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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 0-16143
FIRST ESSEX BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2943217
(State or other jurisdiction of (I.R.S. Employer incorporation or
incorporation or organization) organization Identification No.)
71 MAIN STREET, ANDOVER, MA 01810
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 681-7500
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
(TITLE OF CLASS)
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 of the registrant held by
non-affiliates of the registrant, based on the closing sale price on The Nasdaq
Stock Market on February 29, 2000 was $100,341,079.
As of February 29, 2000, 7,593,400 shares of the registrant's common stock, $.10
par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Selected information from the Registrant's Proxy Statement for the annual
meeting to be held May 4, 2000, to be filed with the Securities and Exchange
Commission within 120 days after December 31, 1999, is incorporated by reference
into Part III of this report
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
First Essex Bancorp, Inc. ("First Essex" or the "Company") desires to take
advantage of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995. This Report contains certain "forward-looking statements"
including statements concerning plans, objectives, future events or performance,
assumptions, and other statements which are other than statements of historical
fact. The Company wishes to caution readers that the following important
factors, among others, may have affected, and could in the future affect, the
Company's actual results and could cause the Company's actual results for
subsequent periods to differ materially from those expressed in any
forward-looking statement made by, or on behalf of, the Company herein: (i) the
effect of changes in laws and regulations, including federal and state banking
laws and regulations, with which the Company and the Bank must comply, the cost
of compliance either currently or in the future as applicable; (ii) the effect
of changes in accounting policies and practices, as may be adopted by the
regulatory agencies as well as by the Financial Accounting Standards Board, or
of changes in the Company's organization, compensation and benefit plans; (iii)
the effect on the Company's competitive position within in its market area,
increasing consolidation within the banking industry, and increasing competition
from larger regional and out-of-state banking organizations as well as nonbank
providers of various financial services; (iv) the effect of unforeseen changes
in interest rates; and (v) the effect of changes in the business cycle and
downturns in the New England and national economy.
TABLE OF CONTENTS
PART I
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for the Registrant's Equity and Related Stockholder Matters 12
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 28
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 70
PART III
Item 10. Directors and Executive Officers of the Registrant 70
Item 11. Executive Compensation 70
Item 12. Security Ownership of Certain Beneficial Owners and Management 70
Item 13. Certain Relationships and Related Transactions 70
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 70
Signatures 73
PART I
ITEM 1. BUSINESS
GENERAL
FIRST ESSEX BANCORP, INC.
The Company is a Delaware corporation whose primary activity is to act as the
parent holding company for First Essex Bank, FSB (the "Bank"). Until December 1,
1993, the business of First Essex Bancorp, Inc. was conducted through two
banking subsidiaries, First Essex Savings Bank, a Massachusetts-chartered
savings bank and First Essex Savings Bank of New Hampshire, a New
Hampshire-chartered guaranty savings bank. The New Hampshire bank was owned
through a second tier holding company, First Essex Bancorp of New Hampshire,
Inc., which was merged into First Essex Bancorp, Inc. on December 1, 1993.
On December 30, 1996, Finest Financial Corp. ("Finest"), the parent holding
company of Pelham Bank and Trust Company ("Pelham"), a New Hampshire chartered
bank, was merged into the Company in a transaction that was accounted for as a
purchase. Pelham was simultaneously merged into the Bank. The purchase price was
composed of 1,353,998 shares of common stock issued at a price of $11.50 per
share and a total cash outlay of $16.3 million. Included in the total
acquisition cost was approximately $1.4 million of capitalized costs incurred in
connection with the acquisition. This transaction was accounted for as a
purchase and, accordingly, the consolidated statement of operations includes the
results of Finest's operations since the acquisition.
FIRST ESSEX BANK, FSB
The Bank was originally founded under a Massachusetts legislative charter issued
in 1847. On December 1, 1993, First Essex Savings Bank converted to a federal
savings bank with a charter issued by the Office of Thrift Supervision (the
"OTS") under the name of First Essex Bank, FSB. On the same day First Essex
Savings Bank of New Hampshire was merged into First Essex Bank, FSB. As stated
above, the Bank merged with Pelham on December 30, 1996.
Pursuant to a Purchase and Assumption Agreement, the Bank purchased certain
assets and assumed certain deposit liabilities of another financial institution
in June 1998. Because this branch acquisition was an acquisition of assets and
not the acquisition of a business, separate entity or a subsidiary, no
historical financial statements or pro-forma financial statements are required,
and because the deposit liabilities assumed exceed the assets acquired, there
was a cash payment made to the Bank as a result of this transaction.
At December 31, 1999, the Bank had total assets of $1.4 billion. The Bank is
principally engaged in the business of attracting deposits from the general
public and investing in residential mortgage, construction, commercial real
estate, commercial and consumer loans. The Bank also makes investments in
various investment securities to provide a source of interest and dividend
income. The Bank currently maintains 19 full-service banking offices at various
locations throughout its market area. Deposits at First Essex Bank, FSB are
insured up to the applicable limits by the Federal Deposit Insurance Corporation
(the "FDIC") and Massachusetts deposits in excess of FDIC limits are fully
insured by the additional coverage provided contractually by the Depositors
Insurance Fund of Massachusetts.
MARKET AREA
First Essex's market area is centered approximately 25 miles north of Boston at
the intersection of two major highways: Interstate Route 93, the major
north-south roadway connecting Boston with the northern Boston suburban
communities and New Hampshire, and Interstate Route 495. The Bank's principal
executive offices are located in Andover, Massachusetts, and its main banking
office and two of its branches are located in Lawrence, Massachusetts. Other
branches are in the surrounding communities of Andover, North Andover,
Haverhill, Lowell and Methuen, Massachusetts and Concord, Hillsboro,
Londonderry, Manchester, Pelham, Salem and Windham, New Hampshire.
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CURRENT MARKET CONDITIONS
The New England region, including those portions of northeastern Massachusetts
and southern New Hampshire that constitute First Essex's market area, continues
to experience growth.
Loan demand to finance new and existing home sales has remained strong for the
last four years. Commercial loans to small and mid-size businesses in the area
continue to benefit from a growing economy characterized by expansion with
little price inflation, although the competition among lenders for these loans
remains intense. Automobile sales continued to show strength in 1999 and First
Essex participated in that growth through an indirect automobile lending program
that was begun early in 1994. The general improvement in consumer confidence and
the consumer's willingness to take on additional debt was reflected in the
growth in direct lending to consumers.
REGULATION
GENERAL
The Office of Thrift Supervision ("OTS") is the primary regulator of the Company
and the Bank. The Bank's deposits are insured up to applicable limits by the
Bank Insurance Fund ("BIF") of the FDIC. The Company and the Bank must file
reports with the OTS concerning activities and financial condition, in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with or acquisitions of other financial institutions. Periodic
examinations are conducted by the OTS to test the Company's and the Bank's
compliance with various regulatory requirements. The Bank is also a member of
the Federal Home Loan Bank ("FHLB") system, which provides a central credit
facility primarily for member institutions. The Company, as a thrift holding
company, is also required to file certain reports with, and otherwise comply
with the rules and regulations of the OTS and the Securities and Exchange
Commission ("SEC") under the federal securities laws.
BUSINESS ACTIVITIES
The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit
Insurance Act (the "FDI Act"). The HOLA and the FDI Act were amended by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FDICIA, among other things, requires that federal banking regulators intervene
promptly when a depository institution experiences financial difficulties,
mandates the establishment of a risk-based deposit insurance assessment system
and requires the imposition of numerous additional safety and soundness
operational standards and restrictions. FDICIA contains provisions affecting
numerous aspects of the operations of federal savings institutions and empowers
the OTS and the FDIC, among other agencies, to promulgate regulations
implementing its provision.
QUALIFIED THRIFT LENDER TEST
The HOLA requires saving institutions to meet a qualified thrift lender ("QTL")
test. Under the QTL test, as modified by FDICIA, a savings association is
required to maintain at least 65% of its "portfolio assets" (total assets less
(i) specified liquid assets up to 20% of total assets, (ii) intangibles,
including goodwill, and (iii) the value of property used to conduct the
association's business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) on a monthly basis in 9 out of every 12 months.
LIMITATION ON CAPITAL DISTRIBUTIONS
OTS regulations impose limitations upon all capital distributions, other than
stock dividends, by savings institutions. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that meets or exceeds all fully phased-in capital requirements
before and after a proposed capital distribution ("Tier I Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice but without the approval of the OTS, make capital
distributions during a calendar year equal to the greater of: (i) 100% of its
net income to date during the calendar year plus the amount that would reduce by
one-half its "surplus capital ratio" (the percentage by which its capital to
assets ratio exceeds the ratio of its fully phased-in capital requirements to
its assets) at the beginning of the calendar year; or (ii) 75% of its net income
for the previous four quarters. Any additional capital distributions would
require prior regulatory approval. In the event the Bank's capital fell below
its fully phased in requirement or the OTS notified the Bank that it was in need
of more than normal supervision, the Bank's ability to make capital
distributions would be restricted. In addition, the OTS could prohibit any
proposed capital distribution by any institution if it determines that such
distribution would constitute an unsafe or unsound practice. Furthermore, under
the OTS prompt corrective action regulations, which took effect on December 19,
1992, the Bank generally would be
2
prohibited from making any capital distribution if, after the distribution, the
Bank would have (i) a total risk-based capital ratio of less than 8%, (ii) a
Tier I risk-based capital ratio of less than 4% or (iii) a Tier I core capital
ratio of less than 3%. As of December 31, 1999, the Bank exceeded all capital
requirements.
BRANCHING
The Bank currently meets the tests provided in the HOLA and OTS regulations to
permit savings institutions to branch nationwide. Additionally, the OTS
authority preempts any state law purporting to regulate branching by savings
institutions.
CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
the components of capital, risk weightings of assets, and other factors.
Quantitative measures are established by regulation regarding minimum amounts
and ratios of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1999, that the
Company meets all capital adequacy requirements to which it is subject.
As of December 31, 1999, the most recent notification received from the OTS
categorized the Company as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Company must
maintain the total risk-based, Tier I risk-based and Tier I adjusted asset
ratios. There are no conditions or events since that notification that
management believes have changed the institution's category.
FDICIA required that the OTS revise risk-based capital standards, with
appropriate transition rules, to ensure that they take account of interest rate
risk, concentration of risk and the risks of nontraditional activities. Under
OTS regulation effective January 1, 1994, a savings institution with interest
rate risk exposure above a specified percentage must deduct a specified interest
rate risk component when calculating total capital for purposes of determining
whether it meets OTS risk-based capital requirements. As of December 31, 1999,
the OTS did not deem it necessary for an interest-rate risk component to be
deducted from capital in determining risk-based capital requirements.
The Company may not declare or pay cash dividends on its shares of common stock
if the effect thereof would cause stockholders' equity to be reduced below
applicable capital maintenance requirements or if such declaration and payment
would otherwise violate regulatory requirements.
The capital ratios discussed above, along with the Company's actual capital
amounts and ratios are presented in a table within Note 16 to the Consolidated
Financial Statements included in Item 8 - "Financial Statements and
Supplementary Data" of this report.
INSURANCE OF DEPOSIT ACCOUNTS
As required by FDICIA, in 1993, the FDIC established a risk-based assessment
system for insured depository institutions that takes into account the risks
attributable to different categories and concentrations of assets and
liabilities, the likely amounts of any loss, and the revenue needs of the
insurance fund.
Insurance of deposits may be terminated by the FDIC after notice and hearing,
upon finding by the FDIC that the savings institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations,
or has violated any applicable law, rule, regulation, order or condition imposed
by, or written agreement with, the FDIC. Additionally, if insurance termination
proceedings are initiated against a savings institution, the FDIC temporarily
may suspend insurance on new deposits received by an institution under certain
circumstances. Management
3
is not aware of any activity or condition, which could result in a termination
of its deposit insurance. Deposits in Massachusetts are insured in full by the
coverage provided by the Depositors Insurance Fund of Massachusetts.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require financial institutions to maintain
noninterest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). Due to the required reserves needing to be
maintained in the form of either vault cash, a noninterest bearing account at a
Federal Reserve Bank or a pass-through account as defined by the Federal Reserve
Board, the effect of this reserve requirement is to reduce the Bank's
interest-earning assets.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As such, the Company has registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. As a unitary savings and loan holding company, the Company
generally will not be restricted under existing laws as to the types of business
activities in which it may engage, provided that the Bank continues to be a QTL.
The HOLA requires the Company to obtain regulatory approvals prior to entering
into certain transactions such as mergers with or acquisitions of other
institutions or holding companies.
LENDING ACTIVITIES
GENERAL
At December 31, 1999, the loan portfolio, before deducting the allowance for
loan losses, totaled $812.3 million, which represented 59.0% of total assets and
an increase of $78.4 million over the prior year. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Allowance for Loan Losses."
Due to the Company's continued emphasis on higher yielding commercial and
consumer loans, every major category of loans evidenced growth during 1999 with
the exception of residential real estate. First Essex originates residential
first mortgage loans, commercial real estate loans, construction loans, consumer
loans and commercial loans. See Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition."
4
The following table sets forth information concerning First Essex's loan
portfolio, including mortgage loans held for sale, at the dates indicated. The
balances shown in the table are net of unadvanced funds and unearned discounts
and fees. Required disclosure regarding maturity distribution is shown on pages
30 and 31.
Years Ended December 31,
-------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------- ----------------- ------------------ ----------------- ------------------
(Dollars in Thousands)
Real Estate:
Residential $144,021 17.7% $189,983 25.9% $274,865 38.2% $ 301,869 42.9% $ 235,204 47.0%
Commercial 111,272 13.7 88,774 12.1 83,077 11.6 102,718 14.6 53,504 10.7
Construction 51,353 6.3 43,220 5.9 31,851 4.4 24,855 3.5 14,210 2.8
---------- ------ ---------- ------- ---------- ------ ---------- ------ ---------- ------
Total real estate loans 306,646 37.7 321,977 43.9 389,793 54.2 429,442 61.0 302,918 60.5
---------- ------ ---------- ------- ---------- ------ ---------- ------ ---------- ------
Owner occupied
commercialreal estate 63,367 7.8 62,800 8.6 52,335 7.3 29,465 4.2 -- --
Commercial loans 98,701 12.1 89,690 12.2 67,018 9.3 63,695 9.0 66,737 13.4
Aircraft loans 107,007 13.2 59,657 8.1 41,220 5.8 33,802 4.8 14,478 2.9
Consumer loans:
Home Equity, Home
Improvement &
Second Mortgage 51,622 6.4 59,003 8.0 59,897 8.3 52,280 7.4 35,257 7.1
Automobile 180,075 22.2 134,613 18.4 103,551 14.4 92,175 13.1 76,590 15.3
Other 4,867 0.6 6,143 0.8 4,901 0.7 3,800 0.5 4,071 0.8
---------- ------ ---------- ------- ---------- ------ ---------- ------ ---------- ------
Total consumer loans 236,564 29.2 199,759 27.2 168,349 23.4 148,255 21.0 115,918 23.2
---------- ------ ---------- ------- ---------- ------ ---------- ------ ---------- ------
$812,285 100.0% $733,883 100.0% $718,715 100.0% $ 704,659 100.0% $ 500,051 100.0%
========== ====== ========== ======= ========== ====== ========== ====== ========== ======
RESIDENTIAL MORTGAGE LOANS
The Bank originates residential first mortgage loans in its market area. At
December 31, 1999, the residential mortgage loan portfolio was $144.0 million,
representing 17.7% of the loan portfolio. The Bank's residential first mortgage
loan products consist of six-month, one-year, three-year, five-year and
seven-year adjustable-rate mortgages and fixed-rate mortgages, having terms of
15 to 30 years.
COMMERCIAL REAL ESTATE LOANS
The Bank also holds loans secured by commercial real estate, such as
manufacturing, retail, apartment and office buildings. At December 31, 1999, the
commercial real estate loan portfolio had an outstanding balance of $111.3
million, representing 13.7% of the Bank's loan portfolio.
Generally, commercial real estate loans in the portfolio have been made to
finance the acquisition or retention of income producing properties. The current
policy of the Company is to limit commercial real estate loans primarily to
properties in eastern Massachusetts and southern New Hampshire.
Commercial real estate loans generally reprice over periods ranging from six
months to five years based on a published prime rate or other index.
CONSTRUCTION LOANS
Construction loans are primarily made to developers and builders for the
construction of commercial and single-family properties. Construction loans have
generally been made with maturities of one year or less and a price based on the
published prime rate, subject to renewal or extension by the Bank. Additionally,
loans are made to qualified individuals for construction of single-family
owner-occupied homes that convert to permanent mortgages upon completion of
construction. At December 31, 1999, the Bank's construction loan portfolio had
an outstanding balance of $51.4 million, representing 6.3% of the loan
portfolio.
5
OWNER-OCCUPIED COMMERCIAL REAL ESTATE LOANS
Owner-occupied commercial real estate loans are extensions of credit to
commercial borrowers for the construction or purchase of business space,
primarily for the borrower's own use, or loans to commercial borrowers for
operating purposes in which the Bank has taken real estate occupied by the
borrower as collateral. In these instances, the cash flow of the borrower's
business is the primary source of repayment. At December 31, 1999, this
portfolio had total outstandings of $63.4 million, representing 7.8% of the
Bank's loan portfolio.
COMMERCIAL LOANS
At December 31, 1999, the portfolio of commercial loans totaled $98.7 million,
representing 12.1% of the loan portfolio. The Bank offers secured and unsecured
demand loans, time loans, term loans, lines of credit and working capital loans,
which are short term or have adjustable rates. Commercial loans are originated
by the Bank's commercial lending officers who are supported by a credit,
processing and documentation staff.
AIRCRAFT LOANS
The Bank also has an expanding market in commercial and consumer aircraft
lending, which represented 13.2% of the loan portfolio, at December 31, 1999. At
that date, commercial aircraft loans totaled $105.9 million and consumer
aircraft loans totaled $1.1 million of the $107.0 million aircraft portfolio.
CONSUMER LOANS
The portfolio of consumer loans, representing 29.2% of the loan portfolio,
consists of automobile loans, fully or partially secured personal loans, boat
loans, second mortgage loans, home equity loans and unsecured personal loans,
which totaled $236.6 million at December 31, 1999. Automobile loans include
dealer indirect loans, as well as loans originated directly in retail branches.
The Bank offers a variable rate home equity line of credit called "First Line
Equity Credit". This product consists of a line of credit, secured by a second
mortgage on residential property, with a monthly adjustable interest rate at a
margin above a published prime rate.
RISKS ASSOCIATED WITH COMMERCIAL REAL ESTATE, COMMERCIAL, OWNER-OCCUPIED
COMMERCIAL REAL ESTATE AND CONSTRUCTION LOANS
Commercial real estate and commercial lending involve significant additional
risks compared with one-to-four family residential mortgage lending, and,
therefore, typically account for a disproportionate share of delinquent loans
and real estate owned through foreclosure. Such lending generally involves
larger loan balances to single borrowers or groups of related borrowers than
does residential lending, and repayment of the loan depends in part on the
underlying business and financial condition of the borrower and is more
susceptible to adverse future developments. If the cash flow from
income-producing property is reduced (for example, because leases are not
obtained or renewed), the borrower's ability to repay the loan may be materially
impaired. These risks can be significantly affected by considerations of supply
and demand in the market for office, manufacturing and retail space and by
general economic conditions. As a result, commercial real estate and commercial
loans are likely to be subject, to a greater extent than residential property
loans, to adverse conditions in the economy generally.
Construction loans are, in general, subject to the same risks as commercial real
estate loans, but involve additional risks as well. Such additional risks are
due to uncertainties inherent in estimating construction costs, delays arising
from labor problems, shortages of material, uncertain marketability of a
complete project and other unpredictable contingencies that make it relatively
difficult to determine accurately the total loan funds required to complete a
project or the value of the completed project. Construction loan funds are
advanced on the security of the project under construction, which is of
uncertain value prior to the completion of construction. When a construction
project encounters cost overruns, marketing or other problems, it may become
necessary, in order to sustain the project and to preserve collateral values,
for the lender to advance additional funds and to extend the maturity of its
loan. In a declining market, there is no assurance that this strategy will
successfully enable the lender to recover outstanding loan amounts and interest
due. Moreover, foreclosing on such properties results in administrative expense
and substantial delays in recovery of outstanding loan amounts and provides no
assurance that the lender will recover all monies due to it, either by
developing the property, subject to regulatory limitations and to the attendant
risks of development, or by selling the property to another developer.
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RESIDENTIAL LOAN SERVICING AND SALE OF LOANS
The Bank generally writes residential mortgage loans to meet the requirements
for sale in the secondary market. From time to time, the Bank sells residential
mortgage loans and residential loan servicing. Such loan sales represent a
potential source of liquidity to meet lending demand and deposit flows. See Item
7 - "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset/Liability Management."
At December 31, 1999, the Bank's residential loan servicing portfolio totaled
$26.0 million.
NONPERFORMING ASSETS
GENERAL
Nonperforming assets consist of nonaccruing loans (including impaired and
restructured loans) and foreclosed property. For further information regarding
the impairment of loans see "Provision for Loan Losses" included in Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
NONACCRUING LOANS
It is the general practice of the Bank to discontinue accrual of interest on
loans for which payment of interest or principal is 90 days or more past due and
such other loans where collection of interest and principal is doubtful. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on nonaccrual status. At December 31,
1999, the Bank's nonaccruing loans totaled $3.4 million, representing a decrease
of $2.1 million or 37.7% from $5.5 million at December 31, 1998. For further
information regarding the Bank's nonaccruing loans, see Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Non-Performing Assets."
RESTRUCTURED LOANS
These are loans on which concessions have been made in light of the debtor's
financial difficulty with the objective of maximizing recovery. At December 31,
1999 and 1998, the Bank had restructured loans totaling $303,000 and $447,000
respectively. Restructured loans are nonperforming assets and are included in
the totals for nonaccrual loans described above. For further information
regarding restructured loans, see Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operations Nonperforming Assets."
FORECLOSED PROPERTY
Foreclosed property at December 31, 1999 totaled $447,000 compared to $575,000
at December 31, 1998.
Foreclosed property consists of real or tangible property that collateralized a
loan prior to foreclosure or repossession. These properties are carried at the
lower of cost or the estimated net realizable values. Any decreases in value
prior to sale are charged to operations.
For further information regarding the Bank's foreclosed property, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Nonperforming Assets."
INVESTMENT ACTIVITIES
The Company maintains an investment portfolio to provide a source of interest
and dividend income and a potential source of liquidity to meet lending demand
and deposit flows. At December 31, 1999, the investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities, stock
in the Federal Home Loan Bank of Boston and stock of the Savings Bank Life
Insurance Company of Massachusetts, totaled $455.2 million, or 33.1% of total
assets.
Interest and dividend income on the investment portfolio generated 30.4% of
total interest and dividend income for the year ended December 31, 1999. See
Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Investments" for further
information regarding the investment portfolio.
The Bank's investment strategy seeks to provide liquidity and realize current
income while preserving principal. The Bank will generally invest only in
government or corporate bonds or securities issued in the United States and will
only purchase bonds which are rated A or higher at the time of purchase.
7
DEPOSITS
The Bank offers a range of deposit accounts including regular and passbook
savings, NOW, money market and demand deposit accounts. The Bank offers a number
of relationship products that allow customers to combine balances in checking
and savings accounts in order to avoid service and maintenance fees, and obtain
free banking services. These relationship products also include discounts on
installment loans and bonus rates on certificates of deposit. The Bank also
offers term deposit certificates ranging from 32 days to seven years. Interest
rates on these certificates vary according to the term selected. From time to
time, the Bank promotes various types of accounts with the intention of changing
the maturity schedule of its liabilities. See also Item 7. - "Management's
Discussion and Analysis of Financial Condition and Results of Operation -
Deposits."
The Bank offers its retail banking customers a wide range of deposit services
and the convenience of drive-up ATMs. The Bank is a member of the NYCE-TM-,
EXCHANGE-TM-, TX-TM- and CIRRUS-TM- networks. These networks allow the Bank's
depositors access to their accounts through ATMs at the Bank, other banks and
locations nationwide and worldwide.
COMPETITION
The Bank faces competition both in originating loans and in attracting deposits.
Competition in originating loans comes from a variety of sources, including, but
not limited to, other thrift institutions, commercial banks, mortgage companies,
insurance companies and consumer and commercial finance companies. The Bank
competes for loans principally on the basis of interest rates and loan fees, the
types and terms of loans originated and the quality of services provided to
borrowers. In attracting deposits, the primary competitors are other thrift
institutions, commercial banks, mutual funds and credit unions. The ability to
attract and retain deposits depends on the ability to provide investment
opportunities that satisfy the requirements of investors with respect to rate of
return, liquidity, risk, service, convenience and other factors.
The Bank competes for deposits on the basis of interest rates and by offering
convenient branch locations, extended business hours and an automated teller
network.
EMPLOYEES
At December 31, 1999, the Bank had 312 full time equivalent employees. None of
the employees of the Bank are represented by a collective bargaining group and
management considers its relations with its employees to be good.
8
ITEM 2. PROPERTIES
The following table sets forth certain information relating to properties owned
or used in banking activities at December 31, 1999.
OWNED LEASE RENEWAL TOTAL OFFICE SPACE
FIRST ESSEX BANK OR LEASED EXPIRATION DATE OPTION THROUGH IN SQUARE FEET
---------------- --------- --------------- -------------- ------------------
Corporate Headquarters (1):
71 Main Street Leased January 31, 2005 January 31, 2015 12,859
Andover, MA
Main Banking Office (2):
296 Essex Street Owned N/A N/A 32,000
Lawrence, MA
Operations Center:
900 Chelmsford Street Leased May 12, 2005 May 12, 2010 31,478
Lowell, MA
Mortage Origination Office:
216 Lafayette Road Leased October 31, 2000 October 31, 2001 661
North Hampton, NH
Consumer Lending Office:
211 North Main Street Leased May 31, 2001 N/A 1,260
Andover, MA May 31, 2003 May 30, 2008 800
Branch Offices:
460 South Union Street Leased February 28, 2009 February 28, 2029 3,500
Lawrence, MA
555 Broadway Owned N/A N/A 2,000
Lawrence, MA
750 Main Street Owned N/A N/A 3,100
Haverhill, MA
555 Chickering Road Leased March 31, 2002 March 31, 2012 4,549
North Andover, MA
211 North Main Street Leased April 30, 2002 April 30, 2007 4,710
Andover, MA
125 Merrimack Street Owned N/A N/A 3,000
Methuen, MA
9
ITEM 2. PROPERTIES
(CONTINUED)
OWNED LEASE RENEWAL TOTAL OFFICE SPACE
FIRST ESSEX BANK OR LEASED EXPIRATION DATE OPTION THROUGH IN SQUARE FEET
---------------- --------- --------------- -------------- ------------------
Branch Offices (continued):
15 Burnham Road Leased June 30, 2005 June 30, 2015 3,700
Methuen, MA
539 South Broadway (3) Leased September 30, 2002 September 30, 2012 5,400
Salem, NH
1 Wall Street (4) Owned N/A N/A 7,400
Windham, NH
100 Bridge Street Leased June 30, 2003 June 30, 2008 6,899
Pelham, NH
24 Orchard View Drive Leased November 30, 2003 November 30, 2008 3,130
Londonderry, NH
900 Chelmsford Street Leased September 30, 2001 September 30, 2006 1,400
Lowell, MA
20 North Broadway Owned N/A N/A 3,800
Salem, NH
73 West Street Owned N/A N/A 5,600
Concord, NH
161 North State Street (5) Owned N/A N/A 22,560
Concord, NH
53 West Main Street Owned N/A N/A 4,276
Hillsborough, NH
1 Wall Street Leased June 30, 2001 June 30, 2011 21,787
Manchester, NH
(1) This site also serves as a branch location.
(2) Includes two contiguous buildings at 284 Essex Street and 286-288 Essex
Street which were aquired in 1972 and 1980, respectively, as well as an
adjacent parking lot at 7 Lawrence Street which was acquired in 1981.
(3) Second floor of building is subleased for a two year term, commencing on
April 1, 1998 and terminating on March 31, 2000. There is an option to
renew for three additional 3 year terms.
(4) Second floor of building is leased for a two year term, commencing on March
1, 1999 and terminating on February 28, 2001. There is an option to renew
for two additional 1 year terms.
(5) 4,000 s/f is leased for a three year term, commencing on January 1, 2000
and terminating December 31, 2002. There is an option to renew for one
additional two year term.
Management believes that the Company's existing facilities are adequate for the
conduct of its business.
10
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its business,
none of which are believed by management to be material to the financial
condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders during the fourth
quarter of 1999.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on the Nasdaq
National Market System under the symbol FESX.
At December 31, 1999, there were 7,591,900 shares outstanding and approximately
1,200 shareholders of record. This does not reflect the number of persons or
entities who hold their stock in nominee or street name through various
brokerage firms.
The price information regarding the Company's common stock in the following
table is based on high and low closing sales prices.
DIVIDEND DECLARED
PRICES PER SHARE PER SHARE
------------------------------------------------------------
HIGH LOW
1999
First Quarter $18.250 $15.062 $ .16
Second Quarter 17.250 14.000 .16
Third Quarter 16.750 14.000 .16
Fourth Quarter 16.875 14.160 .18
1998
First Quarter $26.125 $20.000 $ .14
Second Quarter 25.250 21.250 .14
Third Quarter 23.984 15.000 .14
Fourth Quarter 18.875 13.750 .16
------------------------------------------------------------
The only funds available to the Company for the payment of dividends are cash
and cash equivalents held at the holding company level, dividends from the Bank
and borrowings. In addition, bank regulatory authorities generally restrict the
amounts available for the payment of dividends by the Bank to the Company to the
net profit of the Bank for that year, see Item 1 - "Business - Regulation
Limitation on Capital Distributions". The Federal Reserve Act also restricts the
Bank in lending or advancing funds to the Company unless such loans are
collateralized by specific obligations, and limits collateralized loans to 10%
of the Bank's capital stock and surplus.
The Bank is prohibited from paying cash dividends, to the extent that any such
payment would reduce its capital below required regulatory capital levels or
would impair the liquidation account established in connection with its
conversion from mutual to stock form. See Item 1. "Business - Regulation -
Limitation on Capital Distributions" and Note 16 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report for further discussion.
The payment of dividends by the Bank could carry significant adverse tax
consequences. To the extent that distributions by the Bank to the holding
company exceed the Bank's current and accumulated earnings and profits (as
computed for federal income tax purposes for taxable years beginning after
December 31, 1951), those distributions would be treated for tax purposes as
first being made out of the Bank's bad debt reserve. In that case, the Bank
would have federal taxable income equal to approximately one and one-half times
the amount of the actual shareholder distribution that is treated as made out of
the Bank's bad debt reserves.
12
ITEM 6. SELECTED FINANCIAL DATA
AT DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------- --------------- -------------- --------------- --------------
(DOLLARS IN THOUSANDS)
Balance Sheet Data:
Total assets $1,377,318 $ 1,248,014 $ 1,197,459 $ 1,067,175 $ 808,792
Loans receivable, net 800,946 722,622 708,145 694,121 493,499
Investment securities (1) 455,220 367,019 416,021 315,749 275,900
Foreclosed property 447 575 891 1,880 1,756
Deposits 1,002,761 934,695 744,322 690,953 491,469
Borrowed funds 268,962 201,499 343,557 274,958 245,569
Stockholders' equity 91,578 97,082 91,065 83,141 60,172
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------- --------------- -------------- --------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
Interest and
dividend income $ 96,742 $ 93,460 $ 90,078 $ 63,545 $ 60,914
Interest expense 50,183 52,512 52,377 37,317 37,081
-------------- --------------- -------------- --------------- --------------
Net interest income 46,559 40,948 37,701 26,228 23,833
Provision for loan losses 2,400 1,440 2,040 1,415 770
Net gain (loss) on sales
of securities 54 1,344 439 497 (13)
Net gain on sales of mortgage loans
and mortgage servicing rights 1,208 1,338 1,628 1,352 1,431
Other income 4,833 4,183 3,021 2,416 2,290
Noninterest expenses 30,071 28,178 24,364 19,925 19,244
Income tax
expense (benefit) 7,491 7,130 6,672 40 75
-------------- --------------- -------------- --------------- --------------
Net income $ 12,692 $ 11,065 $ 9,713 $ 9,113 $ 7,452
============== =============== ============== =============== ==============
PER SHARE DATA:
Earnings per share - basic $1.67 $1.46 $1.30 $1.51 $1.24
Earnings per share - diluted 1.63 1.41 1.25 1.47 1.22
Dividends declared 0.66 0.58 0.50 0.48 0.40
Book value at
end of period 12.06 12.75 12.08 11.20 9.99
SELECTED FINANCIAL RATIOS:
Return on average assets 0.96% 0.90% 0.80% 1.08% 0.91%
Return on average equity 13.16 11.73 10.54 14.37 12.79
Average equity as a
percentage of average assets 7.29 7.63 7.32 7.54 7.09
Weighted average interest
rate spread 3.24 2.84 2.77 2.72 2.56
Net yield on average
earning assets 3.71 3.44 3.31 3.22 2.99
(1) Investment securities include short term investments, U.S. government and
agency obligations, mortgage-backed securities, other bonds and
obligations, stock in the Federal Home Loan Bank of Boston and stock in the
Savings Bank Life Insurance Company.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
GENERAL
The results of operations of the Company consist primarily of the results of
operations of the Bank, which is the Company's sole subsidiary. Net income for
the year ended December 31, 1999 totaled $12.7 million (or $1.63 per diluted
share) compared to $11.1 million (or $1.41 per diluted share) for the same
period in 1998, an increase of 14.7% or $1.6 million. The improvement was
primarily due to the increase in the net yield on average earnings assets,
partially offset by higher provisions for loan losses, lower noninterest income
and increases in noninterest expenses.
14
ANALYSIS OF AVERAGE YIELDS EARNED AND RATES PAID
The following table presents an analysis of average yields earned and rates paid
for the years indicated:
YEARS ENDED DECEMBER 31,
1999 1998 1997
------------------------------------ ------------------------------- ------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
-------- ------- ---- -------- ------- ---- -------- ------- ----
(DOLLARS IN THOUSANDS)
Assets
Earning assets:
Short-term investments $ 17,043 $ 807 4.74% $ 42,580 $ 2,318 5.45% $ 9,826 $ 585 5.95%
Investment securities 455,589 28,607 6.28 390,182 25,054 6.42 405,639 26,418 6.51
Other earning assets 17,436 1,051 6.03 17,336 1,043 6.02 7,333 517 7.05
Total loans (1) 764,400 66,277 8.67 739,091 65,045 8.80 715,772 62,558 8.74
---------- -------- ---------- ------- ---------- -------
Total earning assets 1,254,468 96,742 7.71 1,189,189 93,460 7.86 1,138,570 90,078 7.91
---------- -------- ---------- ------- ---------- -------
Allowance for loan losses (11,293) (11,037) (10,197)
---------- ---------- ----------
Total earning assets less allowance
for loan losses 1,243,175 1,178,152 1,128,373
Other assets 80,041 57,071 57,841
---------- ---------- ----------
Total Assets $1,323,216 $1,235,223 $1,186,214
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
NOW accounts $ 51,910 450 0.87 $ 44,048 518 1.18 $ 40,806 527 1.29
Money market accounts 94,593 2,990 3.16 66,263 2,200 3.32 73,571 1,698 2.31
Savings accounts 240,141 7,854 3.27 196,343 7,037 3.58 123,204 4,134 3.36
Time deposits 473,237 24,433 5.16 450,104 25,602 5.69 422,978 24,870 5.88
---------- -------- ---------- ------- ---------- -------
Total interest bearing
deposits 859,881 35,727 4.15 756,758 35,357 4.67 660,559 31,229 4.73
Borrowed funds 263,224 14,456 5.49 289,229 17,155 5.93 359,390 21,148 5.88
---------- -------- ---------- ------- ---------- -------
Total interest bearing deposits
and borrowed funds 1,123,10 550,183 4.47 1,045,987 52,512 5.02 1,019,949 52,377 5.14
-------- ------- -------
Demand deposits 93,679 77,467 62,220
Other liabilities 9,971 17,473 17,204
---------- ---------- ----------
Total liabilities 1,226,755 1,140,927 1,099,373
Stockholders' equity 96,461 94,296 86,841
---------- ---------- ----------
Total liabilities and
stockholders' equity $1,323,216 $1,235,223 $1,186,214
========== ========== ==========
Net interest income $ 46,559 $40,948 $37,701
======== ======= =======
Weighted average rate spread 3.24% 2.84% 2.77%
---- ---- ----
Net yield on earning assets (2) 3.71% 3.44% 3.31%
---- ---- ----
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for loan losses divided by average
interest earnings assets.
15
RATE/VOLUME ANALYSIS
The following table presents, for the periods indicated, the changes in interest
and dividend income and the changes in interest expense attributable to changes
in interest rates and changes in the volume of interest earning assets and
interest bearing liabilities. The change attributable to both volume and rate
has been allocated proportionally to the two categories.
YEARS ENDED DECEMBER 31,
1999 COMPARED TO 1998 1998 COMPARED TO 1997
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
----------------------------- -------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
---------- --------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Interest and dividend income:
Loans before the allowance for
loan losses $ 2,204 $ (972) $ 1,232 $ 2,038 $ 449 $ 2,487
Investment securities 4,118 (565) 3,553 (1,007) (357) (1,364)
Other earning assets 6 2 8 705 (179) 526
Federal funds sold and short-term
investments (1,241) (270) (1,511) 1,788 (55) 1,733
---------- --------- -------- -------- -------- ----------
Total interest and dividend income 5,087 (1,805) 3,282 3,524 (142) 3,382
---------- --------- -------- -------- -------- ----------
Interest expense:
Savings deposits 2,386 (847) 1,539 2,457 449 2,906
Time deposits 1,272 (2,441) (1,169) 1,162 60 1,222
Borrowed funds (1,480) (1,219) (2,699) (4,125) 132 (3,993)
---------- --------- -------- -------- -------- ----------
Total interest expense 2,178 (4,507) (2,329) (506) 641 135
---------- --------- -------- -------- -------- ----------
Net interest and dividend income $ 2,909 $2,702 $ 5,611 $ 4,030 $ (783) $ 3,247
========== ========= ======== ======== ======== ==========
NET INTEREST INCOME
Net interest income increased by $5.6 million to $46.6 million for the year
ended December 31, 1999, representing a 13.7% increase from $40.9 million in
1998. The increase in net interest income was primarily due to the increase of
27 basis points in the net yield on average earning assets combined with the
volume increases in outstanding loans and investment securities.
Net interest income increased by $3.2 million to $40.9 million for the year
ended December 31, 1998, representing an 8.6% increase from $37.7 million in
1997. The increase in net interest income was primarily due to the increase of
13 basis points in the net yield on average earning assets combined with the
volume increases in outstanding loans and short term investments partially
offset by the decreased investment securities.
INTEREST AND DIVIDEND INCOME
Interest and dividend income increased by $3.3 million (3.5%) to $96.7 million
for the year ended December 31, 1999 from $93.5 million for the year ended
December 31, 1998. This increase was due to a $65.3 million or 5.5% increase in
average earning assets from $1,189.2 million in 1998 to $1,254.5 million in
1999. The net yield on average earning assets rose 27 basis points from the 1998
yield of 3.44% to 3.71% in 1999 primarily due to a decrease in the cost of
funds.
Interest and dividend income increased by $3.4 million (3.8%) to $93.5 million
for the year ended December 31, 1998 from $90.1 million for the year ended
December 31, 1997. This increase was due to an overall increase in average
earning assets from $1,138.6 million in 1997 to $1,189.2 million in 1998, a 4.4%
increase. The net yield on average earning assets rose 13 basis points from the
1997 yield of 3.31% to 3.44% in 1998 primarily due to a decrease in the cost of
funds and secondarily due to a shift to higher yielding commercial loans.
INTEREST EXPENSE
Interest expense decreased $2.3 million or 4.4% to $50.2 million for the year
ended December 31, 1999 from $52.5 million in 1998. The volume increases in core
deposits were more than offset by decreases in the rates paid on deposits
16
and borrowed funds combined with the volume decreases in borrowed funds. The
total weighted cost of funds decreased 55 basis points from 5.02% in 1998 to
4.47% in 1999.
Interest expense increased marginally ($135,000 or 0.3%) to $52.5 million for
the year ended December 31, 1998 from $52.4 million in 1997. The volume
increases in savings and time deposits were more than offset by the volume
decreases in borrowed funds. The total weighted cost of funds decreased 12 basis
points from 5.14% in 1997 to 5.02% in 1998.
PROVISION FOR LOAN LOSSES
Losses on loans are provided for under the accrual method of accounting.
Assessing the adequacy of the allowance for loan losses involves substantial
uncertainties and is based upon management's evaluation of the amount required
to meet estimated losses inherent in the loan portfolio after weighing various
factors. Among the factors management may consider are the quality of specific
loans, risk characteristics of the loan portfolio generally, the level of
non-accruing loans, current economic conditions, trends in delinquencies and
charge-offs and collateral values of the underlying security. See "Financial
Condition - Allowance for Loan Losses". Ultimate losses may vary significantly
from the current estimates. Losses on loans, including impaired loans, are
charged against the allowance when management believes the collectability of
principal is doubtful.
Provisions for loan losses totaled $2.4 million, $1.4 million, and $2.0 million
for the years ended December 31, 1999, 1998 and 1997, respectively. Provisions
result from management's continuing internal review of the loan portfolio as
well as its judgment as to the adequacy of the reserves in light of the
condition of the regional real estate market and the economy generally. As a
result of increased loans, there is an expectation that the Bank will continue
to find it necessary to make provisions for loan losses in the future. See
"Financial Condition - Non-Performing Assets."
The Bank's total allowance for loan losses was $11.3 million or 331.1% of
non-accruing loans at December 31, 1999 compared to $11.3 million or 204.8% at
December 31, 1998 and $10.6 million or 190.7% at December 31, 1997.
NONINTEREST INCOME
Noninterest income consists of net gains from sales of securities, net gains
from sales of loans and loan servicing rights, fee and other noninterest income.
Noninterest income decreased 11.2% to $6.1 million for the year ended December
31, 1999 compared to $6.9 million in 1998. The primary reasons for this decrease
are attributable to nonrecurring gains on sales of investment securities during
1998, partially offset by increased fee income for 1999. Other noninterest
income for 1999 includes approximately $345,000 of income from bank owned life
insurance on policies purchased during 1999.
Noninterest income increased 34.9% to $6.9 million for the year ended December
31, 1998 compared to $5.1 million in 1997. The primary reasons for this $1.8
million increase were a $905,000 increase in gains on the sales of investment
securities (of which approximately $231,000 were the result of gains realized on
the sale of securities transferred from the held-to-maturity classification),
and a $71,000 increase in total fee income, offset by a $290,000 decrease in
gains on sales of mortgage loans. Other noninterest income was a result of a
special payment received from the Massachusetts Depositors Insurance Fund of
$346,000 and interest on a state tax refund of $145,000.
NONINTEREST EXPENSES
Noninterest expenses increased by $1.9 million (6.7%) to $30.1 million for the
year ended December 31, 1999 compared to $28.2 million in 1998. The majority of
this increase is related to the amortization of intangible assets associated
with branches acquired during the second quarter of 1998. The remaining
increases in other noninterest expenses reflect costs associated with the full
year of operating those additional branch locations.
Noninterest expenses increased by $3.8 million (15.7%) to $28.2 million for the
year ended December 31, 1998 compared to $24.4 million in 1997. The majority of
this increase relates to the acquisition of four banking offices in June 1998,
and the operation, throughout the reminder of the year, of these additional
banking offices.
17
Salaries and employee benefits increased by $1.0 million (7.9%) to $14.1 million
for the year ended December 31, 1999 from $13.0 million in 1998 and $11.6
million in 1997. The increases were primarily due to the acquisition of four
additional branches in June of 1998.
Amortization of intangible assets associated with the branch acquisition in 1998
and the purchase of Finest Financial Corp. in 1996 amounted to $2.6 million in
1999, $1.7 million in 1998 and $780,000 in 1997.
The remaining categories of noninterest expenses remained flat at $13.4 million
for the years ended December 31, 1999 and 1998, up from $11.9 million in 1997.
Included in these expenses is "Other", which totaled $4.0 million in 1999 and
represents a decrease of $1.2 million or 23.5% when compared to 1998. This
decrease is primarily attributable to 1998 one-time write-downs in the carrying
values of certain other assets associated with bank and branch acquisitions and
the conversion to new operating systems. Other totaled $3.8 million in 1997.
INCOME TAXES
The net provision for income taxes amounted to $7.5 million in 1999 compared to
provisions of $7.1 million and $6.7 million recorded in 1998 and 1997,
respectively. The effective tax rate in 1999 is lower when compared to 1998 and
1997 due to favorable tax rates on certain investment income.
18
FINANCIAL CONDITION
Total assets increased by $129.3 million or 10.4% to $1.4 billion at December
31, 1999 compared to $1.2 billion at December 31, 1998.
LOANS
At December 31, 1999, the loan portfolio, excluding the allowance for loan
losses, and including mortgage loans held-for-sale, was $812.3 million,
representing 59.0% of total assets. This is an increase of $78.4 million or
10.7% when compared to $733.9 million or 58.8% of total assets at December 31,
1998. See Item 1 - "Business - Lending Activities - General" for a table setting
forth the composition of the loan portfolio of the Bank at the end of each of
the past five years.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccruing and restructured loans (including
impaired loans), and foreclosed property. Nonperforming assets totaled $3.9
million at December 31, 1999, compared to $6.1 million at December 31, 1998 and
$6.4 million at December 31, 1997.
The Bank's general practice is to discontinue the accrual of interest on loans
(including impaired loans) for which payment of interest or principal is ninety
days or more past due or for such other loans as considered necessary by
management if collection of interest and principal is doubtful. When a loan is
placed on nonaccrual status, all previously accrued but uncollected interest is
reversed against current period interest income.
The recorded investment of restructured loans was $303,000 for the year ended
December 31, 1999, $447,000 for the year ended December 31, 1998 and $905,000
for the year ended December 31, 1997.
The amount of interest that would have been earned had the nonaccrual and
restructured loans performed in accordance with original terms and conditions
was $164,000, $456,000 and $570,000 for the years ended December 31, 1999, 1998
and 1997, respectively.
Foreclosed property at December 31, 1999 totaled $447,000 compared to $575,000
at December 31, 1998 and consists mainly of real estate collateral from loans
that were foreclosed, as well as repossessed automobiles.
At December 31, 1999, the recorded investment in loans that are considered to be
impaired totaled $857,000 of which $507,000 had a related allowance for loan
losses of $304,000. The remaining $350,000 of impaired loans did not require a
related allowance for loan losses. The average recorded investment in impaired
loans during 1999 was approximately $1.3 million.
19
The following table shows the composition of nonperforming assets for the five
years ended December 31, 1999:
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Nonaccruing loans:
Real estate $1,422 $3,260 $3,159 $2,693 $2,559
Other 1,700 1,792 1,480 1,004 814
Restructured loans 303 447 905 1,042 1,043
-------- -------- -------- -------- --------
Total nonaccruing loans 3,425 5,499 5,544 4,739 4,416
Foreclosed property 447 575 891 1,880 1,756
-------- -------- -------- -------- --------
Total nonperforming assets $3,872 $6,074 $6,435 $6,619 $6,172
======== ======== ======== ======== ========
Percentage of nonperforming
to total assets 0.28% 0.49% 0.54% 0.62% 0.76%
Percentage of allowance for
loan losses
to nonaccruing loans 331.1% 204.8% 190.7% 222.4% 148.4%
The following table summarizes the activity of foreclosed property during the
year ended December 31, 1999:
OTHER
RESIDENTIAL CONSTRUCTION COMMERCIAL REPOSSESSED
REAL ESTATE REAL ESTATE REAL ESTATE ASSETS TOTAL
---------- ------------ ------------ ------------ ---------
(DOLLARS IN THOUSANDS)
Balance at beginning of year $ -- $ -- $ 276 $ 299 $ 575
Transfer from loans 85 48 -- 2,261 2,394
Write-downs -- -- -- -- ---
Sales (85) -- (276) (2,161) (2,522)
---------- ------------ ------------ ------------ ---------
Balance at end of year $ -- $ 48 $ -- $ 399 $ 447
========== ============ ============ ============ =========
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level determined by management
to be adequate to provide for probable losses inherent in the loan portfolio
including commitments to extend credit. The allowance for loan losses is
maintained through the provision for loan losses, which is a charge to
operations. The potential for loss in the portfolio reflects the risks and
uncertainties inherent in the extension of credit.
The determination of the adequacy of the allowance for loan losses is based upon
management's assessment of risk elements in the portfolio, factors affecting
loan quality and assumptions about the economic environment in which the Company
operates. The process includes identification and analysis of loss potential in
various portfolio segments utilizing a credit risk grading process and specific
reviews and evaluations of significant individual problem credits. In addition,
management reviews overall portfolio quality through an analysis of current
levels and trends in charge-off, delinquency and nonaccruing loan data,
forecasted economic conditions and the overall-banking environment. These
reviews are of necessity dependent upon estimates, appraisals and judgments,
which may change quickly because of changing economic conditions and the
Company's perception as to how these factors may affect the financial condition
of debtors.
20
The methodology for assessing the appropriateness of the allowance consists of a
review of the following key elements:
- A formula allowance for the various loan portfolio classifications,
- A valuation allowance for loans identified as impaired, and
- The unallocated allowance.
The formula allowance is a percentage-based reflection of historical loss
experience and assigns required allowance allocations by loan classification
based on a fixed percentage of all outstanding loan balances and commitments to
extend credit. The formula allowance employs a risk-rating model that grades
loans based on general characteristics of credit quality and relative risk. As
credit quality becomes more suspect, so-called "watch list" loans, the risk
rating and allocation percentage increase. The sum of these allocations comprise
the Company's "formula" or "general" allowance.
The Company also has "valuation" allowances for impaired loans. Loans are
evaluated for impairment by measuring the net present value of the expected
future cash flows using the loan's original effective interest rate, or looking
at the fair value of the collateral if the loan is collateral dependent. When
the difference between the net present value of a loan (or fair value of the
collateral if the loan is collateral dependent) is lower than the recorded
investment of the loan, the difference is provided to expense with a resulting
"valuation" allowance.
In addition to the formula and valuation components, there is an unallocated
allowance that is composed of two additional elements. The first element, which
is based on the Company's credit policy, consists of an amount that is at least
20% to 25% of the formula and valuation allowances. This element recognizes the
estimation risks associated with the formula model and the valuation allowance.
The second element is based upon management's evaluation of various conditions,
the effects of which are not directly measured in determining the formula and
valuation allowances. The evaluation of the inherent loss resulting from these
conditions involves a higher degree of uncertainty because they are not
identified with specific problem credits or portfolio segments. The conditions
evaluated in connection with the unallocated allowance include the following:
- then-existing general economic and business conditions affecting the
Company's key lending areas,
- credit quality trends, including trends in nonperforming loans
expected to result from existing conditions,
- collateral values,
- loan volumes and concentrations,
- seasoning of the loan portfolio,
- specific industry conditions within portfolio segments,
- recent loss experience in particular segments of the portfolio,
- duration of the current business cycle,
- bank regulatory examination results, and
- findings of our internal credit examiners.
When an evaluation of these conditions signifies a change in the level of risk,
the Company adjusts the formula allowance. Periodic credit reviews enable
further adjustment to the allowance through the risk rating of loans and
identification of loans requiring a valuation allowance. In addition, the
formula model is designed to be self-correcting by taking into account recent
loss experience.
21
The annual provision for loan losses is set based on the factors discussed
above. In addition, it is management's intent to maintain the allowance at a
level consistent with the Company's peers in the banking industry. The allowance
to loans ratio of 1.40% at December 31, 1999 was slightly below the Company's
peer group's average allowance ratio of 1.48% (1) Although the Company realized
total loan growth of $78.4 million or 10.7% during 1999, there were no
significant changes in loan concentrations, loan quality or loan terms during
the period. Estimation methods and assumptions affecting the allowance for loan
losses remained unchanged from those used in prior periods. There was no
significant reallocation of the allowance for loan losses among the various
segments of the portfolio.
The following table summarizes the activity in the allowance for loan losses for
the five years ended December 31, 1999:
1999 1998 1997 1996 1995
--------- ---------- --------- ---------- ---------
(DOLLARS IN THOUSANDS)
Balance at beginning of year $ 11,261 $ 10,570 $ 10,538 $ 6,552 $ 7,237
Acquired allowance - Finest -- -- -- 4,080 --
Acquired allowance - branch
acquisition -- 765 -- -- --
Provision for loan losses 2,400 1,440 2,040 1,415 770
Charge-offs:
Mortgage (396) (709) (1,212) (1,148) (1,448)
Construction (10) -- -- (1) (96)
Owner-occupied commercial
real estate -- -- -- -- --
Commercial (607) (726) (2) (157) (230)
Consumer (2,221) (2,111) (1,612) (1,029) (711)
--------- ---------- --------- ---------- ---------
Total charge-offs (3,234) (3,546) (2,826) (2,335) (2,485)
--------- ---------- --------- ---------- ---------
Recoveries:
Mortgage 604 1,288 575 277 234
Construction 4 12 14 6 279
Owner-occupied commercial
real estate -- -- -- -- --
Commercial 84 578 85 461 431
Consumer 220 154 144 82 86
--------- ---------- --------- ---------- ---------
Total recoveries 912 2,032 818 826 1,030
--------- ---------- --------- ---------- ---------
Net Charge-offs (2,322) (1,514) (2,008) (1,509) (1,455)
--------- ---------- --------- ---------- ---------
Balance at end of year $ 11,339 $ 11,261 $ 10,570 $ 10,538 $ 6,552
========= ========== ========= ========== =========
Total loans at end of year $812,285 $733,883 $718,715 $704,659 $500,051
Average loans for the year 764,400 739,091 715,772 538,758 473,069
Allowance to loans ratio 1.40% 1.53% 1.47% 1.50% 1.31%
Net Charge-offs to average
loans ratio 0.30% 0.20% 0.28% 0.28% 0.30%
- ------------------------
(1) Based on the most recently available peer group date as of September 30,
1999.
22
INVESTMENTS
At December 31, 1999, the Company's investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities,
Federal Home Loan Bank ("FHLB") stock and Savings Bank Life Insurance Company of
Massachusetts stock, totaled $461.1 million or 33.5% of assets, compared to
$367.4 million or 29.4% of assets at December 31, 1998. The portfolio included
U.S. government and agency obligations having a book value of $114.0 million and
mortgage-backed securities with a value of $310.0 million. Interest and dividend
income on the Company's investment portfolio, which amounted to $29.4 million,
generated 30.4% of total interest and dividend income for the year ended
December 31, 1999.
To identify and control risks associated with the investment portfolio, the
Company has established policies and procedures, which include stop loss limits
and stress testing on a periodic basis. During the second quarter of 1998, the
Company reclassified to available-for-sale all securities previously classified
as held-to-maturity. This reclassification was the result of an analysis of the
strategic alternatives for the securities portfolio. Under Securities and
Exchange Commission guidelines, this reclassification prohibits the Company from
classifying securities as held-to-maturity for a period of at least two years.
The Company does not have any investments in off-balance-sheet financial
instruments, except as noted in Note 11 to the consolidated financial statements
included in response to Item 8 - "Financial Statements and Supplementary Data"
of this report.
The following table sets forth the composition of the investment portfolio for
the years indicated:
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
Short-term investments:
Interest bearing deposits $ 134 $ 107 $ 122
Federal funds sold 5,775 281 4,000
------------- ------------- -------------
Total short-term investments 5,909 388 4,122
------------- ------------- -------------
Investment securities held-to-maturity:
U.S. government & agency obligations --- --- 54,421
Mortgage backed securities --- --- 109,661
Other bonds and obligations --- --- 14,917
------------- ------------- -------------
Total investment securities held-to-maturity --- --- 178,999
------------- ------------- -------------
Investment securities available-for-sale:
U.S. government & agency obligations 113,981 100,122 67,960
Mortgage-backed securities 310,003 244,083 121,977
Other bonds and obligations 10,057 1,635 21,966
------------- ------------- -------------
Total investment securities available for sale 434,041 345,840 211,903
------------- ------------- -------------
Stock in Federal Home Loan Bank of Boston 19,985 19,985 19,803
Stock in Savings Bank Life Insurance Company 1,194 1,194 1,194
------------- ------------- -------------
$ 461,129 $ 367,407 $ 416,021
============= ============= =============
Percent of total assets 33.5% 29.4% 34.7%
For further information regarding the Company's investment portfolio, including
information regarding amortized cost and fair value as of December 31, 1999, see
notes 1, 4 and 21 to the Company's consolidated financial statements included in
response to Item 8 hereof.
23
Set forth below is a breakdown of yields and contractual maturities for the
amortized cost of indicated investment securities at December 31, 1999:
U.S. Other
government bonds Mortgage-
and agency and backed
obligations obligations securities Total
-------------- -------------- -------------- --------------
(Dollars in thousands)
Due in 1 year or less:
Amount $ 5,026 $ 422 $ 34,756 $ 40,204
Yield 4.67% 6.85% 6.11% 5.94%
Due from 1 to 2 years:
Amount 10,004 349 23,183 33,536
Yield 5.88% 7.29% 6.21% 6.12%
Due from 2 to 3 years:
Amount 5,032 -- 24,442 29,474
Yield 6.39% -- 6.21% 6.24%
Due from 3 to 5 years:
Amount 10,061 645 55,165 65,871
Yield 6.27% 5.15% 6.25% 6.24%
Due from 5 to 10 years:
Amount 86,941 6,729 115,531 209,201
Yield 6.63% 3.97% 6.32% 6.37%
Due after 10 years:
Amount 556 2,638 71,640 74,834
Yield 5.96% 4.32% 6.51% 6.43%
----------- ---------- ----------- -----------
Total:
Amount $ 117,620 $ 10,783 $ 324,717 $ 453,120
Yield 6.44% 4.35% 6.32% 6.30%
24
DEPOSITS
Deposits have historically been the Bank's primary source of funds for lending
and investment activities. Deposit flows vary significantly and are influenced
by prevailing interest rates, market conditions, economic conditions and
competition. At December 31, 1999 the Bank had total deposits of $1,002.8
million, representing a net increase of $68.1 million compared to $934.7 million
at December 31, 1998.
While deposit flows are unpredictable by nature, the Bank attempts to manage its
deposits through selective pricing. Due to the uncertainty of market conditions,
it is not possible for the Bank to predict how aggressively it will compete for
deposits in the future or the likely effect of any such decision on deposit
levels, interest expense and net interest income.
The following table sets forth the composition of average deposits and rates for
the years indicated:
1999 1998 1997
------------------------------- -------------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Amount Rate Amount Rate Amount Rate
------------- --------------- ------------- --------------- ------------- ------------
(Dollars in thousands)
NOW $ 51,910 0.87% $ 44,048 1.18% $ 40,806 1.29%
Money market accounts 94,593 3.16 66,263 3.32 73,571 2.31
Savings and notice accounts 240,141 3.27 196,343 3.58 123,204 3.36
Time deposits 473,237 5.16 450,104 5.69 422,978 5.88
------------- ------------- -------------
Total interest bearing deposits 859,881 4.15 756,758 4.67 660,559 4.73
------------- ------------- -------------
Demand deposits 93,679 77,467 62,220
------------- ------------- -------------
$ 953,560 $ 834,225 $ 722,779
============= ============= =============
At December 31, 1999, 1998 and 1997, outstanding certificates of deposits in
denominations of $100,000 and over had maturities as follows:
Remaining Term to Maturity 1999 1998 1997
- -------------------------- ---- ---- ----
(Dollars in thousands)
Three months or less $ 27,171 $ 13,220 $ 10,644
Three to six months 29,278 8,709 6,673
Six to twelve months 28,752 36,688 27,543
Over twelve months 33,481 12,494 16,926
------------ ------------ ------------
$ 118,682 $ 71,111 $ 61,786
============ ============ ============
25
BORROWED FUNDS
The primary source of the Bank's borrowings come from the Federal Home Loan Bank
("FHLB"). The Bank also utilizes short-term repurchase agreements, generally
with maturities less than three months, as an additional source of funds.
Repurchase agreements are secured by U.S. government and agency securities.
Borrowings are an alternative source of funds compared to deposits and totaled
$269.0 million at December 31, 1999 compared to $201.5 million and $343.6
million at December 31, 1998 and 1997, respectively. The increase in borrowings
in 1999 was used to fund the growth in the investment and loan portfolios during
the year. The decrease in borrowings in 1998 to 1997 reflects the years' growth
in deposits and the Company's diminished need to borrow funds to support its
assets.
The following table summarizes the maximum and average amounts of borrowings
outstanding, the majority of which are short-term, during 1999, 1998 and 1997
together with the weighted average interest rates thereon.
For the Year Ended December 31, 1999 At December 31, 1999
----------------------------------------------- -------------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Interest Rate
----------- ----------- ------------- ----------- -------------
(Dollars in thousands)
FHLB Borrowings $ 265,337 $ 234,843 5.67 % $ 238,677 5.82 %
Repurchase Agreements 32,114 28,381 4.06 30,285 4.35
For the Year Ended December 31, 1998 At December 31, 1998
----------------------------------------------- -------------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Interest Rate
----------- ----------- ------------- ----------- -------------
(Dollars in thousands)
FHLB Borrowings $ 411,605 $ 261,662 6.07 % $ 161,582 5.93 %
Repurchase Agreements 49,495 27,567 4.65 39,917 4.04
For the Year Ended December 31, 1997 At December 31, 1997
----------------------------------------------- -------------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Interest Rate
----------- ----------- ------------- ----------- -------------
(Dollars in thousands)
FHLB Borrowings $ 394,184 $ 342,975 5.94 % $ 319,744 5.98 %
Repurchase Agreements 27,708 16,415 4.75 23,813 4.90
26
YEAR 2000
The following constitutes the Company's Year 2000 Readiness disclosure under the
Year 2000 Information and Readiness Disclosure Act. The potential problem with
the Year 2000 concerned the inability of information systems, primarily software
programs, to properly recognize and process date sensitive information for the
year 2000 and beyond.
The Company took numerous remedial steps over the past several years to prepare
for the change of century. These steps included: forming a bank-wide project
team to address and resolve Y2K issues; and forming a Year 2000 Compliance
Oversight Committee of the Board of Directors to oversee the activities of
management and others in dealing with Y2K issues; replacing or upgrading
non-compliant hardware and software; working with third party service bureaus
and other vendors to ensure that the Company's mission critical information
systems were Y2K compliant; and establishing contingency plans in the event that
an unforeseen problem were to arise.
Subsequent to December 31, 1999, the Company has not experienced any material
Year 2000 transition issues. However there can be no assurance that a material
vendor will not experience a Year 2000 transition issue, or that such transition
issue will not have a material negative impact on the Company's consolidated
financial position, results of operations or cash flows.
The following table details the aggregate expenditures (period and capital)
incurred to date by the Company, to bring the Y2K project to closure. Period
expenditures were expensed in the period incurred. Capital expenditures were
capitalized and amortized over the estimated useful life of the item. All
capital expenditures reflect hardware and software upgrades that were either
previously planned or would have occurred in the normal course, and not as a
direct result of Y2K remediation efforts.
----------------------- ------------------
DESCRIPTION TOTAL
EXPENDITURES
----------------------- ------------------
PERIOD EXPENDITURES: ($000'S)
Management and staff $300
salaries and Board
fees
----------------------- ------------------
Y2K consulting fees $140
----------------------- ------------------
Third party vendor $ 60
expense and system
testing
----------------------- ------------------
CAPITAL EXPENDITURES:
Replacement of $600
non-compliant systems
----------------------- ------------------
27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET/LIABILITY MANAGEMENT
The Bank's asset/liability management strategy is designed to increase net
interest income and provide adequate earnings in expected future interest rate
environments. As part of this strategy, a balance is sought between the
repricing characteristics of its earning assets and funding sources while
maximizing the spread between interest income and expense. The Bank adjusts the
level of its liquid assets and the mix of its loans and investments based on
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
In order to achieve a better repricing balance between its assets and
liabilities, the Bank continued to originate and hold in portfolio adjustable
rate residential mortgage loans. The Bank generally writes substantially all
newly originated fixed rate residential loans to meet the requirements for sale
in the secondary market. During 1999, the Bank sold $62.6 million of residential
loans. As a result of this strategy residential loans decreased by $46.0 million
during the year.
The Bank's commercial real estate, construction, consumer and commercial
business lending programs also provide opportunities to better match the
interest rate sensitivity of its loan portfolio and liabilities due to the
adjustable rate or short term characteristics of these types of loans. These
types of loans increased by $124.4 million during the year. Total loans
increased by $78.4 million during the year.
During 1999, investments increased by $88.2 million. This was a result of
management's planned strategy to grow the investment portfolio. These
investments were funded by the increase in deposits and Federal Home Loan Bank
borrowings. Total Federal Home Loan Bank borrowings increased by $77.1 million
during the year.
Deposits increased by $68.1 million in 1999. The Bank maintains an aggressive
marketing campaign for savings and time deposit products, which resulted in a
significant increase in the balances of these products during 1999.
It is management's opinion that interest rates will continue to exhibit
volatility. With this in mind, the Bank will continue to follow a strategy that
seeks to achieve a balance in the repricing characteristics of its assets and
liabilities and provide adequate earnings in a variety of interest rate
environments.
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices such as interest rates, foreign currency exchange
rates, commodity prices and equity prices. The Company's primary market risk
exposure is interest rate risk. The ongoing monitoring and management of this
risk is an important component of the Company's asset/liability management
process which is governed by policies established by its Board of Directors that
are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee ("ALCO"). In this capacity ALCO develops guidelines
and strategies impacting the Company's asset/liability management related
activities based upon estimated market risk sensitivity, policy limits and
overall market interest rate levels/trends.
28
INTEREST RATE RISK
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change the interest income and expense streams
associated with the Company's financial instruments also change thereby
impacting net interest income (NII), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling two-year
horizon, it also utilizes additional tools to monitor potential longer-term
interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all assets and
liabilities reflected on the Company's balance sheet. This sensitivity
analysis is compared to ALCO policy limits which specify a maximum tolerance
level for NII exposure over a one year horizon, assuming no balance sheet
growth, given both a 200 basis point (bp) upward and downward shift in
interest rates. A parallel and pro rata shift in rates over a 12-month period
is assumed. The following reflects the Company's NII sensitivity analysis as
of December 31, 1999.
---------------------------- --------------------------
RATE CHANGE ESTIMATED NII SENSITIVITY
---------------------------- --------------------------
+ 200 bp (4.49%)
- 200 bp 3.99%
---------------------------- --------------------------
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cashflows,
and others. While assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis,
actual results will also differ due to: prepayment/refinancing levels likely
deviating from those assumed, the varying impact of interest rate change caps or
floors on adjustable rate assets, the potential effect of changing debt service
levels on customers with adjustable rate loans, depositor early withdrawals and
product preference changes, and other internal/external variables. Furthermore,
the sensitivity analysis does not reflect actions that ALCO might take in
responding to or anticipating changes in interest rates.
29
The following table sets forth the maturity and repricing information relating
to interest sensitive assets and liabilities at December 31, 1999. Fixed-rate
investment securities, fixed rate mortgage-backed investments, fixed rate loans,
loans held for sale, short-term investments, and other earning assets are shown
in the table in the time period corresponding to computed principal amortization
based on their respective contractual maturity. Adjustable rate investment
securities, adjustable rate mortgage-backed investments, and adjustable rate
loans are allocated to the period in which the rates are next adjusted. The
table reflects an "expected" prepayment assumption on residential loans and
mortgage-backed investments. Certificates of deposit and borrowed funds are
shown in the table in the time period based on their respective contractual
maturity. Money market deposit accounts and anniversary savings accounts are not
subject to contractual interest rate adjustments, however, these products are
generally more interest rate sensitive and are assumed to reprice within the
1-180 day time period. Regular savings and NOW accounts ("other deposits") are
assumed to reprice within the 5 years + period. These deposit products are not
subject to contractual interest rate adjustments either, however, the Bank
believes that these deposits are less interest rate sensitive over long periods
of time.
December 31, 1999
---------------------------------------------------------------------------------------------
1-180 181-365 1-3 3-5 5+
Days Days Years Years Years Total
------------- ------------ ------------- ------------- ------------ ------------
(Dollars in thousands)
Interest-earning assets:
Short-term investments $ 5,909 $ -- $ -- $ -- $ -- $ 5,909
Investment securities 16,684 5,407 15,323 15,637 92,166 145,217
Mortgage-backed securities 35,939 31,038 37,958 45,029 160,039 310,003
Loans held for sale 3,054 -- -- -- -- 3,054
Loans in process -- -- -- -- -- --
Fixed rate loans 42,707 38,225 144,679 101,182 137,010 463,803
Adjustable rate loans 173,720 55,941 51,144 43,999 9,284 334,088
Other earning assets -- -- -- -- 17,491 17,491
---------- ---------- ---------- ---------- ---------- ----------
Total rate sensitive assets 278,013 130,611 249,104 205,847 415,990 1,279,565
---------- ---------- ---------- ---------- ---------- ----------
Interest-bearing liabilities:
Money market deposit accounts 95,680 -- -- -- -- 95,680
Certificates of deposit 220,642 130,989 135,188 4,189 639 491,647
Other deposits 182,232 -- -- -- 136,347 318,579
Borrowed funds 240,785 1,872 23,185 -- 3,120 268,962
---------- ---------- ---------- ---------- ---------- ----------
Total rate sensitive liabilities 739,339 132,861 158,373 4,189 140,106 1,174,868
---------- ---------- ---------- ---------- ---------- ----------
Excess (deficiency) of
interest sensitive assets
over interest sensitive
liabilities $ (461,326) $ (2,250) $ 90,731 $ 201,658 $ 275,884 $ 104,697
========== ========== ========== ========== ========== ==========
Cumulative excess
(deficiency) of interest
sensitive assets over
interest sensitive
liabilities $ (461,326) $ (463,576) $ (372,845) $ (171,187) $ 104,697
========== ========== ========== ========== ==========
Cumulative excess
(deficiency)
percentage of
total assets (33.49)% (33.66)% (27.07)% (12.43)% 7.60%
30
The following table reflects the scheduled maturities of selected loans at
December 31, 1999:
One
One Through Over
Year Five Five
or Less Years Years Total
------------ ------------- -------------- -------------
(Dollars in thousands)
Construction loans $ 25,146 $ 15,150 $ 11,057 $ 51,353
Owner-occupied commercial real estate 4,220 17,075 42,072 63,367
Commercial loans 21,110 59,580 18,011 98,701
------------ ------------- -------------- -------------
Total $ 50,476 $ 91,805 $ 71,140 $ 213,421
============ ============= ============== =============
A summary of the above categories of loans due after one year as to the rate
variability follows (dollars in thousands):