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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, 2003
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-23129
NORTHWAY FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
New Hampshire 04-3368579
------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9 Main Street
Berlin, New Hampshire 03570
--------------------- -----
Address of principal executive offices (Zip Code)
(603) 752-1171 (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. [X]
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 30, 2003
was 1,291,891 shares with an aggregate market value, computed by reference to
the last reported sales price on the NASDAQ National Market on such date, of
$38,550,027. 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 24, 2004, there were 1,499,574 shares of common stock
outstanding, par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2004 Annual Meeting of
Stockholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of
Part III.
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NORTHWAY FINANCIAL, INC.
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1 Business ...................................................... 1
ITEM 2 Properties .................................................... 10
ITEM 3 Legal Proceedings ............................................. 11
ITEM 4 Submission of Matters to a Vote of Security Holders ........... 11
PART II
ITEM 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ............. 11
ITEM 6 Selected Financial Data ....................................... 12
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations ..................................... 13
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk .... 27
ITEM 8 Financial Statements and Supplementary Data ................... 28
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ...................................... 59
ITEM 9A Controls and Prcedures ........................................ 59
PART III
ITEM 10 Directors and Executive Officers of the Registrant ............ 59
ITEM 11 Executive Compensation ........................................ 59
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters .................... 59
ITEM 13 Certain Relationships and Related Transactions ................ 60
ITEM 14 Principal Accountant Fees and Services ........................ 60
ITEM 15 Exhibits, Financial Statement Schedules and Reports on
Form 8-K ...................................................... 60
Signatures ................................................ 61
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 (the "Company", see description of business below). 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, The Pemigewasset National Bank of Plymouth, New Hampshire, 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 derives substantially all of its revenue and income from the
furnishing of bank and bank-related services, principally to individuals and
small and medium sized companies in New Hampshire. BCB and PNB 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. 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 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 as of December 31, 2003, 2002 and 2001 (dollars in
thousands):
2003 2002 2001
------- ------- -------
US Treasury and other
US government agency securities $37,840 $36,188 $10,977
Mortgage-backed securities(1) 2,903 12,646 21,097
Marketable equity securities 2,766 2,377 3,255
Corporate bonds 21,983 33,848 14,230
State and political subdivision bonds
and notes 8,224 6,338 6,005
------- ------- -------
Total securities $73,716 $91,397 $55,564
======= ======= =======
(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, 2003
(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 $ - $25,023 $12,922 $ - $37,945
Mortgage-backed
securities (1) 62 1,090 1,220 446 2,818
Corporate bonds 1,805 14,584 4,468 - 20,857
State and political
subdivision bonds and
notes 196 220 3,274 4,376 8,066
------ ------- ------- ------ -------
Total amortized cost $2,063 $40,917 $21,884 $4,822 $69,686
====== ======= ======= ====== =======
Market value $2,097 $41,828 $22,177 $4,848 $70,950
====== ======= ======= ====== =======
Weighted average yield 5.44% 4.48% 4.96% 7.44% 4.86%
(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,
2003, 2002, 2001, 2000 and 1999 (dollars in thousands):
December 31,
----------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Real estate:
Residential $129,493 $114,526 $109,261 $129,805 $139,389
Commercial 120,366 111,941 111,642 100,608 93,061
Construction 3,851 6,330 1,581 5,752 4,360
Commercial 24,528 23,885 22,727 22,270 28,833
Installment 30,291 40,169 28,210 28,177 24,147
Indirect installment 150,807 139,477 120,761 98,919 75,781
Other 8,896 6,031 6,303 7,881 7,369
-------- -------- -------- -------- --------
Total loans 468,232 442,359 400,485 393,412 372,940
Less:
Unearned income 247 207 169 154 174
Allowance for loan losses 5,036 4,920 4,642 4,354 4,887
-------- -------- -------- -------- --------
Total unearned income
and allowance
for loan losses 5,283 5,127 4,811 4,508 5,061
-------- -------- -------- -------- --------
Net loans $462,949 $437,232 $395,674 $388,904 $367,879
======== ======== ======== ======== ========
The following table presents the maturity distribution of the Company's real
estate construction and commercial loans at December 31, 2003 (dollars in
thousands):
Percent of
Amount Total
Within one year $ 10,917 38.47%
One to five years 8,922 31.44
Over five years 8,540 30.09
------- ------
$28,379 100.00%
======= ======
The Company's real estate construction and commercial loans due after one year
at December 31, 2003 were comprised of the following (dollars in
thousands):
Amount
Fixed interest rate $ 7,311
Adjustable interest rate 10,151
-------
$17,462
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, 2003, 2002, 2001, 2000 and 1999
(dollars in thousands):
Years ended December 31,
----------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Balance at the beginning of
period $4,920 $4,642 $4,354 $4,887 $4,404
Charge-offs:
Real estate - 83 110 213 159
Commercial 120 12 95 1,006 25
Installment loans to
individuals 750 729 529 424 120
Credit card - - - - -
Other - - - - -
------ ------ ------ ------ ------
Total 870 824 734 1,643 304
------ ------ ------ ------ ------
Recoveries:
Real estate 25 64 35 32 213
Commercial 11 4 - - 21
Installment loans to
individuals 145 134 87 96 12
Credit card - - - 2 1
Other - - - - -
------ ------ ------ ------ ------
Total 181 202 122 130 247
------ ------ ------ ------ ------
Net charge-offs 689 622 612 1,513 57
Provision charged to expense 805 900 900 980 540
------ ------ ------ ------ ------
Balance at the end of period $5,036 $4,920 $4,642 $4,354 $4,887
====== ====== ====== ====== ======
Ratio of net charge-offs to
average loans 0.15% 0.15% 0.15% 0.39% 0.02%
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,
---------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------------- ---------------------- ---------------------- ------------------- ------------------
Percent of Percent of Percent of Percent of Percent of
of loans of loans of loans of loans of loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Commercial $ 155 5.2% $ 216 5.4% $ 208 5.7% $ 719 5.7% $ 530 7.7%
Real estate:
Commercial &
construction 1,724 26.5 2,008 26.7 1,621 28.3 1,009 27.0 1,773 26.1
Residential 624 27.7 598 25.9 585 27.2 1,160 32.9 503 37.3
Installment 2,505 38.7 2,084 40.6 1,719 37.2 1,440 32.4 1,125 26.9
Other 28 1.9 14 1.4 17 1.6 26 2.0 60 2.0
Unallocated - N/A - N/A 492 N/A - N/A 896 N/A
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$5,036 100.0% $4,920 100.0% $4,642 100.0% $4,354 100.0% $4,887 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
DEPOSITS
See "Financial Statements and Supplementary Data" in Item 8 of this report.
SUPERVISION AND REGULATION
The business in which the Company is engaged is subject to extensive
supervision, regulation and examination by various bank regulatory authorities
and other governmental agencies. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, and depositors in particular,
rather than the specific protection of stockholders of a bank or its parent
company.
Set forth below is a brief description of certain laws and regulations that
relate to the regulation of the Company. To the extent the following material
describes statutory or regulatory provisions, it is qualified in its entirety
by reference to the particular statute or regulation.
Regulation of the Company
General. As a registered bank holding company, the Company is subject to
regulation under the Bank Holding Company Act of 1956, as amended, ("BHCA") and
to inspection, examination and supervision by the Board of Governors of the
Federal Reserve System, ("FRB"). The Company is also subject to the laws of the
State of New Hampshire.
The FRB 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 FRB. The FRB is also empowered to
assess civil money penalties against companies or individuals who violate the
BHCA 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. Under the BHCA, the Company may not generally engage in
activities or acquire more than 5% of any class of voting securities of any
company engaged in activities other than banking or activities that are closely
related to banking. However, if the Company elects to be treated as a financial
holding company, the Company may engage in activities that are financial in
nature or incidental or complimentary to such financial activities, as
determined by the FRB and the Secretary of the Department of the Treasury. The
Company has not elected financial holding company status. Under certain
circumstances, the Company may be required to give notice to or seek approval
of the FRB before engaging in activities other than banking.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"). Riegle-Neal permits adequately capitalized and adequately
managed bank holding companies, as determined by the FRB, to acquire banks in
any state subject to certain concentration limits and other conditions.
Riegle-Neal also generally authorizes the interstate merger of banks. In
addition, among other things, Riegle-Neal permits banks to establish new
branches on an interstate basis provided that the law of the host state
specifically authorizes such action. However, as a bank holding company, we are
required to obtain prior FRB approval before acquiring more than 5% of a class
of voting securities, or substantially all of the assets of a bank holding
company, bank or savings association.
Control Acquisitions. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company, such as
the Company, unless the FRB has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the FRB, the
acquisition of 10% or more of a class of voting securities of a bank holding
company with a class of securities registered under Section 12 of the
Securities Exchange Act of 1934, as amended, would, under the circumstances set
forth in the presumption, constitute acquisition of control of the bank holding
company. In addition, a company is required to obtain the approval of the FRB
under the BHCA before acquiring 25% (5% in the case of an acquirer that is a
bank holding company) or more of any class of outstanding voting securities of
a bank holding company, or otherwise obtaining control or a "controlling
influence" over that bank holding company.
Bank Holding Company Dividends. The FRB has authority to prohibit bank holding
companies from paying dividends if such payment is deemed to be an unsafe or
unsound practice. The FRB has indicated generally that it may be an unsafe or
unsound practice for bank holding companies to pay dividends unless the bank
holding company's net income over the preceding year is sufficient to fund the
dividends and the expected rate of earnings retention is consistent with the
organization's capital needs, asset quality and overall financial condition.
The Company depends in part upon dividends received from its subsidiary banks
to fund its activities, including the payment of dividends. As described below,
the Federal Deposit Insurance Corporation ("FDIC") and the Banks' regulatory
agencies may regulate the amount of dividends payable by the subsidiary banks.
The inability for the bank to pay the dividend may have an adverse effect on
the Company.
Regulation of the Banks
General. 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 FRB 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 Gramm-Leach-Bliley Act (1999) ("GLBA"), 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 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 FRB regarding bank holding
companies as described above.
Insurance of Accounts and FDIC Regulation. The Banks pay deposit insurance
premiums to the FDIC based on an assessment rate established by the FDIC for
Bank Insurance Fund-member institutions. The FDIC has established a risk-based
premium system under which the FDIC classifies institutions based on their
capital ratios and on other relevant factors and generally assesses higher
rates on those institutions that tend to pose greater risks to the federal
deposit insurance funds. The Federal Deposit Insurance Act ("FDIA") does not
require the FDIC to charge all banks deposit insurance premiums when the ratio
of deposit insurance reserves to insured deposits is maintained above specified
levels. However, as a result of general economic conditions and bank failures,
it is possible that the ratio of deposit insurance reserves to insured deposits
could fall below the minimum ratio that FDIA requires, which would result in
the FDIC setting deposit insurance assessment rates sufficient to increase
deposit insurance reserves to the required ratio. We cannot predict whether the
FDIC will be required to increase deposit insurance assessments above their
current levels.
Bank Holding Company Support of Subsidiary Banks. Under FRB policy, a bank
holding company is expected to act as a source of financial and managerial
strength to each of its subsidiary banks and to commit resources to their
support. This support may be required at times when the bank holding company
may not have the resources to provide it. Similarly, under the cross-guarantee
provisions of FDIA, the FDIC can hold any FDIC-insured depository institution
liable for any loss suffered or anticipated by the FDIC in connection with (1)
the "default" of a commonly controlled FDIC-insured depository institution; or
(2) any assistance provided by the FDIC to a commonly controlled FDIC-insured
depository institution "in danger of default." Both BCB and PNB are
FDIC-insured depository institutions.
Regulatory Capital Requirements. The FRB and the FDIC have issued substantially
similar risk-based and leverage capital guidelines applicable to United States
banking organizations. In addition, these regulatory agencies may from time to
time require that a banking organization maintain capital above the minimum
levels, whether because of its financial condition or actual or anticipated
growth.
The FRB risk-based guidelines define a three-tier capital framework. Tier 1
capital includes common stockholders' equity and qualifying preferred stock,
less goodwill and other adjustments. Tier 2 capital consists of preferred stock
not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts
of subordinated debt, other qualifying term debt and the allowance for loan
losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes
subordinated debt that is unsecured, fully paid, has an original maturity of at
least two years, is not redeemable before maturity without prior approval by
the FRB and includes a lock-in clause precluding payment of either interest or
principal if the payment would cause the issuing bank's risk-based capital
ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier
2 capital less investments in unconsolidated subsidiaries represents qualifying
total capital. Risk-based capital ratios are calculated by dividing Tier 1 and
total capital by risk-weighted assets. Assets and off-balance sheet exposures
are assigned to one of four categories of risk-weights, based primarily on
relative credit risk. The minimum Tier 1 capital ratio is four percent and the
minimum total capital ratio is eight percent. The Company's tier 1 calculation
equals 9.66% and its total capital ratio is 12.81%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average
total assets. Although the stated minimum ratio is 100 to 200 basis points
above three percent, banking organizations are required to maintain a ratio of
at least five percent to be classified as well capitalized. The Company's
leverage ratio is 7.22%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
among other things, identifies five capital categories for insured depository
institutions (well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized) and requires
the federal bank regulatory agencies to implement systems for "prompt
corrective action" for insured depository institutions that do not meet minimum
capital requirements within such categories. FDICIA imposes progressively more
restrictive constraints on operations, management and capital distributions,
depending on the category in which an institution is classified. Failure to
meet the capital guidelines could also subject a banking institution to capital
raising requirements. An "undercapitalized" bank must develop a capital
restoration plan and its parent holding company must guarantee that bank's
compliance with the plan. The liability of the parent holding company under any
such guarantee is limited to the lesser of five percent of the bank's assets at
the time it became "undercapitalized" or the amount needed to comply with the
plan. Furthermore, in the event of the bankruptcy of the parent holding
company, such guarantee would take priority over the parent's general unsecured
creditors. In addition, FDICIA requires the various regulatory agencies to
prescribe certain non-capital standards for safety and soundness relating
generally to operations and management, asset quality and executive
compensation and permits regulatory action against a financial institution that
does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations
that define the five capital categories identified by FDICIA, using the total
risk-based capital, Tier 1 risk-based capital and leverage capital ratios as
the relevant capital measures. Such regulations establish various degrees of
corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 risk-based capital ratio of at least six percent, a total
risk-based capital ratio of at least ten percent and a leverage ratio of at
least five percent and not be subject to a capital directive order. Regulators
also must take into consideration (a) concentrations of credit risk; (b)
interest rate risk (when the interest rate sensitivity of an institution's
assets does not match the sensitivity of its liabilities or its
off-balance-sheet position); and (c) risks from non-traditional activities, as
well as an institution's ability to manage those risks, when determining the
adequacy of an institution's capital. This evaluation will be made as a part of
the institution's regular safety and soundness examination. In addition, the
Company, and any Bank with significant trading activity, must incorporate a
measure for market risk in their regulatory capital calculations. As of
December 31, 2003, the most recent notification from the FDIC categorized both
Banks as well capitalized.
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, including changes (such as those relating to lending to registered
broker-dealers) that are of particular relevance to banks, such as the Banks,
that engage in significant securities activities. Among other things, the Basel
Committee rules, which were proposed formally for public comment in May 2003
and are expected to become effective around early 2007, would add operational
risk as a third component to the denominator of the risk-capital calculation,
which currently includes only credit and market risks.
Limitations on Bank Dividends. The FDIC has the authority to use its
enforcement powers to prohibit a bank from paying dividends if, in its opinion,
the payment of dividends would constitute an unsafe or unsound practice.
Federal law also prohibits the payment of dividends by a bank that will result
in the bank failing to meet its applicable capital requirements on a pro forma
basis.
The Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
lenders to identify the communities served by the institution's offices and
other deposit taking facilities and to make loans and investments and provide
services that meet the credit needs of these communities. Regulatory agencies
examine each of the banks and rate such institutions' compliance with CRA as
"Outstanding", "Satisfactory", "Needs to Improve" or "Substantial
Noncompliance". Failure of an institution to receive at least a "Satisfactory"
rating could inhibit such institution or its holding company from undertaking
certain activities, including engaging in activities newly permitted as a
financial holding company under the GLBA and acquisitions of other financial
institutions. The FRB must take into account the record of performance of banks
in meeting the credit needs of the entire community served, including low-and
moderate-income neighborhoods. New Hampshire also has enacted substantially
similar community reinvestment requirements. PNB has achieved a rating of
outstanding and BCB a rating of satisfactory on their most recent examinations.
Customer Information Security. The FDIC and other bank regulatory agencies have
adopted guidelines for establishing standards for safeguarding nonpublic
personal information about customers that implement provisions of GLBA, which
establishes a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the BHCA framework. Specifically, the
Information Security Guidelines established by the GLBA require each financial
institution, under the supervision and ongoing oversight of its board of
directors or an appropriate committee thereof, to develop, implement and
maintain a comprehensive written information security program designed to
ensure the security and confidentiality of customer information, to protect
against anticipated threats or hazards to the security or integrity of such
information; and to protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to any
customer.
Privacy. The GLBA requires financial institutions to implement policies and
procedures regarding the disclosure of nonpublic personal information about
consumers to nonaffiliated third parties. In general, the statute requires
financial institutions to explain to consumers their policies and procedures
regarding the disclosure of such nonpublic personal information, and, unless
otherwise required or permitted by law, financial institutions are prohibited
from disclosing such information except as provided in their policies and
procedures.
USA PATRIOT Act. The USA PATRIOT Act of 2001 (The "USA PATRIOT Act"), designed
to deny terrorists and others the ability to obtain anonymous access to the
U.S. financial system, has significant implications for depository
institutions, broker-dealers and other businesses involved in the transfer of
money. The USA PATRIOT Act, together with the implementing regulations of
various federal regulatory agencies, have caused financial institutions,
including banks, to adopt and implement additional, or amend existing, policies
and procedures with respect to, among other things, anti-money laundering
compliance, suspicious activity and currency transaction reporting, customer
identity verification and customer risk analysis. The statute and its
underlying regulations also permit 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 FRB (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 BHCA or under the Bank
Merger Act. Management believes that the Company is in compliance with all the
requirements prescribed by the USA PATRIOT Act and all applicable final
implementing regulations.
The Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002 ("S-O Act") implements a
broad range of corporate governance and accounting measures for public
companies (including publicly-held bank holding companies such as the Company)
designed to promote honesty and transparency in corporate America and better
protect investors from corporate wrongdoings. The S-O Act's principal
provisions, many of which have been interpreted through regulations released in
2003, provide for and include, among other things:
o the creation of an independent accounting oversight board;
o auditor independence provisions which restrict non-audit services that
accountants may provide to their audit clients;
o additional corporate governance and responsibility measures, including the
requirement that the chief executive officer and chief financial officer of a
public company certify financial statements;
o the forfeiture of bonuses or other incentive-based compensation and profits
from the sale of an issuer's securities by directors and senior officers in
the twelve month period following initial publication of any financial
statements that later require restatement;
o an increase in the oversight of, and enhancement of certain requirements
relating to, audit committees of public companies and how they interact with
the company's independent auditors;
o requirements that audit committee members must be independent and are barred
from accepting consulting, advisory or other compensatory fees from the
issuer;
o requirements that companies disclose whether at least one member of the audit
committee is a `financial expert' (as such term is defined by the SEC) and if
not, why not;
o expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a prohibition on
insider trading during pension blackout periods;
o a prohibition on personal loans to directors and officers, except certain
loans made by insured financial institutions, such as the Banks, on
nonpreferential terms and in compliance with other bank regulatory
requirements;
o disclosure of a code of ethics and filing a Form 8-K for a change or waiver
of such code; and
o a range of enhanced penalties for fraud and other violations.
The Company has taken steps to comply with and anticipates that it will incur
additional expenses in continuing to comply with the provisions of the S-O Act
and its underlying regulations. Management believes that such compliance
efforts have strengthened the Company's overall corporate governance structure
and does not expect that such compliance has to date, or will in the future
have a material impact on the Company's results of operations or financial
condition.
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.
Recent accounting changes could give rise to adverse changes in the regulatory
capital treatment of junior subordinated debentures, including currently
outstanding junior subordinated debentures of the Company which, in turn, could
adversely affect the Company's regulatory capital position. In January 2003,
the Financial Accounting Standards Board ("FASB") issued FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN 46") that addresses
the consolidation rules to be applied to "variable interest entities" as
defined in FIN 46. FIN 46, which applies to certain variable interest entities
as of February 1, 2003 and to all variable interest entities as of December 14,
2003, provides that certain variable interest entities should not be treated as
consolidates subsidiaries. Northway Capital Trust I and Northway Capital Trust
II, the Company's Delaware statutory business trusts, may constitute variable
interest entities. Historically, issuer trusts, such as Northway Capital Trust
I and Northway Capital Trust II that issued junior subordinated debentures have
been consolidated by their parent companies. In addition, junior subordinated
debentures have been treated as eligible for Tier 1 capital treatment by bank
holding companies under the FRB's rules and regulations relating to minority
interests in equity accounts of consolidated subsidiaries. Accordingly, the
Company has consolidated its existing issuer trusts in preparing its
consolidated financial statements in the past, and the Company's outstanding
junior subordinated debentures have been treated as Tier 1 capital.
On December 24, 2003, FASB issued a revision to FIN 46 ("FIN46R"), to clarify
some of the provisions of FIN 46. Based on FIN46R, the Company deconsolidated
its existing issuer trusts as of December 31, 2003, and restated their
historical financial statements. The adoption of FIN46R results in the
reclassification of the redeemable junior subordinated debentures from
mezzanine capital to other liabilities as well as the reclassification of
interest cost from minority interest to interest expense.
This deconsolidation could result in a change to the regulatory capital
treatment of junior subordinated debentures issued by the Company and other
U.S. bank holding companies. Specifically, it is possible that since its issuer
trust would no longer be consolidated by the Company the junior subordinated
debentures issued by such issuer trust would not be considered a minority
interest in equity accounts of a consolidated subsidiary and therefore not be
accorded Tier 1 capital treatment by the FRB. The FRB has indicated in
supervisory letter SR 03-13, dated July 2, 2003 (the "Supervisory Letter"),
that junior subordinated debentures will be treated as Tier 1 capital until
notice is given to the contrary, but the Supervisory Letter also indicates that
the FRB will review the regulatory implications of any accounting treatment
changes and will provide further guidance if necessary or warranted.
If Tier 1 capital treatment were disallowed by the FRB, the Company would be
able to redeem its owner junior subordinated debentures, thereby causing a
mandatory redemption of capital securities pursuant to the terms and conditions
of the applicable governing documents. As of December 31, 2003, assuming it
were not allowed to include the junior subordinated debentures in Tier 1
Capital, the Company would still exceed the regulatory required minimums for
capital adequacy purposes.
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 5 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 including acts of terrorism, war, 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 adversely affected by those events.
Interest rate volatility may adversely impact the Company's results of
operations. The principal component of the Company's income stream is 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 could 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
incorrect, 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. In recent years the securities market has experienced a significant
downturn and will likely continue to experience 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, 2003 the Company has 266 full-time equivalent employees. The
Company considers its employee relations to be good.
WEBSITE ACCESS TO COMPANY REPORTS
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports are available
free of charge on the Company's website at www.northwayfinancialinc.com as soon
as reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission. Also, copies of the
Company's annual report will be made available, free of charge, upon written
request.
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 April 30, 2004 and December 31, 2008. Seventeen of the
Company's branches have drive-up facilities and all 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, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
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
2003 4th Quarter $29.99 $35.49 $0.17
3rd Quarter 29.10 30.97 0.17
2nd Quarter 28.01 30.65 0.17
1st Quarter 28.81 31.25 0.17
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
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 2, 2004, the closing sales price of the common stock on the Nasdaq
National Market was $35.65 per share. As of such date, there were approximately
1,300 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, 2003. 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, 2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Balance Sheet Data:
Total assets $609,216 $598,945 $513,939 $485,144 $462,552
Securities available-for-sale, at fair value 73,716 91,397 55,564 50,288 51,542
Securities held-to-maturity - - - 2,752 5,151
Loans, net of unearned income 467,985 442,152 400,316 393,258 372,766
Allowance for loan losses 5,036 4,920 4,642 4,354 4,387
Other real estate owned - 175 22 25 115
Unidentifiable intangible assets - - 8,080 5,098 1,271
Goodwill 10,152 10,152 - - -
Core deposit intangible 3,903 4,857 - - -
Deposits 463,307 476,194 412,840 391,772 343,029
Long-term debt 87,620 66,620 48,028 35,528 58,528
Stockholders' equity 47,872 44,266 43,339 41,562 39,286
Income Statement Data:
Net interest and dividend income $ 23,050 $ 21,664 $ 20,721 $ 21,253 $ 19,342
Provision for loan losses 805 900 900 980 540
Noninterest income 5,375 3,396 2,909 2,692 2,718
Noninterest expense 22,136 20,035 17,149 16,699 15,794
Net income 3,617 2,598 3,873 4,159 3,764
Per Common Share Data:
Net income - basic $ 2.40 $ 1.71 $ 2.55 $ 2.61 $ 2.25
Net income - assuming dilution 2.39 1.71 2.54 2.61 2.25
Cash dividends declared 0.68 0.68 0.68 0.60 0.56
Book value 31.92 29.19 28.68 26.74 24.32
Tangible book value 22.30 19.07 23.16 23.41 23.54
Selected Ratios:
Return on average assets 0.59% 0.49% 0.78% 0.86% 0.90%
Return on average equity 7.82 5.86 9.14 10.29 9.37
Dividend payout 28.28 39.65 26.54 22.96 25.03
Average equity to average assets 7.61 8.33 8.58 8.31 9.62
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. 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 discussion set forth below contains 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 derives substantially all of its revenue and income from community
bank-related activities. The Banks operate as typical community banking
institutions and do not engage in any specialized finance or capital markets
activities. Northway Financial, Inc. functions primarily as the holder of stock
of its subsidiaries and assists in the management of the operations of its
subsidiaries as appropriate.
The principal components of the Company's income sources are net interest and
dividend income. Net interest and dividend income is the difference between
interest and fee income received on income earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities,
such as deposits and borrowed funds. Our other sources of income include
revenues from fee-based services, such as debit card and ATM fees and sales of
securities.
Economic and industry factors that could cause the Company's financial
performance to differ from expected results include changes in applicable
federal and state regulations, changes in the hospitality industry on which the
Company's business is largely dependent, interest rate volatility, significant
changes in loan losses which may affect the Company's allowance for loan losses
and the related provision for loan losses, and changes in the securities market
that would affect the performance of the Company's investment portfolio.
Management evaluates each of these factors on an ongoing basis to determine
their impact and to effect any strategies necessary to mitigate these risks.
The Company reported net income of $3,617,000, or $2.40 per common share, in
2003 compared to net income of $2,598,000, or $1.71 per common share, in 2002
and $3,873,000, or $2.55 per common share, in 2001. Return on average equity
was 7.82% in 2002, compared to 5.86% in 2002 and 9.14% in 2001. Return on
average assets was 0.59% in 2003, compared to 0.49% in 2002 and 0.78% in 2001.
During 2003, the Company took advantage of the improved market conditions for
investment securities and realized securities gains totaling $1,522,000
compared to $151,000 for the prior year. The low interest rate environment
resulted in significant mortgage refinancing activity. The Company decided to
sell a portion of this loan volume in the secondary market based on our
underwriting standards. The result of these sales was an increase in gain on
sale of loans of $163,000 to $422,000 in 2003. The current low interest rate
environment also provided the Company an opportunity to reduce its average cost
of interest bearing liabilities by 0.59%. In addition, this rate environment
allowed the Company to increase its average outstanding borrowings at very
attractive rates and use the proceeds to fund increases in both average loans
and investments.
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 acquired and installed
technology the cost of which was 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 equity securities of $910,000.
Costs associated with the expansion of the Company's 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.
NET INTEREST AND DIVIDEND INCOME ANALYSIS
Fluctuations in interest rates as well as changes in volume and mix of income
earning assets and interest-bearing liabilities can materially impact net
interest and dividend income, the principal source of our 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 below under the caption "Consolidated Average Balances, Interest and
Dividend Income/Expense and Average Yields/Rates," presents the average
balances, income earned or interest paid, and average yields earned or rates
paid on our assets and liabilities for the years ended December 31, 2003, 2002,
and 2001.
Net interest and dividend income for 2003 increased $1,466,000, or 7%, over
2002. Interest and dividend income increased $85,000 in 2003 compared to 2002.
This was due to an increase in average earning assets of $66,200,000 which
increase was partially offset by a 0.74% decrease in the yield on average
earning assets. Interest and dividend income on securities increased $423,000
as an increase in average securities of $17,360,000 was partially offset by a
decrease in the average yield on securities of 0.56%. The increase in interest
and dividend income on securities was partially offset by a decrease in
interest income and fees on loans of $185,000 which decrease was primarily due
to a decrease in the average yield of 0.82% and was partially offset by an
increase in the average balance of $52,679,000. In addition, interest income on
federal funds sold decreased $153,000 as the average balance decreased
$3,818,000 and was accompanied by a decrease in the average yield of 0.65%.
Interest expense decreased $1,381,000, or 14%, in 2003 compared to 2002. The
decrease in net interest expense was due primarily to a 0.59% decrease in the
average rate paid on interest bearing liabilities partially offset by an
increase in average interest bearing liability balances of $65,798,000. The
decrease in the rate paid on interest bearing liabilities was a function of
both the acquisition of long-term debt at attractive rates as well as a
decision by management to lower rates on interest bearing deposits. The
increase in the average liability balance is the result of increases in average
FHLB advances of $16,570,000 as the Company took advantage of the current low
rate environment to borrow $28,000,000 in medium-term advances at an average
rate of 2.74%. Further, the average balance in junior subordinated debentures
increased $8,971,000 as a result of the inclusion of this debt, which was
issued during 2002, for the full 2003 fiscal year as compared to six months in
fiscal 2002. . Average interest bearing deposits increased $40,527,000 due
primarily to the fact that deposits acquired in October 2002 were recorded for
the full 2003 fiscal year. Average securities sold under agreements to
repurchase declined $270,000.
Net interest and dividend income for 2002 increased $802,000, or 4%, over 2001.
While net interest and dividend increased, interest and dividend income
decreased $3,653,000, or 10%, in 2002 compared to 2001. The continued decline
in market interest rates during 2002 resulted in a 1.24% decrease in the yield
on average earning assets. A 1.19% 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%, in interest and fees on loans. Federal
funds sold income decreased $157,000 as a decrease in average yield of 1.67%
was partially offset by a $5,175,000 increase in the average balance. The
decrease in interest and fees on loans 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%.
Interest expense decreased $4,455,000, or 31%, in 2002 compared to 2001. The
decrease in net interest expense was due primarily to a 1.33% decrease in rates
paid on interest bearing liabilities partially offset by an increase in average
balances of $30,832,000. The increase in average balances is the result of the
issuance of junior subordinated debentures by the Company's Delaware statutory
business trusts, Northway Capital Trust I and Northway Capital Trust II, with
an average balance of $11,649,000 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.
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 0.26% to 4.16% in 2003 after having decreased 0.14%
to 4.42% in 2002. The decrease in the net interest margin for 2003 was a direct
result of the decrease in the yield on earning assets, which decrease was only
partially offset by the decrease in the cost of funds. The portion of interest
earning assets funded by interest bearing liabilities increased to 87% in 2003
compared to 85% in 2002 and 84% in 2001.
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 fluctuations. During
2003, the net interest rate spread decreased 0.15% to 3.92% as the yield on
earning assets declined 0.74% and was only partially offset by a decrease in
the cost of interest bearing liabilities of 0.59%. During 2002, the net
interest rate spread increased 0.09% to 4.07% as the cost of interest bearing
liabilities decreased 1.33% while the yield on earning assets declined 1.24%.
See the tables below under the captions "Consolidated Average Balances,
Interest and Dividend Income/Expense and Average Yields/Rates" and
"Consolidated Rate/Volume Variance Analysis" for more information.
CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND AVERAGE YIELDS/RATES
($000 Omitted)
For the Year Ended December 31,
2003 2002 2001
------------------------------ --------------------------- ---------------------------
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 $ 15,153 $ 118 0.78% $ 18,971 $ 271 1.43% $ 13,796 $ 428 3.10%
Interest bearing deposits 224 2 0.89 225 2 0.89 109 3 2.75
Securities(1)(2) 85,074 3,943 4.64 67,714 3,520 5.20 54,134 3,279 6.06
Loans, net(3)(4) 461,472 27,756 6.01 408,793 27,941 6.83 394,964 31,677 8.02
-------- ------- -------- ------- -------- -------
Total interest earning
assets(5) 561,923 31,819 5.66 495,703 31,734 6.40 463,003 35,387 7.64
------- ------- -------
Cash and due from banks 14,907 14,597 13,529
Allowance for loan losses (4,983) (4,794) (4,481)
Premises and equipment, net 12,447 12,064 11,283
Other assets 23,753 14,960 10,811
-------- -------- --------
Total assets $608,047 $532,530 $494,145
======== ======== ========
Liabilities
Interest bearing liabilities:
Regular savings $ 80,741 338 0.42 $ 70,559 712 1.01 $ 62,596 992 1.58
NOW and super NOW 87,212 285 0.33 66,742 273 0.41 56,326 359 0.64
Money market accounts 66,159 495 0.75 54,676 894 1.64 38,232 1,111 2.91
Certificates of deposit 161,405 3,304 2.05 163,013 4,650 2.85 178,297 8,862 4.97
Securities sold under
agreements to Repurchase 7,895 123 1.56 8,165 136 1.67 10,990 469 4.27
FHLB advances 63,271 2,876 4.55 46,701 2,508 5.37 44,232 2,500 5.65
Junior subordinated debentures 20,620 1,036 5.02 11,649 665 5.71 - - -
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest bearing
liabilities 487,303 8,457 1.74 421,505 9,838 2.33 390,673 14,293 3.66
------- ------- -------
Noninterest bearing deposits 71,160 64,513 57,621
Other liabilities 3,307 2,180 3,474
-------- -------- --------
Total liabilities 561,770 488,198 451,768
Stockholders' equity 46,277 44,332 42,377
-------- -------- --------
Total liabilities and
stockholders' Equity $608,047 $532,530 $494,145
======== ======== ========
Net interest and dividend
income (6) $23,362 $21,896 $21,094
======= ======= =======
Interest rate spread(7) 3.92% 4.07% 3.98%
Net interest margin(8) 4.16% 4.42% 4.56%
(1) Reported on a tax equivalent basis. Reported interest on securities of $3,705,000, $3,330,000 and $2,996,000 was adjusted by
$238,000, $190,000 and $283,000, for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(2) Average balances are calculated using the adjusted cost basis.
(3) Reported on a tax equivalent basis. Reported interest and fees on loans of $27,682,000, $27,879,000 and $31,587,000 was
adjusted by $74,000, $62,000 and $90,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(4) Net of unearned income. Includes loans held for sale and nonperforming loans.
(5) Reported on a tax equivalent basis. Reported interest and dividend income of $31,507,000, $31,482,000 and $35,014,000 was
adjusted by $312,000, $252,000 and $373,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(6) Reported on a tax equivalent basis. Reported net interest and dividend income of $23,050,000, $21,644,000 and $20,721,000 was
adjusted by $312,000, $252,000 and $373,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(7) Interest rate spread equals the yield on interest earning assets minus the rate paid on interest bearing liabilities.
(8) The net interest margin equals net interest income divided by total average interest earning assets.
CONSOLIDATED RATE/VOLUME VARIANCE ANALYSIS(1)
2003 Compared to 2002 2002 Compared to 2001
Increase (Decrease) Due to Change In Increase (Decrease) Due to Change In
---------------------------------------- ----------------------------------------
Volume Rate Mix Total Volume Rate Mix Total
------ ---- --- ----- ------ ---- --- -----
Interest and dividend income
Federal funds sold $ (55) $ (123) $ 25 $ (153) $ 161 $ (231) $ (87) $ (157)
Interest bearing deposits -- -- -- -- 3 (2) (2) (1)
Securities 902 (381) (98) 423 823 (465) (117) 241
Loans 3,600 (3,353) (432) (185) 1,109 (4,681) (164) (3,736)
------- ------- ------- ------- ------- ------- ------ -------
Total interest and dividend income 4,447 (3,857) (505) 85 2,096 (5,379) (370) (3,653)
------- ------- ------- ------- ------- ------- ------ -------
Interest expense:
Regular savings 103 (417) (60) (374) 126 (360) (46) (280)
NOW and super NOW 83 (55) 16 12 67 (129) (24) (86)
Money market accounts 188 (485) (102) (399) 478 (486) (209) (217)
Certificates of deposit (46) (1,313) 13 (1,346) (760) (3,776) 324 (4212)
Securities sold under agreements
to repurchase (4) (9) -- (13) (121) (286) 74 (333)
FHLB advances 890 (385) (137) 368 140 (125) (7) 8
Junior subordinated debentures 512 (80) (61) 371 665 -- -- 665
------- ------- ------- ------- ------- ------- ------ -------
Total interest expense 1,726 (2,744) (363) (1,381) 595 (5,162) 112 (4,455)
------- ------- ------- ------- ------- ------- ------ -------
Net interest and dividend income $ 2,721 $(1,113) $ (142) $ 1,466 $ 1,501 $ (217) $ (482) $ 802
======= ======= ======= ======= ======= ======= ====== =======
(1) Reported on a tax equivalent basis.
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 determined by management based 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 provision for loan losses was $805,000 in 2003, a decrease of $95,000 from
the provision recorded in 2002. The 2002 provision of $900,000 was unchanged
from 2001. The provision for each of the three years was based upon a review of
the adequacy of the allowance for loan losses, which review is conducted on a
quarterly basis. This review is based upon many factors including the risk
characteristics of the portfolio, trends in loan delinquencies, and an
assessment of existing economic conditions. In addition, various regulatory
agencies, as part of their examination process, review the banks' allowances
for loan losses and such review may result in changes to the allowance based on
judgments different from those of management.
The decrease in the provision was due in part to the recording of $70,000 to
other expense for a provision for losses related to unfunded loan commitments
such as unused lines of credit and unused portions of home-equity loans. This
provision had previously been calculated as part of the allowance for loan
losses.
Although management utilizes its best judgment in providing for losses, there
can be no assurance that the Company will not have to change its provision for
loan losses in subsequent periods. Management will continue to monitor the
allowance for loan losses and modify the provision to the allowance for loan
losses as appropriate. For additional information regarding estimates in the
assessment of the allowance for loan losses see "Application of Critical
Accounting Policies" below.
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,
---------------------------
2003 2002 2001
---- ---- ----
Service charges and fees on deposit accounts $1,673 $1,473 $1,169
Gain on sales of securities
available-for-sale, net 1,522 151 128
Gain on sales of loans, net 422 259 438
Other 1,758 1,513 1,174
------ ------ ------
Total noninterest income $5,375 $3,396 $2,909
====== ====== ======
Fee income from service charges and fees on deposit accounts increased 14% in
2003, 26% in 2002 and 11% in 2001. The improvement in 2003 is due principally
to increases in overdraft fee income and service charge income resulting from
the full year impact of the branch acquisitions completed in October 2002. 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 were due to an increased number of deposit accounts as a result of the
Littleton branch purchase in October 2001.
Net gains on sales of securities were $1,522,000 in 2003 compared to $151,000
in 2002 and $128,000 in 2001. Securities gains in 2003 were the result of
improved market conditions for investment securities. Securities gains, net, in
2003 included $175,000 of net losses on sales of equity securities compared to
net losses of $410,000 in 2002 and net gains of $55,000 in 2001. Net gains on
the sales of debt securities totaled $1,669,000 in 2003 compared to $561,000 in
2002 and $73,000 in 2001.
The low interest rate environment resulted in significant mortgage refinancing
activity. The Company decided to sell a portion of this loan volume in the
secondary market based on our underwriting standards. The result of these sales
was an increase in gain on sale of loans of $163,000 to $422,000 in 2003.
During 2002 and 2001, the Company recorded a gain on sale of loans of $259,000
and $438,000, respectively. The gain on sale of loans in 2002 resulted from the
sale of mortgage loans to the secondary market. 2001 gains reflect loans sold
to the secondary market as well as a realized gain of approximately $148,000
from the sale of a pool of nonperforming loans.
Other noninterest income (sources of which include debit card interchange fees,
credit card merchant and fee income, automated teller machine fees, loan fees
and safe deposit fees) increased $245,000, or 16%, to $1,758,000 in 2003
following an increase of $339,000, or 29%, to $1,513,000 in 2002 from
$1,174,000 in 2001. The increase in 2003 was due primarily to the recognition
of approximately $191,000 in other loan fees resulting from transactions with
Federal Home Loan Mortgage Corporation ("FHLMC"). The increase in 2002 compared
to 2001 was the result of increases in several categories including official
check fees, debit card interchange fees, the sale of bank owned real estate,
and the introduction of a loan extension skip-a-payment program for indirect
installment loans.
NONINTEREST EXPENSE
Total noninterest expense increased $2,101,000, or 10%, during 2003 following
an increase of $2,886,000, or 17%, during 2002 and an increase of $450,000, or
3%, during 2001. The increase in expenses during 2003 is due in large part to
the full year impact of the October 2002 branch purchases, which contributed to
the overall in increase in salaries and benefits expense, office occupancy and
equipment expense and increased expenses associated with the amortization of
core deposit intangibles. 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 additions and
technology initiatives. During 2001 expenses increased due to the Company's
initiatives to standardize product offerings at the subsidiary banks, to
increase market share in existing markets and entry into 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.
The following table sets forth information relating to the Company's
noninterest expense during the periods indicated:
($000 Omitted)
Years Ended December 31,
--------------------------------
2003 2002 2001
------- -------- ------
Salaries and employee benefits $11,426 $ 9,758 $9,014
Office occupancy and equipment 3,753 3,298 2,864
Amortization of unidentifiable intangible
assets - - 625
Amortization of core deposit intangible 954 476 -
Write-down of equity securities
available-for-sale 184 910 -
Professional fees 1,166 1,096 886
Stationery and supplies 556 596 486
Telephone 571 505 283
Postage and shipping 378 378 323
ATM expense 442 366 352
Other 2,706 2,652 2,316
------- ------- -------
Total noninterest expense $22,136 $20,035 $17,149
======= ======= =======
Salaries and employee benefits increased $1,668,000, or 17%, from 2002 to 2003
and $744,000, or 8%, from 2001 to 2002. These increases reflect staff additions
in connection with the expansion of the retail franchise, increased lending
activities and normal salary and wage increases. Also, during 2003, the Company
recorded a liability to deferred compensation related to a Supplemental
Employee Retirement Plan ("SERP"). Refer to Note 15 to the Consolidated
Financial Statements for a further discussion regarding the SERP.
Office occupancy and equipment expense increased $455,000, or 14%, from 2002 to
2003 and $434,000, or 15%, from 2001 to 2002. These increases were due to
increases in depreciation expense associated with technology purchases made in
2002 as well as the expansion of the retail franchise.
The amortization of core deposit intangibles, net, increased $478,000 from 2002
to 2003 due to the full year impact of the October 2002 branch purchases.
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.
These increases were offset, in part, by a decrease in the write-down on equity
securities of $726,000. During 2003, the Company recorded a write-down of
equity securities of $184,000 compared to $910,000 for the prior year. During
2003, five securities were determined to be other than temporarily impaired due
to sustained weakness in their sector as well as weaknesses related to the
individual companies. During 2002, the sustained overall weakness in the equity
market as well as significant declines in certain sectors and specific
companies within those sectors, resulted in the Company determining that the
market values of certain of its marketable equity securities were other than
temporarily impaired. As a result, during 2002 the Company recorded a
write-down of equity securities of $910,000.
INCOME TAX EXPENSE
The Company recognized $1,867,000, $1,507,000 and $1,708,000 in income tax
expense for the years ended December 31, 2003, 2002 and 2001, respectively. The
effective tax rate was 34.1% for 2003, 36.7% for 2002 and 30.6% for 2001. The
increase in the effective tax rate in 2002 compared to 2001 is due to the fact
that, during 2001, the Company had obtained a number of state tax credits in
New Hampshire 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, or 0.50%, in
the State of New Hampshire Business Profits Tax. For additional information
relating to income taxes, see Note 14 to the Consolidated Financial Statements.
ASSETS
Total assets increased $10,271,000, or 2%, to $609,216,000 at December 31, 2003
compared to $598,945,000 at December 31, 2002. The following is a summary of
significant balance sheet changes.
($000 Omitted)
Years Ended December 31,
--------------------------------------
2003 2002 Change % Change
---- ---- ------ --------
Total assets $609,216 $598,945 $ 10,271 1.7%
Earning assets 562,311 548,980 13,331 2.4
Federal funds sold 16,470 10,170 6,300 61.9
Securities available-for-sale,
at fair value* 78,786 96,109 (17,323) (18.0)
Loans, net of unearned income 467,985 442,152 25,833 5.8
Deposits 463,307 476,194 (12,887) (2.7)
Borrowings 95,021 74,871 20,150 26.9
Stockholders' equity 47,872 44,266 3,606 8.1
* Includes Federal Home Loan Bank stock and Federal Reserve Bank stock.
The increase in earning assets of $13,331,000 was due primarily to an increase
in gross loans partially offset by a decrease in securities available-for-sale.
The increase in earning assets was funded by an increase in borrowings,
specifically FHLB medium-term advances which were acquired at attractive rates
in the current low interest rate environment. This increase in borrowings was
partially offset by a decrease in deposits, primarily time accounts.
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. At December 31, 2003 and 2002 the Company
had no securities designated as held-to-maturity.
The following table summarizes the Company's securities portfolio at December
31, 2003 and 2002, showing amortized cost and fair value for each category:
($000 Omitted)
December 31,
---------------------------------------
2003 2002
------------------ ----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Securities available-for-sale:
US Treasury and US government
agencies $37,945 $37,840 $36,167 $36,188
Mortgage-backed securities 2,803 2,888 7,286 7,476
Collateralized mortgage obligations 15 15 5,103 5,170
Marketable equity securities 2,589 2,766 3,163 2,377
Corporate bonds 20,857 21,983 33,407 33,848
State and political subdivisions 8,066 8,224 6,154 6,338
------- ------- ------- -------
Total securities
available-for-sale $72,275 $73,716 $91,280 $91,397
======= ======= ======= =======
Total securities decreased $17,861,000 during 2003 to $73,716,000. One of the
primary functions of the investment portfolio is to provide liquidity to the
Company. During 2003, the Company had the ability to increase outstanding
loans, which are a higher yielding asset. As a result of the low interest rate
environment during 2003, the Company sold several corporate bonds at attractive
gains and reinvested these proceeds into the loan portfolio.
The net unrealized gain on securities available-for-sale was $1,441,000 at
December 31, 2003 compared to $117,000 at December 31, 2002. At December 31,
2003, the net unrealized gain on debt securities was $1,264,000 and the net
unrealized gain on marketable equity securities was $177,000. 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 for both years is
primarily the result of the low rate environment during 2003 and 2002, which
resulted in an appreciation in value of existing debt holdings. The net
unrealized loss on marketable equity securities for 2002 is primarily the
result of the weak equity market.
Due to the decline in the performance of securities 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 2003 net losses on sales of
marketable equity securities amounted to $147,000 and write-downs of marketable
equity securities amounted to $184,000. 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, 2003, the Company's investment in equity securities totaled
$2,766,000. This amount is net of a market value adjustment of $177,000, of
which the full amount was reflected in accumulated other comprehensive loss in
stockholders' equity.
The Company has a general policy of purchasing investment grade securities and
U.S. government securities to minimize credit risk. 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 of securities.
LOANS
Loans increased 6% in 2003 with the most significant increases occurring in
residential real estate, commercial real estate and indirect installment loans.
At December 31, 2002 loans increased 10% over the prior year 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, 2003 and 2002:
($000 Omitted)
Percent Percent
2003 of Total 2002 of Total
-------- -------- -------- --------
Real estate:
Residential $129,493 27.7% $114,526 25.9%
Commercial 120,366 25.7 111,941 25.3
Construction 3,851 0.8 6,330 1.4
Commercial 24,528 5.2 23,885 5.4
Installment 30,291 6.5 40,169 9.1
Indirect installment 150,807 32.2 139,477 31.5
Other 8,896 1.9 6,031 1.4
-------- ----- -------- -----
$468,232 100.0% $442,359 100.0%
======== ===== ======== =====
The loan portfolio mix shifted slightly 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, comprised 32.2% of the
loan portfolio at December 31, 2003 as compared to 31.5% at the end of 2002.
Residential real estate loans increased to account for 27.7% of the portfolio
from 25.9% at December 31, 2002 due in part to the decision to retain high
credit quality fixed rate mortgages in the portfolio rather than sell in the
secondary market. Installment loans, which include consumer loans, fixed rate
equity loans, and home equity lines of credit, comprised 6.5% of the portfolio
at December 31, 2003 compared to 9.1% a year ago due primarily to a decrease in
home equity lines of credit. The Company strives to maintain a balanced
portfolio consisting of approximately 30% residential real estate loans, 33-35%
commercial loans, and 35-37% 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 federal Small Business
Administration. Commercial real estate and commercial loans increased by
$9,068,000 in 2003 as compared to 2002. 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 $14,967,000 in 2003, a 13% increase
from 2002, compared to an increase of $5,265,000, or 5%, in 2002 compared to
2001. 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 2003 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 during 2002. During 2003, installment loan balances decreased
$9,878,000 compared to 2002. Indirect installment loans increased by
$13,330,000, or 8%, in 2003.
NONPERFORMING ASSETS
Nonperforming assets were $4,180,000, or 0.69% of total assets, at December 31,
2003 compared to $3,892,000, or 0.65% of total assets, at December 31, 2002, an
increase of $288,000, or 7%. 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, 2003, nonaccrual loans totaled $4,089,000, or 0.87% of total
loans, compared to $3,619,000, or 0.82% of total loans, in 2002. There was no
other real estate owned at December 31, 2003 compared to $175,000 of other real
estate owned at December 31, 2002. Other chattels owned decreased $7,000 to
$91,000 at December 31, 2003 compared to $98,000 at December 31, 2002.
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. In addition various federal and state
regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of the Company's allowance for loan losses.
For additional information regarding estimates in the assessment of the
allowance for loan losses see "Application of Critical Accounting
Policies-Allowance for Loan Losses" below.
The Company's allowance for loan losses increased $116,000 from December 31,
2002 to $5,036,000, or 1.08% of total loans, at December 31, 2003.
The following table sets forth the composition of the allowance for loan losses
for the periods indicated:
($000 Omitted)
Years Ended December 31,
2003 2002 2001
------ ------ ------
Beginning allowance $4,920 $4,642 $4,354
Provision for loan losses 805 900 900
Loans charged-off (870) (824) (734)
Recoveries of loans previously charged-off 181 202 122
------ ------ ------
Net charge-offs (689) (622) (612)
------ ------ ------
Ending allowance $5,036 $4,920 $4,642
====== ====== =======
Allowance as a percentage of loans outstanding 1.08% 1.11% 1.16%
Allowance as a percentage of nonperforming loans 123.2 135.95 333.48
Net charge-offs as a percentage of average loans 0.15 0.15 0.15
DEPOSITS
Total deposits at December 31, 2003 were $463,307,000, a decrease of
$12,887,000, or 3%, compared to $476,194,000 at December 31, 2002. The decrease
in deposits was due primarily to a decrease in time deposits partially offset
by an increase in regular savings, NOW and money market accounts.
The following table sets forth the components of deposits for the periods
indicated:
($000 Omitted)
December 31,
2003 2002
--------- ---------
Demand $ 69,599 $ 71,759
Regular savings, NOW and money market 244,766 232,892
Time 148,942 171,543
-------- --------
Total deposits $463,307 $476,194
======== ========
At December 31, 2003, time deposits of $100,000 or more are scheduled to mature
as follows:
($000 Omitted)
3 months or less $ 6,069
Over 3 to 6 months 4,771
Over 6 to 12 months 7,354
Over 12 months 4,514
-------
$22,708
BORROWINGS
At December 31, 2003 short-term borrowings consisted of securities sold under
agreements to repurchase of $7,401,000 compared to $8,251,000 for 2002.
Long-term debt in 2003 consists of FHLB term advances of $67,000,000 as well as
$20,620,000 of junior subordinated debentures, compared to $46,000,000 of FHLB
term advances and $20,620,000 of junior subordinated debentures in 2002. Many
of the long-term term FHLB advances are callable quarterly with call dates in
January, February and March 2004. The increase in FHLB advances is the result
of twelve new advances, totaling $28,000,000, during the year ranging in term
from two years to seven years with an average interest rate of 2.74% which was
partially offset by the maturity of $7,000,000 in advances.
Junior subordinated debentures consist of two issues of floating rate trust
preferred securities acquired during April and July 2002 in the amount of
$7,217,000 and $13,403,000, respectively, 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, 2003, of the $20,620,000
principal amount outstanding, $10,858,000 qualified as Tier 1 capital and
$9,142,000 was allocated to Tier 2 capital.
See Notes 9 and 10 to the Consolidated Financial Statements for additional
information regarding our borrowings.
The following table sets forth certain information concerning the Company's
borrowings at the dates indicated:
($000 Omitted)
December 31,
2003 2002
------- -------
Short-term borrowings $ 7,401 $ 8,251
Long-term debt 87,620 66,620
------- -------
$95,021 $74,871
======= =======
At December 31, 2003, long-term debt is scheduled to mature as follows:
($000 Omitted)
Less than one year $ 9,000
One to three years 19,000
Three to five years 11,000
Over five years 48,620
-------
$87,620
=======
OFF-BALANCE SHEET ARRANGEMENTS
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans and standby letters of
credit. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby
letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, 2003
and 2002 totaled $45,276,000 and $58,229,000, respectively.
See Note 16 to the Consolidated Financial Statements for additional information
regarding off-balance sheet arrangements.
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 a