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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the fiscal year ended December 31, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-23129
NORTHWAY FINANCIAL, INC.
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(Exact name of registrant as specified in its charter)
New Hampshire 04-3368579
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9 Main Street
Berlin, New Hampshire 03570
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Address of principal executive offices (Zip Code)
(603) 752-1171
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(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.00
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve 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 ninety days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
The number of shares of voting and nonvoting common stock, par value $1.00
per share, held by nonaffiliates of the registrant as of June 28, 2002 was
1,304,858 shares with an aggregate market value, computed by reference to the
last reported sales price on the NASDAQ National Market on such date, of
$36,862,239. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for purposes of this calculation,
this classification is not to be interpreted as an admission of such status.
At March 3, 2003, there were 1,506,574 shares of common stock outstanding,
par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2002 Annual Meeting of
Stockholders are incorporated by reference in Items 10, 11, 12 and 13 of Part
III.
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NORTHWAY FINANCIAL, INC.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1 Business...........................................................1
ITEM 2 Properties.........................................................9
ITEM 3 Legal Proceedings..................................................9
ITEM 4 Submission of Matters to a Vote of Security Holders................9
PART II
ITEM 5 Market for the Registrant's Common Stock and Related
Security Holder Matters............................................9
ITEM 6 Selected Financial Data...........................................10
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations. .......................................11
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk........22
ITEM 8 Financial Statements and Supplementary Material...................23
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..........................................52
PART III
ITEM 10 Directors and Executive Officers of the Registrant................52
ITEM 11 Executive Compensation............................................52
ITEM 12 Security Ownership of Certain Beneficial Owners and Management....52
ITEM 13 Certain Relationships and Related Transactions....................52
ITEM 14 Controls and Procedures...........................................53
ITEM 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K...53
Signatures....................................................54
Certifications................................................56
FORWARD-LOOKING STATEMENTS
Certain statements in this report are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements may include, but are not limited to, projections of
revenue, income or loss, plans for future operations and acquisitions,
projections based on assumptions regarding market and liquidity risk, and plans
related to products or services of Northway Financial, Inc. and its
subsidiaries. Such forward-looking statements are subject to known and unknown
risks, uncertainties and contingencies, many of which are beyond the control of
the Company. To the extent any such risks, uncertainties and contingencies are
realized, the Company's actual results, performance or achievements could differ
materially from anticipated results, performance or achievements. Factors that
might affect such forward-looking statements include, among other factors, the
factors described under the caption "Risk Factors" in Item 1 of this report,
overall economic and business conditions, economic and business conditions in
the Company's market areas, interest rate fluctuations, the demand for the
Company's products and services, competitive factors in the industries in which
the Company competes, changes in government regulations, and the timing, impact
and other uncertainties of future acquisitions.
In addition to the factors described above, the following are some additional
factors that could cause our financial performance to differ from any
forward-looking statement contained herein: i) the current economic downturn
nationwide and regionally; ii) changes in interest rates over the past year and
the relative relationship between the various interest rate indices that the
Company uses; iii) a determination in the financial market affecting the
valuation of securities held in the Company's investment portfolio; (iv) a
change in product mix attributable to changing interest rates, customer
preferences or competition; v) a significant portion of the Company's loan
customers are in the hospitality business and therefore could be affected by a
slower economy, adverse weather conditions and/or rising gasoline prices; and
vi) the effectiveness of advertising, marketing and promotional programs.
The words "believe," "expect," "anticipate," "intend," "estimate," "project" or
the negative of such terms and other similar expressions which are predications
of or indicate future events and trends and which do not relate to historical
matters identify forward-looking statements. Reliance should not be placed on
forward-looking statements because they involve known or unknown risks,
uncertainties or other factors, which may cause the actual results, performance
or achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements. The Company expressly disclaims any obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
Though the Company has attempted to list comprehensively the factors which might
affect forward-looking statements, the Company wishes to caution you that other
factors may in the future prove to be important in affecting the Company's
results of operations. New factors emerge from time to time and it is not
possible for management to anticipate all of such factors, nor can it assess the
impact of each such factor, or combination of factors, which may cause actual
results to differ materially from forward-looking statements.
PART 1
ITEM 1. BUSINESS
Description of Business
Northway Financial, Inc. (the "Company") was incorporated on March 7, 1997,
under the laws of the State of New Hampshire, for the purpose of becoming the
holding company of The Berlin City Bank, a New Hampshire chartered bank
headquartered in Berlin, New Hampshire ("BCB"), pursuant to a reorganization
transaction (the "BCB Reorganization") by and among the Company, BCB, and a
subsidiary of BCB, and, thereafter, effecting the merger (the "Merger") by and
among the Company, BCB, Pemi Bancorp, Inc. ("PEMI"), and PEMI's wholly owned
subsidiary, Pemigewasset National Bank, a national bank headquartered in
Plymouth, New Hampshire ("PNB"). The BCB Reorganization and the Merger became
effective on September 30, 1997. As of such date, BCB and PNB (collectively the
"Banks"), became wholly owned subsidiaries of the Company. Unless the context
otherwise requires, references herein to the "Company" include Northway
Financial, Inc. and its consolidated subsidiaries.
The Company and its subsidiaries derive substantially all of their revenue and
income from the furnishing of bank and bank-related services, principally to
individuals and small and medium sized companies in New Hampshire. The Banks
operate as typical community banking institutions and do not engage in any
specialized finance or capital market activities. The Company functions
primarily as the holder of stock of its subsidiaries and assists the management
of its subsidiaries as appropriate.
The Company is subject to regulation by the New Hampshire Bank Commissioner (the
"commissioner"), the Federal Deposit Insurance Corporation (the "FDIC"), the
Comptroller of the Currency of the United States (the "OCC"), and the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). See
"Supervision and Regulation."
BCB, which was first organized in 1891, and PNB, which was first organized in
1881, are engaged in a general commercial banking business and offer commercial
and construction loans, real estate mortgages, consumer loans, including
personal secured and unsecured loans, and lines of credit. During 1998, the
Company, through the BCB subsidiary, established an indirect lending business
unit in Concord, New Hampshire. The unit has substantially increased the volume
of secured consumer installment loans originated for the Banks and for sale to
third parties. The Banks accept savings, time, demand, NOW and money market
deposit accounts, and offer a variety of banking services including safe deposit
boxes, credit card accounts, official checks and money orders, overdraft lines
of credit and wire transfer services. The Banks have 20 automatic teller
machines to allow customers limited banking services on a 24 hour basis.
The Company is a legal entity separate and distinct from its subsidiaries. The
right of the Company to participate in any distribution of assets or earnings of
any subsidiary is subject to the prior claims of creditors of the subsidiary,
except to the extent that claims, if any, of the Company itself as a creditor
may be recognized. See "Supervision and Regulation".
The following information concerning the Company's investment activities,
lending activities, asset quality and allowance for loan losses should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," appearing under Item 7 of this report and the
Company's Consolidated Financial Statements and Notes thereto.
Investment Activities
The following table presents the carrying amount of the Company's
securities available-for-sale and held-to-maturity as of December 31, 2002,
2001 and 2000 (dollars in thousands):
2002 2001 2000
------- ------- -------
Available-for-sale:
US Treasury and other
US government agency securities $36,188 $10,977 $28,780
Mortgage-backed securities(1) 12,646 21,097 14,652
Marketable equity securities 2,377 3,255 2,409
Corporate bonds 33,848 14,230 1,003
State and political subdivision bonds and notes 6,338 6,005 3,444
------- ------- -------
91,397 55,564 50,288
------- ------- -------
Held-to-maturity
Mortgage-backed securities(1) -- -- 2,252
State and political subdivision bonds and notes -- -- 500
------- ------- -------
-- -- 2,752
------- -------
Total securities $91,397 $55,564 $53,040
======= ======= =======
(1) Includes Collateralized Mortgage Obligations.
The following table sets forth the amortized cost of the Company's
investment in debt securities maturing within stated periods and their
related weighted average yields, reported on a tax equivalent basis, as of
December 31, 2002 (dollars in thousands):
Maturities
-----------------------------------------------------
One to Five to Over Total
Within five ten ten amortized
one year years years years cost
-------- ------- ------- ------- ---------
Available-for-sale:
US Treasury and other
US government agency securities $13,996 $20,134 $ 2,037 $ -- $36,167
Mortgage-backed securities (1) 80 4,259 2,058 5,992 12,389
Corporate bonds 1,002 26,249 6,156 -- 33,407
State and political subdivision bonds
and notes 278 221 3,412 2,243 6,154
------- ------- ------- ------- -------
Total amortized cost $15,356 $50,863 $13,663 $ 8,235 $88,117
======= ======= ======= ======= =======
Market value $15,372 $51,090 $14,227 $ 8,331 $89,020
======= ======= ======= ======= =======
Weighted average yield 1.64% 4.71% 6.48% 5.86% 4.56%
(1) Includes Collateralized Mortgage Obligations
Lending Activities
The following table sets forth information with respect to the composition
of the Company's loan portfolio, excluding loans held for sale, as of
December 31, 2002, 2001, 2000, 1999 and 1998 (dollars in thousands):
December 31,
---------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Real estate:
Residential $114,526 $109,261 $129,805 $139,389 $146,603
Commercial 111,941 111,642 100,608 93,061 77,680
Construction 6,330 1,581 5,752 4,360 4,118
Commercial 23,885 22,727 22,270 28,833 25,874
Installment 40,169 28,210 28,177 24,147 25,070
Indirect installment 139,477 120,761 98,919 75,781 18
Other 6,031 6,303 7,881 7,369 4,795
-------- -------- -------- -------- --------
Total loans 442,359 400,485 393,412 372,940 284,158
Less:
Unearned income 207 169 154 174 332
Allowance for loan losses 4,920 4,642 4,354 4,887 4,404
-------- -------- -------- -------- --------
5,127 4,811 4,508 5,061 4,736
-------- -------- -------- -------- --------
Net loans $437,232 $395,674 $388,904 $367,879 $279,422
======== ======== ======== ======== ========
The following table presents the maturity distribution of the Company's
real estate construction and commercial loans at December 31, 2002 (dollars
in thousands):
Percent of
Amount Total
------- ----------
Within one year $ 9,349 30.94%
One to five years 9,626 31.86
Over five years 11,240 37.20
------- ------
$30,215 100.00%
======= ======
The Company's real estate construction and commercial loans due after one year
at December 31, 2002 were comprised of the following (dollars in
thousands):
Amount
Fixed interest rate $ 6,045
Adjustable interest rate 14,821
--------
$20,866
Analysis of the Allowance for Loan Losses
The following table reflects activity in the Company's allowance for loan losses
for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 (dollars in
thousands):
Years ended December 31,
----------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Balance at the beginning of period $4,642 $4,354 $4,887 $4,404 $4,156
Charge-offs:
Real estate 83 110 213 159 383
Commercial 12 95 1,006 25 67
Installment loans to individuals 729 529 424 120 74
Credit card -- -- -- -- --
Other -- -- -- -- --
------ ------ ------ ------ ------
Total 824 734 1,643 304 524
------ ------ ------ ------ ------
Recoveries:
Real estate 64 35 32 213 115
Commercial 4 -- -- 21 98
Installment loans to individuals 134 87 96 12 17
Credit card -- -- 2 1 2
Other -- -- -- -- --
------ ------ ------ ------ ------
Total 202 122 130 247 232
------ ------ ------ ------ ------
Net charge-offs 622 612 1,513 57 292
Provision charged to expense 900 900 980 540 540
------ ------ ------ ------ ------
Balance at the end of period $4,920 $4,642 $4,354 $4,887 $4,404
====== ====== ====== ====== ======
Ratio of net charge-offs to average loans 0.15% 0.15% 0.39% 0.02% 0.11%
Allocation of the Allowance for Loan Losses
The following table sets forth the breakdown of the Company's allowance for
loan losses in the Company's portfolio by category of loan and the
percentage of loans in each category to total loans in the respective
portfolios at the dates indicated (dollars in thousands):
December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------- ---------------- ---------------- ---------------- ----------------
Percent of loans Percent of loans Percent of loans Percent of loans Percent of loans
in each in each in each in each in each
category category category category category
to to to to to
total total total total total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Commercial $ 216 5.4% $ 208 5.7% $ 719 5.7% $ 530 7.7% $ 651 9.1%
Real estate:
Commercial &
construction 2,008 26.7 1,621 28.3 1,009 27.0 1,773 26.1 1,325 28.8
Residential 598 25.9 585 27.2 1,160 32.9 503 37.3 1,478 51.6
Installment 2,084 40.6 1,719 37.2 1,440 32.4 1,125 26.9 210 8.8
Other 14 1.4 17 1.6 26 2.0 60 2.0 58 1.7
Unallocated -- N/A 492 N/A -- N/A 896 N/A 682 N/A
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
$4,920 100.0% $4,642 100.0% $4,354 100.0% $4,887 100.0% $4,404 100.0%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
Deposits
See "Financial Statements and Supplementary Material" in Item 8 of this report.
Supervision and Regulation
General. In addition to state and federal laws generally applicable to
businesses and employers, the Company, PNB and BCB are further regulated by
federal and state laws and regulations applicable to financial institutions and
their parent companies. State and federal banking laws have as their principal
objective either the maintenance of safety and soundness of financial
institutions and the federal deposit insurance system or the protection of
consumers or classes of consumers, rather than the protection of stockholders of
a bank or its parent company. To the extent the following discussion describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the particular statute or regulation. Any change in applicable law or
regulation may have a material effect on the Company's business, prospects, and
operations, as well as those of its subsidiaries.
The Company. As a bank holding company registered under the Bank Holding Company
Act of 1956, as amended (the "BHC Act"), the Company is subject to substantial
regulation and supervision by the Federal Reserve Board and is required to file
periodic reports and such additional information as the Federal Reserve Board
may require. The Federal Reserve Board also makes periodic inspections of the
Company and its subsidiaries. The Federal Reserve Board has the authority to
issue orders to bank holding companies to cease and desist from unsound banking
practices and violations of conditions imposed by, or violations of agreements
with, the Federal Reserve Board. The Federal Reserve Board is also empowered to
assess civil money penalties against companies or individuals who violate the
BHC Act, or orders or regulations thereunder, to order termination of
non-banking activities of non-banking subsidiaries of bank holding companies,
and to order termination of ownership and control of a non-banking subsidiary by
a bank holding company.
The BHC Act prohibits a bank holding company from acquiring substantially all
the assets of a bank or acquiring direct or indirect ownership or control of
more than 5 percent of the voting shares of any bank, or increasing such
ownership or control of any bank, or merging or consolidating with any bank
holding company without prior approval of the Federal Reserve Board. The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally
authorizes bank holding companies to acquire banks located in any state,
possibly subject to certain state-imposed age and deposit concentration limits,
and also generally authorizes interstate mergers and to a lesser extent,
interstate branching.
Unless a bank holding company becomes a financial holding company under the
Gramm-Leach-Bliley Act of 1999 (the "GLB Act") (as discussed below), the BHC Act
also prohibits a bank holding company from acquiring a direct or indirect
interest in or control of more than 5 percent of the voting shares of any
company that is not a bank or a BHC and from engaging directly or indirectly in
activities other than those of banking, managing or controlling banks or
furnishing services to its subsidiary banks, except that it may engage in and
may own shares of companies engaged in certain activities the Federal Reserve
Board determined to be so closely related to banking or managing and controlling
banks as to be a proper incident thereto. In making such determinations, the
Federal Reserve Board is required to weigh the expected benefit to the public,
such as greater convenience, increased competition or gains in efficiency,
against the possible adverse effects, such as undue concentration of resources,
decreased or unfair competition, conflicts of interests or unsound banking
practices. In addition, as discussed more fully below, New Hampshire law imposes
certain approval requirements with respect to acquisitions by a bank holding
company of certain banking institutions.
The GLB Act established a comprehensive framework to permit affiliations among
banks, securities firms, insurance firms and other financial companies by
substantially modifying the BHC Act to authorize bank holding companies that
qualify and elect to become financial holding companies to engage in securities,
insurance and other activities that are financial in nature or incidental to a
financial activity and allowing subsidiaries of banks to engage in a broad range
of financial activities that are not permitted for banks themselves. To qualify,
all of a bank holding company's subsidiary banks must be well-capitalized and
well-managed, as measured by regulatory guidelines. In addition, to engage in
the new activities, each of the bank holding company's banks must have been
rated "satisfactory" or better in its most recent federal Community Reinvestment
Act ("CRA") evaluation. The activities of bank holding companies would continue
to be limited to activities authorized currently under the BHC Act. The Company
is qualified but has not elected to become a financial holding company at this
time and is therefore subject to the restrictions of the BHC Act as outlined
above.
The Federal Reserve Board has adopted capital adequacy guidelines pursuant to
which it assesses the adequacy of capital in examining and supervising a bank
holding company and in analyzing applications to it under the BHC Act. These
capital adequacy guidelines generally require bank holding companies to maintain
total capital equal to 8.0 percent of total risk-adjusted assets and off-balance
sheet items (the "Total Risk-Based Capital Ratio"), with at least 50 percent of
that amount consisting of Tier 1, or core capital, and the remaining amount
consisting of Tier 2, or supplementary capital. Tier 1 capital for bank holding
companies generally consists of the sum of common stockholders' equity and
perpetual preferred stock (subject in the case of the latter to limitations on
the kind and amount of such stocks which may be included as Tier 1 capital),
less goodwill and other non-qualifying intangible assets. Tier 1 capital may
also include certain types of trust preferred securities that meet the
requirements specified by the Federal Reserve Board, subject to a limitation in
amount includable in Tier 1 capital. Tier 2 capital generally consists of hybrid
capital instruments; perpetual debt and mandatory convertible debt securities;
perpetual preferred stock, which is not eligible to be included in Tier 1
capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan and lease losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics.
In addition to the risk-based capital requirements, the Federal Reserve Board
requires bank holding companies to maintain a minimum leverage capital ratio of
Tier 1 capital (defined by reference to the risk-based capital guidelines) to
its average total consolidated assets (the "Leverage Ratio") of 3.0 percent.
Total average consolidated assets for this purposes does not include, for
example, goodwill and any other intangible assets and investments that the
Federal Reserve Board determines should be deducted from Tier 1 capital. The
Federal Reserve Board has determined that the 3.0 percent Leverage Ratio
requirement is the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies or those, which
are not experiencing or anticipating significant growth. All other bank holding
companies are required to maintain a minimum Leverage Ratio of 4.0 percent. Bank
holding companies with supervisory, financial, operational or managerial
weaknesses, as well as bank holding companies that are anticipating or
experiencing significant growth, are expected to maintain capital ratios well
above the minimum levels. Because the Company anticipates significant future
growth, it expects to be subjected to required ratios of 4.0 percent to 5.0
percent or more.
The Company is currently in compliance with both the Risk-Based Capital Ratio
and the Leverage Ratio requirements. At December 31, 2002, it had a Tier 1
Risk-Based Capital Ratio and a Total Risk-Based Capital Ratio equal to 8.57
percent and 12.04 percent, respectively, and a Leverage Ratio equal to 6.70
percent.
U.S. bank regulatory authorities and international bank supervisory
organizations, principally the Basel Committee on Banking Supervision ("Basel
Committee"), currently are considering changes to the risk-based capital
adequacy framework, which ultimately could affect the appropriate capital
guidelines. Among other things, the Basel Committee rules, which are expected to
be proposed formally for public comment in the next six months and are expected
to become effective around 2006, would add operational risk as a third component
to the denominator of the risk-based capital calculation, which currently
includes only credit and market risks.
The federal Change in Bank Control Act prohibits a person or group of persons
from acquiring "control" of a bank holding company unless the Federal Reserve
Board has been given at least 60 days to review, and does not object to, the
proposal. Under a rebuttable presumption established by the Federal Reserve
Board, the acquisition of 10 percent or more of a class of voting stock of a
bank holding company, such as the Company, with a class of securities registered
under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") would, under the circumstances set forth in the presumption,
constitute the acquisition of control.
In addition, any company, as that term is broadly defined in the statute, would
be required to obtain the approval of the Federal Reserve Board under the BHC
Act before acquiring 25 percent (5 percent in the case of an acquirer that is a
bank holding company) or more, or such lesser percentage of our outstanding
common stock as the Federal Reserve Board deems to constitute control over the
Company.
PNB. PNB is a national banking association, organized under the National Bank
Act. As such, its primary regulatory authority is the OCC. The OCC regularly
examines national banks and their operations. In addition, operations of
national banks are subject to federal statutes and regulations. Such statutes
and regulations relate to required capital and reserves, investments, loans,
mergers, payment of dividends, issuance of securities and many other aspects of
operations. Capital requirements applicable to PNB are substantially similar to
those adopted by the Federal Reserve Board regarding bank holding companies as
described above.
The OCC's approval is required for a national bank to pay dividends if the total
dividends declared by a national bank in any year will exceed the total of its
net profits for that year combined with its retained net profits for the
preceding two years, less any required transfer to surplus. The OCC also has
authority to approve or disapprove mergers, consolidations, the establishment of
branches and similar corporate actions. The OCC also has the power to prevent a
national bank from engaging in unsafe or unsound practices or violating
applicable laws in conducting its business.
Under the GLB Act, the OCC permits national banks, to the extent permitted under
state law, to engage in certain new activities which are permissible for
subsidiaries of a financial holding company. Further, it expressly preserves the
ability of national banks to retain all existing subsidiaries.
PNB is also subject to applicable provisions of New Hampshire law insofar as
they do not conflict with or are not otherwise preempted by federal banking law.
BCB. BCB is organized under New Hampshire law and is subject to the regulations
of the Commissioner and the FDIC. BCB's operations are subject to various
requirements and restrictions under the laws of the United States and the State
of New Hampshire, including those related to the maintenance of adequate levels
of capital, the payment of dividends, investments, the nature and amount of
loans which can be originated and the rate of interest that can be charged
thereon, and other activities. Capital requirements applicable to BCB are
substantially similar to those adopted by the Federal Reserve Board regarding
bank holding companies as described above.
Community Reinvestment Act. Both BCB and PNB are subject to the provisions of
the Community Reinvestment Act ("CRA"). Under the terms of the CRA, the
appropriate federal bank regulatory agency is required, in connection with its
examination of a subsidiary institution, to assess such institution's record in
meeting the credit needs of the communities served by the institution, including
those of low and moderate income neighborhoods. The regulatory agency's
assessment of the institution's record is made available to the public.
An institution's CRA rating is taken into account by its regulators in
considering various types of applications. In addition, an institution receiving
a rating of substantial noncompliance is subject to civil money penalties or a
cease and desist order under Section 8 of the Federal Deposit Insurance Act
("FDIA"). CRA remains a critical component of the regulatory examination
process. CRA examination results and related concerns have been cited as a
reason to reject and or modify branching and merger applications by various
federal and state banking agencies. Formation of a financial holding company
under the GLB Act is also dependent of the maintenance of a "satisfactory" CRA
rating. Management of BCB and PNB believe that BCB and PNB are currently in
compliance with all CRA requirements.
Customer Information Security. The Federal Reserve Board, the FDIC and other
bank regulatory agencies have adopted final guidelines (the "Guidelines") for
safeguarding nonpublic personal information about customers. Among other things,
the Guidelines require each financial institution, under the supervision and
ongoing oversight of its Board of Directors, to create a comprehensive written
information security program designed to ensure the security and confidentiality
of customer information, protect against any anticipated threats or hazards to
the security or integrity of such information; and protect against unauthorized
access to or use of such information that could result in substantial harm or
inconvenience to any customer.
Privacy. The FDIC and other regulatory agencies have published final privacy
rules pursuant to provisions of the GLB Act ("Privacy Rules"). The Privacy
Rules, which govern the treatment of nonpublic personal information about
consumers by financial institutions, require a financial institution to provide
notice to customers (and other consumers in some circumstances) about its
privacy policies and practices, describe the conditions under which a financial
institution may disclose nonpublic personal information to nonaffiliated third
parties and provide a method for consumers to prevent a financial institution
from disclosing that information to most nonaffiliated third parties by
"opting-out" of that disclosure, subject to certain exceptions.
USA Patriot Act. The USA Patriot Act of 2001 (the "Patriot Act"), designed to
deny terrorists and others the ability to obtain anonymous access to the United
States financial system, has significant implications for depository
institutions, brokers, dealers and other businesses involved in the transfer of
money. The Patriot Act, together with the implementing regulations of various
federal regulatory agencies, requires financial institutions to implement
additional policies and procedures with respect to, or additional measures
designed to address, any or all of the following matters, among others: money
laundering; suspicious activities and currency transaction reporting; and
currency crimes. The Patriot Act also permits information sharing for
counter-terrorist purposes between federal law enforcement agencies and
financial institutions, as well as among financial institutions, subject to
certain conditions, and require the Federal Reserve Board (and other federal
banking agencies) to evaluate the effectiveness of an applicant in combating
money laundering activities when considering applications filed under Section 3
of the BHC Act or the Bank Merger Act. Management believes that we are currently
in compliance with all currently effective requirements prescribed by the
Patriot Act and all applicable final implementing regulations.
Government Monetary Policy. The Company's banking subsidiaries are affected by
the credit policies of monetary authorities, including the Federal Reserve
Board. An important function of the Federal Reserve Board is to regulate the
national supply of bank credit. Among the instruments of monetary policy used by
the Federal Reserve Board are open market operations in U. S. Government
securities, changes in the discount and fed funds rates, reserve requirements on
member bank deposits, and funds availability regulations. The monetary policies
of the Federal Reserve Board have in the past had a significant effect on the
operations of financial institutions, including the Company and its
subsidiaries, and will continue to do so in the future. Changing conditions in
the national economy and money markets, as well as the impact of actions by
monetary and fiscal authorities, make it difficult to predict the effect of
future changes in interest rates, deposit levels or loan demand on the business
and income of the Company and its subsidiaries.
Competition
The banking industry in the United States, which includes commercial banks,
savings and loan associations, mutual savings banks, capital stock savings
banks, credit unions, and bank and savings and loan holding companies, is part
of the broader financial services industry which includes insurance companies,
mutual funds, and the brokerage industry, among others. In recent years, intense
market demands and economic pressures have eroded once clearly defined industry
classifications and have forced financial services institutions to diversify
their services, increase returns on deposits, and become more cost effective as
a result of competition with one another and with new types of financial
services companies, including non-bank competitors.
The Company's banking subsidiaries face significant competition in their
respective markets from commercial banks, savings banks, credit unions, consumer
finance companies, insurance companies, "non-bank banks," mutual funds,
government agencies, investment management companies, investment advisors,
brokers and investment bankers. In addition, increasing consolidation within the
banking and financial services industry, as well as increased competition from
larger regional and out-of-state banking organizations and non-bank providers of
various financial services, may adversely affect the Company's ability to
achieve its financial goals. Federal banking laws permit adequately capitalized
bank holding companies to venture across state lines to offer banking services
through bank subsidiaries to a wider geographic market. Consequently, it is
possible for large organizations to enter many new markets including the markets
served by the Company. Certain of these competitors, by virtue of their size and
resources, may enjoy certain efficiencies and competitive advantages over the
Company in pricing, delivery, and marketing of their products and services. The
Company's long-term success depends on the ability of the Company's banking
subsidiaries to compete successfully with other financial institutions in their
service areas. It is not possible to assess what impact these changes in the
regulatory environment will have on the Company. Many of these large competitors
have significantly more financial resources, larger market share and greater
name recognition in the market areas served by the Company and its banking
subsidiaries.
BCB and PNB compete in this environment by providing a broad range of financial
services, competitive interest rates and a personal level of service that,
combined, tend to retain the loyalty of its customers in its market areas
against competitors with far larger resources. To a lesser extent, convenience
of branch locations and hours of operations are also considered competitive
advantages of the Banks.
Risk Factors
The discussions set forth below contain certain statements that may be
considered "forward-looking statements." Forward-looking statements involve
unknown risks, uncertainties and other factors that may cause the Company's
actual results to materially differ from those projected in the forward-looking
statements. For further information regarding forward-looking statements, you
should review the discussion under the caption "FORWARD-LOOKING STATEMENTS" on
page 1 of this report.
The Company could be adversely impacted by changes in applicable regulations.
The Company is subject to extensive federal and state laws and regulations and
is subject to supervision, regulation and examination by various federal and
state bank regulatory agencies. The restrictions imposed by such laws and
regulations limit the manner in which the Company and its bank subsidiaries may
conduct business and obtain financing. There can be no assurance that any
modification of these laws and regulations, or new legislation that may be
enacted, in the future will not make compliance more difficult or expensive,
restrict the Company's ability to originate, broker or sell loans or otherwise
adversely affect the operations of the Company. See "Supervision and Regulation"
on page 4 of this report.
The Company's business is largely dependent upon the hospitality industry. A
number of the Company's loan customers are in the hospitality industry. The
hospitality industry is dependent on personal discretionary spending levels.
Consequently, the hospitality industry has been adversely impacted by current
negative economic trends, including recession and increased unemployment.
Additionally, unforeseen events, such as political instability, including the
potential war with Iraq, increases in fuel prices, travel-related accidents and
unusual weather patterns also may adversely affect the hospitality industry. As
a result, the Company's business also is likely to be affected by those events.
Interest rate volatility may adversely impact the Company's results of
operations. The principal components of the Company's income stream are net
interest and dividend income. Net interest and dividend income is the difference
between interest and fee income on earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities, such
as deposits and borrowed funds. The Company's net interest and dividend income
may be significantly affected by changes in market interest rates, which are
currently at historically low levels. A decrease in interest rates could reduce
the Company's net interest and dividend income as the difference between
interest and fee income and interest expense decreases. An increase in interest
rates could also negatively impact the Company's results of operations by
reducing borrowers' ability to repay their current loan obligations, resulting
in increased loan defaults, foreclosures and write-offs and may necessitate
increases to the Company's allowance for loan losses. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7 of this report.
The Company's allowance for loan losses may not be adequate to cover actual
losses. The Company makes various assumptions and judgments about the
collectibility of its loan portfolio and provides an allowance for potential
loan losses based on several factors. If the Company's assumptions are wrong,
its allowance for loan losses may be insufficient to cover its actual losses,
which would have an adverse effect on the Company's results of operations, and
may cause the Company to increase the allowance in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7 of this report.
Changes in the securities market may adversely impact the Company's results of
operations. The securities market has experienced a significant downturn and
will likely continue to experience significant volatility as a result of, among
other things, world economic and political conditions. Continued declines in
equity prices, as well as declines in the performance of certain sectors or
specific companies, may result in a corresponding decline in the value of
Company-held securities. The decline in the value of Company-held securities may
decrease the Company's earnings. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Item 7 of this report.
Employees
As of December 31, 2002 the Company and its subsidiaries had approximately 269
full-time equivalent employees. The Company considers its employee relations to
be good.
ITEM 2. PROPERTIES
The Company operates 21 branch offices and one loan origination facility that
are located in the central and northern New Hampshire communities of Berlin,
Conway (four offices), Gorham (two offices), Groveton, Littleton, West Ossipee,
West Plymouth, Plymouth, Campton, Ashland, North Woodstock, Tilton (two
offices), Franklin, Laconia, Belmont, Pittsfield and Concord. Fourteen of these
offices, including its main offices in Berlin, New Hampshire and Plymouth, New
Hampshire, are located on properties the Company owns. The Company leases seven
of its branches and the loan origination facility under five-year leases
expiring between June 28, 2003 and December 31, 2008. Seventeen of the Company's
branches have drive-up facilities and twenty are equipped with automated teller
machines.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor are any of its subsidiaries the subject of,
any material pending legal proceedings, other than ordinary routine litigation
incidental to the business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock is traded on The Nasdaq Stock Market, Inc.'s National
Market under the symbol "NWFI." The following table sets forth, for the periods
indicated, the high and low closing sale prices for the common stock, as
reported by The Nasdaq National Market, and the dividends paid on the common
stock:
Price Per Share
--------------------- Dividends
Low High Per Share
------ ----- -----------
2002 4th Quarter $26.18 $31.50 $0.17
3rd Quarter 27.75 29.90 0.17
2nd Quarter 28.15 30.00 0.17
1st Quarter 27.50 29.40 0.17
2001 4th Quarter $27.25 $29.75 $0.17
3rd Quarter 25.75 30.95 0.17
2nd Quarter 23.50 30.00 0.17
1st Quarter 22.88 24.19 0.17
The Company intends to continue to pay dividends on a quarterly basis subject
to, among other things, the financial condition and earnings of the Company,
capital requirements, and other factors, including applicable governmental
regulations. No dividends will be payable unless declared by the Board of
Directors and then only to the extent funds are legally available for the
payment of such dividends.
On March 3, 2003, the closing sales price of the common stock on the Nasdaq
National Market was $29.26 per share. As of such date, there were approximately
1,302 holders of record of the Company common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth the selected consolidated financial information
of the Company for the five years in the period ended December 31, 2002. This
selected consolidated financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing under Item 7 of this report and "Financial Statements and
Supplementary Data" appearing under Item 8 of this report.
At or for the years ended December 31, 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Balance Sheet Data:
Total assets $598,318 $513,939 $485,144 $462,552 $403,972
Securities available-for-sale 91,397 55,564 50,288 51,542 48,529
Securities held-to-maturity -- -- 2,752 5,151 6,509
Loans, net of unearned income 442,152 400,316 393,258 372,766 283,826
Allowance for loan losses 4,920 4,642 4,354 4,887 4,404
Other real estate owned 175 22 25 115 158
Unidentifiable intangible assets -- 8,080 5,098 1,271 860
Goodwill 10,152 -- -- -- --
Core deposit intangible 4,857 -- -- -- --
Deposits (1) 476,194 412,840 391,772 343,029 350,921
Securities sold under agreements to repurchase 8,251 8,155 9,390 7,468 6,791
Stockholders' equity 44,266 43,339 41,562 39,286 40,956
Income Statement Data:
Net interest and dividend income $ 21,664 $ 20,721 $ 21,253 $ 19,342 $ 17,536
Provision for loan losses 900 900 980 540 540
Noninterest income 3,376 2,909 2,692 2,718 2,063
Noninterest expense 20,035 17,149 16,699 15,794 12,955
Net income 2,598 3,873 4,159 3,764 4,068
Per Common Share Data:
Net income - basic $ 1.71 $ 2.55 $ 2.61 $ 2.25 $ 2.35
Net income - assuming dilution 1.71 2.54 2.61 2.25 2.35
Cash dividends declared 0.68 0.68 0.60 0.56 0.42
Book value 29.19 28.68 26.74 24.32 23.67
Tangible book value 19.07 23.16 23.41 23.54 23.18
Selected Ratios:
Return on average assets 0.49% 0.78% 0.86% 0.90% 1.06%
Return on average equity 5.86 9.14 10.29 9.37 10.25
Dividend payout 39.65 26.54 22.96 25.03 17.90
Average equity to average assets 8.33 8.58 8.31 9.62 10.35
(1) 1998 includes a short-term money market deposit of $14,500.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of this discussion is to focus on significant changes in the
financial condition and results of operations of the Company and its
subsidiaries. It is intended to supplement and highlight information contained
in the accompanying consolidated financial statements and the selected financial
data presented elsewhere in this report. The discussions set forth below contain
certain statements that may be considered "forward-looking statements."
Forward-looking statements involve risks, uncertainties and other factors that
may cause the Company's actual results to materially differ from those projected
in the forwarding-looking statements. For further information regarding
forward-looking statements, you should review the discussion under the caption
"FORWARD-LOOKING STATEMENTS" on page 1 of this report.
OVERVIEW OF PERFORMANCE
The Company and its Bank subsidiaries derive substantially all of their revenue
and income from furnishing bank and bank-related services, principally to
individuals and small and medium sized companies in New Hampshire. The Banks
operate as typical community banking institutions and do not engage in any
specialized finance or capital market activities. Northway functions primarily
as the holder of stock of its subsidiaries and assists the management of its
subsidiaries as appropriate.
The Company reported net income of $2,598,000, or $1.71 per common share, in
2002 compared to net income of $3,873,000, or $2.55 per common share, in 2001
and $4,159,000, or $2.61 per common share, in 2000. Return on average equity was
5.86 percent in 2002, compared to 9.14 percent in 2001 and 10.29 percent for
2000. Return on average assets was 0.49 percent in 2002, compared to 0.78
percent and 0.86 percent for 2001 and 2000, respectively.
During the year 2002, the Company continued the implementation of its growth
initiatives with the purchase of three branches located in Laconia, Belmont and
Pittsfield, New Hampshire. Also during 2002 the Company installed technology
totaling approximately $1,700,000 including a wide-area network, a voice over
internet protocol telephone system, a new on-line teller system, document
imaging and computer upgrades. The Company also made increases to staff during
the year, most notably in the lending area. In addition, the sustained weakness
of the equity market and the impact it had on certain holdings of the Company's
equity securities resulted in net losses on sale of equity securities of
$410,000 and write-downs of equities of $910,000. Costs associated with the
expansion of our branch network, new technology and personnel resulted in
increased noninterest expense which, when added to the loss on sale of equity
securities and the write-down of equity securities, caused a decline in 2002
earnings as compared to 2001.
During 2001, the Company purchased a branch location in Littleton, New
Hampshire, completed construction of a new branch location in Tilton, New
Hampshire and moved its existing Tilton branch into this location. During 2000,
the Company purchased a branch in West Ossipee, New Hampshire. These investments
resulted in increased noninterest expense which, when added to the decline in
net interest income associated with the rapidly declining interest rate
environment, caused a decline in 2001 earnings as compared to 2000.
NET INTEREST AND DIVIDEND INCOME ANALYSIS
Net interest and dividend income is the principal component of a financial
institution's income stream and represents the difference, or spread, between
interest and fee income generated from earning assets and the interest expense
paid on deposits and borrowed funds. Fluctuations in interest rates as well as
changes in volume and mix of earning assets and interest-bearing liabilities can
materially impact net interest and dividend income. The discussion of net
interest and dividend income is presented on a taxable equivalent basis, unless
otherwise noted, to facilitate performance comparisons among various taxable and
tax-exempt assets.
The table on page 13, entitled "Consolidated Average Balances, Interest and
Dividend Income/Expense and Average Yields/Rates," presents average balances,
income earned or interest paid, and average yields earned or rates paid on major
categories of assets and liabilities for the years ended December 31, 2002,
2001, and 2000.
Net interest and dividend income for 2002 increased $822,000, or 4 percent, over
2001 while decreasing $435,000, or 2 percent, in 2001 over 2000.
Interest and dividend income decreased $3,653,000, or 10 percent, in 2002
compared to 2001. The continued decline in market interest rates caused a 1.24
percent decrease in the yield on average earning assets. A 1.19 percent decrease
in the yield on loans was partially offset by an increase in average loan
balances of $13,829,000. This resulted in a net decrease of $3,736,000, or 12
percent, in interest and fees on loans. Federal funds sold income decreased
$157,000 as a decrease in average yield of 1.67 percent was partially offset by
a $5,175,000 increase in the average balance. This was partially offset by an
increase in interest and dividend income on securities of $241,000, which was
the result of an increase in average balances of $13,580,000 partially offset by
a decrease in average yield of 0.86 percent.
Interest expense decreased $4,475,000, or 31 percent, in 2002 compared to 2001.
The decrease in net interest expense was due primarily to a 1.33 percent
decrease in rates paid on interest bearing liabilities partially offset by an
increase in average balances of $30,482,000. The increase in average balances is
the result of the addition of guaranteed preferred beneficial interest in junior
subordinated debentures issued by the Company's Delaware statutory business
trusts, Northway Capital Trust I and Northway Capital Trust II, with an average
balance of $11,299,000 as well as an increase in average interest bearing
deposit balances of $19,539,000 associated primarily with the branches acquired
in the fourth quarter of 2002.
Interest and dividend income decreased $2,199,000, or 6 percent, in 2001
compared to 2000. A rapidly declining rate environment caused a 0.52 percent
decrease in the yield on average earning assets. A 0.48 percent decrease in the
yield on loans that was partially offset by an increase in average loan balances
of $3,525,000, resulted in a $1,582,000, or 5 percent, decrease in interest and
fees on loans. Interest and dividend income on securities decreased $556,000, or
14 percent. This decrease resulted from a 12 percent decrease in the average
balance of securities as well as a 0.21 percent decline in the yield.
Interest expense decreased $1,764,000, or 11 percent, in 2001 compared to 2000.
The decrease in interest expense was due primarily to a 0.48 percent decrease in
rates paid on interest bearing liabilities, partially offset by an increase in
average interest bearing liabilities of $2,503,000, or 1 percent. A decrease of
$25,785,000, or 37 percent, in the average balance of Federal Home Loan Bank
("FHLB") advances, coupled with a decrease in the rate on such advances of 0.35
percent, resulted in a decrease in interest expense on FHLB advances of
$1,698,000. In addition, rates paid on deposit liabilities declined 0.32 percent
resulting in a decrease in interest expense of $1,054,000. These changes were
partially offset by an increase in average interest bearing deposits of
$26,538,000, or 9 percent, which increased interest expense by $1,168,000.
The trend in net interest and dividend income is commonly evaluated in terms of
average rates using net interest margin and interest rate spread. The net
interest margin is computed by dividing fully taxable equivalent net interest
and dividend income by average total earning assets. This ratio represents the
difference between the average yield returned on average earning assets and the
average rate paid for all funds used to support those earning assets, including
both interest bearing and noninterest bearing sources of funds. The net interest
margin decreased 0.14 percent to 4.42 percent in 2002 after having decreased
0.11 percent to 4.56 percent in 2001. The decrease in 2002's net interest margin
was a direct result of the decrease in the yield on earning assets, which was
only partially offset by the decrease in the cost of funds. The portion of
interest earning assets funded by interest bearing liabilities rose to 85
percent in 2002 compared to 84 percent in both 2001 and 2000.
The interest rate spread measures the difference between the average yield on
earning assets and the average rate paid on interest bearing liabilities. The
interest rate spread eliminates the impact of noninterest bearing funds and
gives a direct perspective on the effect of interest rate movements. During
2002, the net interest rate spread increased 0.09 percent to 4.07 percent as the
cost of interest bearing liabilities decreased 1.33 percent while the yield on
earning assets declined 1.24 percent. During 2001, the net interest rate spread
decreased 0.04 percent to 3.98 percent as the yield on earning assets declined
0.52 percent while the cost of interest bearing liabilities decreased 0.48
percent.
See the accompanying schedules entitled "Consolidated Average Balances, Interest
and Dividend Income/Expense and Average Yields/Rates" and "Consolidated
Rate/Volume Variance Analysis" for more information.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents the annual cost of providing an
allowance for losses inherent in the loan portfolio. The size of the provision
for each year is dependent upon many factors, including loan growth, net
charge-offs, changes in the composition of the loan portfolio, delinquencies,
management's assessment of loan portfolio quality, the value of collateral and
general economic factors.
The Company made a $900,000 provision for loan losses in 2002, which provision
was unchanged from 2001. The 2001 provision of $900,000 was $80,000 lower than
2000's provision of $980,000. The provision for each of the three years was
based upon the Company's judgment regarding the adequacy of the coverage ratio
and level of portfolio risk.
Although management utilizes its best judgment in providing for losses, there
can be no assurance that the Company will not have to change its provisions for
loan losses in subsequent periods. Management will continue to monitor the
allowance for loan losses and make additional provisions to the allowance as
appropriate.
CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND AVERAGE YIELDS/RATES
($000 Omitted)
For the Year Ended December 31,
2002 2001 2000
-------------------------- -------------------------- --------------------------
Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
-------- -------- ---- -------- -------- ---- -------- -------- ----
Assets
Interest earning assets:
Federal funds sold $ 18,971 $ 271 1.43% $ 13,796 $ 428 3.10% $ 7,374 $ 480 6.51%
Interest bearing deposits 225 2 0.89 109 3 2.75 262 12 4.58
Securities (1) (2) 67,714 3,520 5.20 54,134 3,279 6.06 61,555 3,835 6.27
Loans, net (1) (3) 408,793 27,941 6.83 394,964 31,677 8.02 391,439 33,259 8.50
-------- -------- -------- -------- -------- --------
Total interest earning assets(1) 495,703 31,734 6.40 463,003 35,387 7.64 460,630 37,586 8.16
-------- -------- -------- -------- -------- --------
Cash and due from banks 14,597 13,529 13,045
Allowance for loan losses (4,794) (4,481) (4,417)
Premises and equipment, net 12,064 11,283 10,531
Other assets 14,607 10,811 6,577
-------- -------- --------
Total assets $532,177 $494,145 $486,366
======== ======== ========
Liabilities
Interest bearing liabilities:
Regular savings $ 70,559 712 1.01 $ 62,596 992 1.58 $ 65,438 1,254 1.92
NOW and super NOW 66,742 273 0.41 56,326 359 0.64 52,888 447 0.85
Money market accounts 54,676 894 1.64 38,232 1,111 2.91 26,670 1,000 3.75
Certificates of deposit 163,013 4,650 2.85 178,297 8,862 4.97 163,917 8,649 5.28
Securities sold under
agreements to
repurchase 8,165 136 1.67 10,990 469 4.27 9,240 509 5.51
FHLB advances 46,701 2,508 5.37 44,232 2,500 5.65 70,017 4,198 6.00
Guaranteed preferred
beneficial interest
in junior subordinated
debentures 11,299 645 5.71 -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total interest bearing liabilities 421,155 9,818 2.33 390,673 14,293 3.66 388,170 16,057 4.14
-------- -------- --------
Noninterest bearing deposits 64,513 57,621 53,275
Other liabilities 2,177 3,474 4,508
-------- -------- --------
Total liabilities 487,845 451,768 445,953
Stockholders' equity 44,332 42,377 40,413
-------- -------- --------
Total liabilities and
stockholders' equity $532,177 $494,145 $486,366
======== ======== ========
Net interest and dividend income (1) $ 21,916 $ 21,094 $ 21,529
======== ======== ========
Interest rate spread (4) 4.07% 3.98% 4.02%
Net interest margin (5) 4.42% 4.56% 4.67%
(1) Reported on a tax equivalent basis.
(2) Average balances are calculated using the adjusted cost basis.
(3) Net of unearned income. Includes nonperforming loans.
(4) Interest rate spread equals the yield on interest earning assets minus the rate paid on interest bearing liabilities.
(5) The net interest margin equals net interest income divided by total average interest earning assets.
CONSOLIDATED RATE/VOLUME VARIANCE ANALYSIS
($000 Omitted)
2002 Compared to 2001 2001 Compared to 2000
Increase (Decrease) Increase (Decrease)
Due to Change In Due to Change In
--------------------------------- ---------------------------------
Volume Rate Mix Total Volume Rate Mix Total
------ ------ ------ ------ ------ ------ ------ ------
Interest and dividend income:
Federal funds sold $ 161 $ (231) $ (87) $ (157) $ 418 $ (251) $ (219) $ (52)
Interest bearing deposits 3 (2) (2) (1) (7) (5) 3 (9)
Securities 823 (465) (117) 241 (462) (107) 13 (556)
Loans 1,109 (4,681) (164) (3,736) 300 (1,865) (17) (1,582)
------ ------ ------ ------ ------ ------ ------ ------
Total interest and dividend income 2,096 (5,379) (370) (3,653) 249 (2,228) (220) (2,199)
------ ------ ------ ------ ------ ------ ------ ------
Interest expense:
Regular savings 126 (360) (46) (280) (54) (217) 9 (262)
NOW and super NOW 67 (129) (24) (86) 29 (110) (7) (88)
Money market accounts 478 (486) (209) (217) 434 (225) (98) 111
Certificates of deposit (760) (3,776) 324 (4,212) 759 (502) (44) 213
Securities sold under agreements
to repurchase (121) (286) 74 (333) 97 (115) (22) (40)
FHLB advances 140 (125) (7) 8 (1,546) (241) 89 (1,698)
Guaranteed preferred beneficial
interest in junior
subordinated debentures 645 -- -- 645 -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------
Total interest expense 575 (5,162) 112 (4,475) (281) (1,410) (73) (1,764)
------ ------ ------ ------ ------ ------ ------ ------
Net interest and dividend income $1,521 $ (217) $ (482) $ 822 $ 530 $ (818) $ (147) $ (435)
====== ====== ====== ====== ====== ====== ====== ======
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities, including fee-based services and income
earned through securities sales.
The following table sets forth the components of the Company's noninterest
income:
($000 Omitted)
Years Ended December 31,
--------------------------------
2002 2001 2000
----- ------ ------
Service charges and fees on deposit accounts $1,473 $1,169 $1,049
Securities gains, net 151 128 512
Loan servicing income 365 401 130
Other 1,387 1,211 1,001
------ ------ ------
Total noninterest income $3,376 $2,909 $2,692
====== ====== ======
Fee income from service charges on deposit accounts increased 26 percent in
2002, 11 percent in 2001 and 12 percent in 2000. The improvement in 2002 is due
principally to the introduction of new overdrawn account procedures and fee
schedules introduced in January 2002 as well as the impact of the branch
purchases during the fourth quarter 2002. The improvements in 2001 and 2000 were
due to an increased number of deposit accounts as a result of branch purchases
and openings during those years as well as a product and fee standardization
effort completed during the year 2000.
Net gains on sales of securities were $151,000 in 2002 compared to $128,000 in
2001 and $512,000 in 2000. Securities gains in 2002 included net losses of
$410,000 on sales of equity securities compared to net gains of $55,000 in 2001
and $512,000 in 2000. Net gains on the sales of debt securities totaled $561,000
in 2002 compared to $73,000 in 2001 and none in 2000.
Loan servicing income consists of income from the servicing of Federal Home Loan
Mortgage Corporation ("FHLMC") mortgage loans and indirect installment loans as
well as the net income recognized from the creation and amortization of
servicing assets under Statement of Financial Accounting Standards ("SFAS") 140.
During 2002, the Company recognized $365,000 in loan servicing income compared
to $401,000 in 2001 and $130,000 in 2000. The $36,000 decrease in 2002 loan
servicing income is due to a decrease in income recognized under SFAS 140 and a
reduction in servicing income on indirect loans partially offset by an increase
in FHLMC servicing income. In 2001, the increase in loan servicing income is
directly attributable to the increase in the volume of loans serviced for
others.
Other noninterest income (sources of which include gains on sale of loans, debit
card interchange fees, credit card merchant and fee income, automated teller
machine fees and safe deposit fees) increased $176,000, or 15 percent, to
$1,387,000 in 2002 following an increase of $210,000, or 21 percent, to
$1,211,000 in 2001. Other noninterest income decreased $21,000, or 2 percent, to
$1,001,000 in 2000.
NONINTEREST EXPENSE
Total noninterest expense increased $2,886,000, or 17 percent, during 2002
following an increase of $450,000, or 3 percent, during 2001 and $905,000, or 6
percent, in 2000. The increase to expenses during 2002 is due in large part to
the $910,000 write-down of equity securities, expenses related to the
acquisition of three branches during the fourth quarter, staff upgrades and
technology initiatives. During 2001 and 2000, expenses increased due to the
Company's initiatives to standardize product offerings at the subsidiary banks,
to increase market share in existing markets and enter new markets. In 2001 the
Company acquired a branch in Littleton, New Hampshire and completed construction
of a new branch location in Tilton, New Hampshire. In 2000 the Company acquired
a branch in West Ossipee, New Hampshire. In 1999 two branches were opened and an
indirect lending group began operations.
The following table sets forth information relating to the Company's noninterest
expense during the periods indicated:
($000 Omitted)
Years Ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Salaries and employee benefits $ 9,758 $ 9,014 $ 8,868
Office occupancy and equipment 3,298 2,864 2,708
Amortization of unidentifiable intangible assets -- 625 513
Amortization of core deposit intangible 476 -- --
Write-down of equity securities available-for-sale 910 -- --
Professional fees 1,096 886 1,073
Stationery and supplies 596 486 605
Telephone 505 283 287
Postage and shipping 378 323 286
ATM expense 366 352 322
Other 2,652 2,316 2,037
------- ------- -------
Total noninterest expense $20,035 $17,149 $16,699
======= ======= =======
Salaries and employee benefits increased $744,000, or 8 percent, from 2001 to
2002, $146,000, or 2 percent from 2000 to 2001, and $420,000, or 5 percent, from
1999 to 2000. These increases reflect staff additions in connection with the
expansion of the retail franchise, increased lending activities and normal
salary and wage increases. The expansion initiatives as well as the technology
improvements implemented during 2002 caused occupancy and equipment expense to
increase $434,000, or 15 percent, from 2001 to 2002. In addition, retail
expansion accounted for the $155,000, or 6 percent, increase in occupancy and
equipment from 2000 to 2001 and the $167,000, or 7 percent, from 1999 to 2000.
Amortization of unidentifiable intangible assets and amortization of core
deposit intangible, net, decreased $149,000 from 2001 to 2002. On October 1,
2002, the Company adopted SFAS 147 which resulted in a decrease of amortization
expense of $281,000 over the prior year which was partially offset by the
recording of $132,000 of amortization of core deposit intangible associated with
the fourth quarter branch acquisitions. Amortization of unidentifiable
intangible assets increased $113,000, or 22 percent during 2001. This increase
was due to the Littleton branch acquisition on October 26, 2001 as well as a
full year of amortization on the branch purchased in West Ossipee during 2000.
This increase was partially offset by the completion of amortization in July
2001 of branches acquired in 1994. During 2000 amortization of unidentifiable
intangible assets increased $156,000, or 44 percent due to the West Ossipee
branch acquisition on August 25, 2000 as well as incurring a full year of
amortization on the branches acquired in 1999.
INCOME TAX EXPENSE
The Company recognized $1,507,000, $1,708,000 and $2,107,000 in income tax
expense for the years ended December 31, 2002, 2001 and 2000, respectively. The
effective tax rate was 36.2 percent for 2002, 30.6 percent for 2001 and 33.6
percent for 2000. The increase in the effective tax rate in 2002 over both 2001
and 2000 is due to the fact that, during 2001 and 2000, the Company had obtained
a number of State of New Hampshire tax credits related to economic development
grants. In addition, the 2001 tax rate as compared to 2000 was reduced by the
increased level of municipal income. This was partially offset by a 50 basis
point increase in the Business Profits Tax. For additional information relating
to income taxes, see Note 15 to the Consolidated Financial Statements.
ASSETS
Total assets increased $84,379,000, or 16 percent, to $598,318,000 at December
31, 2002 compared to $513,939,000 at December 31, 2001. The composition of
earning assets has continued to change in order to meet corporate goals.
BALANCE SHEET HIGHLIGHTS
($000 Omitted)
Years Ended December 31,
------------------------------
2002 2001 Change
--------- ----------- ---------
Total assets $598,318 $513,939 $ 84,379
Earning assets 548,980 470,482 78,498
Securities 96,109 60,276 35,833
Loans, net of unearned income 442,152 400,316 41,836
Deposits 476,194 412,840 63,354
Stockholders' equity 44,266 43,339 927
SECURITIES AVAILABLE-FOR-SALE
The Company's securities are classified into one of two categories based on
management's intent to hold the securities: (i) "held-to-maturity" securities,
or (ii) securities "available-for-sale." Securities designated to be
held-to-maturity are reported at amortized cost. Securities classified as
available-for-sale are required to be reported at fair value with unrealized
gains and losses, net of taxes, excluded from earnings and shown separately as a
component of stockholders' equity.
The following table summarizes the Company's securities portfolio at December
31, 2002 and 2001, showing amortized cost and market value for each category:
($000 Omitted)
December 31,
--------------------------------------
2002 2001
------------------ ------------------
Amortized Market Amortized Market
Cost Value Cost Value
--------- ------- --------- -------
Securities available-for-sale:
US Treasury and US government agencies $36,167 $36,188 $10,969 $10,977
Mortgage-backed securities 7,286 7,476 13,810 13,744
Collateralized mortgage obligations 5,103 5,170 7,317 7,353
Marketable equity securities 3,163 2,377 4,358 3,255
Corporate bonds 33,407 33,848 14,167 14,230
State and political subdivisions 6,154 6,338 5,907 6,005
------- ------- ------- -------
Total securities available-for-sale $91,280 $91,397 $56,528 $55,564
======= ======= ======= =======
Total securities increased $35,833,000 during 2002 to $91,397,000. On January 1,
2001, the Company elected, in conjunction with the adoption of SFAS No. 133, to
transfer all securities held-to-maturity to the available-for-sale category at
their market value.
The net unrealized gain on securities available-for-sale was $117,000 at
December 31, 2002 compared to a net unrealized loss on securities
available-for-sale of $964,000 at December 31, 2001. At December 31, 2002, the
net unrealized gain on debt securities totaled $903,000, which was partially
offset by a net unrealized loss on marketable equity securities of $786,000. The
net unrealized gain on debt securities is primarily the result of the low rate
environment during 2002, which resulted in an appreciation in value of existing
debt holdings. The net unrealized loss on marketable equity securities is
primarily the result of the weak equity market during 2002.
Due to the sustained overall weakness in the equity market as well as
significant declines in certain sectors and specific companies within those
sectors, the Company determined, through the evaluations described in Note 1 to
the Consolidated Financial Statements, that the market values of certain of its
marketable equity securities were other than temporarily impaired. As a result,
during 2002 net losses on sales of marketable equity securities amounted to
$410,000 and write-downs of marketable equity securities amounted to $910,000.
At December 31, 2002, the Company's investment in equity securities totaled
$2,377,000. This amount is net of a market value adjustment of $786,000, of
which the full amount was reflected in accumulated other comprehensive loss in
shareholders' equity.
The Company has a general policy of purchasing debt securities primarily rated A
or better by Moody's Investor Services and U.S. government securities to
minimize credit risk. However, a corporate bond with an amortized cost of
$987,000 and a fair value of $660,000 was downgraded by both Moody's and
Standard & Poor's during 2002. This bond is being carried at fair value and
continues to perform in accordance with its original terms. All securities,
however, carry interest rate risk, which affect their market values such that as
market yields increase, the value of the Company's securities decline and vice
versa. Additionally, mortgage-backed securities carry prepayment risk whereby
expected yields may not be achieved due to the inability to reinvest proceeds
from prepayment at comparable yields. Moreover, such mortgage-backed securities
may not benefit from price appreciation in periods of declining rates to the
same extent as the remainder of the portfolio.
A portion of the securities portfolio is pledged to secure public deposits,
short-term securities sold under agreements to repurchase and treasury, tax and
loan accounts. Refer to Note 3 to the Consolidated Financial Statements for a
further discussion of pledging.
LOANS
Loans increased 10 percent in 2002 as all categories of loans, with the
exception of other loans, recognized increases, with the greatest increases
occurring in residential real estate, installment loans and indirect installment
loans. The following table presents the composition of the loan portfolio as of
December 31, 2002 and 2001:
($000 Omitted)
Percent Percent
2002 of Total 2001 of Total
-------- -------- -------- --------
Real estate:
Residential $114,526 25.9% $109,261 27.3%
Commercial 111,941 25.3 111,642 27.9
Construction 6,330 1.4 1,581 0.4
Commercial 23,885 5.4 22,727 5.7
Installment 40,169 9.1 28,210 7.0
Indirect installment 139,477 31.5 120,761 30.1
Other 6,031 1.4 6,303 1.6
-------- ----- -------- -----
$442,359 100.0% $400,485 100.0%
======== ===== ======== =====
The loan portfolio mix continued to change during the year. Indirect installment
loans, which are fixed-rate loans secured by automobiles originated through
automobile dealers with an average term of 60 months, now comprise 31.5 percent
of the loan portfolio versus 30.1 percent at the end of 2001. In addition the
purchase of installment loans as a result of the branch acquisitions increased
installment loans as a percent of the total portfolio. Residential real estate
loans declined to 25.9 percent of the portfolio from 27.3 percent at December
31, 2001; and commercial real estate loans declined to 25.3 percent of the
portfolio from 27.9 percent at December 31, 2001. The Company wishes to maintain
a balanced portfolio and is working to maintain a portfolio mix of approximately
30 percent residential real estate loans, 33-35 percent commercial loans, and
35-37 percent installment and other loans.
Commercial real estate loans consist of loans secured by income producing
commercial real estate and commercial loans consist of loans that are either
unsecured or are secured by inventories, receivables or other corporate assets,
and many are additionally secured by a guarantee of the Small Business
Administration. Commercial real estate and commercial loans increased by
$1,457,000 in 2002 as compared to 2001. The Company continues to emphasize
commercial real estate and commercial loans in order to enhance earnings and
maintain the balance of its portfolio.
Residential real estate loans increased by $5,265,000 in 2002, a 5 percent
increase from 2001, compared to a decrease of $20,544,000, or 16 percent, in
2001 as compared to 2000. The Company originates both fixed-rate and
adjustable-rate residential loans for its portfolio. Some fixed-rate residential
loans are originated for sale to investors in the secondary market. The increase
in residential real estate loans in 2002 resulted primarily from the Company's
decision to retain a greater percentage of fixed-rate residential mortgage
loans.
Installment loans consist primarily of loans originated directly by the Company,
however, as part of the Laconia, Belmont and Pittsfield branch acquisitions the
Company purchased installment loans totaling approximately $18,102,000. As a
result of these acquired loans, installment loans balances increased a net of
$11,959,000 compared to 2001. Indirect installment loans increased by
$18,716,000, or 15 percent, in 2002.
NONPERFORMING ASSETS
Nonperforming assets were $3,892,000, or 0.65 percent of total assets, at
December 31, 2002 compared to $1,519,000, or 0.30 percent of total assets, at
December 31, 2001, an increase of $2,373,000, or 156 percent. This increase was
due primarily to the addition to nonperforming status of a large commercial
credit totaling $1,625,000. In addition, nonaccrual mortgage loans increased
over the prior year.
Nonperforming assets are comprised primarily of nonaccrual loans, other chattels
owned and real estate acquired by foreclosure or a similar conveyance of title.
The accrual of interest on a loan is discontinued when there is reasonable doubt
as to its collectibility or whenever the payment of principal or interest is
more than 90 days past due. However, there are loans within this nonaccrual
classification that provide periodic payments, but which have a weakness with
respect to the collateral securing the loan.
At December 31, 2002, nonaccrual loans totaled $3,619,000, or 0.82 percent of
total loans, compared to $1,392,000, or 0.35 percent of total loans, in 2001.
Other real estate owned at December 31, 2002 was $175,000 compared to $22,000 at
December 31, 2001.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan losses to absorb losses inherent in
the existing loan portfolio. When a loan, or portion thereof, is considered
uncollectible, it is charged against the allowance. Recoveries of amounts
previously charged-off are added to the allowance when collected. The adequacy
of the allowance for loan losses is evaluated on a regular basis by management.
Factors considered in evaluating the adequacy of the allowance include previous
loss experience, current economic conditions and their effect on borrowers and
the market area in general, and the performance of individual credits in
relation to the contract terms. The provision for loan losses charged to
earnings is based on management's judgment of the amount necessary to maintain
the allowance at a level adequate to absorb losses. In addition various
regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of the Company's allowance for loan losses.
The Company's allowance for loan losses increased $278,000 from December 31,
2001 to $4,920,000, or 1.11 percent of total loans, at December 31, 2002. The
2002 provision for loan losses was $900,000, unchanged from the prior year.
The following table sets forth the composition of the allowance for loan losses
for the periods indicated:
($000 Omitted)
Years Ended December 31,
-------------------------------
2002 2001 2000
------- ------- -------
Beginning allowance $ 4,642 $ 4,354 $ 4,887
Provision for loan losses 900 900 980
Loans charged-off (824) (734) (1,643)
Recoveries of loans previously charged-off 202 122 130
------- ------- -------
Net charge-offs (622) (612) (1,513)
------- ------- -------
Ending allowance $ 4,920 $ 4,642 $ 4,354
======= ======= =======
Allowance as a percentage of loans
outstanding 1.11% 1.16% 1.11%
Allowance as a percentage of nonperforming
loans 135.95 333.48 454.96
Net charge-offs as a percentage of average
loans 0.15 0.15 0.39
DEPOSITS AND BORROWINGS
Total deposits at December 31, 2002 were $476,194,000, an increase of
$63,354,000, or 15 percent, compared to $412,840,000 at December 31, 2001. The
increase in deposits was due primarily to the acquisition of three branches in
October 2002, which netted the Company additional deposits of approximately
$54,932,000.
The following table sets forth the components of deposits for the periods
indicated:
($000 Omitted)
December 31,
-------------------
2002 2001
-------- --------
Demand $ 71,759 $ 62,846
Regular savings, NOW and money market 232,892 177,392
Time 171,543 172,602
-------- --------
Total deposits $476,194 $412,840
======== ========
At December 31, 2002, time deposits of $100,000 or more are scheduled to mature
as follows:
($000 Omitted)
3 months or less $ 7,106
Over 3 to 6 months 3,596
Over 6 to 12 months 9,648
Over 12 months 5,363
--------
$ 25,713
========
At December 31, 2002 short-term borrowings consisted of securities sold under
agreements to repurchase of $8,251,000 compared to $8,155,000 for 2001.
Long-term debt consisted solely of FHLB term advances of $46,000,000 compared to
$48,028,000 in 2001. Many of the long-term term advances, however, are callable
quarterly with call dates in February and March 2003. The decrease in FHLB
advances is the result of maturing advances partially offset by one new advance.
See Notes 9 and 10 to the Consolidated Financial Statements for additional
information.
The following table sets forth certain information concerning the Company's
borrowings at the dates indicated:
($000 Omitted)
December 31,
-------------------------
2002 2001
------- ---------
Short-term borrowings $ 8,251 $ 8,155
Long-term debt 46,000 48,028
------- -------
$54,251 $56,183
======= =======
GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES
During April and July 2002 the Company completed the private placement of
$7,000,000 and $13,000,000, respectively, of floating rate trust preferred
securities due in 2032. These trust preferred securities were offered for the
purpose of providing capital to the subsidiary banks to ensure adequate capital
following the recent branch acquisitions and for general corporate purposes. As
of December 31, 2002, $9,463,000 qualified as Tier 1 capital and $10,537,000 was
allocated to Tier 2 capital.
CAPITAL
The Company's stockholders' equity serves to support growth and provide
depositors and other creditors protection against loss. Equity capital
represents the stockholders' investment in the Company. Management strives to
maintain an optimal level of capital on which an attractive return to the
stockholders will be realized over both the short-term and long-term, while
serving depositors' and creditors' needs.
The Company must also observe the minimum requirements enforced by the federal
banking regulators. There are three capital requirements that banks and bank
holding companies must meet: Tier 1 capital, total capital (combination of Tier
1 capital and Tier 2 capital), and leverage (Tier 1 capital to average assets)
ratios. Tier 1 capital consists of stockholders' equity, net of intangible
assets as well as a portion of capital securities. Tier 2 capital consists of a
limited amount of allowance for loan losses and the portion of capital
securities not allocated to Tier 1 capital. Tier 1 capital, total capital and
leverage ratios do not include any adjustments for unrealized gains and losses
relating to securities available-for-sale except net unrealized losses relating
to marketable equity securities. The minimum requirements for the leverage
ratio, risk-based Tier 1 capital and risk-based total capital are 4 percent, 4
percent and 8 percent, respectively. As of December 31, 2002, the subsidiary
banks of the Company were "well capitalized" as defined under FDIC regulations.
The following table sets forth the Company's risk-based capital and leverage
ratios:
($000 Omitted)
December 31,
------------------------
2002 2001
-------- --------
Risk-adjusted assets $445,281 $386,941
Tier 1 capital (to average assets) 6.70% 6.95%
Tier 1 capital (to risk weighted assets) 8.57 9.08
Total capital (to risk weighted assets) 12.04 10.28
Total stockholders' equity includes a $1,366,000 and $585,000 negative
adjustment for accumulated other comprehensive loss, net of tax, at December 31,
2002 and 2001, respectively. At December 31, 2002, this adjustment was comprised
of a net unrealized loss on securities available-for-sale of $240,000, net of
taxes, and an unfunded pension accumulated benefit obligation of $1,126,000, net
of taxes. The net unrealized loss on securities available-for-sale is
attributable to the downturn in the securities market. While the Company
continues to contribute the maximum amount permitted by law to its pension plan,
the discount rate used to calculate the future value of such contribution and
the poor asset performance of investment securities has resulted in the unfunded
pension accumulated benefit obligation.
The Company intends to continue to pay dividends on a quarterly basis subject to
the financial condition and earnings of the Company, capital requirements, and
other factors, including applicable governmental regulations. No dividends will
be payable unless declared by the Board of Directors and then only to the extent
funds are legally available for the payment of such dividends.
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices, such as interest rates, foreign currency
exchange rates, commodity prices and equity prices. The Company's primary market
risk exposure is interest rate risk. The ongoing monitoring and management of
this risk is an important component of the Company's asset/liability management
process which is governed by policies established by the Company's Boards of
Directors that are reviewed and approved annually. The Board of Directors
delegates responsibility for carrying out the asset/liability management
policies to Company's management Asset Liability Committee ("ALCO"). In this
capacity ALCO develops guidelines and strategies impacting the Company's
asset/liability management-related activities based upon estimated market risk
sensitivity, policy limits and overall market interest rate levels/trends.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change, the interest income and interest
expenses associated with the Company's financial instruments also change,
thereby impacting net interest income ("NII"), the primary component of the
Company's earnings. ALCO utilizes the results of a detailed and dynamic
simulation model to quantify the estimated exposure of NII to sustained interest
rate changes. While ALCO routinely monitors simulated NII sensitivity over a
rolling 2-year horizon, it also utilizes additional tools to monitor potential
longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all interest-earning
assets and interest-bearing liabilities reflected on the Company's balance
sheet. The Company uses computer simulations to determine the impact on net
interest income of various interest rate scenarios, balance sheet trends and
strategies. These simulations incorporate assumptions about balance sheet
dynamics such as loan and deposit growth, loan and deposit pricing, changes in
funding mix, and asset and liability repricing and maturity characteristics.
Simulations based on numerous assumptions are run under various interest rate
scenarios to determine the impact on net interest income and capital. From these
scenarios, interest rate risk is quantified and appropriate strategies are
developed and implemented.
This sensitivity analysis is compared to ALCO policy limits which specify a
maximum tolerance level for NII exposure over a 1-year horizon given both an
immediate 200 basis point upward and downward shift in interest rates. Using an
immediate rate shock simulation where interest rates increase 200 basis points,
the December 31, 2003 earnings simulation model projects that net interest
income for the next twelve months would increase by an amount equal to
approximately 0.72 percent. In addition, utilizing an immediate rate shock
simulation where interest rates decrease 200 basis points, the December 31, 2003
earnings simulation model projects that net interest income for the next twelve
months would decrease by an amount equal to approximately 9.21 percent.
Using an immediate rate shock simulation where interest rates increase 200 basis
points, the December 31, 2002 earnings simulation model projected that net
interest income for the following twelve months would increase by an amount
equal to approximately 4.24 percent. In addition, utilizing an immediate rate
shock simulation where interest rates decrease 200 basis points, the December
31, 2002 earnings simulation model projected that net interest income for the
following twelve months would decrease by an amount equal to approximately 4.86
percent.
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including,
among others, the nature and timing of interest rate levels, yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, and reinvestment/replacement of asset and liability
cashflows The assumptions differed in each of the periods included in the
sensitivity analysis above. While assumptions are developed based upon current
economic and local market conditions, the Company cannot make any assurances as
to the predictive nature of these assumptions, including how customer
preferences or competitor influences might change.
The most significant factors affecting the changes in market risk exposure
during 2002 compared to 2001 were the decrease in interest rates market-wide,
changes in the yield curve for investment securities, the increase in the
aggregate principal amount in fixed-rate loans extended by the subsidiary banks,
the aggregate increase in securities available-for-sale, and increase in total
deposits, as well as the increase in floating rate subordinated debentures.
LIQUIDITY RISK
Liquidity risk management involves the Company's and its subsidiaries' ability
to raise funds in order to meet their existing and anticipated financial
obligations. These obligations are the withdrawal of deposits on demand or at
contractual maturity, the repayment of debt as it matures, the ability to fund
new and existing loan commitments and the ability to take advantage of new
business opportunities. Liquidity may be provided through amortization, maturity
or sale of assets such as loans and securities available-for-sale, liability
sources such as increased deposits, utilization of the FHLB credit facility,
purchased or other borrowed funds, and access to the capital markets. Liquidity
targets are subject to change based on economic and market conditions and are
controlled and monitored by the Company's Asset/Liability Committee. At the bank
level, liquidity is managed by measuring the net amount of marketable assets
after deducting pledged assets, plus lines of credit, primarily with the FHLB,
which are available to fund liquidity requirements. Management then measures the
adequacy of that aggregate amount relative to the aggregate amount of
liabilities deemed to be sensitive or volatile. These include brokered deposits,
deposits in excess of $100,000, term deposits with short maturities, and credit
commitments outstanding.
Additionally, the parent holding company requires cash for various operating
needs including dividends to shareholders, the purchase of treasury stock,
capital injections to the subsidiary banks, and the payment of general corporate
expenses. The primary sources of liquidity for the parent holding company are
dividends from the subsidiary banks and reimbursement for services performed on
behalf of the banks. Additionally, the parent holding company may utilize
outside sources of funding such as the trust preferred issues undertaken during
2002.
As shown in the consolidated statements of cash flows, cash and cash equivalents
decreased by $2,215,000 during 2002. Cash used for investing activities totaled
$80,734,000 with lending activities utilizing $43,516,000 and investment
purchases utilizing $35,757,000. Cash provided by financing activities totaled
$73,127,000. This cash consisted of $47,527,000 from a branch acquisition,
$20,000,000 from the issuance of guaranteed preferred beneficial interest in
junior subordinated debentures, as well as an increase in other deposits of
$8,422,000. The net cash provided by operating activities totaled $5,392,000 and
consisted primarily of net income of $2,598,000 as well as a decrease in loans
held for-sale partially offset by an increase in other assets and other
liabilities, net.
CAPITAL EXPENDITURES AND COMMITMENTS
During 2002, the Company incurred approximately $2,628,000 in capital
expenditures. These expenditures included approximately $1,700,000 in technology
improvements including installation of a wide-area network, a voice over
internet protocol telephone system, a new on-line teller system, document
imaging and computer upgrades. In addition, $430,000 was recorded for the
purchase of real estate in Laconia, New Hampshire as part of the recent branch
acquisition. The remaining expenditures were for normal maintenance and
replacement of, or upgrades in, existing property and equipment.
During 2001, the Company incurred approximately $1,714,000 in capital
expenditures. These expenditures included $947,000 of construction and equipment
costs for the branch constructed in Tilton, New Hampshire. Approximately
$388,000 was spent on technology initiatives, including Internet banking and
cash management as well as a down-payment for technology initiatives to be
completed in 2002. The remaining expenditures were for normal maintenance and
replacement of, or upgrades in, existing property and equipment.
The Company's estimated capital expenditure projections for 2003 total $710,000.
The Company has budgeted approximately $145,000 for ATM replacement and upgrades
and $115,000 for software purchases for indirect lending to improve workflow.
The remaining expenditures will be incurred for normal maintenance and
replacement of, or upgrades to, existing property and equipment. These
expenditures are expected to be funded through normal Company cashflows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market risk
is included in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing under Item 7 of this report and is hereby
incorporated by reference in this Item 7A.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY MATERIAL
CONSOLIDATED STATEMENTS OF INCOME
($000 Omitted, Except Per Share Data)
FOR THE YEAR ENDED DECEMBER 31, 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $27,879 $31,587 $33,145
Interest on debt securities available-for-sale:
Taxable 2,781 2,169 2,971
Tax-exempt 308 485 249
Dividends 241 342 453
Interest on federal funds sold 271 428 480
Interest on interest bearing deposits 2 3 12
- ------------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 31,482 35,014 37,310
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense
Interest on deposits:
Regular savings, NOW and money market deposit accounts 1,878 2,462 2,701
Certificates of deposit (in denominations of $100,000 or more) 703 1,363 1,259
Other time 3,947 7,499 7,390
Interest on short-term borrowings 141 513 1,819
Interest on long-term debt 2,504 2,456 2,888
Interest on guaranteed preferred beneficial interest in junior subordinated debentures 645 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total interest expense 9,818 14,293 16,057
- ------------------------------------------------------------------------------------------------------------------------------
Net interest and dividend income 21,664 20,721 21,253
Provision for loan losses 900 900 980
- ------------------------------------------------------------------------------------------------------------------------------
Net interest and dividend income after provision for loan losses 20,764 19,821 20,273
- ------------------------------------------------------------------------------------------------------------------------------
Noninterest income
Service charges and fees on deposit accounts 1,473 1,169 1,049
Gains on sales of securities available-for-sale, net 151 128 512
Loan servicing income 365 401 130
Other 1,387 1,211 1,001
Total noninterest income 3,376 2,909 2,692
Noninterest expense
Salaries and employee benefits 9,758 9,014 8,868
Office occupancy and equipment 3,298 2,864 2,708
Amortization of core deposit intangible 476 -- --
Amortization of unidentifiable intangible assets