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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Fiscal Year Ended December 31, 1998
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File Number: 1-14671
WORONOCO BANCORP, INC.
- --------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Delaware 04-3444269
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
31 Court Street, Westfield, Massachusetts 01085
- --------------------------------------------- -------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (413) 568-9141
-------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, par value $0.01 per share The American Stock Exchange
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
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 |_|
YES |_| NO |X|
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 the 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. |X|
The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of March 24, 1999 was $57,053,833.
As of March 24, 1999, there were 5,998,860 shares of the Registrant's
Common Stock outstanding.
INDEX
PART I
Page No.
--------
Item 1. Business............................................... 1
Item 2. Properties............................................. 33
Item 3. Legal Proceedings...................................... 34
Item 4. Submission of Matters to a Vote of Security Holders.... 34
PART II
Item 5. Market for the Company's Common Equity
and Related Stockholder Matters........................ 34
Item 6. Selected Financial Data................................ 35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 37
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk................................................... 48
Item 8. Financial Statements and Supplementary Data............ 53
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure.................... 54
PART III
Item 10. Directors and Executive Officers of the Registrant..... 54
Item 11. Executive Compensation................................. 56
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................. 59
Item 13. Certain Relationships and Related Transactions......... 60
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K............................................... 61
SIGNATURES.............................................................. 63
PART I
Item 1. Business.
Woronoco Bancorp, Inc. (the "Company") was incorporated in October 1998
under Delaware law. On March 19, 1999, the Company acquired Woronoco Savings
Bank (the "Bank") as part of the Bank's conversion from a
Massachusetts-chartered mutual to stock savings bank (the "Conversion"). The
Company is currently a savings and loan holding company regulated by the Office
of Thrift Supervision ("OTS"). In connection with the Conversion, the Company
issued an aggregate of 5,998,860 shares of its common stock, par value $0.01 per
share ("Common Stock") at a purchase price of $10 per share, of which 5,554,500
shares were issued in a subscription offering and 444,360 shares were issued to
Woronoco Savings Charitable Foundation, a charitable foundation established by
the Bank.
The Bank is a community-oriented Massachusetts savings bank which was
organized in 1871. The Bank's principal business consists of the acceptance of
retail deposits from the general public in the areas surrounding its 12 banking
offices and the investment of those deposits, together with funds generated from
operations and borrowings, primarily in mortgage loans secured by real property
which contain one to four residences ("one- to four-family residences") and
consumer loans, primarily home equity loans and lines of credit. The Bank, to a
lesser extent, also invests those funds in multi-family and commercial real
estate loans, construction and development loans, commercial business loans and
other types of consumer loans, primarily automobile and personal loans. The Bank
originates loans primarily for investment. However, the Bank will sell some
loans in the secondary market, while generally retaining the servicing rights.
The Bank also invests in mortgage-backed securities, equity securities and other
permissible investments. The Bank's revenues are derived principally from the
generation of interest and fees on loans originated and, to a lesser extent,
interest and dividends on investment securities. The Bank's primary sources of
funds are deposits, principal and interest payments on loans and investment
securities and advances from the Federal Home Loan Bank (the "FHLB").
Market Area
The Bank is headquartered in Westfield, Massachusetts. The Bank's primary
deposit gathering area is concentrated in the communities surrounding its main
office located in Westfield and its eleven other banking offices located in the
communities of Southwick, Feeding Hills, South Hadley, Springfield, Westfield,
West Springfield and Amherst, Massachusetts. The Bank's primary lending area is
significantly broader than its deposit gathering area and includes all of
Hampden and Hampshire Counties in western Massachusetts and parts of northern
Connecticut.
The city of Westfield is largely suburban and is located in the Pioneer
Valley near the intersection of U.S. Interstates 90 (the Massachusetts Turnpike)
and 91. Interstate 90 is the major east-west highway that transverses
Massachusetts. Interstate 91 is the major north-south highway that runs directly
through the heart of New England. Westfield is located approximately 90 miles
west of Boston, Massachusetts, 70 miles southeast of Albany, New York and 30
miles north of Hartford, Connecticut. Westfield's estimated 1996 population was
approximately 38,194 and the estimated 1996 population for Hampden and Hampshire
Counties was 441,280 and 150,373, respectively. The economy in the Bank's
primary market area has benefitted from the presence of large employers such as
the University of Massachusetts, Baystate Medical Center, MassMutual Life
Insurance Company, Big Y Foods, Inc., Friendly Ice Cream Corporation, Old Colony
Envelope, Hamilton Standard, Pratt and Whitney and Strathmore Paper Company.
Other employment and economic activity is provided by financial institutions,
eight other colleges and universities, seven other hospitals and a variety of
wholesale and retail trade businesses.
Competition
The Bank faces significant competition both in generating loans and in
attracting deposits. The Bank's primary market area is highly competitive and
the Bank faces direct competition from a significant number of financial
institutions, many with a local, state-wide or regional presence and, in some
cases, a national presence. Many of these financial institutions are
significantly larger and have greater financial resources than the Bank. The
Bank's competition for loans comes principally from commercial banks, other
savings banks, co-operative banks, mortgage brokers,
1
mortgage banking companies and insurance companies. Its most direct competition
for deposits has historically come from savings, co-operative and commercial
banks. In addition, the Bank faces significant competition for deposits from
non-bank institutions such as brokerage firms and insurance companies in such
instruments as short-term money market funds, corporate and government
securities funds, mutual funds and annuities. Competition may also increase as a
result of the lifting of restrictions on the interstate operations of financial
institutions. The Bank has also experienced significant competition from credit
unions which have a competitive advantage as they do not pay state or federal
income taxes. Such competitive advantage has placed increased pressure on the
Bank with respect to its loan and deposit pricing.
Lending Activities
Loan Portfolio Composition. The types of loans that the Bank may originate
are limited by federal and state laws and regulations. Interest rates charged by
the Bank on loans are affected principally by the Bank's current asset/liability
strategy, the demand for such loans, the supply of money available for lending
purposes and the rates offered by its competitors. These factors are, in turn,
affected by general and economic conditions, monetary policies of the federal
government, including the Federal Reserve Board ("FRB"), legislative tax
policies and governmental budgetary matters.
At December, 31, 1998, the Bank's total loan portfolio was $287.0 million,
of which $157.7 million were one- to four-family residential mortgage loans, or
55.0% of total loans. At such date, the remainder of the loan portfolio
consisted of $23.0 million of multi-family loans, or 8.0% of total loans; $20.6
million of commercial real estate loans, or 7.2% of total loans; $3.5 million of
construction and development loans, or 1.2% of total loans; $77.6 million of
consumer loans, or 27.0% of total loans consisting primarily of $64.7 million of
home equity loans and lines of credit, or 83.4% of consumer loans; and $4.6
million of commercial loans, or 1.6% of total loans. Primarily all loans in the
Bank's portfolio, with the exception of home equity loans and lines of credit,
are located in the Bank's primary market area.
2
The following table sets forth the composition of the Bank's loan
portfolio in dollar amounts and as a percentage of the respective portfolio at
the dates indicated.
At December 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Real estate loans:
One- to four-family............ $157,698 54.95% $139,811 52.84% $138,289 58.39% $127,811 62.73% $140,614 74.11%
Multi-family................... 22,962 8.00 19,047 7.20 17,826 7.53 11,843 5.81 8,823 4.65
Commercial..................... 20,595 7.18 21,757 8.22 19,697 8.32 3,032 1.49 16,500 8.70
Construction and development... 3,464 1.21 2,868 1.08 1,124 0.47 18,580 9.12 1,037 0.55
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans...... 204,719 71.34 183,483 69.34 176,936 74.71 161,266 79.15 166,974 88.01
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer loans:
Home equity loans and lines of
credit....................... 64,705 22.55 62,227 23.52 43,662 18.43 29,305 14.39 13,404 7.06
Automobile..................... 9,460 3.30 10,287 3.89 7,969 3.36 5,507 2.70 2,701 1.42
Other.......................... 3,454 1.20 4,291 1.62 4,397 1.86 4,286 2.10 3,868 2.04
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans.......... 77,619 27.05 76,805 29.03 56,028 23.65 39,098 19.19 19,973 10.52
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial loans................. 4,613 1.61 4,319 1.63 3,879 1.64 3,382 1.66 2,795 1.47
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans................... 286,951 100.00% 264,607 100.00% 236,843 100.00% 203,746 100.00% 189,742 100.00%
====== ====== ====== ====== ======== ======
Less:
Unadvanced loan funds(1)....... (1,453) (1,866) (1,395) (2,089) (1,212)
Net deferred loan origination
costs (fees)................. 711 934 598 370 (92)
Allowance for loan losses...... (2,166) (1,952) (1,911) (1,838) (1,657)
-------- -------- -------- --------
Loans, net................... $284,043 $261,723 $234,135 $200,189 $186,781
======== ======== ======== ======== ========
- ----------
(1) Includes committed but unadvanced loan amounts.
3
Origination, Sale and Servicing of Loans. The Bank's mortgage lending
activities are conducted primarily by its salaried loan representatives
operating at its eleven full service banking offices. All loans originated by
the Bank are underwritten by the Bank under the Bank's policies and procedures.
The Bank originates both adjustable-rate and fixed-rate mortgage loans. The
Bank's ability to originate fixed- or adjustable-rate loans is dependent upon
the relative customer demand for such loans, which is affected by the current
and expected future level of interest rates. Consistent with its current
business strategy, the Bank plans to hire at least two commissioned loan
officers in the future with the primary responsibility of originating one- to
four-family mortgage loans for the Bank.
The Bank is primarily a portfolio lender, originating substantially all of
its loans for investment. Recently, however, the Bank completed the
securitization of $19.1 million of 30-year fixed-rate one- to four-family
mortgage loans with Fannie Mae. Such loans are serviced as mortgage-backed
securities for Fannie Mae. The Bank may continue to securitize a portion of its
loans, mostly 30-year fixed-rate one- to four-family mortgage loans, in the
future. Any loans originated for sale by the Bank conform to the underwriting
standards specified by Fannie Mae and Freddie Mac. The Bank generally retains
the servicing rights on any mortgage loans which it sells or securitizes.
At December 31, 1998, the Bank was servicing $41.4 million of loans for
others, consisting of conforming fixed-rate mortgage loans sold by the Bank.
Loan servicing includes collecting and remitting loan payments, accounting for
principal and interest, contacting delinquent mortgagors, supervising
foreclosures and property dispositions when there are unremedied defaults,
making insurance and tax payments on behalf of the borrowers and generally
administering the loans. Substantially all of the loans currently being serviced
for others are loans which have been sold or securitized by the Bank. The gross
servicing fee income from loans sold is generally 25 basis points of the total
balance of the loan being serviced.
During the years ended December 31, 1998, December 31, 1997 and December
31, 1996, the Bank originated $53.3 million, $9.9 million and $15.6 million of
fixed-rate one- to four-family loans, respectively, of which $45.9 million, $5.1
million and $9.8 million, respectively, were retained by the Bank. During these
same periods, the Bank also originated $5.6 million, $8.6 million and $12.4
million of adjustable-rate one- to four-family loans, respectively, all of which
were retained by the Bank. The Bank recognizes, at the time of sale, the cash
gain or loss on the sale of loans based on the difference between the net cash
proceeds received and the carrying value of the loans sold. The Bank has, from
time-to-time, participated in loans, primarily multi-family and commercial real
estate loans and commercial business loans and, at December 31, 1998, had $3.8
million in loan participation interests.
4
The following table sets forth the Bank's loan originations, sales and
principal repayments for the periods indicated.
For the Year Ended December 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands)
Loans, net, beginning of period .................. $ 261,723 $ 234,135 $ 200,189
--------- --------- ---------
Loans originated:
Real estate .................................. 67,216 25,233 39,467
Consumer:
Home equity loans and lines of credit ...... 23,286 40,976 35,352
Automobile ................................. 4,774 6,829 5,651
Other ...................................... 3,196 2,980 3,325
--------- --------- ---------
Total consumer ........................... 31,256 50,785 44,328
--------- --------- ---------
Commercial ................................... 4,717 3,131 3,853
--------- --------- ---------
Total loans originated ................... 103,189 79,149 87,648
--------- --------- ---------
Principal repayments, unadvanced funds and
other, net ................................... (61,681) (51,141) (52,256)
Sale/securitization of mortgage loans,
principal balance ............................ (19,068) -- (815)
Net loan charge-offs ........................... (26) (139) (107)
Transfers to REO ............................... (94) (281) (524)
--------- --------- ---------
Total deductions ........................... (80,869) (51,561) (53,702)
--------- --------- ---------
Net loan activity ................................ 22,320 27,588 33,946
--------- --------- ---------
Loans, net, end of period .................. $ 284,043 $ 261,723 $ 234,135
========= ========= =========
5
Loan Maturity. The following table shows the remaining contractual
maturity of the Bank's loan portfolio at December 31, 1998. The table does not
include prepayments or scheduled principal amortization. Prepayments and
scheduled principal amortization on loans totalled $83.0 million, $52.7 million
and $51.0 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
At December 31, 1998
---------------------------------------------------------------------------------------------------------
One- to Construction Home Equity Total
Four- Multi- Commercial and Loans and Other Loans
Family Family Real Estate Development Lines of Credit Automobile Consumer Commercial Receivable
------- ------ ----------- ----------- --------------- ---------- -------- ---------- ----------
(In thousands)
Amounts due:
One year or less ....... $ 607 $ -- $ 804 $1,279 $ -- $ 337 $ 476 $ 399 $ 3,902
After one year:
More than one year to
three years ........ 841 -- 1,104 660 31 5,083 1,982 1,886 11,587
More than three years
to five years....... 2,198 -- 378 1,525 3,631 4,040 108 856 12,736
More than five years
to 10 years ........ 31,068 3,736 1,686 -- 5,178 -- 107 1,142 42,917
More than 10 years to
15 years ........... 41,198 3,769 6,353 -- 2,653 -- 52 44 54,069
More than 15 years ... 81,786 15,457 10,270 -- 53,212 -- 729 286 161,740
-------- ------- ------- ------ ------- ------ ------ ------ --------
Total amount due ... $157,698 $22,962 $20,595 $3,464 $64,705 $9,460 $3,454 $4,613 286,951
======== ======= ======= ====== ======= ====== ====== ======
Less:
Unadvanced loan funds ................................................................................................ (1,453)
Net deferred loan
origination costs .................................................................................................. (2,166)
Allowance for loan
losses ............................................................................................................. 711
--------
Loans, net ............................................................................................................. $284,043
========
6
The following table sets forth at December 31, 1998, the dollar amount of
gross loans receivable contractually due after December 31, 1999, and whether
such loans have fixed interest rates or adjustable interest rates.
Due After December 31, 1999
----------------------------
Fixed Adjustable Total
-------- ---------- --------
(In thousands)
Real estate loans:
One- to four-family ............................ $103,114 $ 53,977 $157,091
Multi-family and commercial real estate ........ 2,594 40,159 42,753
Construction and development ................... -- 2,185 2,185
-------- -------- --------
Total real estate loans ..................... 105,708 96,321 202,029
-------- -------- --------
Consumer loans:
Home equity loans and lines of credit .......... 55,487 9,218 64,705
Automobile loans ............................... 9,123 -- 9,123
Other .......................................... 2,870 108 2,978
Commercial loans ................................. 1,807 2,407 4,214
-------- -------- --------
Total loans ................................. $174,995 $108,054 $283,049
======== ======== ========
One- to Four-Family Lending. The Bank currently offers both fixed-rate and
adjustable-rate mortgage ("ARM") loans with maturities of up to 30 years secured
by one- to four-family residences substantially all of which are located in the
Bank's primary market area. One- to four-family mortgage loan originations are
generally obtained from the Bank's in-house loan representatives from existing
or past customers, through advertising, and through referrals from local
builders, real estate brokers and attorneys. At December 31, 1998, the Bank's
one- to four-family mortgage loans totalled $157.7 million, or 55.0% of total
loans. Of the one- to four-family mortgage loans outstanding at that date, 65.4%
were fixed-rate mortgage loans and 34.6% were ARM loans.
The Bank currently offers fixed-rate mortgage loans with terms of up to 30
years. The Bank also currently offers a number of ARM loans with terms of up to
30 years and interest rates which adjust every one or three years from the
outset of the loan or which adjust annually after a five year initial fixed
period. The interest rates for the Bank's ARM loans are indexed to either the
one, three or five year Constant Maturity Treasury ("CMT") Index. The Bank
originates ARM loans with initially discounted rates. The Bank's ARM loans
generally provide for periodic (not more than 2%) and overall (not more than 6%)
caps on the increase or decrease in the interest rate at any adjustment date and
over the life of the loan. The Bank retains for its portfolio substantially all
loans originated, selling or securitizing, from time to time, 30-year fixed-rate
mortgage loans. Loans that are sold are generally sold to Freddie Mac and Fannie
Mae. The Bank generally retains the servicing on all loans sold.
The origination of adjustable-rate residential mortgage loans, as opposed
to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to
increases in interest rates. However, adjustable-rate loans generally pose
credit risks not inherent in fixed-rate loans, primarily because as interest
rates rise, the underlying payments of the borrower also rise, thereby
increasing the potential for default. The Bank attempts to minimize such risk by
assuming a 200 basis point increase in the loan's interest rate when evaluating
a borrower's creditworthiness based on the assumed higher payment. Periodic and
lifetime caps on interest rate increases also help to reduce the risks
associated with adjustable-rate loans but also limit the interest rate
sensitivity of such loans.
All one- to four-family mortgage loans are underwritten according to the
Bank's policies and secondary market underwriting guidelines. Generally, the
Bank originates one- to four-family residential mortgage loans in amounts up to
80% of the lower of the appraised value or the selling price of the property
securing the loan and up to 95% of the lesser of the appraised value or selling
price if private mortgage insurance ("PMI") is obtained. Mortgage loans
originated by the Bank generally include due-on-sale clauses which provide the
Bank with the contractual right to
7
redeem the loan immediately due and payable if a borrower transfers ownership of
the property without the Bank's consent. Due-on-sale clauses are an important
means of adjusting the yields on the Bank's fixed-rate mortgage loan portfolio
and the Bank has generally exercised its rights under these clauses. The Bank
requires fire, casualty, title and flood insurance, if applicable, on all
properties securing real estate loans made by the Bank.
In an effort to provide financing for first-time home buyers, the Bank
offers its own first-time home buyer loan program. This program offers one-and
two-family residential mortgage loans to qualified low-to-moderate income
individuals. These loans are offered with initial five year fixed-rates of
interest which adjust annually thereafter with terms of up to 30 years. The
program includes initially discounted rates and periodic (not more than 1%) and
overall (not more than 4%) caps on the increase or decrease in the interest rate
at any adjustment date and over the life of the loan. With this program,
borrowers receive reduced loan origination fees and closing costs. Such loans
must be secured by an owner-occupied residence. These loans are originated using
similar underwriting guidelines as are the Bank's other one- to four-family
mortgage loans. Such loans are originated in amounts of up to 95% of the lower
of the property's appraised value or the sale price. Private mortgage insurance
is required for loans with loan-to-value ("LTV") ratios of over 80%.
Home Equity Loans and Lines of Credit. The Bank offers home equity
revolving lines of credit, substantially all of which are secured by second
mortgages on owner-occupied one- to four-family residences located in the Bank's
primary market area and, to a lesser extent, by properties in northern
Connecticut and in Franklin County, Massachusetts. The lines of credit
maintained outside of the Bank's primary market were generated through the
services of a third party telemarketing firm and later approved by the Bank.
Such third party currently does very little solicitation on behalf of the Bank.
At December 31, 1998, home equity loans and lines of credit totalled $64.7
million, or 22.6% of the Bank's total loans and 83.4% of consumer loans. Home
equity lines of credit have adjustable-rates of interest which adjust on a
monthly basis. The adjustable-rate of interest charged on such loans is indexed
to the prime rate as reported in The Wall Street Journal. Home equity lines of
credit generally have an 18% lifetime limit on interest rates. Generally, the
maximum LTV ratio on home equity lines of credit is 75% of the assessed value of
the property less the outstanding balance of the first mortgage up to a maximum
of $100,000. The underwriting standards employed by the Bank for home equity
lines of credit include a determination of the applicant's credit history and an
assessment of the applicant's ability to meet existing obligations and payments
on the proposed loan and the value of the collateral securing the loan. The
stability of the applicant's monthly income may be determined by verification of
gross monthly income from primary employment and, additionally, from any
verifiable secondary income.
The home equity line of credit may be drawn down by the borrower for a
period of ten years from the date of the loan agreement (the "draw period").
During the draw period, the borrower has the option of paying, on a monthly
basis, either principal and interest or only the interest. Following the draw
period, the borrower has fifteen years in which to pay back the line of credit
(the "repayment period"). A borrower is precluded from accessing the home equity
line of credit during the repayment period unless terms are renegotiated with
the Bank. At any time during the draw period, all, or a portion of the
outstanding balance of a home equity line of credit, may be converted into a
fixed-rate, home equity loan with terms of five, ten or 15 years.
Multi-Family and Commercial Real Estate Lending. The Bank originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small office buildings, industrial facilities or retail facilities primarily
located in the Bank's primary market area. The Bank's multi-family and
commercial real estate underwriting policies provide that such real estate loans
may be made in amounts of up to 80% of the appraised value of the property, 75%
if the property is being refinanced, provided such loan complies with the Bank's
current loans-to-one-borrower limit, which at December 31, 1998 was $4.0
million. The Bank's multi-family and commercial real estate loans may be made
with terms of up to 25 years and are offered with interest rates that adjust
periodically and are generally indexed to the prime rate as reported in The Wall
Street Journal. In reaching its decision on whether to make a multi-family or
commercial real estate loan, the Bank considers the net operating income of the
property, the borrower's expertise, credit history and profitability and the
value of the underlying property. In addition, with respect to commercial real
estate rental properties, the Bank will also consider the term of the lease and
the quality of the tenants. The Bank has generally required that the properties
securing these
8
real estate loans have debt service coverage ratios (the ratio of earnings
before debt service to debt service) of at least 1.15x. Environmental impact
surveys are generally required for commercial real estate loans. Generally, all
multi-family and commercial real estate loans made to corporations, partnerships
and other business entities require personal guarantees by the principals. The
Bank's multi-family real estate loan portfolio at December 31, 1998 was $23.0
million, or 8.0% of total loans, and the Bank's commercial real estate loan
portfolio at such date was $20.6 million, or 7.2% of total loans. The largest
multi-family or commercial real estate loan in the Bank's portfolio at December
31, 1998 was a $3.1 million multi-family real estate loan secured by a 126-unit
apartment building located in West Springfield, Massachusetts.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on successful operation or management of the properties, repayment of
such loans may be affected by adverse conditions in the real estate market or
the economy. The Bank seeks to minimize these risks through its underwriting
standards.
Construction and Development Lending. The Bank originates construction and
development loans primarily to finance the construction of one- to four-family,
owner-occupied residential real estate and commercial real estate properties
located in the Bank's primary market area. Commercial real estate construction
loans typically convert into permanent financing. Construction and development
loans are generally offered to customers and experienced builders with whom the
Bank has an established relationship. Construction and development loans are
typically offered with terms of up to 12 months; however, terms may be extended
up to four years under certain circumstances. The maximum loan-to-value limit
applicable to such loans is 80% for contract sales and 75% for speculative
properties. Construction loan proceeds are disbursed periodically in increments
as construction progresses and as inspections by the Bank's lending officers or,
on larger projects, independent architects or engineering firms, warrant. At
December 31, 1998, the Bank's largest construction and development loan was a
performing revolving line of credit for $1.4 million secured by a condominium
development project in Easthampton, Massachusetts. At December 31, 1998,
construction and development loans totalled $3.5 million, or 1.2%, of the Bank's
total loans.
The Bank originates land loans to local contractors and developers for the
purpose of making improvements thereon, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 60% of the lower of the acquisition price or the appraised value
of the land and have a term of up to three years with a floating interest rate
based on the prime rate as reported in The Wall Street Journal. The Bank's land
loans are generally secured by property in its primary market area. The Bank
requires title insurance and, if applicable, a hazardous waste survey reporting
that the land is free of hazardous or toxic waste.
Construction and development financing is generally considered to involve
a higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction compared to the estimated cost (including interest)
of construction and other assumptions, including the estimated time to sell
residential properties. If the estimate of value proves to be inaccurate, the
Bank may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Automobile and Other Consumer Lending. The Bank offers automobile loans
with term of up to 60 months and loan-to-value ratios of 80% for new cars. For
used cars, the maximum loan-to-value ratio is 75% of the lesser of the retail
value shown in the NADA Used Car Guide or the purchase price, and the terms for
used automobile loans range between 48 months (for automobiles up to four years
old) to 36 months (for older vehicles). The interest rates offered are the same
for new and used automobile loans. At December 31, 1998, automobile loans
totalled $9.5 million, or 3.3% of the Bank's total loans and 12.2% of consumer
loans. Other consumer loans at December 31, 1998 amounted to $3.5 million, or
1.2% of the Bank's total loans and 4.4% of consumer loans. These loans include
education, second mortgages, collateral, motorcycle, boat, mobile home and
unsecured personal loans. Motorcycle, boat and mobile home loans are generally
made in amounts of up to 80% of the fair market value of the property securing
the loan. Collateral
9
loans are generally secured by a passbook account, a certificate of deposit,
securities or life insurance. Unsecured personal loans generally have a maximum
borrowing limitation of $5,000 and a maximum term of three years.
Loans secured by rapidly depreciable assets such as automobiles,
motorcycles and boats or that are unsecured entail greater risks than one- to
four-family mortgage loans. In such cases, repossessed collateral for a
defaulted loan may not provide an adequate source of repayment of the
outstanding loan balance, since there is a greater likelihood of damage, loss or
depreciation of the underlying collateral. Further, collections on these loans
are dependent on the borrower's continuing financial stability and, therefore,
are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Finally, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans if a borrower defaults.
Commercial Lending. At December 31, 1998, the Bank had $4.6 million in
commercial loans which amounted to 1.6% of total loans. In addition, at such
date, the Bank had $1.2 million of unadvanced commercial lines of credit. The
Bank makes commercial business loans primarily in its market area to a variety
of professionals, sole proprietorships and small businesses. The Bank offers a
variety of commercial lending products, including term loans for fixed assets
and working capital, revolving lines of credit, letters of credit, and Small
Business Administration guaranteed loans. The maximum amount of a commercial
business loan is limited by the Bank's loans-to-one-borrower limit which at
December 31, 1998, was $4.0 million. Term loans are generally offered with
initial fixed rates of interest for the first five years and with terms of up to
7 years. Business lines of credit have adjustable rates of interest and are
payable on demand, subject to annual review and renewal. Business loans with
variable rates of interest adjust on a monthly basis and are indexed to the
prime rate as published in The Wall Street Journal.
In making commercial business loans, the Bank considers the financial
statements of the borrower, the Bank's lending history with the borrower, the
debt service capabilities of the borrower, the projected cash flows of the
business and the value of the collateral. Commercial business loans are
generally secured by a variety of collateral, primarily equipment, assets and
accounts receivable, and are supported by personal guarantees. Depending on the
collateral used to secure the loans, commercial loans are made in amounts of up
to 80% of the adjusted value of the collateral securing the loan. The Bank
generally does not make unsecured commercial loans. In addition, the Bank
participates in loans, often community-based, with area lenders with whom the
Bank has a relationship. When determining whether to participate in such loans,
the Bank will underwrite its participation interest according to its own
underwriting standards. At December 31, 1998, $148,000, or 3.2% of the
commercial loan portfolio, were participation loans of this nature. In an effort
to increase its emphasis on commercial loans, the Bank intends to hire an
experienced commercial loan officer with the primary responsibility of
increasing commercial business and real estate loan volume.
Unlike mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment or other income,
and which are secured by real property whose value tends to be more easily
ascertainable, commercial loans are of higher risk and typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
borrower's business. As a result, the availability of funds for the repayment of
commercial loans may be substantially dependent on the success of the business
itself. Further, any collateral securing such loans may depreciate over time,
may be difficult to appraise and may fluctuate in value. At December 31, 1998,
the Bank's largest commercial loan was a $200,000 revolving line of credit to a
retail business located in South Hadley, Massachusetts.
Loan Approval Procedures and Authority. The lending policies and loan
approval limits of the Bank are established by the Board of Investment and
ratified by the Board of Trustees. In connection with one- to four-family
mortgage loans, the Board of Investment has authorized the following persons to
approve the loans up to the amounts indicated: one assistant vice president and
the vice president of commercial lending may approve loans up to $150,000; the
other assistant vice president and all loan origination and underwriting
officers may approve loans up to $227,150; and the Chief Executive Officer and
the Senior Vice President, Lending may approve loans up to $250,000.
10
With respect to consumer loans, the Board of Investment has authorized the
following persons to approve loans up to the amounts indicated: assistant branch
managers and all but one branch supervisor may approve secured and unsecured
loans of up to $15,000 and $5,000, respectively; the remaining branch
supervisor, branch managers, loan originators and underwriting officers and the
vice president, operations may approve secured and unsecured loans of up to
$25,000 and $10,000, respectively; and the Chief Executive Officer and the
Senior Vice President, Lending may approve loans up to $75,000 and $50,000,
respectively.
The Board of Investment has authorized the following individuals to
approve home equity loans and lines of credit up to the amounts indicated: one
loan origination officer may approve such loans up to $25,000; lending vice
presidents, assistant vice presidents and loan origination and underwriting
officers may approve loans up to $100,000; and the Chief Executive Officer and
the Senior Vice President, Lending may approve loans up to $125,000.
All loans in excess of these amounts must be approved by either the Senior
Vice President, Lending, the Officers' Loan Committee and/or the Board of
Investment. The Officers' Loan Committee, which currently consists of three
lending officers, is selected by the Board of Investment and ratified by the
Board of Trustees. Specifically, all loans, commitments or other extensions of
credit, which either alone or in the aggregate total up to $350,000 may be
approved by the Senior Vice President, Lending. Those loan commitments or other
extensions of credit, either alone or in the aggregate, which are greater than
$350,000 but are less than $750,000 must be approved by the Officers' Loan
Committee and those loans commitments or other extensions of credit, either
alone or in the aggregate, which exceed $750,000 must be approved by the Board
of Investment. Additionally, those loans less than $750,000 must be ratified by
the Board of Investment. All loans, commitments and other extensions of credit
which increase the total aggregate unsecured liability of a borrower to $75,000
or more must be approved by the Officers' Loan Committee.
With respect to commercial loans, the Board of Investment has authorized
the following persons to approve loans up to the amounts indicated: the
Assistant Vice President, Loan Servicing and Collection may approve commercial
real estate loans, commercial secured and unsecured loans in amounts of up to
$125,000, $50,000 and $10,000, respectively; the vice president/commercial
lending officer may approve commercial real estate loans, commercial secured and
unsecured loans in amounts of up to $250,000, $200,000 and $100,000,
respectively; and the Chief Executive Officer and the Senior Vice President,
Lending may approve commercial real estate loans, commercial secured and
unsecured loans in amounts of up to $350,000, $250,000 and $125,000,
respectively.
All loans in excess of these amounts must be approved by either the
Officer's Loan Committee and/or the Board of Investment. The Officers' Loan
Committee, which currently consists of three lending officers, is selected by
the Board of Investment and ratified by the Board of Trustees. Specifically, all
loans, commitments or other extensions of credit, either alone or in the
aggregate which exceed $350,000 or $750,000 must be approved by the Officers'
Loan Committee and the Board of Investment, respectively. Additionally, all
loans, commitments and other extensions of credit which increase the total
aggregate unsecured liability of a borrower to $125,000 or more must be approved
by the Officers' Loan Committee.
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquent Loans. Reports listing all delinquent accounts are generated
and reviewed by management and the Board of Investment on a monthly basis and
the Board of Trustees performs a bi-monthly review of all loans or lending
relationships delinquent 90 days or more. The procedures taken by the Bank with
respect to delinquencies vary depending on the nature of the loan, period and
cause of delinquency and whether the borrower is habitually delinquent. When a
borrower fails to make a required payment on a loan, the Bank takes a number of
steps to have the borrower cure the delinquency and restore the loan to current
status. The Bank generally sends the borrower a written notice of non-payment
after the loan is 15 days past due. The Bank's guidelines provide that telephone
and written correspondence will be attempted to ascertain the reasons for
delinquency and the prospects of repayment. When contact is made with the
borrower at any time before foreclosure, the Bank will offer to work out a
repayment schedule with the borrower to avoid foreclosure. If payment is not
then received or the loan not otherwise satisfied, additional letters and
telephone calls generally are made. If the loan is still not brought current or
satisfied and it becomes
11
necessary for the Bank to take legal action, which typically occurs after a loan
is 90 days or more delinquent, the Bank will demand the loan and then commence
foreclosure proceedings against any real property that secured the loan or
accept a deed in lieu of foreclosure. If a foreclosure action is instituted and
the loan is not brought current, paid in full, or refinanced before the
foreclosure sale, the property securing the loan generally is sold at
foreclosure and, if purchased by the Bank, becomes real estate owned.
Classified Assets. Federal regulations and the Bank's internal policies
require that the Bank utilize an internal asset classification system as a means
of reporting problem and potential problem assets. The Bank currently classifies
problem and potential problem assets as "Substandard," "Doubtful" or "Loss"
assets. An asset is considered Substandard if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Substandard assets include those characterized by the distinct
possibility that the Bank will sustain some loss if the deficiencies are not
corrected. Assets classified as Doubtful have all of the weaknesses inherent in
those classified Substandard with the added characteristic that the weaknesses
present make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, highly questionable and improbable.
Assets classified as Loss are those considered uncollectible and of such little
value that their continuance as assets, without the establishment of a specific
loss reserve, is not warranted. Assets which do not currently expose the Bank to
a sufficient degree of risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"Special Mention."
When the Bank classifies one or more assets, or portions thereof, as
Substandard or Doubtful, it is required to establish an allowance for possible
loan losses in an amount deemed prudent by management unless the loss of
principal appears to be remote. When the Bank classifies one or more assets, or
portions thereof, as Loss, it is required either to establish a specific
allowance for losses equal to 100% of the amount of the assets so classified or
to charge off the loan in full.
The Bank determines the classification of its assets and the amount of its
valuation allowances. These determinations can be reviewed by the Federal
Deposit Insurance Corporation ("FDIC") and the Commissioner of Banks for the
Commonwealth of Massachusetts (the "Commissioner"), which can order the
establishment of additional general or specific loss allowances. The FDIC, in
conjunction with the other federal banking agencies, recently adopted an
interagency policy statement on the allowance for loan and lease losses. The
policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation guidelines. Generally, the policy statement
recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; that management has analyzed all
significant factors that affect the collectibility of the portfolio in a
reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
While the Bank believes that it has established an adequate allowance for
possible loan losses, there can be no assurance that regulators, in reviewing
the Bank's loan portfolio, will not request the Bank to materially increase at
that time its allowance for possible loan losses, thereby negatively affecting
the Bank's financial condition and earnings at that time. Although management
believes that adequate specific and general loan loss allowances have been
established, future provisions are dependent upon future events such as loan
growth and portfolio diversification and, as such, further additions to the
level of specific and general loan loss allowances may become necessary.
Management of the Bank and the Board of Investment review and classify the
assets of the Bank on a monthly basis and the Board of Trustees reviews the
results of the reports on a bi-monthly basis. The Bank classifies its assets in
accordance with the management guidelines described above. At December 31, 1998,
the Bank had $3.2 million, or 0.8%, of assets designated as Substandard,
consisting of 23 one- to four-family loans, three commercial real estate loans,
seven multi-family loans, three home equity lines of credit , eight consumer
loans and two commercial business loans. At such date, the Bank had no loans
classified as Doubtful or Loss. Also, at December 31, 1998, the Bank had
$864,000, or 0.2% of assets designated as Special Mention, consisting of seven
one- to four-family loans, three commercial real estate loans, two home equity
lines of credit and four commercial business loans. At December 31, 1998, all of
these classified assets represented 1.4% of total loans.
12
At December 31, 1998, the Bank had two loans, each with balances of
$500,000 or more, which had been adversely classified or identified as a problem
credit. The first, which is classified as substandard, was restructured in 1994
and is secured by a blanket first mortgage on ten multi-family properties
located in Westfield, Massachusetts. Currently, the borrower provides the Bank
with monthly financial statements and the Bank actively monitors the properties'
vacancy rates. The borrower is current with respect to payments. The second
loan, which was originally restructured in 1992 and, more recently in December
1997, is classified as impaired. This loan is secured by an office/retail
building located in Wilbraham, Massachusetts. The borrower is current with
respect to payments. As of December 31, 1998, the aggregate outstanding carrying
balance of these loans was $1.4 million.
The following table sets forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
At December 31, 1998 At December 31, 1997
------------------------------------ ------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
----------------- ----------------- ----------------- -----------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
One- to four-family..................... 1 $74 2 $167 2 $ 80 1 $ 95
Commercial real estate.................. -- -- 2 109 2 192 1 790
Home equity loans and lines of credit... 1 6 1 30 1 30 -- --
Other consumer.......................... 3 5 -- -- 6 38 -- --
---- ---- --- ---- ---- ---- ---- ----
Total loans............................. 5 $85 5 $306 11 $340 2 $885
==== ==== === ==== ==== ==== ==== ====
Delinquent loans to total loans(1)...... 0.03% 0.11% 0.13% 0.34%
==== ==== ==== ====
At December 31, 1996 At December 31, 1995
------------------------------------ ------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
----------------- ----------------- ----------------- -----------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
One- to four-family..................... 2 $51 1 $ 71 6 $340 4 $384
Commercial real estate.................. 1 43 2 124 1 43 1 61
Home equity loans
and lines of credit................... -- -- 1 30 2 39 -- --
Other consumer.......................... 1 4 4 27 4 22 1 93
---- ---- ---- ---- ---- ---- ---- ----
Commercial.............................. -- -- -- -- -- -- 1 28
---- ---- ---- ---- ---- ---- ---- ----
Total loans............................. 4 $98 8 $252 13 $444 7 $566
==== ==== ==== ==== ==== ==== ==== ====
Delinquent loans to total loans(1)...... 0.04% 0.11% 0.22% 0.28%
==== ==== ==== ====
- ----------
(1) Total loans includes loans, less unadvanced loan funds, plus deferred loan
costs (fees), net.
Nonperforming Assets and Impaired Loans. The following table sets forth
information regarding nonaccrual loans and real estate owned ("REO"). At
December 31, 1998, nonaccrual loans totalled $306,000, consisting of five loans.
It is the general policy of the Bank to cease accruing interest on loans 90 days
or more past due and to fully reserve for all previously accrued interest. If
interest payments on all nonaccrual loans for the years ended December 31, 1998,
1997 and 1996 had been made in accordance with original loan agreements,
interest income of $11,000, $48,000 and $13,000, respectively, would have been
recognized. On January 1, 1995, the Bank adopted Statement of Financial
Accounting Standards No. 114 "Accounting by Creditors for Impairment of a Loan,"
as amended by SFAS No. 118. At December 31, 1998, the Bank had a $1.2 million
recorded investment in impaired loans which had specific allowances of $283,000.
At December 31, 1997, there were $1.2 million of impaired loans with specific
loan loss allowances of $200,000. At December 31, 1998, REO totalled $241,000,
consisting of three residential building lots, a 25 lot residential subdivision
and a mobile home. When the Bank acquires property through foreclosure or deed
in lieu of foreclosure, it is initially recorded at the lower of the recorded
investment in the corresponding loan
13
or the fair value of the related assets at the date of foreclosure, less costs
to sell. Thereafter, if there is a further deterioration in value, the Bank
provides for a specific allowance and charges operations for the diminution in
value.
At December 31,
-----------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(Dollars in thousands)
Nonaccrual loans:
Real estate:
One- to four-family ............. $ 167 $ 95 $ 71 $ 412 $ 404
Multi-family .................... -- -- -- -- 180
Commercial ...................... 109 790 124 61 880
Home equity loans and lines of
credit .......................... 30 -- 30 93 113
Other consumer .................... -- -- 27 -- 5
------ ------ ---- ------ ------
Total ........................... 306 885 252 566 1,582
Real estate owned (REO), net(1) ..... 241 189 348 534 955
Real estate in possession ........... -- 192 75 107 --
------ ------ ---- ------ ------
Total nonperforming assets ........ 547 1,266 675 1,207 2,537
Troubled debt restructurings ........ 773 274 -- 1,947 939
------ ------ ---- ------ ------
Troubled debt restructurings and
total nonperforming assets ........ $1,320 $1,540 $675 $3,154 $3,476
====== ====== ==== ====== ======
Total nonperforming loans and
troubled debt restructurings as a
percentage of total loans(2)(3) ... 0.38% 0.44% 0.11% 1.24% 1.34%
Total nonperforming assets and
troubled debt restructurings as a
percentage of total assets(3) ..... 0.31% 0.45% 0.21% 1.15% 1.31%
- ----------
(1) Real estate owned balances are shown net of related loss allowances.
(2) Total loans includes loans, less unadvanced loan funds, plus deferred loan
costs (fees), net.
(3) Nonperforming assets consist of nonperforming loans and REO. Nonperforming
loans consist of nonaccruing loans and all loans 90 days or more past due
and other loans which have been identified by the Bank as presenting
uncertainty with respect to the collectibility of interest or principal.
Allowance for Loan Losses
The allowance for loan losses is maintained through provisions for loan
losses based on management's on-going evaluation of the risks inherent in its
loan portfolio in consideration of the trends in its loan portfolio, the
national and regional economies and the real estate market in the Bank's primary
lending area. The allowance for loan losses is maintained at an amount
management considers adequate to cover estimated losses in its loan portfolio
which are deemed probable and estimable based on information currently known to
management. The Bank's loan loss allowance determinations also incorporate
factors and analyses which consider the potential principal loss associated with
the loan, costs of acquiring the property securing the loan through foreclosure
or deed in lieu thereof, the periods of time involved with the acquisition and
sale of such property, and costs and expenses associated with maintaining and
holding the property until sale.
Management calculates a loan loss allowance sufficiency analysis on a
bi-monthly basis based upon the loan portfolio composition, asset
classifications, loan-to-value ratios, potential impairments in the loan
portfolio and other factors. The analysis is compared to actual losses, peer
group comparisons and economic conditions. As of December 31, 1998, the Bank's
allowance for loan losses was $2.2 million or 0.76% of total loans, and 201% of
nonperforming loans and troubled debt restructurings as compared to $2.0 million
or 0.74% of total loans, and 168% of nonperforming loans and troubled debt
restructurings as of December 31, 1997. The Bank had total nonperforming loans
and troubled debt restructurings of $1.1 and $1.2 million at December 31, 1998
and 1997, respectively, and
14
nonperforming loans and troubled debt restructurings to total loans of 0.38% and
0.44%, respectively. Management believes that, based on information available at
December 31, 1998, the Bank's allowance for loan losses was sufficient to cover
losses inherent in its loan portfolio at that time. Based upon the Bank's plan
to increase its emphasis on non-one- to four-family mortgage lending, the Bank
may further increase its allowance for loan losses over future periods as
conditions dictate. However, no assurances can be given that the Bank's level of
allowance for loan losses will be sufficient to cover future loan losses
incurred by the Bank or that further future adjustments to the allowance for
loan losses will not be necessary if economic and other conditions differ
substantially from the economic and other conditions used by management to
determine the current level of the allowance for loan losses. In addition, the
FDIC and the Commissioner, as an integral part of their examination processes,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to make additional provisions for estimated loan losses based
upon judgments different from those of management.
The following table sets forth activity in the Bank's allowance for
loan losses for the periods set forth in the table.
At or For the Year Ended December 31,
------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(Dollars in thousands)
Allowance for loan losses, beginning of period $1,952 $1,911 $1,838 $1,657 $1,667
Charged-off loans:
Real estate ................................ -- 52 34 30 271
Consumer ................................... 100 109 72 45 73
Commercial ................................. -- 10 30 -- --
------ ------ ------ ------ ------
Total charged-off loans .................. 100 171 136 75 344
------ ------ ------ ------ ------
Recoveries on loans previously charged-off:-
Real estate ................................ 37 11 10 24 11
Consumer ................................... 37 21 19 22 23
Commercial ................................. -- -- -- -- --
------ ------ ------ ------ ------
Total recoveries ......................... 74 32 29 46 34
------ ------ ------ ------ ------
Net loans charged-off ........................ 26 139 107 29 310
Provision for loan losses .................... 240 180 180 210 300
------ ------ ------ ------ ------
Allowance for loan losses, end of period ..... $2,166 $1,952 $1,911 $1,838 $1,657
====== ====== ====== ====== ======
Net loans charged-off to average
interest-earning loans ..................... 0.01% 0.06% 0.05% 0.01% 0.17%
Allowance for loan losses to total loans(1) .. 0.76% 0.74% 0.81% 0.91% 0.88%
Allowance for loan losses to nonperforming
loans and troubled debt restructuring(2) ... 200.74% 168.42% 758.33% 73.14% 65.73%
Net loans charged-off to allowance for loan
losses ..................................... 1.20% 7.12% 5.60% 1.58% 18.71%
Recoveries to charge-offs .................... 74.00% 18.71% 21.32% 61.33% 9.88%
- ----------
(1) Total loans includes loans, less unadvanced loan funds, plus deferred loan
costs (fees), net.
(2) Nonperforming loans and troubled debt restructuring consist of all loans
90 days or more past due and other loans which have been identified by the
Bank as presenting uncertainty with respect to the collectibility of
interest or principal.
15
The following table sets forth the Bank's percent of allowance for loan
losses to total allowances and the percent of loans to total loans in each of
the categories listed at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. These
allocations are not necessarily indicative of future losses and do not restrict
the use of the allowance to absorb losses in any other loan category.
At December 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ------------------------------ ------------------------------
% of % of % of
Allowance Percent of Allowance Percent of Allowance Percent of
in each Loans in in each Loans in in each Loans in
Category Each Category Each Category Each
to Total Category to to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------ --------- ----------- ------ --------- ----------- ------ --------- -----------
(Dollars in thousands)
Real estate loans................... $1,543 71.24% 71.34% $1,506 77.15% 69.34% $1,547 80.95% 74.71%
Consumer loans...................... 525 24.24 27.05 348 17.83 29.03 256 13.40 23.65
Commercial loans.................... 98 4.52 1.61 98 5.02 1.63 108 5.65 1.64
------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses................... $2,166 100.00% 100.00% $1,952 100.00% 100.00% $1,911 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
At December 31,
---------------------------------------------------------------
1995 1994
------------------------------- ------------------------------
% of % of
Allowance Percent of Allowance Percent of
in each Loans in in each Loans in
Category Each Category Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------ --------- ----------- ------ --------- -----------
(Dollars in thousands)
Real estate loans........................... $1,555 84.60% 79.15% $1,441 86.96% 88.01%
Consumer loans.............................. 145 7.89 19.19 78 4.71 10.52
Commercial loans............................ 138 7.51 1.66 138 8.33 1.47
------ ------ ------ ------ ------ ------
Total allowance for loan losses.......... $1,838 100.00% 100.00% $1,657 100.00% 100.00%
====== ====== ====== ====== ====== ======
16
Investment Activities
The Board of Trustees establishes the investment policy and procedures of
the Bank and has delegated investment authority and responsibility to the Bank's
Board of Investment. It is the general policy of the Bank that all investment
transactions be conducted in a safe and sound manner. The Bank's investment
policy further provides that investment decisions be based upon a thorough
analysis of each proposed investment to determine its quality, inherent risks,
fit within the Bank's overall asset/liability management objectives, the effect
on the Bank's risk-based capital and prospects for yield and/or appreciation.
While general investment strategies are developed and authorized by the Board of
Investment, the execution of specific investment actions and the day-to-day
oversight of the Bank's investment portfolio rests with the President and Senior
Vice President/Treasurer. These officers are authorized to execute investment
transactions of up to $5 million per transaction without the prior approval of
the Board of Investment if such transactions are within the scope of the Bank's
established investment policy. On a monthly basis, the Board of Investment
reviews and evaluates all investment activities for safety and soundness,
adherence to the Bank's investment policy and assurance that authority levels
are maintained.
As required by SFAS No. 115, the Bank has established an investment
portfolio of securities that are categorized as held-to-maturity,
available-for-sale or held-for-trading. The Bank generally invests in securities
as a method of utilizing funds not utilized for loan origination activity and as
a method of maintaining liquidity at levels deemed appropriate by management.
The Bank does not currently maintain a portfolio of securities categorized as
held-for-trading or held-to-maturity. At December 31, 1998, the Bank's
securities portfolio totalled $111.4 million, or 26.1% of assets, all of which
was categorized as available-for-sale.
Mortgage-Backed Securities. In the past, the Bank has purchased
mortgage-backed securities to (1) achieve positive interest rate spreads with
minimal administrative expense and (2) lower its credit risk as a result of the
guarantees provided by Freddie Mac, Fannie Mae, and Ginnie Mae. The Bank
purchases mortgage-backed securities insured or guaranteed by Fannie Mae,
Freddie Mac and Ginnie Mae. More recently, the Bank completed the securitization
of $19.1 million of fixed-rate one- to four-family mortgage loans with Fannie
Mae. The loans are serviced as mortgage-backed securities for Fannie Mae. In
addition to resulting in a decrease in loans receivable and a related increase
in mortgage-backed securities, the securitization provides several benefits to
the Bank, including (1) improvement in the credit risk profile of the Bank's
balance sheet by converting whole loans into mortgage-backed securities
guaranteed by Fannie Mae, (2) reduction of the required level of risk-based
capital, and (3) addition of high quality collateral designated as
"available-for-sale" which can be pledged for borrowings or sold in the
secondary market to fund future loan growth. Additionally, in the fourth quarter
of 1998, the Bank borrowed funds to purchase $40.0 million of mortgage-backed
securities insured or guaranteed by Ginnie Mae in anticipation of receiving
proceeds from the Bank's conversion.
Mortgage-backed securities are created by the pooling of mortgages and
issuance of a security with an interest rate which is less than the interest
rate on the underlying mortgage. Mortgage-backed securities typically represent
a participation interest in a pool of single-family or multi-family mortgages,
although the Bank focuses its investments on mortgage-backed securities backed
by one- to four-family mortgages. The issuers of such securities (generally U.S.
government agencies and government sponsored enterprises, including Fannie Mae,
Freddie Mac and Ginnie Mae) pool and resell the participation interests in the
form of securities to investors such as the Bank and guarantee the payment of
principal and interest to investors. Mortgage-backed securities generally yield
less than the loans that underlie such securities because of the cost of payment
guarantees and credit enhancements. However, mortgage-backed securities are
usually more liquid than individual mortgage loans and may be used to
collateralize specific liabilities and obligations of the Bank.
Although the Bank no longer invests in Real Estate Mortgage Investment
Conduits ("REMICs"), the Bank did maintain $8.1 million of such investments in
its securities portfolio at December 31, 1998. Generally, REMICs hold commercial
and/or residential real estate mortgages in trust and issue securities
representing an undivided interest in such mortgages. A REMIC, which can be a
corporation, trust, association or partnership, assembles mortgages
17
into pools and issues pass-through certificates, multiclass bonds (similar to a
collateralized mortgage obligation) or other securities to investors in the
secondary mortgage market.
At December 31, 1998, mortgage-backed securities totalled $88.8 million,
or 20.8%, of assets and 22.0% of interest earning assets, all of which were
classified as available-for-sale. At December 31, 1998, 9.1% of the
mortgage-backed securities were backed by adjustable-rate loans and 90.9% were
backed by fixed-rate loans. The mortgage-backed securities portfolio had a
stated rate of 6.7% at December 31, 1998. The estimated fair value of the Bank's
mortgage-backed securities at December 31, 1998, was $88.8 million, which is
$791,000 more than the amortized cost of $88.0 million. Investments in
mortgage-backed securities involve a risk that actual prepayments may differ
from estimate prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments thereby changing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities or if such securities are redeemed by the issuer. In addition, the
market value of such securities may be adversely affected by changes in interest
rates.
Equity Securities. The Bank currently maintains a diversified equity
security portfolio. At December 31, 1998, the Bank's equity securities portfolio
totalled $22.6 million, or 5.3% of assets, all of which were classified as
available-for-sale. Such portfolio consisted of $15.4 million of diversified
common stock and $3.8 million of preferred stock issued by corporate issuers and
$1.5 million of mutual funds at cost. The Bank's current policies generally
provide that the maximum equity investment in any one corporation shall not
exceed $300,000 and the maximum aggregate investment in equity securities shall
not exceed 10% of the Bank's total assets.
Investments in equity securities involve risk as they are not insured or
guaranteed investments and are affected by stock market fluctuations. Such
investments are carried at their market value and can directly affect the net
surplus of the Bank. The Bank also utilizes, from time to time, "covered" call
options with respect to common stocks as a means to further supplement its
revenues associated with equity investments. Such investment activity is
specifically authorized by both federal and Massachusetts law.
18
The following table sets forth at the dates indicated information
regarding the amortized cost and market values of the Bank's investment
securities.
At December 31,
-----------------------------------------------------------
1998 1997 1996
----------------- ------------------ ------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
-------- ------- --------- ------- -------- --------
(Dollars in thousands)
Debt Securities:
U.S. Government and federal
agency obligations ...... $ -- $ -- $ -- $ -- $ -- $ --
Other debt securities ..... -- -- -- -- 250 250
-------- -------- ------- ------- ------- -------
Total debt securities ... -- -- -- -- 250 250
-------- -------- ------- ------- ------- -------
Equity securities available-
for-sale:
Preferred stock ........... 3,754 3,815 3,177 3,345 4,527 4,723
Common stock .............. 15,438 17,436 9,425 12,382 7,576 9,122
Mutual funds .............. 1,524 1,394 -- -- -- --
-------- -------- ------- ------- ------- -------
Total equity securities . 20,716 22,645 12,602 15,727 12,103 13,845
-------- -------- ------- ------- ------- -------
Mortgage-backed securities
available-for sale:
Freddie Mac ............... 5,459 5,546 7,923 8,059 11,218 11,268
Fannie Mae ................ 31,955 32,435 18,353 18,476 22,275 22,116
Ginnie Mae ................ 42,726 42,670 2,814 2,941 2,937 2,999
REMICs .................... 7,833 8,113 10,169 10,437 10,874 11,148
-------- -------- ------- ------- ------- -------
Total mortgage-backed
securities ............ 87,973 88,764 39,259 39,913 47,304 47,531
-------- -------- ------- ------- ------- -------
Total securities(1) ..... $108,689 $111,409 $51,861 $55,640 $59,657 $61,626
======== ======== ======= ======= ======= =======
- ----------
(1) Does not include $5.6 million, $2.4 million and $2.1 million of
FHLB-Boston stock held by the Bank in 1998, 1997 and 1996 respectively.
19
The following table sets forth the Bank's securities activities for the
periods indicated. This table does not include FHLB stock held by the Bank.
For the Year Ended December 31,
-------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
Mortgage-backed securities (available-for-sale):
Mortgage-backed securities, beginning of period ....... $ 39,913 $ 47,531 $ 35,561
-------- -------- --------
Purchases and securitization .......................... 59,637 -- 18,039
Calls: mortgage-backed securities ..................... -- (496) (120)
Repayments and prepayments ............................ (10,937) (7,561) (6,017)
Net accretion ......................................... 15 12 13
Increase in unrealized gain ........................... 136 427 55
-------- -------- --------
Net increase (decrease) in mortgage-backed securities 48,851 (7,618) 11,970
-------- -------- --------
Mortgage-backed securities, end of period ............. $ 88,764 $ 39,913 $ 47,531
======== ======== ========
Debt and equity securities:
Debt and equity securities, beginning of period ....... $ 15,727 $ 14,095 $ 18,476
-------- -------- --------
Purchases: equity securities (available-for-sale) .... 16,376 10,285 8,569
Sales: equity securities (available-for-sale) ......... (7,588) (7,521) (10,727)
Calls:
Debt securities (held-to-maturity) .................. -- -- --
Debt securities (available-for-sale) ................ -- -- (241)
Equity securities (available-for-sale) .............. (642) (1,716) --
Principal payments: Corporate bonds ................... -- -- (166)
Transfer to Charitable Foundation: equity securities .. (33) (549) --
(available-for-sale)
Maturities:
Debt securities (held-to-maturity) .................. -- -- --
Debt securities (available-for-sale) ................ -- (250) (2,386)
Net amortization ...................................... -- -- (28)
Increase (decrease) in unrealized gain ................ (1,195) 1,383 598
-------- -------- --------
Net increase (decrease) in debt and equity securities 6,918 1,632 (4,381)
-------- -------- --------
Debt and equity securities, end of period ............. $ 22,645 $ 15,727 $ 14,095
======== ======== ========
20
The table below sets forth information regarding the carrying value,
weighted average yields and contractual maturities of the Bank's securities
portfolio as of December 31, 1998. There were no securities with contractual
maturities of one year or less.
At December 31, 1998
------------------------------------------------------------------------------
More than One More than Five
Year to Five Years to Ten More than Ten
Years Years Years Total
------------------ ------------------ ------------------ ------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Available-for-sale securities:
Mortgage-backed securities:
Freddie Mac.................... $10 10.00% $ 3 7.75% $ 5,533 6.44% $ 5,546 6.44%
Fannie Mae..................... 32 7.00 13,428 6.31 18,975 7.42 32,435 7.43
Ginnie Mae..................... -- -- -- -- 42,670 6.95 42,670 6.69
REMICs......................... -- -- -- -- 8,113 6.55 8,113 6.55
--- ------- ------- --------
Total mortgage-backed
securities.................. 42 7.73% 13,431 6.31% 75,291 6.71% 88,764 6.65%
Equity securities................ -- -- -- -- -- -- 22,645
--- ------- ------- --------
Total securities(1).......... $42 $13,431 $75,291 $111,409
=== ======= ======= ========
- ----------
(1) Does not include $5.6 million of FHLB stock held by the Bank.
Sources of Funds
General. Deposits, repayments and prepayments of loans, cash flows
generated from operations and FHLB advances are the primary sources of the
Bank's funds for use in lending, investing and for other general purposes.
Deposits. The Bank offers a variety of consumer and commercial deposit
accounts with a range of interest rates and terms. The Bank's deposit accounts
consist of savings, retail checking/NOW accounts, commercial checking accounts,
money market accounts, club accounts and certificate of deposit accounts. The
Bank offers certificate of deposit accounts with balances in excess of $100,000
at preferential rates (jumbo certificates) and also offers Individual Retirement
Accounts ("IRAs") and other qualified plan accounts.
At December 31, 1998, the Bank's deposits totalled $275.0 million, or
70.3%, of total liabilities. For the year ended December 31, 1998, the average
balance of core deposits (savings, NOW, money market and demand accounts)
totalled $129.6 million, or 48.0% of total average deposits. At December 31,
1998, the Bank had a total of $138.4 million in certificates of deposit, of
which $106.4 million had maturities of less than one year. For the year ended
December 31, 1997, the average balance of core deposits represented
approximately 45.6% of total deposits and certificate accounts represented
54.4%, as compared to core deposits representing 46.8% of total deposits and
certificate accounts representing 53.2% of deposits for the year ended December
31, 1996. Although the Bank has a significant portion of its deposits in core
deposits, management monitors activity on the Bank's core deposits and, based on
historical experience and the Bank's current pricing strategy, believes it will
continue to retain a large portion of such accounts. The Bank is not limited
with respect to the rates it may offer on deposit products.
The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and
competition. The Bank's deposits are obtained predominantly from the areas in
which its banking offices are located. The Bank relies primarily on customer
service, advertising and long-standing relationships with customers to attract
and retain these deposits; however, market interest rates and rates offered by
competing financial institutions affect the Bank's ability to attract and retain
deposits. The Bank uses traditional means of advertising its deposit products,
including radio and print media and generally does not actively solicit
deposits from outside
21
its market area. While certificate accounts in excess of $100,000 are accepted
by the Bank, and may receive preferential rates, the Bank does not actively
solicit such deposits as such deposits are more difficult to retain than core
deposits. Although the Bank's policies allow for the use of brokered deposits,
the Bank does not currently solicit brokered deposits. All Massachusetts savings
banks are required to be members of the Mutual Savings Central Fund and as such,
must pay its assessments. The Mutual Savings Central Fund maintains the DIF, a
private deposit insurer, which insures all deposits in member banks in excess of
FDIC deposit insurance limits.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Year Ended December 31,
-------------------------------
1998 1997 1996
------- ------- -------
Increase before interest credited .......... $ 1,977 $ 3,512 $ 7,848
Interest credited(1) ....................... 10,385 10,185 9,445
------- ------- -------
Net increase ............................... $12,362 $13,697 $17,293
======= ======= =======
- ----------
(1) Does not include escrow interest credited of $8,000, $7,000 and $7,000 for
the periods ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998, the Bank had $23.2 million in certificate accounts
in amounts of $100,000 or more, maturing as follows:
Weighted
Average
Maturity Period Amount Rate
------ --------
(Dollars in thousands)
Three months or less ............................. $ 6,999 5.02%
Over three through six months .................... 3,473 5.11
Over six through 12 months ....................... 7,468 5.72
Over 12 months ................................... 5,277 6.45
-------
Total ............................................ $23,217 5.58
=======
22
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. Averages for the periods presented
utilize average daily balances.
For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997
------------------------------ -------------------------------
Percent Weighted Percent Weighted
Average of Total Average Average of Total Average
Balance Deposits Rate Balance Deposits Rate
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
Demand deposits........................ $ 10,184 3.77% --% $ 7,939 3.11% --%
Savings accounts(1).................... 66,805 24.75 2.39 64,285 25.16 2.74
Money Market accounts.................. 24,465 9.06 2.89 19,238 7.53 2.12
NOW accounts........................... 28,116 10.42 1.04 24,941 9.76 1.01
Total certificates of deposit.......... 140,371 52.00 5.56 139,119 54.44 5.56
-------- ------ -------- ------
Total average deposits............. $269,941 100.00% 3.85% $255,522 100.00% 3.97%
======== ====== ======== ======
For the Year Ended December 31,
---------------------------------
1996
---------------------------------
Percent Weighted
Average of Total Average
Balance Deposits Rate
------- -------- --------
(Dollars in thousands)
Demand deposits .......................... $ 6,933 2.90% --%
Savings accounts(1) ...................... 65,042 27.25 2.59
Money Market accounts .................... 16,825 7.05 2.62
NOW accounts ............................. 22,831 9.57 1.06
Total certificates of deposit ............ 127,068 53.23 5.54
-------- ------
Total average deposits ............... $238,699 100.00% 3.94%
======== ======
- ----------
(1) Savings accounts include mortgagors' escrow deposits.
The following table presents by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1998.
Period to Maturity from
December 31, 1998
------------------------------------
Less One Two
than to to Over Total At December 31,
One Two Three Three December 31, -------------------
Year Years Years Years 1998 1997 1996
-------- ------- ------ ----- ------------ -------- --------
(Dollars in thousands)
Certificate accounts:
0 to 4.00%............ $ 34 $ 11 $ 32 $ 2 $ 79 $ 75 $ 132
4.01% to 5.00%........ 43,667 4,569 1,954 -- 50,190 3,744 29,506
5.01% to 6.00%........ 52,795 11,604 3,660 -- 68,059 107,995 85,788
6.01% to 7.00%........ 3,253 5 -- -- 3,258 15,306 7,282
7.01% to 8.00%........ 6,681 10,137 -- -- 16,818 16,129 15,689
-------- ------- ------ --- -------- -------- ---------
Total............. $106,430 $26,326 $5,646 $ 2 $138,404 $143,249 $138,397
======== ======= ====== === ======== ======== ========
23
Borrowed Funds. As part of its operating strategy, the Bank utilizes
advances from the FHLB as an alternative to retail deposits to fund its
operations. By utilizing FHLB advances, which possess varying stated maturities,
the Bank can meet its liquidity needs without otherwise being dependent upon
retail deposits, which have no stated maturities (except for certificates of
deposit), which are interest rate sensitive and which may be withdrawn from the
Bank at any time. These FHLB advances are collateralized primarily by the Bank's
mortgage loans and mortgage-backed securities and secondarily by the Bank's
investment in capital stock of the FHLB. FHLB advances are made under several
different credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time-to-time in accordance
with the policies of the FHLB. At December 31, 1998, the Bank had $111.2 million
in outstanding advances from the FHLB compared to $41.7 million at December 31,
1997.
The following table sets forth information regarding the Bank's borrowed
funds at or for the periods ended on the dates indicated:
At or For the Year Ended
December 31,
-------------------------------
1998 1997 1996
--------- ------- -------
(Dollars in thousands)
FHLB advances:
Average balance outstanding ............... $ 55,588 $40,099 $26,941
========= ======= =======
Maximum amount outstanding at any
month-end during the period ............. $ 111,163 $44,878 $38,145
========= ======= =======
Balance outstanding at end of period ...... $ 111,163 $41,726 $35,441
========= ======= =======
Weighted average interest rate during
the period .............................. 5.54% 5.84% 5.97%
==== ==== ====
Weighted average interest rate at end
of period ............................... 5.15% 5.94% 5.66%
==== ==== ====
Trust Services
In 1994, the Bank established the Woronoco Savings Bank Trust & Investment
Management Department (the "trust department"). The trust department provides
trust and investment services to individuals, partnerships, corporations and
institutions and acts as a fiduciary of estates and conservatorships and as a
trustee under various wills, trusts and other plans. The Bank believes that the
trust department is an important element of its operating strategy to attract
and retain customers. The Bank has implemented several policies governing the
practices and procedures of the trust department, including policies relating to
maintaining confidentiality of trust records, drafting trust documents and
instruments, investment of trust property, handling conflicts of interest, and
maintaining impartiality. Such policies are aimed at maintaining the highest
standards of fiduciary conduct. At December 31, 1998, the trust department was
managing 200 accounts for others with assets of $17.8 million, in the aggregate.
Subsidiary Activities
Walshingham Enterprises, Inc. was established in July 1983 for the purpose
of acquiring, holding and selling residential and commercial real estate.
However, the subsidiary no longer holds any real property and currently is
inactive. Woronoco Security Corp. was established in November 1996, for the
purpose of acquiring and holding investment securities of a type that are
permissible for banks to hold under applicable law. Woronoco Security Corp. was
established to qualify as a "securities corporation" for Massachusetts tax
purposes. The results of operations of all of the Bank's subsidiaries will be
consolidated in the results and operations of the Company.
24
The Woronoco Foundation, Inc.
In 1996, the Bank established a private charitable foundation, The
Woronoco Foundation, Inc. (the "foundation"). The foundation, which is not a
subsidiary of the Bank, was established for the purpose of providing grants to
charitable organizations in the communities in which the Bank operates. The
foundation was funded in 1997 by a donation from the Bank of marketable equity
securities with a cost basis and fair value of approximately $235,000 and
$549,000, respectively, at the date of donation and transfer. The foundation's
current nine member Board of Directors consists of three of each of the Bank's
current Trustees, officers and corporators. The Bank will continue to maintain
the foundation after conversion but may, in the future, wind down its operations
and affairs. It is not expected that the existence of the Bank's current
foundation will impact the business and affairs of the Woronoco Savings
Charitable Foundation which is being established in connection with the Bank's
Conversion.
REGULATION AND SUPERVISION
General
As a savings bank chartered by the Commonwealth of Massachusetts, the Bank
is extensively regulated under state law with respect to many aspects of its
banking activities; this state regulation is administered by the Commissioner.
In addition, as a bank whose deposits are insured by the FDIC under the Bank
Insurance Fund ("BIF"), the Bank must pay deposit insurance assessments and is
examined and supervised by the FDIC. These laws and regulations have been
established primarily for the protection of depositors, customers and borrowers
of the Bank, not bank stockholders.
The Holding Company is also required to file reports with, and otherwise
comply with the rules and regulations, of the OTS, the Commissioner and of the
Securities and Exchange Commission ("SEC") under the federal securities laws.
The following discussion of the laws and regulations material to the operations
of the Company and the Bank is a summary and is qualified in its entirety by
reference to such laws and regulations.
Massachusetts Banking Laws and Supervision
Massachusetts savings banks are regulated and supervised by the
Commissioner. The Commissioner is required to regularly examine each
state-chartered bank. The approval of the Commissioner is required to establish
or close branches, to merge with another bank, to form a holding company, to
issue stock or to undertake many other activities. Any Massachusetts bank that
does not operate in accordance with the regulations, policies and directives of
the Commissioner may be sanctioned. The Commissioner may suspend or remove
trustees or officers of a bank who have violated the law, conducted a bank's
business in a manner which is unsafe, unsound or contrary to the depositors'
interests, or been negligent in the performance of their duties.
All Massachusetts-chartered savings banks are required to be members of
the Mutual Savings Central Fund and as such must pay its assessments. The Mutual
Savings Central Fund maintains the Deposit Insurance Fund, a private deposit
insurer, which insures all deposits in member banks in excess of FDIC deposit
insurance limits. In addition, the Mutual Savings Central Fund acts as a source
of liquidity to its members in supplying them with low-cost funds, and
purchasing qualifying obligations from them.
Payment of Dividends. A savings bank may only pay dividends on its capital
stock if such payment would not impair the bank's capital stock and surplus
account. No dividends may be paid to stockholders of a bank if such dividends
would reduce stockholders' equity of the bank below the amount of the
liquidation account required by Massachusetts conversion regulations.
25
Assessments. Savings banks are required to pay assessments to the
Commissioner to fund operations. Assessments paid by the Bank for the fiscal
year ended December 31, 1998 totalled $32,000.
Federal Regulations
Capital Requirements. Under FDIC regulations, federally insured
state-chartered banks that are not members of the Federal Reserve System ("state
non-member banks"), such as the Bank, are required to comply with minimum
leverage capital requirements. For an institution determined by the FDIC to not
be anticipating or experiencing significant growth and to be in general a strong
banking organization, receiving the highest examination rating, the minimum
capital leverage requirement is a ratio of Tier 1 capital to total assets of 3%.
For all other institutions, the minimum leverage capital ratio is 3% plus an
additional "cushion" amount of at least 100 to 200 basis points. Tier 1 capital
is the sum of common stockholders' equity, noncumulative perpetual preferred
stock (including any related surplus) and minority investments in certain
subsidiaries, less intangible assets (except for certain servicing rights and
credit card relationships).
The FDIC has also adopted risk-based capital guidelines to which the Bank
is subject. The FDIC guidelines require state non-member banks to maintain
certain levels of regulatory capital in relation to regulatory risk-weighted
assets. Risk-based capital ratios are determined by allocating assets and
specified off-balance sheet items to four risk-weighted categories ranging from
0% to 100%, with higher levels of capital being required for the categories
perceived as representing greater risk.
State non-member banks must maintain a minimum ratio of qualifying capital
to risk-weighted assets of at least 8%, of which at least one-half be Tier 1
capital. Qualifying total capital consists of Tier 1 capital plus Tier 2 or
supplementary capital items, which include allowances for loan losses in an
amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, and
other capital instruments. The includable amount of Tier 2 capital cannot exceed
the amount of the institution's Tier 1 capital.
The following is a summary of the Bank's regulatory capital at December
31, 1998:
GAAP Capital to Total Assets........................ 8.38%
Total Capital to Risk-Weighted Assets............... 13.87%
Tier I Leverage Ratio............................... 9.35%
Tier I to Risk-Weighted Assets...................... 13.04%
Standards for Safety and Soundness. The federal banking agencies have
adopted final regulations and Interagency Guidelines Establishing Standards for
Safety and Soundness (the "Guidelines") to implement safety and soundness
standards. The Guidelines set forth the safety and soundness standards that the
federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. If the appropriate
federal banking agency determines that an institution fails to meet any standard
prescribed by the Guidelines, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard.
Investment Activities
Under federal law, all state-chartered FDIC insured banks, including
savings banks, have generally been limited to activities as principal and equity
investments of the type and in the amount authorized for national banks,
notwithstanding state law. There are certain exceptions to these limitations.
For example, state chartered banks, such as the Bank, may, with FDIC approval,
continue to exercise state authority to invest in common or preferred stocks
listed on a national securities exchange or the Nasdaq National Market and in
the shares of an investment company registered under federal law. In addition,
the FDIC is authorized to permit such institutions to engage in state authorized
activities or investments that do not meet this standard (other than
non-subsidiary equity investments) for institutions that meet all applicable
capital requirements if it is determined that such activities or investments do
not
26
pose a significant risk to the BIF. The Bank received grandfathering authority
from the FDIC in February 1993 to invest in listed stocks and/or regi