding companies and their nonsavings institution subsidiaries may engage in
activities permitted for bank holding companies pursuant to the regulations
adopted by the Governors of the Federal Reserve System, although prior OTS
11
approval is required to commence such activity whether de novo or by an
acquisition (in whole or part) of a going concern.
The Company could be prohibited from engaging in any activity (including
those otherwise permitted under the HOLA) not allowed for bank holding
companies if the Bank fails to constitute a qualified thrift lender. See " --
Savings Institution Regulation --- Qualified Thrift Lender Requirement."
Savings Institution Regulation
______________________________
General.
________
As a federally chartered institution, the Bank is subject to supervision and
regulation by the OTS, the FHLB's successor under the FIRRE Act. As a result
of its conversion to a federal mutual savings bank in 1984, the Bank retains
the then-authorized powers of a Maine-chartered mutual savings bank. Under OTS
regulations, the Bank is required to obtain audits by independent accountants
and to be examined periodically by the OTS. These examinations must be
conducted no less frequently than every twelve (12) months. The Bank is
subject to assessments by the OTS and the FDIC to cover the costs of such
examinations. The OTS may revalue assets of the Bank, based upon appraisals,
and require the establishment of specific reserves in amounts equal to the
difference between such revaluation and the book value of the assets. The OTS
is also authorized to promulgate regulations to ensure the safe and sound
operations of savings institutions and may impose various requirements and
restrictions on the activities of savings institutions. The FIRRE Act requires
that all regulations and policies of the OTS for the safe and sound operations
of savings institutions be no less stringent than those established by the
Office of the Comptroller of the Currency (the "OCC") for national banks. The
Bank is also subject to regulation and supervision by the FDIC, in its capacity
as insurer of deposits in the Bank, to ensure the safety and soundness of the
BIF and the SAIF. See "--- Savings Institution Regulation --- Insurance of
Deposits."
Capital Requirements.
_____________________
General.
________
Since 1989, OTS capital regulations have established capital
standards applicable to all savings institutions, including a core capital
requirement (or leverage ratio), a tangible capital requirement and a risk-
based capital requirement. The OTS also has established pursuant to FDICIA five
classifications for institutions based upon the capital requirements: well
capitalized, adequately capitalized, under capitalized, significantly under
capitalized, and critically under capitalized. At June 30, 1998, the Bank was
"well capitalized". Failure to maintain an adequately capitalized status
would result in greater regulatory oversight or restrictions on the Bank's
activities. The capital requirements established by the OTS requires savings
institutions to maintain: (i) "core capital" in an amount of not less than 3%
of total assets, (ii) "tangible capital" in an amount not less than 1.5% of
adjusted total assets, and (iii) a level of risk-based capital equal to 8.0% of
risk-weighted assets. The capital standards established for savings
institutions must generally be no less stringent than those applicable to
national banks and must use all relevant substantive definitions used in the
capital standards for national banks. Since most national banks are required
to maintain a level of core capital of at least 100 to 200 basis points above
12
the 3% minimum, savings institutions are generally required to satisfy the
higher core capital standards.
Under the OTS regulations, the term "core capital" includes common
stockholders' equity, noncumulative perpetual preferred stock and related
surplus, nonwithdrawable accounts and pledged deposits of mutual savings
associations, and minority interests in the equity accounts of fully
consolidated subsidiaries, less intangible assets, other than certain amounts
of supervisory goodwill, and up to 90% of the fair market value of readily
marketable mortgage servicing rights ("MSRs") (subject to certain conditions).
The term "tangible capital," for purposes of the HOLA, is defined as core
capital minus intangible assets (as defined by the OCC for national banks),
provided, however, that savings institutions may include up to 90% of the fair
market value of readily marketable purchased MSRs included in core capital as
tangible capital (subject to certain conditions, including any limitations
imposed by the FDIC on the maximum percentage of the tangible capital
requirement that may be satisfied with such servicing rights). In determining
compliance with capital standards, a savings institution must deduct from
capital its entire investment in and loans to any subsidiary engaged as
principal in activities not permissible for a national bank, other than
subsidiaries (i) engaged in such nonpermissible activities solely as agent for
their customers; (ii) engaged in mortgage banking activities, or (iii) that are
themselves savings institutions, or companies the only investment of which is
another savings institution.
In determining total risk-weighted assets for purposes of the risk-based
capital requirement, (i) each off-balance sheet asset must be converted to its
on-balance sheet credit equivalent amount by multiplying the face amount of
each such item by a credit conversion factor ranging from 0% to 100% (depending
upon the nature of the asset), (ii) the credit equivalent amount of each off-
balance sheet asset and the book value of each on-balance sheet asset must be
multiplied by a risk factor ranging from 0% to 100% (depending upon the nature
of the asset), and (iii) the resulting amounts are added together and
constitute total risk-weighted assets. Total capital, for purposes of the
risk-based capital requirement, equals the sum of core capital plus
supplementary capital (which, as defined, includes, among other items,
perpetual preferred stock, not counted as core capital, limited life preferred
stock, mandatorily convertible securities, subordinated debt, and general loan
and lease loss allowances up to 1.25% of risk-weighted assets), less certain
deductions. The amount of supplementary capital that may be counted towards
satisfaction of the total capital requirement may not exceed 100% of core
capital, and OTS regulations require the maintenance of a minimum ratio of core
capital to total risk-weighted assets of at least 4.0%. As of June 30, 1998,
the Bank's total of risk-based capital to total risk-weighted assets was
11.20%.
See Item 8a. "Financial Statements and Supplementary Data - Footnote 10" for
a table reflecting the Bank's minimum regulatory capital requirements, actual
capital and the level of excess capital by category.
In addition, the OTS requires institutions with an "above-normal" degree of
interest rate risk to maintain an additional amount of capital. The test of
"above-normal" is determined by postulating a 200 basis point shift (increase
or decrease) in interest rates and determining the effect on the market value
of an institution's portfolio equity. If the decline is less than 2 percent, no
addition to risk-based capital is required (i.e., an institution has only a
normal degree of interest rate risk). If the decline is greater than 2
13
percent, the institution must add additional capital equity to one-half the
difference between its measured interest rate risk and 2 percent multiplied by
the market value of its assets. Management believes that the Bank's interest
rate risk is within the normal range.
In March 1998, the OTS issued a final rule which requires savings
associations to comply with an overlapping set of regulatory capital standards,
as follows: (i) Tangible equity: to be deemed other than "critically
undercapitalized", the minimum ratio, as a percentage of tangible assets, is
2%; (ii) Tier 1 or leverage capital: to be deemed "adequately capitalized" or
"well capitalized", the minimum ratios, as a percent of adjusted total assets,
are 4% or 5%, respectively; (iii) Tier 1 risk-based capital: to be deemed
"adequately capitalized" or "well capitalized", the minimum ratios, as a
percent of risk-weighted assets, are 4% or 6%, respectively; and (iv) Total
risk-based capital: to be deemed "adequately capitalized" or "well
capitalized", the minimum ratios, as a percent of risk-weighted assets, are 8%
or 10%, respectively.
Any insured depository institution which falls below minimum capital
standards must submit a capital restoration plan. In general, undercapitalized
institutions will be precluded from increasing their assets, acquiring other
institutions, establishing additional branches, or engaging in new lines of
business without an approved capital plan and an agency determination that such
actions are consistent with the plan. Savings institutions that are
significantly undercapitalized or critically undercapitalized are subject to
additional restrictions and may be required to (i) raise additional capital;
(ii) limit asset growth; (iii) limit the amount of interest paid on deposits to
the prevailing rate of interest in the region where the institution is located;
(iv) divest or liquidate any subsidiary which the OTS determines poses a
significant risk; (v) order a new election for members of the board of
directors; (vi) require the dismissal of a director or senior executive
officer, or (vii) take such other action as the OTS determines is appropriate.
Under FDICIA, the OTS is required to appoint a conservator or receiver for a
critically undercapitalized institution no later than 9 months after the
institution becomes critically undercapitalized, subject to a limited exception
for institutions which are in compliance with an approved capital plan and
which the OTS and the FDIC certify are not likely to fail.
FDICIA prohibits any depository institution that is not well capitalized
from accepting deposits through a deposit broker. Previously, only troubled
institutions were prohibited from accepting brokered deposits. The FDIC may
allow adequately capitalized institutions to accept brokered deposits for
successive periods of up to 90 days. FDICIA also prohibits undercapitalized
institutions from offering rates of interest on insured deposits that
significantly exceed the prevailing rate in their normal market area or the
area in which the deposits would otherwise be accepted.
Capital requirements higher than the generally applicable minimum
requirement may be established for a particular savings institution if the OTS
determines that the institution's capital was or may become inadequate in view
of its particular circumstances. Individual minimum capital requirements may
be appropriate where the savings institution is receiving special supervisory
attention, has a high degree of exposure to interest rate risk, or poses other
safety or soundness concerns.
Qualified Thrift Lender Requirement.
____________________________________
14
In order for the Bank to exercise the powers granted to federally chartered
savings institutions, and maintain full access to FHLB advances, it must
satisfy a "qualified thrift lender" ("QTL")test. In order to qualify as a QTL,
the Bank must maintain at least 65% of its total "Portfolio Assets" in
"Qualified Thrift Investments". This level must be maintained on a monthly
average basis in nine out of every twelve months. Qualified Thrift Investments
generally include (i) various housing related loans and investments (such as
residential construction and mortgage loans, home improvement loans, mobile
home loans, home equity loans and mortgage-backed securities), (ii) certain
obligations issued by the federal deposit insurance agencies, and (iii) shares
of stock issued by any FHLB, the Federal Home Loan Mortgage Corporation, or the
Federal National Mortgage Association. In addition, the following assets may
be categorized as Qualified Thrift Investments in an amount not to exceed 20%
in the aggregate of Portfolio Assets: (i) 50% of the dollar amount of
residential mortgage loans originated and sold within 90 days of origination;
(ii) investments in securities of a service corporation that derives at least
80% of its income from residential housing finance; (iii) 200% of loans and
investments made to acquire, develop or construct starter homes or homes in
credit needy areas (subject to certain conditions); (iv) loans for the purchase
or construction of churches, schools, nursing homes and hospitals; and (v)
consumer loans (in an amount up to 20% of portfolio assets). For purposes of
the QTL test, Portfolio Assets means the savings institution's total assets
minus (i) goodwill and other intangible assets, (ii)the value of property used
by the savings institution to conduct its business, and (iii)liquid assets held
by the savings institution in an amount up to 20% of its total assets.
In December 1996, the Economic Growth and Regulatory Paperwork Reduction Act
of 1996 (EGRPRA) amended the QTL requirements to give thrifts a choice of
tests. A thrift must qualify either by meeting the HOLA QTL test described
above, as amended by the EGRPRA, or by meeting the Internal Revenue Service's
(IRS) domestic building and loan tax code (DBLA) test. The EGRPRA amended the
QTL test to allow (1) educational loans, small business loans and credit card
loans to count as Qualified Thrift Investments without limit, and (2) loans for
personal, family or household purposes (other than those included in the
without limit category) to count as Qualified Thrift Investments in the
category limited to 20 percent of Portfolio Assets.
OTS regulations provide that any savings institution that fails to meet the
new QTL test must either convert to a national bank charter or limit its future
investments and activities (including branching and payments of dividends) to
those permitted for both savings institutions and national banks. Additionally,
any such savings institution that does not convert to a bank charter will be
ineligible to receive further FHLB advances and, beginning three years after
the loss of QTL status, will be required to repay all outstanding FHLB
advances, and dispose of or discontinue any pre-existing investments and
activities not permitted for both savings institutions and national banks.
Further, within one year of the loss of QTL status, the holding company of a
savings institution that does not convert to a bank charter must register as a
bank holding company and will be subject to all statutes applicable to bank
holding companies.
These penalties do not apply to a federal savings association, such as the
Bank, which existed as a federal savings association on August 9, 1989 but was
chartered before October 15, 1982 as a savings bank under state law.
Liquidity Requirements.
15
_______________________
Under OTS regulations, savings institutions are required to maintain average
daily balances of liquid assets (which includes cash, certain time deposits,
certain bankers' acceptances, certain corporate debt securities and highly
rated commercial paper, securities of certain mutual funds, balances maintained
in FRB, and specified United States government, state, or federal agency
obligations) equal to a monthly average of not less than a specified percentage
of the average daily balance of the savings institution's net withdrawable
deposit accounts plus short-term borrowings payable in one year or less. This
liquidity requirement may vary from time to time by the OTS to any amount
within the range of 4% to 10%, depending upon economic conditions and the
deposit flows of member institutions. Effective November 24, 1997, the OTS
amended its liquidity regulations to, among other things, provide that a
savings institution shall maintain liquid assets of not less than 4% of the
liquidity base at the end of the preceding calendar quarter. Prior to November
1997, the required liquid asset ratio was 5%. The amendment to the liquidity
rules also eliminated the requirement that institutions hold assets equal to
1% of the liquidity base in cash or short-term liquid assets. At June 30,
1998, the Bank was in compliance with the liquidity ratio regulatory
requirements. In addition, the 1997 amendment to the liquidity rules also
streamlined the calculations used to measure compliance with liquidity
requirements, expanded the types of investments considered to be liquid assets
to conform with provisions of FIRREA, and reduced the liquidity base by
modifying the definition of net withdrawable account to exclude accounts with
maturities exceeding one year. This rule permits savings associations to use
either the previously existing or the newly promulgated method of calculating
their liquidity base. The new method requires the calculation to be made once
each quarter rather than monthly. Another rule change removed the requirement
that certain obligations must mature in five years or less in order to qualify
as a liquid asset. Simply meeting the minimum liquidity requirement does not
automatically mean a thrift institution has sufficient liquidity for safe and
sound operation. The new rule includes a separate additional requirement that
each thrift must maintain sufficient liquidity to ensure its safe and sound
operation. Adequate liquidity may vary from institution to institution
depending on a thrift's asset/liability structure, market conditions, the
activities of financial service competitors and the requirements of its own
deposit and loan customers.
Loans to One Borrower Limitations.
__________________________________
Savings institutions generally are required to comply with the limitations
on loans to one borrower which are applicable to national banks. National
banks generally may not make loans to a single borrower in excess of 15% to 25%
of their unimpaired capital and unimpaired surplus (depending upon the type of
loans and the collateral therefor). Exceptions from the generally applicable
limits on loans to one borrower are available under any of the following
circumstances: (i) for any purpose, in an amount not to exceed $500,000; (ii)
to develop domestic residential housing units, in an amount not to exceed the
lesser of $30 million or 30% of the savings institution's unimpaired capital
and unimpaired surplus, provided other conditions are satisfied; or (iii) to
finance the sale of real property which it owns as a result of foreclosure, in
an amount not to exceed 50% of the savings institution's unimpaired capital and
unimpaired surplus. In addition, further restrictions on a savings
institution's loans to one borrower may be imposed by the OTS if necessary to
protect the safety and soundness of the savings institution.
Pursuant to its authority to impose more stringent requirements on savings
16
associations to protect safety and soundness, however, the OTS has promulgated
a rule limiting loans to one borrower to finance the sale of real property
acquired in satisfaction of debts to 15% of unimpaired capital and surplus. The
rule provides that purchase money mortgages received by a savings association
to finance the sale of such real property do not constitute "loans" (provided
that the savings association is not placed in a more detrimental position
holding the note than holding the real estate) and, therefore, are not subject
to the loan-to-one-borrower limitations.
Commercial Real Property Loans.
_______________________________
The aggregate amount of commercial real estate loans that a federal savings
institution may make is limited to an amount not in excess of 400% of the
savings institution's capital. The OTS has the authority to grant exceptions
to the limit if the additional amount will not pose a significant risk to the
safe or sound operation of the savings institution involved, and is consistent
with prudent operating practices.
Regulatory Restrictions on the Payment of Dividends by Savings Institutions.
____________________________________________________________________________
OTS regulations establish uniform treatment for all capital distributions by
savings associations (including dividends, stock repurchases and cash-out
mergers). Under the rules, a savings association is classified as a tier 1
institution, a tier 2 institution, or a tier 3 institution, depending on its
level of regulatory capital both before and after giving effect to a proposed
capital distribution. A tier 1 institution (i.e., one that both before and
after a proposed capital distribution has net capital equal to or in excess of
its fully phased-in regulatory capital requirement) is allowed, subject to any
otherwise applicable statutory or regulatory requirements or agreements entered
into with regulators, to make capital distributions in any calendar year up to
100% of its net income to date during the capital year plus the amount that
would reduce by one-half its surplus capital ratio (i.e., the percentage by
which (x) its ratio of capital to assets exceeds (y) the ratio of its fully
phased-in capital requirement to assets) as of the beginning of the calendar
year, adjusted to reflect current earnings. No regulatory approval of the
capital distribution is required, but prior notice has to be given to the OTS.
A tier 2 institution (i.e., one that both before and after a proposed capital
distribution has net capital equal to its then-applicable minimum capital
requirement but would fail to meet its fully phased-in capital requirement
either before or after the distribution) may make only limited capital
distributions without prior regulatory approval. A tier 3 institution (i.e.,
one that either before or after a proposed capital distribution fails to meet
its then-applicable minimum capital requirement) may not make any capital
distributions without prior OTS approval. In addition, the OTS may prohibit a
proposed capital distribution, which otherwise would be permitted by the
regulation, if the OTS determines that such a distribution would constitute an
unsafe or unsound practice. Also, an institution meeting the tier 1 criteria
which has been notified that it needs more than normal supervision will be
treated as a tier 2 or tier 3 institution, unless the OTS deems otherwise.
Activities of Subsidiaries.
___________________________
The FIRRE Act requires a savings institution seeking to establish a new
subsidiary, acquire control of an existing company (after which it would be a
subsidiary), or conduct a new activity through a subsidiary, to provide 30 days
prior notice to the FDIC and the OTS and conduct any activities of the
17
subsidiary in accordance with regulations and orders of the OTS. The OTS has
the power to require a savings institution to divest any subsidiary or
terminate any activity conducted by a subsidiary that the OTS determines is a
serious threat to the financial safety, soundness or stability of such savings
institution or is otherwise inconsistent with sound banking practices.
Insurance of Deposits.
______________________
General.
--------
Federal deposit insurance is required for all federal savings
institutions. Federal savings institutions' deposits are insured to a maximum
of $100,000 for each insured depositor by the BIF or the SAIF. As a FDIC-
insured institution, the Bank is subject to regulation and supervision by the
FDIC, to the extent deemed necessary by the FDIC to ensure the safety and
soundness of BIF and SAIF. The FDIC is entitled to have access to reports of
examination of the Banks made by the OTS and all reports of condition filed by
the Bank with the OTS, and may require the Bank to file such additional
reports as the FDIC determines to be advisable for insurance purposes. The
FDIC may determine by regulation or order that any specific activity poses a
serious threat to BIF or SAIF and that no BIF or SAIF member may engage in the
activity directly. The FDIC is also authorized to issue and enforce such
regulations or orders as it deems necessary to prevent actions of savings
institutions that pose a serious threat to BIF or SAIF.
Any insured institution which does not operate in accordance with or conform
to FDIC regulations, policies and directives may be sanctioned for non-
compliance.
The FDIC has the authority, after notice and hearing, to suspend or
terminate insurance of deposits upon the finding that the institution has
engaged in unsafe or unsound practices, is operating in an unsafe or unsound
condition, or has violated any applicable law, regulation, rule, order or
condition imposed by, or written agreement with, the FDIC. In addition, if
insurance termination proceedings are initiated against a savings institution,
under certain circumstances the FDIC has the authority to temporarily suspend
insurance on new deposits received by an institution. If insurance of deposits
is terminated by the FDIC, the deposits in the institution will continue to be
insured by the FDIC for a period of two years following the date of
termination. The FDIC requires an annual audit by independent accountants and
also periodically makes its own examinations of insured institutions.
Insured institutions are members of either the SAIF or the BIF. Pursuant to
the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"), an insured institution may not convert from one insurance fund to
the other without the advance approval of the FDIC. FIRREA also provides,
generally, that the moratorium on insurance fund conversions shall not be
construed to prohibit a SAIF member from converting to a bank charter during
the moratorium, as long as the resulting bank remains a SAIF member during that
period. When a conversion is permitted, each insured institution participating
in the conversion must pay an "exit fee" to the insurance fund it is leaving
and an "entrance fee" to the insurance fund it is entering.
Under applicable law, any company that controls an undercapitalized savings
institution is required, in connection with the submission of a capital
restoration plan by the savings institution, to guarantee that the institution
18
will comply with the plan and to provide appropriate assurances of performance.
The aggregate liability of any such controlling company under such guaranty is
limited to the lesser of (i) 5% of the savings institution's assets at the time
it became undercapitalized; or (ii) the amount necessary to bring the savings
institution into capital compliance as of the time the institution fails to
comply with the terms of its capital plan.
Insurance Premiums and Regulatory Assessments.
______________________________________________
As an insurer, the FDIC issues regulations, conducts examinations and
generally supervises the operations of its insured members. FDICIA directed
the FDIC to establish a risk-based premium system under which each premium
assessed against the Bank would generally depend upon the amount of the Bank's
deposits and the risk that it poses to the SAIF. The FDIC was further directed
to set semiannual assessments for insured depository institutions to maintain
the reserve ratio of the SAIF at 1.25 percent of estimated insured deposits.
The FDIC may designate a higher reserve ratio if it determines there is a
significant risk of substantial future loss to the particular fund. Under the
FDIC's risk-related insurance regulations, an institution is classified
according to capital and supervisory factors. Institutions are assigned to one
of three capital groups: "well capitalized," "adequately capitalized" or
"undercapitalized." Within each capital group, institutions are assigned to
one of three supervisory subgroups. There are nine combinations of groups and
subgroups (or assessment risk classifications) to which varying assessment
rates are applicable. During fiscal 1998, the Bank paid $60,097 to the FDIC
for such assessments. See "--Recent Developments in Savings Institution
Regulations."
In addition to deposit insurance premiums, savings institutions also must
bear a portion of the administrative costs of the OTS through an assessment
based on the level of total assets of each insured institution and which
differentiates between troubled and nontroubled savings institutions. During
fiscal 1998, the Bank paid $70,078 to the OTS for such assessments.
Additionally, the OTS assesses fees for the processing of various applications.
Federal Home Loan Bank System
_____________________________
General.
________
The Bank is a member of the FHLB system, which consists of 12 regional
FHLBs subject to supervision and regulation by the Federal Housing Finance
Board ("FHFB"). The FHLBs maintain central credit facilities primarily for
member institutions.
The Bank, as a member of the FHLB of Boston, is required to acquire and hold
shares of capital stock in the FHLB of Boston in an amount at least equal to
the greater of: (i) 1% of the aggregate outstanding principal amount of its
unpaid residential mortgage loans, home purchase contracts, and similar
obligations as of the beginning of each year, (ii) 5% of its advances
(borrowings) from the FHLB of Boston, or (iii) $500. The Bank is in compliance
with these requirements with an investment in stock of the FHLB of Boston at
June 30, 1998 of $5,680,500.
Advances from Federal Home Loan Bank.
_____________________________________
Each FHLB serves as a reserve or central bank for its member institutions
19
within its assigned regions. It is funded primarily from proceeds derived from
the sale of obligations of the FHLB System. A FHLB makes advances (i.e.,
loans) to members in accordance with policies and procedures established by its
Board of Directors. The Bank is authorized to borrow funds from the FHLB of
Boston to meet demands for withdrawals of savings deposits, to meet seasonal
requirements, and for the expansion of its loan portfolio. Advances may be made
on a secured or unsecured basis depending upon a number of factors, including
the purpose for which the funds are being borrowed and existing advances.
Interest rates charged for advances vary depending upon maturity, the cost of
funds to the regional FHLB and the purpose of the borrowing. The maximum
amount which the FHLB will advance fluctuates from time to time in accordance
with changes in the policies of the FHLB and the FHLB of Boston, and the
maximum amount generally is reduced by borrowings from any other source. In
addition, the amount of FHLB advances that a savings institution may obtain
will be restricted in the event that the institution fails to qualify as a
"qualified thrift lender". See "--- Savings Institution Regulation ---
Qualified Thrift Lender Requirement."
Federal Reserve Board
_____________________
Pursuant to the Depository Institutions Deregulation and Monetary Control
Act of 1980 (the "Deregulation Act"), Federal Reserve Board regulations require
depository institutions to maintain non-interest bearing reserves against their
net transaction accounts (primarily NOW accounts), subject to certain
exemptions. Federal Reserve regulations currently require financial
institutions to maintain average daily reserves equal to 3% on all amounts from
$4.7 million to $47.8 million of net transactions, plus 10% on the remainder.
The balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
Because required reserves must be maintained in the form of vault cash or a
non-interest bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce the institution's interest-earning assets.
Members of the FHLB system also are authorized to borrow from the
appropriate Federal Reserve Bank's "discount window." However, current Federal
Reserve regulations require savings institutions to exhaust all FHLB sources
before borrowing from the Federal Reserve Bank. The FDICIA places limitations
upon a Federal Reserve Bank's ability to extend advances to undercapitalized
and critically undercapitalized depository institutions. The FDICIA provides
that a Federal Reserve bank generally may not have advances outstanding to an
undercapitalized institution for more than 60 days in any 120-day period.
Maine Law
_________
The Department interprets applicable Maine law as giving the Department the
authority to make examinations of the Company and any subsidiaries and to
require periodic and other reports. In addition, under Maine law, a Maine
financial institution holding company such as the Company may not engage in any
activity other than managing or controlling financial institutions, or other
activities deemed permissible by the Department. The Department has by
regulation determined that, with the prior approval of the Department, a
financial institution holding company may engage in those activities deemed
closely related pursuant to Section 408 of the National Housing Act, unless
that activity is prohibited by the Maine Banking Code or regulations.
20
The Maine Business Corporation Act permits the Company to pay dividends on
its capital stock only from its unreserved and unrestricted earned surplus or
from its net profits for the current fiscal year and the next preceding fiscal
year taken as a single period.
Applicable rules further prohibit the payment of a cash dividend by the
Company if the effect thereof would cause its net worth to be reduced below
either the amount required for the liquidation account or the net worth
requirements imposed by federal laws or regulations. The Company is prohibited
from paying dividends on their capital stock if it is in default in the payment
of any assessment to the FDIC.
Earnings appropriated to bad debt reserves for losses and deducted for
federal income tax purposes are not available for dividends without the payment
of taxes at the current income tax rates on the amount used.
Federal Securities Laws
_______________________
The Company has registered its common stock with the Securities and Exchange
Commission (the "SEC") pursuant to the Securities Exchange Act of 1934, as
amended. As a result of such registration, the proxy and tender offer rules,
periodic reporting requirements, insider trading restrictions and reporting
requirements, as well as certain other requirements, of such Act are
applicable.
Statistical Disclosure
______________________
The additional statistical disclosure describing the business of the Company
and the Banks required by Industry Guide 3 under the Securities Exchange Act of
1934, as amended, is provided in Item 8 b.
Item 2. Properties
__________
The executive and administrative offices of the Company and the Bank are
located at 232 Center Street, Auburn, Maine and consist of two floors,
containing a lobby, executive and customer service offices, teller stations,
and vault operations. These office facilities are subject to a lease which
expires in 2007, with an option to renew the lease for 2 additional 10-year
terms.
The Bank has eleven branching locations, including the banking facility
located at its executive offices. The branches located in Bethel, Harrison,
Buckfield, Mechanic Falls, Brunswick, Augusta (Western Avenue), and Lisbon,
Maine, are owned by the Bank in fee simple. In addition to the Auburn
facilities, the branches located in Augusta (Bangor Street) and South Paris,
Maine are leased by the Bank. The Bank also owns in fee simple certain real
property and improvements located in Auburn, Maine at which various accounting
and operations functions of the Company and the Bank are performed. The
facilities owned or occupied under lease by the Bank and its subsidiaries are
considered by management to be adequate.
Item 3. Legal Proceedings
_________________
21
There are no pending legal proceedings to which the Company is a party or
any of its property is the subject. There are no material pending legal
proceedings, other than ordinary routine litigation incidental to the business
of banking, to which the Bank is a party or of which any of the Bank's property
is the subject. There are no material pending legal proceedings to which any
director, officer or affiliate of the Company, any owner of record beneficially
of more than five percent of the common stock of the Company, or any associate
of any such director, officer, affiliate of the Company or any security holder
is a party adverse to the Company or has a material interest adverse to the
Company or the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
___________________________________________________
There were no matters submitted to a vote of the Company's securities-
holders during the fourth quarter of the fiscal year ended June 30, 1998.
Item 4A. Executive Officers of the Registrant
____________________________________
Pursuant to the Instructions of Form 10-K and Item 401(b) of Regulation S-K,
the name, age, and position of each executive officer of the Company and the
Bank are set forth below along with such officer's business experience during
the past five years. Officers are elected annually by the respective Boards of
Directors of the Company and the Bank to hold office until the earlier of their
death, resignation, or removal.
Name Age Position with Company and/or Bank
____ ___ _________________________________
James D. Delamater. . . .46 President and Chief Executive Officer (1)
A. William Cannan . . . .56 Executive Vice President and Chief Operating
Officer (1)
Philip C. Jackson . . . .54 Senior Vice President of Bank - Trust Operations
Richard E. Wyman, Jr. . .42 Chief Financial Officer (1)
Henry Korsiak . . . . . .55 Senior Vice President of Bank - Operations
Marilyn Wyman . . . . . .47 Senior Vice President of Bank - Human Resources
Sterling Williams . . . .47 Senior Vice President of Bank - Commercial
Lending
Marcel Blais. . . . . . .39 Senior Vice President of the Bank - Retail
Banking
Ariel Rose Gill . . . . .49 Clerk (1)
________________
(1) Each of these individuals serve both the Company and the Bank in the same
capacities as indicated above.
James D. Delamater has been President, Chief Executive Officer, and a
director of the Company and the Bank since 1987.
A. William Cannan has been Executive Vice President and Chief Operating
Officer of the Company and the Bank since 1993, and a director of the Company
and the Bank since 1996. From 1991 to 1993 Mr. Cannan served as President of
Casco Northern Bank, N.A., located in Portland, Maine.
Philip C. Jackson has been a director of the Company and the Bank since
22
1987. Mr. Jackson also has served as the Senior Vice President of the Bank's
Trust Operations since 1997. From 1991 to 1994, Mr. Jackson served as
President of Bethel Savings, the predecessor to the Bank.
Richard E. Wyman, Jr. has been the Chief Financial Officer of the Company
and the Bank since 1992.
Henry Korsiak has been the Senior Vice President of the Bank - Operations
since 1994. From 1993 to 1994, Mr. Korsiak was a Vice President of ASI Data
Services, Inc., a data processing subsidiary of the Company. He was a manager
of Systems Analysis for Fleet Services Corp. from 1991 to 1993. He served as
Vice President of Data Processing at Maine National Bank from 1978 until June
1991.
Marilyn Wyman has been the Senior Vice President of the Bank - Human
Resources since 1987. From 1982 to 1987, she served as the Executive Vice-
President and Administrative Vice-President of the Bank's predecessor, Bethel
Savings Bank.
Sterling Williams has been the Senior Vice President of the Bank -
Commercial Lending since 1994. From 1984 to 1994, Mr. Williams served as a
Vice President of Fleet Bank of Maine when he was a commercial loan officer and
officer in its Managed Assets Division. As of September 1998, the Company has
been informed that Mr. Williams will be resigning his position with the Bank.
Marcel Blais has been the Senior Vice President of the Bank - Retail Lending
since 1998. Mr. Blais joined the Company in 1997 as the Vice President of the
Bank - Branch Administration. Prior to joining the Company he served as Vice
President of Atlantic Bank from 1995 to 1997, and as Vice President - Branch
Manager of Casco Bank from 1977 until 1995.
Ariel Rose Gill has been Clerk of the Company since joining the Company in
1994.
Part II
Item 5. Market Prices of Common Stock and Dividends Paid
________________________________________________
The Common Stock of Northeast Bancorp trades on the American Stock Exchange
("AMEX") under the symbol NBN. As of the close of business on September 14,
1998, there were approximately 2,614,285 of shares of common stock outstanding
held by approximately 470 stockholders of record.
The following table sets forth the high and low closing sales prices of the
Company's Common Stock as reported on NASDAQ - NMS through April 13, 1997 and
thereafter on AMEX, and dividends paid during each quarter for fiscal years
ending June 30, 1997 and 1998. All information set forth on the table below
has been revised to reflect a 50% stock dividend paid December 15, 1997.
1997-98 High Low Div Pd
_______ ____________ ______
23
Jul 1- Sep 30 13.33 9.66 .053
Oct 1 - Dec 31 18.66 18.50 .053
Jan 1 - Mar 31 19.50 17.00 .053
Apr 1 - Jun 30 18.00 15.00 .053
1996-97 High Low Div Pd
_______ ____________ ______
Jul 1 - Sep 30 9.00 8.33 .053
Oct 1 - Dec 31 9.33 8.67 .053
Jan 1 - Mar 31 9.50 8.83 .053
Apr 1 - Jun 30 9.83 9.17 .053
The amount and timing of future dividends payable on the Company's Common Stock
will depend on, among other things, the financial condition of the Company,
regulatory considerations, and other factors, including the ability of the Bank
to pay dividends to the Company, the amount of cash on hand, and any
obligations to pay dividends to holders of its preferred stock.
The Company has 45,454 shares of Series A preferred stock outstanding. The
Series A preferred stock is convertible into Common Stock on a three-for-one
basis and carries a dividend rate of two percent below the prime rate of the
First National Bank of Boston, but in no event to be less than 7% per annum.
There is only one holder of the Series A preferred stock, and there is no
trading market for the Series A preferred stock. Although convertible into
three shares of Common Stock, each share of Series A preferred stock is
entitled only to one vote on all matters submitted to a vote of the Company's
stockholders.
Item 6. Selected Financial Data
-----------------------
Years Ended June 30,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
Interest income $ 24,283 $ 21,936 $ 20,105 $ 18,953 $ 15,668
Interest expense 12,810 11,291 10,087 8,841 7,124
-------- -------- -------- -------- --------
Net interest income 11,473 10,645 10,018 10,112 8,544
Provision for loan losses 706 614 639 691 1,045
Other operating income 1 2,384 1,827 1,909 1,760 2,209
Net securities gains 288 259 279 419 347
Other operating expenses 2 9,560 9,608 9,442 9,093 8,053
Writedowns on equity and
debt securities 172 110 94 0 84
-------- -------- -------- -------- --------
Income before income taxes 3,707 2,399 2,031 2,507 1,918
Income tax expense 1,303 909 738 878 697
24
Cumulative effect of change in
accounting principle - - - - 260
-------- -------- -------- -------- --------
Net income $ 2,404 $ 1,490 $ 1,293 $ 1,629 $ 1,481
======== ======== ======== ======== ========
Basic earnings per share 3 $ 1.00 $ 0.63 $ 0.56 $ 0.77 $ 0.76
Diluted earnings per share 3 $ 0.86 $ 0.56 $ 0.50 $ 0.66 $ 0.67
======== ======== ======== ======== ========
Cash dividends per common
share $ 0.21 $ 0.21 $ 0.16 $ 0.11 $ 0.11
======== ======== ======== ======== ========
Common dividend payout ratio 3 24.42% 37.49% 32.00% 16.66% 16.41%
======== ======== ======== ======== ========
At June 30,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Total assets $322,533 $284,077 $244,782 $231,856 $212,072
Total loans 282,031 222,682 187,210 187,777 175,687
Total deposits 184,024 172,921 164,855 168,682 142,972
Total borrowings 105,433 81,793 54,140 38,274 49,051
Total stockholders' equity 25,140 22,096 20,364 19,388 17,730
Return on assets
(net income/average assets) 0.83% 0.57% 0.55% 0.71% 0.73%
Return on equity
(net income/average equity) 10.35% 7.05% 6.31% 8.81% 8.73%
Average equity/average assets 7.99% 8.09% 8.67% 8.10% 8.34%
1 Includes fees for services to customers and gains on sale of loans.
2 Includes salaries, employee benefits and occupancy.
3 Per share data for the years prior to 1996 has been retroactively restated as
a result of the stock split in December 1995 and has been restated as a
result of the 50% stock split in December 1997. The 1994 through 1997
earnings per share calculations have been restated to comply with FASB No.
128 "Earnings Per Share". Also, the common dividend payout ratios, for 1994
through 1997 and dividends per share have been changed to correspond to the
change in the earnings per share calculations for the effect of adopting FASB
No. 128.
Item 7. Management's Discussion of Financial Condition and Results of
-------------------------------------------------------------
Operations
----------
DESCRIPTION OF OPERATIONS
- -------------------------
Northeast Bancorp (the "Company"), is a unitary savings and loan holding
company with the Office of Thrift Supervision ("OTS") as its primary regulator.
The Company has one wholly-owned banking subsidiary, Northeast Bank, FSB (the
"Bank"), which has branches located in Auburn, Augusta, Bethel, Harrison, South
Paris, Buckfield, Mechanic Falls, Brunswick, Richmond and Lisbon Falls, Maine.
25
The Bank's deposits are primarily BIF-insured. Deposits at the Brunswick
branch are SAIF-insured and represent approximately 27% of the Bank's total
deposits at June 30, 1998.
On October 24, 1997 the Company completed the merger of Cushnoc Bank and Trust
Company, a commercial bank located in Augusta, Maine ("Cushnoc"), with and into
the Bank. On October 24, 1997, Cushnoc had approximately $21,000,000 in total
assets and $2,200,000 in stockholders' equity. Under the terms of the merger,
the Company issued 187,940 shares of its common stock in exchange for all of
the outstanding common stock of Cushnoc (an exchange ratio of 2.089 shares of
the Company's common stock for each share of Cushnoc common stock). The merger
expanded the Company's geographic market area to Augusta, Maine, the State's
capital, and will increase the Company's ability to deliver its wide variety of
products for future growth. The Cushnoc acquisition was accounted for under the
pooling of interests method. In accordance with the pooling of interests
accounting method, the Company's financial statements and information provided
for previous reporting periods have been restated to include Cushnoc's
financial information and are more fully described in footnote 1 and 15 to the
financial statements.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations presents a review of the material changes in the financial condition
of the Company from June 30, 1997 to June 30,1998, and the results of
operations for the fiscal years ended June 30, 1998, 1997, and 1996. This
discussion and analysis is intended to assist in understanding the financial
condition and results of operations of the Company. Accordingly, this section
should be read in conjunction with the consolidated financial statements and
the related notes and other statistical information contained herein.
FINANCIAL CONDITION
- -------------------
The overall strategy of the Company is to increase the core earnings of the
Bank by the development of strong net interest margins, non-interest fee
income, and by increasing deposit and loan volume through a larger market area.
The state of Maine's economy in which the Company operates, including the south
central and mid-coast region of Cumberland, Androscoggin and Sagadahoc
counties, has experienced moderate growth. The banking business has become
increasingly competitive over the past several years. The Bank's major
competitors for deposits and loans consist primarily of other Maine-based
banks, regional and money center banks, and non-bank financial institutions.
Many of the Bank's competitors are larger in size and, consequently, possess
greater financial resources. The principal factors in competing for deposits
are convenient office locations, flexible hours, interest rates and services,
while those relating to loans are interest rates, the range of lending services
offered and lending fees. The Bank believes that the local character of its
business and its "community bank" management philosophy enhances its ability to
compete in its market areas. The Company has enhanced its product lines and now
provides a wide range of financial services such as loans and deposits,
investments through its relationship with Commonwealth Financial Services,
Inc., trust services through the Bank's trust department, employee retirement
benefits through First New England Benefits ("FNEB"), a division of the Bank's
trust department, and provides insurance products through its affiliation with
local insurance agencies.
The Company believes that its level of capital is adequate and that its capital
position will support future growth and development as well as allow for
26
additional provisions to the allowance for loan losses, if needed, without
significant impairment of the financial stability of the Company. As of June
30,1998, the Company's total equity represents 7.79% of its total assets. The
Company's assets totaled $322,532,594 as of June 30, 1998, an increase of
$38,455,163 compared to June 30, 1997, primarily due to loan growth. Loan
volume was enhanced during the 1998 fiscal year due to whole loan purchases on
the secondary market, increased commercial loans, and automobile dealer
finance loans. The increase in loans was funded with advances from the Federal
Home Loan Bank of Boston ("FHLB"), increased deposits, and the reduction in
available for sale securities. The Company has focused its business development
efforts on full service credit packages and financial services, as well as
competitively priced mortgage packages.
Cash and cash equivalents decreased by $6,622,378 at June 30, 1998 compared to
June 30, 1997. The decrease in cash equivalents was primarily due to the use
of excess cash to fund loan growth during fiscal 1998.
The Bank's loan portfolio had a balance of $282,030,950 as of June 30, 1998,
which represents an increase of $59,348,816 compared to June 30, 1997. From
June 30, 1997 to June 30, 1998, the loan portfolio increased by $32,594,000 in
real estate mortgage loans, $19,108,000 in consumer loans, and by $7,647,000 in
commercial loans. The Bank established a new automobile dealer finance
department during the fiscal 1998 and the increase in consumer loans was due
primarily to the volume generated from this new department. The Bank does not
anticipate that it will experience the same growth in real estate mortgage and
automobile dealer finance loans in the current fiscal year as was experienced
in 1998. During fiscal 1998, the Bank purchased approximately $66,284,000 of
residential whole loans on the secondary market. The purchase consisted of 1-4
family adjustable and fixed rate mortgages secured by property located
primarily in the State of Maine and certain Midwestern states. The expansion
into new markets diversifies the credit risk and the potential economic risks
of the credits held in the Bank's purchased loan portfolio, such that the
portfolio is not effected solely by the local State of Maine economy. The
Bank's local market, as well as the secondary market, continues to be very
competitive for loan volume. The local competitive environment and customer
response to favorable secondary market rates have affected the Bank's ability
to increase the loan portfolio. In the effort to increase loan volume, the
Bank's interest rates for its loan products have been reduced to compete in the
various markets.
The loan portfolio contains elements of credit and interest rate risk. The Bank
primarily lends within its local market areas, which management believes helps
it to better evaluate credit risk. As the Bank expands its purchase of loans in
other states, management researches the strength of the economy in the
respective state and underwrites every loan before purchase. These steps are
taken to better evaluate and minimize the credit risk of out-of-state
purchases. The Bank also maintains a well collateralized position in real
estate mortgages.
At June 30, 1998, residential real estate mortgages made up 61% of the total
loan portfolio, in which 54% of the residential loans are variable rate
products, as compared to 63% and 49%, respectively, at June 30, 1997. It has
been management's intent to increase the proportion of variable rate
residential real estate loans to reduce the interest rate risk in this area.
The Bank has primarily purchased adjustable rate residential loans and sold
fixed rate residential loans. However, during the last quarter of fiscal 1998,
the Bank sold approximately $8,000,000 in adjustable rate residential loans and
27
purchased approximately the same amount in fixed rate residential loans. This
purchase and sale improved the Company's asset/liability management position
during the declining rate environment. Due to repositioning the asset/liability
mix, the Bank was able to take advantage of current market prices to attain
gains on the sale of those loans.
At June 30, 1998, 17% of the Bank's total loan portfolio is commercial real
estate mortgages. Commercial real estate loans have minimal interest rate risk
as 88% of the portfolio consists of variable rate products. At June 30, 1997,
commercial real estate mortgages made up 21% of the total loan portfolio, in
which 89% of the commercial real estate loans were variable rate products. The
Bank tries to mitigate credit risk by lending in its local market areas as well
as maintaining a well collateralized position in real estate.
Commercial loans made up 10% of the total loan portfolio at June 30, 1998.
Variable rate loans comprise 59% of this loan portfolio at June 30, 1998. At
June 30, 1997 commercial loans made up 9% of the total loan portfolio, of which
83% of the balance were variable rate instruments. Variable rate commercial
loans have decreased during fiscal 1998, when compared to 1997, due to the
increased market demand for fixed rate loans. The credit loss exposure on
commercial loans is highly dependent on the cash flow of the customers'
business. The Bank mitigates losses by strictly adhering to the Company's
underwriting and credit policies.
Consumer loans make up 12% of the total loan portfolio as of June 30, 1998
which compares to 7% at June 30, 1997. Since these loans are primarily fixed
rate products, they have interest rate risk when market rates increase. These
loans also have credit risk with minimal security. As stated previously, the
increase in consumer loans was primarily due to the volume generated from the
automobile dealer finance department. This department underwrites all the
automobile dealer finance loans to protect credit quality. The Bank primarily
pays a nominal one time origination fee on the loans. The fees are deferred and
amortized over the life of the loans as a yield adjustment. Management
attempts to mitigate credit and interest rate risk by keeping the products
offered short-term, receiving a rate of return commensurate with the risk, and
lending to individuals in the Bank's known market areas.
The Bank's allowance for loan losses was $2,978,000 as of June 30, 1998 versus
$2,741,809 as of June 30, 1997, representing 1.06% and 1.23% of total loans,
respectively. The Bank had non-performing loans totaling $2,248,000 and
$2,881,000 at June 30, 1998 and 1997, which was .80% and 1.29% of total loans,
respectively. Non-performing loans represented .70% and 1.01% of total assets
at June 30, 1998 and 1997, respectively. Non-performing loans are generally
loans ninety days delinquent or greater for which the Bank does not accrue
interest income. The Bank's allowance for loan losses was equal to 132% and 95%
of the total non-performing loans at June 30, 1998 and 1997, respectively. At
June 30, 1998, the Bank had approximately $100,000 of loans classified
substandard, exclusive of the non-performing loans stated above, that could
potentially become non-performing due to delinquencies or marginal cash flows.
As of June 30, 1998, the amount of such loans has decreased from the June 30,
1997 amount by $486,000. This decrease was primarily due to substandard loans
being classified as non-performing or liquidated through the sale of foreclosed
assets. Management takes an aggressive posture in reviewing its loan portfolio
to classify certain loans substandard. The following table represents the
Bank's non-performing loans as of June 30, 1998 and 1997:
28
Description June 30, 1998 June 30, 1997
--------------------- ----------------- -----------------
1-4 Family Mortgages $ 783,000 $ 1,072,000
Commercial Mortgages 956,000 1,247,000
Commercial Loans 509,000 521,000
Consumer Installment 0 41,000
----------------- -----------------
Total non-performing $ 2,248,000 $ 2,881,000
================= =================
Although non-performing, delinquent and substandard loans have decreased the
past several years, management continues to allocate substantial resources to
the collection area in an effort to control the amount of such loans. The
Bank's delinquent loan accounts, as a percentage of total loans, decreased
during the 1998 fiscal year. This decrease was largely due to improved
collection efforts and the increase in the Bank's loan portfolio.
The following table reflects the annual trend of total delinquencies 30 days or
more past due, including non-performing loans, for the Bank as a percentage of
total loans:
06/30/95 06/30/96 06/30/97 06/30/98
2.46% 3.24% 1.93% 1.09%
At June 30, 1998, loans classified as non-performing included approximately
$823,000 of loan balances that are current and paying as agreed, but which the
Bank maintains as non-performing until the borrower has demonstrated a
sustainable period of performance. Excluding these loans, the Bank's total
delinquencies 30 days or more past due, as a percentage of total loans, would
be .80% as of June 30, 1998.
The level of the allowance for loan losses as a percentage of total loans
decreased and the level of the allowance for loan losses as a percentage of
total non-performing loans increased at June 30, 1998 compared to June 30,
1997. The decrease in the level of allowance for loan losses as a percentage of
total loans was primarily due to the increase in purchased loans as well as
loans originated in the Bank's local market. The loans purchased were
residential mortgages and carry less risk than commercial and consumer loans.
The decrease was also supported by the Bank's lower delinquency levels and
decreased non-performing and substandard loans. As previously discussed, loans
classified substandard decreased in the 1998 fiscal year, when compared to the
1997 fiscal year. Classified loans are also considered in management's analysis
of the adequacy of the allowance for loan losses. Based on reviewing the credit
risk and collateral of these classified loans, management has considered the
risks of the classified portfolio and believes the allowance for loan losses is
adequate. Net charge-offs for the Bank were $469,909, $633,490, and $539,234,
for the years ended June 30, 1998, June 30, 1997, and June 30, 1996,
respectively.
29
At June 30, 1998, total impaired loans were $1,623,720, of which $927,355 had
related allowances of $251,474. This compares to total impaired loans of
$1,661,698, of which $844,457 had related allowances of $369,474, at June 30,
1997. During the year ended June 30, 1998, the income recognized related to
impaired loans was $19,693 and the average balance of outstanding impaired
loans was $1,956,488. This compares to income recognized related to impaired
loans of $50,690 and the average balance of impaired loans of $1,330,983 at
June 30, 1997. The Bank recognizes interest on impaired loans on a cash basis
when the ability to collect the principal balance is not in doubt; otherwise,
cash received is applied to the principal balance of the loan.
On a regular and ongoing basis, management evaluates the adequacy of the Bank's
allowance for loan losses. The process of evaluating the allowance involves a
high degree of management judgment. The methods employed to evaluate the
allowance for loan losses are quantitative in nature and consider such factors
as the loan mix, the level of non-performing loans, delinquency trends, past
charge-off history, loan reviews and classifications, collateral, and the
current economic climate.
Management believes that the allowance for loan losses is adequate considering
the level of risk in the loan portfolio. While management uses its best
judgement in recognizing loan losses in light of available information, there
can be no assurance that the Company will not have to increase its provision
for loan losses in the future as a result of changing economic conditions,
adverse markets for real estate or other factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance for loan losses based
on their judgments about information available to them at the time of their
examination. The Bank's most recent examination by the Office of Thrift
Supervision was on September 22, 1997. At the time of the exam the regulators
proposed no additions to the allowance for loan losses.
At June 30, 1998, the Bank had a total of $350,496 in other real estate owned
versus $563,207 as of June 30, 1997. The Bank has an allowance for losses on
other real estate owned that was established to provide for declines in real
estate values and to consider estimated selling costs. The allowance for losses
on other real estate owned totaled $5,100 at June 30, 1998 versus $50,839 at
June 30, 1997. The Company provided for this allowance through a charge against
earnings of $62,300 and $39,000 for the years ended June 30, 1998 and 1997,
respectively. In 1998 and 1997, write downs of other real estate owned totaled
$108,039 and $88,161, respectively. Management periodically receives
independent appraisals to assist in its valuation of the other real estate
owned portfolio. As a result of its review of the independent appraisals and
the other real estate owned portfolio, the Company believes the allowance for
losses on other real estate owned is adequate to state the portfolio at lower
of cost, or fair value less estimated selling costs.
The Company's investment portfolio has been primarily classified as available
for sale at June 30, 1997 and 1998. Equity securities, and debt securities
which may be sold prior to maturity, are classified as available for sale and
are carried at market value. Changes in market value, net of applicable income
taxes, are reported as a separate component of stockholders' equity. Gains and
losses on the sale of securities are recognized at the time of the sale using
the specific identification method. The amortized cost and market value of
available for sale securities at June 30, 1998 was $13,706,472 and $13,608,823,
respectively. The reduction in carrying value from the cost was primarily
30
attributable to the decline in market value of equity securities, which was due
to the change in market prices from the price at the time of purchase. The
decrease of $15,201,802 in securities available for sale, from June 30, 1998 to
June 30, 1997, was due to the Company repositioning the fixed rate mortgage-
backed securities portfolio, taking advantage of price fluctuations in the
current market. The sale of these securities strengthens the Company's asset/
liability management position and helps mitigate the Company's interest rate
risk in an increasing rate environment. The cash from the sale of securities
was utilized to fund loan growth during fiscal 1998. The net unrealized loss on
mortgage-backed securities has decreased from $410,000 at June 30, 1997 to
$9,500 at June 30, 1998 due to improvements in interest rates. Substantially
all of the mortgage-backed securities are high grade government backed
securities. As in any long term earning asset in which the earning rate is
fixed, the market value of mortgage-backed securities will fluctuate based on
changes in market interest rates from the time of purchase. Since these
mortgage-backed securities are backed by the U.S. Government, there is minimal
risk of loss of principal. Management believes that the yields currently
received on this portfolio are satisfactory and intends to hold these
securities for the foreseeable future.
Management reviews the portfolio of investments on an ongoing basis to
determine if there has been an other-than-temporary decline in value. Some of
the considerations management makes in the determination are market valuations
of particular securities and economic analysis of the securities' sustainable
market values based on the underlying companies' profitability. Based on
management's assessment of the securities portfolio in fiscal 1998, 1997 and
1996, there have been other than temporary declines in values of individual
equity securities in the amounts of $172,235, $110,000, and $93,819,
respectively. Such securities have been written down through an adjustment
against earnings and are included in other expenses in the statements of
income.
The Company increased its investment in FHLB stock by $1,559,500, compared to
June 30, 1997, due to the increase in FHLB borrowings. The Bank increased FHLB
borrowings to fund loan growth. The FHLB requires institutions to hold a
certain level of FHLB stock based on advances outstanding.
The Bank continues to attract new local deposit relationships. The Bank
utilizes, as alternative sources of funds, brokered C.D.'s when national
deposit interest rates are less than the interest rates on local market
deposits. Brokered C.D.'s are also used to supplement the growth in earning
assets. Brokered C.D.'s carry the same risk as local deposit C.D.'s, in that
both are interest rate sensitive with respect to the Bank's ability to retain
the funds. The Bank also utilizes FHLB advances, as alternative sources of
funds, when the interest rates of the advances are less than market deposit
interest rates. FHLB advances are also used to fund short-term liquidity
demands.
Total deposits were $184,024,097 and securities sold under repurchase
agreements were $5,205,594 as of June 30, 1998. These amounts represent an
increase of $11,102,811 and $106,972, respectively, as compared to June 30,
1997. The increase in deposits was primarily due to the $9,000,000 increase in
NOW demand deposits. The increase in NOW deposits was attributable to the
development of a demand account where the interest rate increases as deposit
balances increase. Brokered deposits represented $7,574,710 of total deposits
at June 30, 1998, which increased by $389,144 compared to June 30, 1997's
$7,185,566 balance. Total borrowings from the FHLB were $104,439,952 as of
31
June 30, 1998, for an increase of $23,945,481 compared to June 30, 1997.
Mortgages, free of liens, pledges and encumbrances and certain non-pledged
mortgage-backed securities are pledged to secure FHLB advances. The increase in
deposits, repurchase agreements and FHLB advances were utilized to fund the
loan growth during fiscal 1998.
Other liabilities increased by $561,508 compared to June 30, 1997, due
primarily to increases in accrued expenses, escrow accounts and a payable
account resulting from the settlement of a loan sale transaction.
CAPITAL RESOURCES & LIQUIDITY
- -----------------------------
Liquidity is defined as the ability to meet unexpected deposit withdrawals and
increased loan demand of a short-term nature with a minimum loss of principal.
The Bank's primary sources of funds are its interest bearing deposits, cash and
due from banks, deposits with the FHLB, certificates of deposit, loan payments
and prepayments and other investments maturing in less than two years as well
as securities available for sale. In addition, the Bank has unused borrowing
capacity from the FHLB through its advances program. The Bank's current advance
availability, subject to the satisfaction of certain conditions, is
approximately $17,000,000 over and above the 1998 end-of-year advances. The
Company's ability to access the principal sources of liquid funds listed above
is immediate and adequate to support the Company's needs.
Cross selling strategies are employed by the Bank to develop deposit growth.
Even though deposit interest rates increased during fiscal 1998, the rate of
return was much stronger in other financial instruments such as mutual funds
and annuities. Like other companies in the banking industry, the Bank will be
challenged to maintain and or increase its core deposit base.
Total equity of the Company was $25,139,527 as of June 30, 1998 versus
$22,095,580 at June 30, 1997. On December 15, 1997, the Company authorized a
50% stock dividend to all shareholders. As a result of the stock dividend, the
Company's common shares outstanding increased by 740,807 shares. The June 30,
1997 book value per common share has been restated as a result of the stock
dividend. In October of 1997, the Company merged with Cushnoc in a transaction
accounted for as a pooling of interests and as a result issued 2.089 shares of
its common stock for each share of Cushnoc, which had 90,000 common shares
outstanding. The number of common shares issued to Cushnoc shareholders was
187,940 shares and all fractional shares were paid in cash. Earnings per share
have been restated as a result of the stock dividend and the merger with
Cushnoc Bank under the pooling of interests method of accounting.
In March of 1997 Square Lake Holding Corporation exercised 25,000 warrants at
an aggregate price of $175,000 and in fiscal 1998 exercised the remaining
163,146 warrants at an aggregate price of $761,433. There are no additional
warrants outstanding. During the final quarter of fiscal 1998, Square Lake
Holding Corporation converted their Series B preferred stock into common stock,
in which a total of 214,284 shares of common stock were issued. Square Lake
Holding Corporation is a Maine corporation and a subsidiary of a Canadian
corporation of which Ronald Goguen is a 95% shareholder and director. Mr.
Goguen, also is a director, and, through the ownership of his affiliates, a
principal shareholder of the Company. During fiscal 1998 and 1997, 46,000 and
30,000 stock options, respectively, were exercised by various employees of the
Company. The proceeds from the exercised warrants and options were utilized as
general working capital and contributed to the growth of the Company's total
equity. As of June 30, 1998, 444,000 shares of unissued common stock are
32
reserved for issuance pursuant to stock options.
Based on the 50% stock dividend, the converted preferred stock, the exercise of
warrants and options, and the merger with Cushnoc, the common shares
outstanding increased to 2,614,285 shares at June 30, 1998.
The Company repurchased 3,050 treasury shares at a cost of $44,988 during
fiscal 1998, 2,030 treasury shares at a cost of $28,420 during fiscal 1997 and
4,100 treasury shares at a cost of $52,277 during fiscal 1996. These treasury
shares were utilized for the employee stock bonus and option plans as well as
the exercise of warrants.
The total equity to total assets ratio of the Company was 7.79% as of June 30,
1998 and 7.78% at June 30, 1997. Book value per common share was $9.23 as of
June 30, 1998 versus $9.16 at June 30, 1997.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
contains various provisions intended to recapitalize the Bank Insurance Fund
("BIF") and also affects a number of regulatory reforms that impact all insured
depository institutions, regardless of the insurance fund in which they
participate. Among other things, FDICIA grants the OTS broader regulatory
authority to take prompt corrective action against insured institutions that do
not meet capital requirements, including placing undercapitalized institutions
into conservatorship or receivership. FDICIA also grants the OTS broader
regulatory authority to take corrective action against insured institutions
that are otherwise operating in an unsafe and unsound manner.
FDICIA defines specific capital categories based on an institution's capital
ratios. The OTS has issued regulations requiring a minimum regulatory tangible
capital equal to 1.5% of adjusted total assets, core capital of 3.0%, leverage
capital of 4.0% and a risk-based capital standard of 8.0%. The prompt
corrective action regulations define specific capital categories based on an
institution's capital ratios. The capital categories, in declining order, are
"well capitalized", "adequately capitalized", "undercapitalized",
"significantly undercapitalized", and "critically undercapitalized". As of June
30, 1998 and 1997, the most recent notification from the OTS categorized the
Bank as well capitalized. There are no conditions or events since that
notification that management believes has changed the institution's category.
Regulatory capital requirements are also discussed and illustrated in footnote
10 of the consolidated financial statements.
RESULTS OF OPERATIONS
- ---------------------
Net income for the year ended June 30, 1998 was $2,403,783 versus $1,489,745
for the year ended June 30, 1997 and $1,292,849 for the year ended June 30,
1996. Basic earnings per share was $1.00 and diluted earnings per share was
$.86 for the year ended June 30, 1998. Basic and diluted earnings per share
were $.63 and $.56, respectively, for the year ended June 30, 1997 and $.56 and
$.50, respectively for the year ended June 30, 1996. In the first quarter of
fiscal 1998, the Company adopted FASB Statement No. 128, "Earnings Per Share".
Earnings per share for prior periods have been restated in accordance with the
requirements of Statement No. 128. In addition, net income and earnings per
share have been restated for fiscal years 1997 and 1996 to consider the merger
with Cushnoc under the pooling of interests method of accounting and the effect
of the Company's 50% stock dividend. Also, the weighted average number of
shares outstanding in fiscal 1996, as well as the reported earnings per share,
have been restated as a result of the Company's 100% stock dividend in
December, 1995. The increase in net income for the year ended June 30, 1998,
33
when compared to June 30, 1997, was primarily due to the increase in net
interest income and total noninterest income. The increase in net income for
the year ended June 30, 1997, when compared to June 30, 1996, was primarily due
to the increase in net interest income. The Company's overall return on average
assets ("ROAA") was .83% for the year ended June 30, 1998, .57% for the year
ended June 30, 1997, and .55% for the year ended June 30, 1996.
The Company completed the acquisition of Cushnoc in the quarter ended December
31, 1997. The one-time costs associated with the merger totaled approximately
$435,000 before tax of which approximately $424,000 before tax was recognized
in the quarter ended December 31, 1997. The Company's net income, before the
aforementioned one-time expense for the merger with Cushnoc, would have been
$2,686,542, basic earnings per share would have been $1.13 and diluted earnings
per share would have been $.96 for the year ended June 30, 1998.
In September of 1996, Congress enacted comprehensive legislation amending the
FDIC BIF-SAIF deposit insurance assessment on savings and loan institution
deposits. The legislation imposed a one-time assessment on institutions
holding SAIF insured deposits on March 31, 1995, in an amount necessary for the
SAIF to reach its 1.25% Designated Reserve Ratio. Institutions with SAIF
deposits were required to pay an assessment rate of 65.7 cents per $100 of
domestic deposits held as of March 31, 1995. The Bank held approximately
$57,900,000 of SAIF deposits as of March 31, 1995. The net effect of the one
time assessment was $296,860 and decreased the Company's basic earnings per
share by $.09 and the diluted earnings per share by $.08 for the fiscal year
ended June 30, 1997. Commencing in 1997 and continuing through 1999, the Bank
is required to pay an annual assessment of 1.29 cents for every $100 of
domestic BIF insured deposits and 6.44 cents for every $100 of domestic SAIF
insured deposits. Commencing in 2000 and continuing through 2017, banks will
be required to pay a flat annual assessment of 2.43 cents for every $100 of
domestic deposits.
The Company's net interest income for the years ended June 30, 1998, 1997 and
1996 was $11,472,940, $10,644,833, and $10,018,230, respectively. Net interest
income for fiscal 1998 increased $828,107, or 7.78%, compared to the amount at
June 30, 1997. Total interest and dividend income increased $2,347,290 for the
year ended June 30, 1998 compared to the year ended June 30, 1997, resulting
primarily from an increase in the volume of loans offset in part by a decrease
in investment volume and rates. The increase in total interest expense of
$1,519,183 for the twelve months ended June 30, 1998 resulted primarily from
the increased volume of borrowings and deposits. The changes in net interest
income, as explained above, are also presented in the schedule below.
Northeast Bancorp
Rate/Volume Analysis for the Year ended
June 30, 1998 versus June 30, 1997
Difference Due to
Volume Rate Total
------------ ------------ ------------
Investments $ (722,905) $ (27,766) $ (750,671)
Loans 3,377,029 (361,725) 3,015,304
FHLB & Other 79,042 3,615 82,657
------------ ------------ ------------
34
Total Interest Earning Assets 2,733,166 (385,876) 2,347,290
Deposits 390,474 92,868 483,342
Repurchase Agreements 14,929 (7,731) 7,198
Borrowings 1,092,794 (64,151) 1,028,643
------------ ------------ ------------
Total Interest-Bearing
Liabilities 1,498,197 20,986 1,519,183
------------ ------------ ------------
Net Interest Income $ 1,234,969 $ (406,862) $ 828,107
============ ============ ============
Rate/Volume amounts spread proportionately between Volume and Rate.
Net interest income for fiscal 1997 increased $626,603, or 6.25%, compared to
the amount at June 30, 1996. Total interest and dividend income increased
$1,830,582 for the year ended June 30, 1997 compared to the year ended June 30,
1996, resulting primarily from an increase in the volume of loans and
investments offset in part by a decrease in rates. The increase in total
interest expense of $1,203,979 for fiscal 1997 compared to 1996 resulted
primarily from the increased volume of borrowings offset in part by a decrease
in rates. The changes in net interest income, as explained above, are also
presented in the schedule below.
Northeast Bancorp
Rate/Volume Analysis for the Year ended
June 30, 1997 versus June 30, 1996
Difference Due to
Volume Rate Total
------------ ------------ ------------
Investments $ 970,843 $ 21,363 $ 992,206
Loans 1,573,250 (454,479) 1,118,771
FHLB & Other (243,375) (37,020) (280,395)
------------ ------------ ------------
Total Interest Earning Assets 2,300,718 (470,136) 1,830,582
Deposits (36,114) (208,713) (244,827)
Repurchase Agreements 46,631 (13,388) 33,243
Borrowings 1,533,310 (117,747) 1,415,563
------------ ------------ ------------
Total Interest-Bearing
Liabilities 1,543,827 (339,848) 1,203,979
------------ ------------ ------------
Net Interest Income $ 756,891 $ (130,288) $ 626,603
============ ============ ============
Rate/Volume amounts spread proportionately between Volume and Rate.
35
The majority of the Company's income is generated from the Bank. Management
believes that the Bank is slightly asset sensitive based on its own internal
analysis which considers its core deposits long term liabilities that are
matched to long term assets; therefore, it will generally experience a
contraction in its net interest margins during a period of falling rates.
Management believes that the maintenance of a slight asset sensitive position
is appropriate since historically interest rates tend to rise faster than they
decline.
Approximately 21% of the Bank's loan portfolio is comprised of floating rate
loans based on a prime rate index. Interest income on these existing loans
will increase as the prime rate increases, as well as approximately 3