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UNITED STATES
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, 2004
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-23129
NORTHWAY FINANCIAL, INC.
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(Exact name of registrant as specified in its charter)
New Hampshire 04-3368579
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9 Main Street
Berlin, New Hampshire 03570
--------------------- -----
Address of principal executive offices (Zip Code)
(603) 752-1171
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(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.00
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
The number of shares of voting and nonvoting common stock, par value
$1.00 per share, held by nonaffiliates of the registrant as of June 30, 2004
was 1,278,868 shares with an aggregate market value, computed by reference to
the last reported sales price on the NASDAQ National Market on such date, of
$44,696,437. 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 25, 2005, there were 1,507,574 shares of common stock
outstanding, par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2005 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.
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1 Business .................................................... 1
ITEM 2 Properties .................................................. 10
ITEM 3 Legal Proceedings ........................................... 10
ITEM 4 Submission of Matters to a Vote of Security Holders ......... 10
PART II
ITEM 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ........... 10
ITEM 6 Selected Financial Data ..................................... 11
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................... 12
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk .. 26
ITEM 8 Financial Statements and Supplementary Data ................. 27
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure .................................... 55
ITEM 9A Controls and Procedures ..................................... 55
PART III
ITEM 10 Directors and Executive Officers of the Registrant .......... 55
ITEM 11 Executive Compensation ...................................... 55
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters .................. 55
ITEM 13 Certain Relationships and Related Transactions .............. 55
ITEM 14 Principal Accountant Fees and Services ...................... 55
ITEM 15 Exhibits, Financial Statement Schedules and Reports on
Form 8-K .................................................... 56
Signatures .............................................. 57
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. ("Northway") 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) changes in interest rates over
the past year and the relative relationship between the various interest rate
indices that the Company uses; ii) a determination in the financial market
affecting the valuation of securities held in the Company's investment
portfolio; (iii) a change in product mix attributable to changing interest
rates, customer preferences or competition; iv) 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 v) 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. 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. As of July 31, 2004 this line
of business accounted for approximately 30% of the Company's loan portfolio. On
August 25, 2004, the Company announced its exit from the indirect automobile
lending line of business. Effective August 31, 2004, the Company ceased
accepting applications from its dealer network. BCB will continue to service
the existing portfolio of approximately 13,000 loans. The decision to exit this
line of business was predicated on the low interest rate environment and
competitive pressures of the past eighteen months. Over the next twenty-four
months, cash flows from the existing portfolio are expected to be redeployed
into commercial loans, residential mortgage loans, consumer loans such as home
equity loans and automobile loans, and the Company's investment portfolio.
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.
Northway is a legal entity separate and distinct from its subsidiaries. The
right of Northway 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 Northway 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, 2004, 2003 and 2002 (dollars in
thousands):
2004 2003 2002
-------- ------- -------
US Treasury and other
US government agency securities $ 54,563 $37,840 $36,188
Mortgage-backed securities (1) 29,301 2,903 12,646
Marketable equity securities 1,931 2,766 2,377
Corporate bonds 12,287 21,983 33,848
State and political subdivision
bonds and notes 3,051 2,590 2,717
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Total securities $101,133 $68,082 $87,776
======== ======= =======
(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, 2004
(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 $1,999 $47,915 $5,000 $ - $54,914
Mortgage-backed
securities(1) 2 1,158 120 28,177 29,457
Corporate bonds - 9,983 2,018 - 12,001
State and political
subdivision bonds
and notes 1,129 498 819 520 2,966
------ ------- ------ ------- -------
Total amortized cost $3,130 $59,554 $7,957 $28,697 $99,338
====== ======= ====== ======= =======
Market value $3,130 $59,591 $7,961 $28,520 $99,202
====== ======= ====== ======= =======
Weighted average yield 2.71% 3.95% 5.43% 4.64% 4.23%
(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,
2004, 2003, 2002, 2001 and 2000 (dollars in thousands):
December 31,
-------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Real estate:
Residential $147,333 $129,493 $114,526 $109,261 $129,805
Commercial 130,334 120,366 111,941 111,642 100,608
Construction 5,366 3,851 6,330 1,581 5,752
Commercial 27,013 24,528 23,885 22,727 22,270
Installment 29,345 30,291 40,169 28,210 28,177
Indirect installment 116,520 150,807 139,477 120,761 98,919
Other 18,901 14,530 9,652 6,303 7,881
-------- -------- -------- -------- --------
Total loans 474,812 473,866 445,980 400,485 393,412
-------- -------- -------- -------- --------
Less:
Unearned income 106 247 207 169 154
Allowance for loan losses 5,204 5,036 4,920 4,642 4,354
-------- -------- -------- -------- --------
Total unearned income and
allowance for loan losses 5,310 5,283 5,127 4,811 4,508
-------- -------- -------- -------- --------
Net loans $469,502 $468,583 $440,853 $395,674 $388,904
======== ======== ======== ======== ========
The following table presents the maturity distribution of the Company's
real estate construction and commercial loans at December 31, 2004
(dollars in thousands):
Percent of
Amount Total
------ ----------
Within one year $13,361 41.26%
One to five years 9,092 28.08
Over five years 9,926 30.66
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$32,379 100.00%
======= ======
The Company's real estate construction and commercial loans due after one year
at December 31, 2004 were comprised of the following (dollars in thousands):
Amount
Fixed interest rate $ 7,995
Adjustable interest rate 11,023
-------
$19,018
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, 2004, 2003, 2002, 2001 and 2000
(dollars in thousands):
Years ended December 31,
--------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Balance at the beginning
of period $5,036 $4,920 $4,642 $4,354 $4,887
------ ------ ------ ------ ------
Charge-offs:
Real estate 56 - 83 110 213
Commercial 28 120 12 95 1,006
Installment loans to
individuals 581 750 729 529 424
------ ------ ------ ------ ------
Total 665 870 824 734 1,643
------ ------ ------ ------ ------
Recoveries:
Real estate 162 25 64 35 32
Commercial 16 11 4 - -
Installment loans to
individuals 160 145 134 87 96
Credit card - - - - 2
------ ------ ------ ------ ------
Total 338 181 202 122 130
------ ------ ------ ------ ------
Net charge-offs 327 689 622 612 1,513
Provision charged to expense 495 805 900 900 980
------ ------ ------ ------ ------
Balance at the end of period $5,204 $5,036 $4,920 $4,642 $4,354
====== ====== ====== ====== ======
Ratio of net charge-offs to
average loans 0.07% 0.15% 0.15% 0.15% 0.39%
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,
-------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------- ------------------- ------------------ -------------------- ------------------
Percent of Percent of Percent of Percent of Percent of
loans in each loans in each loans in each loans in each loans in each
category to category to category to category to category to
Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
Real estate:
Residential $ 644 31.0% 624 27.3 598 25.9 585 27.2 1,160 32.9
Commercial &
construction 1,892 28.6 1,724 26.2 2,008 26.7 1,621 28.3 1,009 27.0
Commercial 174 5.7 155 5.2 216 5.4 208 5.7 719 5.7
Installment 2,398 30.7 2,505 38.2 2,084 40.6 1,719 37.2 1,440 32.4
Other 96 4.0 28 3.1 14 1.4 17 1.6 26 2.0
Unallocated -- N/A -- N/A -- N/A 492 N/A -- N/A
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$5,204 100.0% $5,036 100.0% $4,920 100.0% $4,642 100.0% $4,354 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
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. 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, the
Company is 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 unsafe or
unsound. 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. 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 of the Bank to pay
a 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 has the
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 to the extent
that such laws 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, including requirements and restrictions 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 on the Banks
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 11.80% and its total capital ratio is 13.94%.
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 8.43%.
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, 2004, 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"), have proposed 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.
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 and Privacy. The FDIC and other bank regulatory
agencies have adopted final 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.
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.
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
consolidated 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 the issuer
trusts would no longer be consolidated by the Company the junior subordinated
debentures issued by each 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. Trust preferred securities have
historically been eligible for Tier 1 capital treatment by bank holding
companies under FRB rules and regulations relating to minority interests in
equity accounts of consolidated subsidiaries. Following the issuance of FIN 46,
including the consolidation rules with respect to variable interest entities,
the FRB requested public comment on a proposed rule that would limit trust
preferred securities in the Tier 1 capital of bank holding companies, but with
stricter limits and clearer qualitative standards. After considering the public
comments, the FRB issued a final rule on March 1, 2005, which provides that
after a five-year transition period ending on March 31, 2009, the aggregate
amount of the trust preferred securities and certain other capital elements
would be limited to 25% of Tier 1 capital elements, net of goodwill and
intangibles. As of December 31, 2004, assuming the aggregate amount of the
trust preferred securities is limited to 25% of 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. As
a result, the hospitality industry may be adversely impacted by 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. 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, global 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, 2004 the Company has 246 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 20 branch offices, one commercial lending and
administration facility and one consumer loan origination facility that are
located in the central and northern New Hampshire communities of Berlin, Conway
(five offices), Gorham (two offices), Groveton, Littleton, West Ossipee, West
Plymouth, Plymouth, Campton, Ashland, North Woodstock, Tilton, Franklin,
Laconia, Belmont, Pittsfield and Concord. Fifteen of these offices are located
on properties the Company owns. The Company leases six of its branches and the
consumer loan origination facility. Two facilities are leased as tenants at
will while the remaining five facilities are leased under contracts that expire
between June 30, 2005 and December 12, 2008. Furthermore, two of the leases
have an option to renew for an additional five years. 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, 2004.
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
----- ------ ---------
2004 4th Quarter $31.30 $34.96 $0.17
3rd Quarter 29.30 35.12 0.17
2nd Quarter 33.50 38.60 0.17
1st Quarter 34.03 38.00 0.17
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
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 4, 2005, the closing sales price of the common stock on the Nasdaq
National Market was $35.41 per share. As of such date, there were approximately
1,150 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, 2004. 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, 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Balance Sheet Data:
Total assets $638,418 $609,216 $598,945 $513,939 $485,144
Securities available-for-sale, at fair value 101,133 68,082 87,776 55,564 50,288
Securities held-to-maturity -- -- -- -- 2,752
Loans, net of unearned income 474,706 473,619 445,773 400,316 393,258
Allowance for loan losses 5,204 5,036 4,920 4,642 4,354
Other real estate owned -- -- 175 22 25
Unidentifiable intangible assets -- -- -- 8,080 5,098
Goodwill 10,152 10,152 10,152 - -
Core deposit intangible 2,949 3,903 4,857 - -
Deposits 475,359 463,307 476,194 412,840 391,772
Long-term debt 98,620 87,620 66,620 48,028 35,528
Stockholders' equity 49,510 47,872 44,266 43,339 41,562
Income Statement Data:
Net interest and dividend income $ 22,846 $ 23,050 $ 21,664 $ 20,721 $ 21,253
Provision for loan losses 495 805 900 900 980
Noninterest income 5,097 5,375 3,396 2,909 2,692
Noninterest expense 22,394 22,136 20,035 17,149 16,699
Net income 3,388 3,617 2,598 3,873 4,159
Per Common Share Data:
Net income - basic $ 2.26 $ 2.40 $ 1.71 $ 2.55 $ 2.61
Net income - assuming dilution 2.24 2.39 1.71 2.54 2.61
Cash dividends declared 0.68 0.68 0.68 0.68 0.60
Book value 32.93 31.92 29.19 28.68 26.74
Tangible book value 24.02 22.30 19.07 23.16 23.41
Selected Ratios:
Return on average assets 0.54% 0.59% 0.49% 0.78% 0.86%
Return on average equity 6.97 7.82 5.86 9.14 10.29
Dividend payout 30.10 28.28 39.65 26.54 22.96
Average equity to average assets 7.75 7.61 8.33 8.58 8.31
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 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 $3,388,000, or $2.26 per common share, in
2004 compared to net income of $3,617,000, or $2.40 per common share, in 2003
and $2,598,000, or $1.71 per common share, in 2002. Return on average equity
was 6.97% in 2004, compared to 7.82% in 2003 and 5.86% in 2002. Return on
average assets was 0.54% in 2004, compared to 0.59% in 2003 and 0.49% in 2002.
During 2004, the Company recorded a decrease in interest and dividend income of
$1,230,000, as a decrease in the average yield on earning assets of 0.40% was
only partially offset by an increase in average earning assets of $18,885,000.
This was partially offset by the fact that the continuation of a low interest
rate environment provided the Company further opportunity to reduce its average
cost of interest bearing liabilities. During 2004, the cost of interest bearing
liabilities decreased 0.25%, resulting in a decrease in interest expense of
$1,026,000. The Company recorded a reduction in the provision for loan losses
of $310,000 as the total provision for 2004 was $495,000 compared to $805,000
for 2003. The decrease in the provision for loan losses was the result of an
ongoing review of the adequacy of the allowance for loan losses. Noninterest
income, excluding securities gains, increased $491,000 from last year. This
reflects, in part, the impact of a new non-deposit product line introduced
earlier in 2004, in addition to our continuing efforts to maximize all
components of noninterest income, including the introduction of Bounce
Protection(TM) in 2004. Less favorable market conditions for investment
securities resulted in lower securities gains for the year than in 2003, as
realized gains decreased $769,000 to $753,000. Noninterest expense increased
$258,000 to $22,394,000 in 2004 compared to $22,136,000 in 2003 due primarily
to an increase in salaries and benefits expense.
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 the
Company's 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.
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, 2004, 2003,
and 2002.
Net interest and dividend income for 2004 decreased $162,000, or 1%, compared
to 2003. Interest and dividend income decreased $1,188,000, or 4%, in 2004
compared to 2003. The continued suppression of market interest rates during
2004 resulted in a 0.39% decrease in the yield on average earning assets. A
0.48% decrease in the yield on loans was partially offset by an increase in
average loan balances of $17,105,000. This resulted in a net decrease of
$1,294,000, or 5%, in interest and fees on loans. The decrease in interest and
fees on loans was partially offset by an increase in interest and dividend
income on securities of $100,000, which was the result of an increase in
average balances of $6,450,000 partially offset by a decrease in average yield
of 0.22%.
Interest expense decreased $1,026,000, or 12%, in 2004 compared to 2003. The
decrease in interest expense was due primarily to a 0.25% decrease in rates
paid on interest bearing liabilities partially offset by an increase in average
balances of $11,061,000. The increase in average balances is primarily the
result of increases in average Federal Home Loan Bank ("FHLB") advances of
$17,473,000. Total average deposits, including noninterest bearing DDA,
decreased $1,373,000 but a shift in the mix of deposits resulted in a decrease
in time deposits of $20,791,000 partially offset by higher average balances in
demand deposits, NOW accounts and savings accounts, which are all lower cost
sources of funds for the Company.
Net interest and dividend income for 2003 increased $1,466,000, or 7%, compared
to 2002. Interest and dividend income increased $85,000 in 2003 compared to
2002. This was due to an increase in average earning assets of $66,220,000
which increase was partially offset by a 0.74% decrease in the yield on average
earning assets. Interest income and fees on loans increased $124,000 which
increase was primarily due to an increase in the average balance of $57,193,000
partially offset by a decrease in the average yield of 0.81%. Furthermore,
interest and dividend income on securities increased $114,000 as an increase in
average securities of $12,846,000 was partially offset by a decrease in the
average yield on securities of 0.69%. These increases in interest and dividend
income were partially offset by a decrease in interest income on federal funds
sold of $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%. Furthermore, 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.
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 0.17% to 3.99% in 2004 after having decreased 0.26%
to 4.16% in 2003. The decrease in the net interest margin for 2004 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 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
2004, the net interest rate spread decreased 0.14% to 3.78% as the yield on
earning assets declined 0.39% and was only partially offset by a decrease in
the cost of interest bearing liabilities of 0.25%. 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%.
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,
2004 2003 2002
------------------------------ ----------------------------- ------------------------------
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 $ 10,564 $ 125 1.18% $ 15,153 $ 118 0.78% $ 18,971 $ 271 1.43%
Interest bearing deposits 143 1 0.70 224 2 0.89 225 2 0.89
Securities (1) (2) 86,236 3,684 4.27 79,786 3,584 4.49 66,940 3,470 5.18
Loans, net (3) (4) 483,865 26,821 5.54 466,760 28,115 6.02 409,567 27,991 6.83
------- ------- -------- ------- -------- -------
Total interest earning
assets (5) 580,808 30,631 5.27 561,923 31,819 5.66 495,703 31,734 6.40
------- ------- -------
Cash and due from banks 15,637 14,907 14,597
Allowance for loan losses (5,104) (4,983) (4,794)
Premises and equipment, net 13,444 12,447 12,064
Other assets 22,574 23,753 14,960
-------- -------- --------
Total assets $627,359 $608,047 $532,530
======== ======== ========
Liabilities
Interest bearing liabilities:
Regular savings $ 85,319 220 0.26 $ 80,741 338 0.42 $ 70,559 712 1.01
NOW and super NOW 97,170 334 0.34 87,212 285 0.33 66,742 273 0.41
Money market accounts 65,286 460 0.70 66,159 495 0.75 54,676 894 1.64
Certificates of deposit 140,614 2,136 1.52 161,405 3,304 2.05 163,013 4,650 2.85
Securities sold under
agreements to repurchase 8,611 87 1.01 7,895 123 1.56 8,165 136 1.67
FHLB advances 80,744 3,115 3.86 63,271 2,876 4.55 46,701 2,508 5.37
Junior subordinated
debentures 20,620 1,079 5.23 20,620 1,036 5.02 11,649 665 5.71
------- ------ ------- ------ ------- ----
Total interest bearing
liabilities 498,364 7,431 1.49 487,303 8,457 1.74 421,505 9,838 2.33
------- ------- -------- ------- -------- -------
Noninterest bearing deposits 76,915 71,160 64,513
Other liabilities 3,475 3,307 2,180
-------- -------- --------
Total liabilities 578,754 561,770 488,198
Stockholders' equity 48,605 46,277 44,332
------ ------ ------
Total liabilities and
stockholders' Equity $627,359 $608,047 $532,530
======== ======== ========
Net interest and dividend
income(6) $23,200 $23,362 $21,896
======= ======= =======
Interest rate spread (7) 3.78% 3.92% 4.07%
Net interest margin (8) 3.99% 4.16% 4.42%
(1) Reported on a tax equivalent basis. Reported interest on securities of $3,582,000, $3,470,000 and $3,297,000 was adjusted by
$102,000, $114,000 and $173,000, for 2004, 2003 and 2002, 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 $26,569,000, $27,917,000 and $27,912,000 was
adjusted by $252,000, $198,000 and $79,000 for 2004, 2003 and 2002, 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 $30,277,000, $31,507,000 and $31,482,000 was
adjusted by $354,000, $312,000 and $252,000 for 2004, 2003 and 2002, respectively, to reflect the tax equivalent adjustment.
(6) Reported on a tax equivalent basis. Reported net interest and dividend income of $22,846,000, $23,050,000 and $21,644,000 was
adjusted by $354,000, $312,000 and $252,000 for 2004, 2003 and 2002, 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)
($000 Omitted)
2004 Compared to 2003 2003 Compared to 2002
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 $ (36) $ 61 $ (18) $ 7 $ (55) $ (123) $ 25 $ (153)
Interest bearing deposits (1) -- -- (1) -- -- -- --
Securities 290 (176) (14) 100 666 (463) (89) 114
Loans 1,030 (2,242) (82) (1,294) 3,909 (3,321) (464) 124
------- ------- ------- ------- ------- ------- ------- -------
Total interest and
dividend income 1,283 (2,357) (114) (1,188) 4,520 (3,907) (528) 85
------- ------- ------- ------- ------- ------- ------- -------
Interest expense:
Regular savings 19 (130) (7) (118) 103 (417) (60) (374)
NOW and super NOW 32 15 2 49 83 (55) (16) 12
Money market accounts (6) (29) -- (35) 188 (485) (102) (399)
Certificates of deposit (426) (852) 110 (1,168) (46) (1,313) 13 (1,346)
Securities sold under
agreements to repurchase 11 (43) (4) (36) (4) (9) -- (13)
FHLB advances 794 (435) (120) 239 890 (385) (137) 368
Junior subordinated debentures -- 43 -- 43 512 (80) (61) 371
------- ------- ------- ------- ------- ------- ------- -------
Total interest expense 424 (1,431) (19) (1,026) 1,726 (2,744) (363) (1,381)
------- ------- ------- ------- ------- ------- ------- -------
Net interest and dividend income $ 859 $ (926) $ (95) $ (162) $ 2,794 $(1,163) $ (165) $ 1,466
======= ======= ======= ======= ======= ======= ======= =======
(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 $495,000 in 2004, a decrease of $310,000 from
the provision recorded in 2003. The 2003 provision of $805,000 decreased
$95,000 from the provision recorded in 2002. The provision for each of the
three years was based upon a review of the adequacy of the allowance for loan
losses, which is conducted on a quarterly basis. These reviews are 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 2004 provision was due in part to a reduction in average
impaired loans of $1,100,000 as well as the fact that the Company realized
significant recoveries during 2004, which allowed the company to maintain its
coverage ratio. The decrease in the 2003 provision was due in large 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,
----------------------------
2004 2003 2002
------ ------ ------
Service charges and fees on deposit accounts $2,229 $1,673 $1,473
Gain on sales of securities
available-for-sale, net 753 1,522 151
Gain on sales of loans, net 374 422 259
Other 1,741 1,758 1,513
------ ------ ------
Total noninterest income $5,097 $5,375 $3,396
====== ====== ======
Fee income from service charges and fees on deposit accounts increased 33% in
2004, 14% in 2003 and 26% in 2002. The improvement in 2004 is due principally
to increases in overdraft fee income as the Company introduced new fee
schedules in December 2003. In addition, the Company introduced Bounce
Protection(TM), an overdraft privilege program, in April 2004 and this has led
to increased overdraft income. 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.
Net gains on sales of securities were $753,000 in 2004 compared to $1,522,000
in 2003 and $151,000 in 2002. Securities gains in 2004 and 2003 were the result
of improved market conditions for investment securities. Securities gains, net,
in 2004 included $253,000 of net gains on sales of equity securities compared
to net losses of $147,000 in 2003 and net losses of $410,000 in 2002. Net gains
on the sales of debt securities totaled $500,000 in 2004 compared to $1,669,000
in 2003 and $561,000 in 2002.
Gains on sales of loans, net, decreased $48,000 in 2004 compared to 2003. Gains
on sales of mortgage loans decreased $228,000 as the Company opted to retain a
greater portion of fixed rate mortgages in portfolio in 2004 compared to 2003.
This was partially offset by the fact that during 2004, the Company sold a
portfolio of commercial loans guaranteed by the Small Business Administration
for a gain of $178,000. The low interest rate environment in 2003 resulted in
significant mortgage refinancing activity. Therefore, during 2003 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, the Company
recorded a gain on sale of loans of $259,000 which resulted from the sale of
mortgage loans to the secondary market.
Other noninterest income (sources of which include debit card interchange fees,
credit card merchant and fee income, automated teller machine fees, loan fees,
safe deposit fees and commissions on alternative investment products) decreased
$17,000, or 1%, to $1,741,000 in 2004 following an increase of $245,000, or
16%, to $1,758,000 in 2003 and $339,000, or 29%, to $1,513,000 in 2002. The
decrease in 2004 was due to the fact that in 2003 the Company recognized
approximately $191,000 in other loan fees resulting from transactions with
Federal Home Loan Mortgage Corporation ("FHLMC"). This decrease was partially
offset by the introduction of alternative investment products offered by the
Company, which increased fee income by approximately $126,000. The increase in
2003 compared to 2002 was due primarily to the increase in other loan fees.
NONINTEREST EXPENSE
Total noninterest expense increased $258,000, or 1%, during 2004 following an
increase of $2,101,000, or 10%, during 2003 and an increase of $2,866,000, or
17%, during 2002. The increase in expenses during 2004 is due primarily to an
increase in salaries and employee benefits. 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 in
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.
The following table sets forth information relating to the Company's
noninterest expense during the periods indicated:
($000 Omitted)
Years Ended December 31,
2004 2003 2002
------- ------- -------
Salaries and employee benefits $11,981 $11,426 $ 9,758
Office occupancy and equipment 3,731 3,753 3,298
Amortization of core deposit
intangible 954 954 476
Write-down of equity securities
available-for-sale -- 184 910
Professional fees 1,234 1,166 1,096
Stationery and supplies 429 556 596
Telephone 595 571 505
Postage and shipping 348 378 378
ATM expense 295 442 366
Other 2,827 2,706 2,652
------- ------- -------
Total noninterest expense $22,394 $22,136 $20,035
======= ======= =======
Salaries and employee benefits increased $555,000, or 5%, from 2003 to 2004 and
$1,668,000 or 17%, from 2002 to 2003. 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 2004 and 2003,
the Company recorded a liability to deferred compensation related to a
Supplemental Employee Retirement Plan ("SERP"). Refer to Note 14 to the
Consolidated Financial Statements for a further discussion regarding the SERP.
Office occupancy and equipment expense decreased $22,000 from 2003 to 2004
after increasing $455,000, or 14%, from 2002 to 2003. The 2003 increase was due
to increases in depreciation expense associated with technology purchases made
in the latter part of 2002 as well as the expansion of the retail franchise.
The amortization of core deposit intangibles, net, remained unchanged from 2003
to 2004 after increasing $478,000 from 2002 to 2003 due to the full year impact
of the October 2002 branch purchases.
During 2004, the Company recorded no write-down of equity securities compared
to $184,000 in 2003 and $910,000 in 2002. During 2003, five equity 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 $1,666,000, $1,867,000 and $1,507,000 in income tax
expense for the years ended December 31, 2004, 2003 and 2002, respectively. The
effective tax rate was 33.0% for 2004, 34.1% for 2003 and 36.7% for 2002. For
additional information relating to income taxes, see Note 13 to the
Consolidated Financial Statements.
ASSETS
Total assets increased $29,202,000, or 5%, to $638,418,000 at December 31, 2004
compared to $609,216,000 at December 31, 2003. The following is a summary of
significant balance sheet changes.
($000 Omitted)
Years Ended December 31,
--------------------------------------------
2004 2003 Change % Change
-------- -------- ------- ---
Total assets $638,418 $609,216 $29,202 4.8%
Earning assets 592,971 562,311 30,660 5.5
Federal funds sold 10,975 16,470 (5,495) (33.4)
Securities available-for-sale, at
fair value (1) 107,013 73,152 33,861 46.3
Loans, net of unearned income 474,706 473,619 1,087 0.2
Deposits 475,359 463,307 12,052 2.6
Borrowings 109,888 95,021 14,867 15.7
Stockholders' equity 49,510 47,872 1,638 3.4
(1) Includes Federal Home Loan Bank stock and Federal Reserve Bank stock.
The increase in earning assets of $30,660,000 was due primarily to an increase
in securities available-for-sale partially offset by a decrease in federal
funds sold. The increase in earning assets was funded by an increase in both
deposits and borrowings.
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, 2004 and 2003 the Company
had no securities designated as held-to-maturity.
The following table summarizes the Company's securities portfolio at December
31, 2004 and 2003, showing amortized cost and fair value for each category:
($000 Omitted)
December 31,
------------------------------------------------
2004 2003
----------------- ------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ---- --------- ----
Securities available-for-sale:
US Treasury and US government
agencies $ 54,914 $ 54,563 $37,945 $37,840
Mortgage-backed securities 29,447 29,291 2,803 2,888
Collateralized mortgage
obligations 10 10 15 15
Marketable equity securities 1,827 1,931 2,589 2,766
Corporate bonds 12,001 12,287 20,857 21,983
State and political subdivisions 2,966 3,051 2,432 2,590
-------- -------- ------- -------
Total securities available-for-sale $101,165 $101,133 $66,641 $68,082
======== ======== ======= =======
Total securities increased $33,051,000 during 2004 to $101,133,000. One of the
primary functions of the investment portfolio is to provide liquidity to the
Company. During 2004, the Company deployed a leverage strategy whereby
$20,000,000 in FHLB advances were offset by the purchase of mortgage-backed
securities providing the Company an attractive spread. The remainder of the
increase in securities was due to the increase in deposits.
The net unrealized loss on securities available-for-sale was $32,000 at
December 31, 2004 compared to a net unrealized gain of $1,441,000 at December
31, 2003. At December 31, 2004, the net unrealized loss on debt securities was
$136,000 and the net unrealized gain on marketable equity securities was
$104,000. 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. The net unrealized gain on debt securities for 2003 is primarily the
result of the low interest rate environment during 2003, which resulted in an
appreciation in value of existing debt holdings.
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, 2004, the Company's investment in equity securities totaled
$1,931,000. This amount is net of a market value adjustment of $104,000, of
which the full amount was reflected as a gain 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
Gross loans remained relatively unchanged in 2004, increasing $946,000 due
primarily to increases in residential real estate, commercial real estate and
commercial loans, partially offset by a decrease in indirect installment loans.
At December 31, 2003 loans increased 6% with the most significant increases
occurring in residential real estate, commercial real estate and indirect
installment loans. The following table presents the composition of the loan
portfolio as of December 31, 2004 and 2003:
($000 Omitted)
Percent Percent
2004 of Total 2003 of Total
-------- ----- -------- -----
Real estate:
Residential $147,333 31.0% $129,493 27.3%
Commercial 130,334 27.5 120,366 25.4
Construction 5,366 1.1 3,851 0.8
Commercial 27,013 5.7 24,528 5.2
Installment 29,345 6.2 30,291 6.4
Indirect installment 116,520 24.5 150,807 31.8
Other 18,901 4.0 14,530 3.1
-------- ----- -------- -----
$474,812 100.0% $473,866 100.0%
======== ===== ======== =====
The loan portfolio mix shifted 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 24.5% of the loan
portfolio at December 31, 2004 as compared to 31.8% at the end of 2003.
Effective August 31, 2004, the Company discontinued the origination of indirect
installment loans; therefore, this portfolio will continue to amortize going
forward. Residential real estate loans increased to account for 31.0% of the
portfolio from 27.3% at December 31, 2003 due in part to the decision to retain
high credit quality fixed-rate mortgages in the portfolio rather than sell in
the secondary market.
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 some are additionally secured by a guarantee of the federal Small Business
Administration. Commercial real estate and commercial loans increased by
$12,453,000 in 2004 as compared to 2003. 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 $17,840,000 in 2004, a 14% increase
from 2003, compared to an increase of $14,967,000, or 13%, in 2003 compared to
2002. 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 2004 and 2003 resulted primarily from the Company's decision to
retain a greater percentage of fixed-rate residential mortgage loans.
During 2004, installment loan balances decreased $946,000, or 3%, from 2003,
compared to a decrease of $9,878,000, or 25%, in 2003 compared to 2002.
Indirect installment loans decreased by $34,287,000, or 23%, in 2004 compared
to an increase of $11,330,000, or 8%, in 2003. As previously mentioned,
indirect installment originations ceased on August 31, 2004.
NONPERFORMING ASSETS
Nonperforming assets were $2,949,000, or 0.46% of total assets, at December 31,
2004 compared to $4,180,000, or 0.69% of total assets, at December 31, 2003, a
decrease of $1,321,000, or 29%. 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, 2004, nonaccrual loans totaled $2,867,000, or 0.60% of total
loans, compared to $4,089,000, or 0.86% of total loans, in 2003. There was no
other real estate owned at either December 31, 2004 or 2003. Other chattels
owned decreased $9,000 to $82,000 at December 31, 2004 compared to $91,000 at
December 31, 2003.
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 $168,000 from December 31,
2003 to $5,204,000, or 1.10% of total loans, at December 31, 2004.
The following table sets forth the composition of the allowance for loan losses
for the periods indicated:
($000 Omitted)
Years Ended December 31,
--------------------------------
2004 2003 2002
------ ------- --------
Beginning allowance $5,036 $4,920 $4,642
Provision for loan losses 495 805 900
Loans charged-off (665) (870) (824)
Recoveries of loans previously
charged-off 338 181 202
------- ------- -------
Net charge-offs (327) (689) (622)
------- ------- -------
Ending allowance $ 5,204 $ 5,036 $ 4,920
======= ======= =======
Allowance as a percentage of loans
outstanding 1.10% 1.06% 1.10%
Allowance as a percentage of
nonperforming loans 181.51 123.16 135.95
Net charge-offs as a percentage of
average loans 0.07 0.15 0.15
DEPOSITS
Total deposits at December 31, 2004 were $475,359,000, an increase of
$12,052,000, or 3%, compared to $463,307,000 at December 31, 2003. The increase
in deposits was due primarily to an increase in demand deposits, NOW accounts
and regular savings partially offset by a decrease in time deposits.
The following table sets forth the components of deposits for the periods
indicated:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Demand $ 78,669 $ 69,599
Regular savings, NOW and money market 263,685 244,766
Time 133,005 148,942
-------- --------
Total deposits $475,359 $463,307
======== ========
At December 31, 2004, time deposits of $100,000 or more are scheduled to mature
as follows:
($000 Omitted)
3 months or less $ 4,360
Over 3 to 6 months 2,868
Over 6 to 12 months 4,109
Over 12 months 7,598
-------
$18,935
=======
BORROWINGS
At December 31, 2004 short-term borrowings consisted of securities sold under
agreements to repurchase of $11,268,000 compared to $7,401,000 for 2003.
Long-term debt in 2004 consists of FHLB term advances of $78,000,000 as well as
$20,620,000 of junior subordinated debentures, compared to $67,000,000 of FHLB
term advances and $20,620,000 of junior subordinated debentures in 2003. Seven
of the long-term term FHLB advances are callable quarterly with call dates in
January, February and March 2005. The increase in FHLB advances is the result
of new advances totaling $20,000,000, which was partially offset by the
maturity of $9,000,000 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, 2004, of the $20,620,000
principal amount outstanding, $16,338,000 qualified as Tier 1 capital and
$4,282,000 was allocated to Tier 2 capital.
See Notes 8 and 9 to the Consolidated Financial Statements for additional
information regarding the Company's borrowings.
The following table sets forth certain information concerning the Company's
borrowings at the dates indicated:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Short-term borrowings $ 11,268 $ 7,401
Long-term debt 98,620 87,620
-------- --------
$109,888 $ 95,021
======== ========
At December 31, 2004, long-term debt is scheduled to mature as follows:
($000 Omitted)
Less than one year $ 2,000
One to three years 44,000
Three to five years 23,000
Over five years 29,620
-------
$98,620
=======
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, 2004
and 2003 totaled $48,199,000 and $45,276,000, respectively.
See Note 15 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 are three capital requirements that banks and bank
holding companies must meet: Tier 1 capital, total capital (combination of Tier
1 capital and Tier 2 capital), and leverage (Tier 1 capital to average assets)
ratios. Tier 1 capital consists of stockholders' equity, net of intangible
assets as well as a portion of junior subordinated debentures. Tier 2 capital
consists of a limited amount of allowance for loan losses and the portion of
junior subordinated debentures not allocated to Tier 1 capital. Tier 1 capital,
total capital and leverage ratios do not include any adjustments for unrealized
gains and losses relating to securities available-for-sale except net
unrealized losses relating to marketable equity securities. The minimum
requirements for the leverage ratio, risk-based Tier 1 capital and risk-based
total capital are 4%, 4% and 8%, respectively. As of December 31, 2004 and
2003, both Banks were "well capitalized" as defined under FDIC regulations.
The following table sets forth the Company's risk-based capital and
leverage ratios:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Risk-adjusted assets $446,807 $453,272
Tier 1 capital (to average assets) 8.43% 7.22%
Tier 1 capital (to risk weighted assets) 11.80 9.66
Total capital (to risk weighted assets) 13.94 12.81
Total stockholders' equity includes a $691,000 negative adjustment for
accumulated other comprehensive loss, net of tax, at December 31, 2004 and a
$149,000 adjustment for accumulated other comprehensive income, net of tax, at
December 31, 2003. At December 31, 2004, this adjustment was comprised of a net
unrealized loss on securities available-for-sale of $18,000, net of taxes, and
an unfunded pension accumulated benefit obligation of $673,000, net of taxes.
While the Company continues to contribute the maximum amount permitted by law
to its pension plan, the discount rate used to calculate the future value of
such contribution and the poor asset performance of investment securities has
resulted in the unfunded pension accumulated benefit obligation. For additional
information regarding estimates see "Application of Critical Accounting
Policies" below.
The Company intends to continue to pay dividends on a quarterly basis subject
to the financial condition and earnings of the Company, capital requirements,
and other factors, including applicable governmental regulations. No dividends
will be payable unless declared by the Board of Directors and then only to the
extent funds are legally available for the payment of such dividends.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 1 of the
Consolidated Financial Statements. As disclosed in Note 1, the preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions about future
events that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ significantly from those
estima