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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996 Commission file number 0-16143
FIRST ESSEX BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2943217
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
71 Main Street, Andover, MA 01810
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 475-4313
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
[ X ]
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The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant, based on the closing sale price on the NASDAQ
National Market System on February 28, 1997 was $115,335,257.
As of February 28, 1997, 7,475,830 shares of the registrant's common stock, $.10
par value, were outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Selected information from the Registrant's Proxy Statement for the annual
meeting to be held May 1, 1997 to be filed with the Securities and Exchange
Commission, is incorporated by reference into Part III of this report
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company desires to take advantage of the new "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This Report contains certain
"forward-looking statements" including statements concerning plans, objectives,
future events or performance, assumptions, and other statements which are other
than statements of historical fact. The Company wishes to caution readers that
the following important factors, among others, may have affected, and could in
the future affect, the Company's actual results and could cause the Company's
actual results for subsequent periods to differ materially from those expressed
in any forward-looking statement made by, or on behalf of, the Company herein:
(i) the effect of changes in laws and regulations, including federal and state
banking laws and regulations, with which the Company and the Bank must comply,
the cost of compliance either currently or in the future as applicable; (ii) the
effect of changes in accounting policies and practices, as may be adopted by the
regulatory agencies as well as by the Financial Accounting Standards Board, or
of changes in the organization, compensation and benefit plans; (iii) the effect
on the Company's competitive position within in its market area, increasing
consolidation within the banking industry, and increasing competition from
larger regional and out-of-state banking organizations as well as nonbank
providers of various financial services; (iv) the effect of unforeseen changes
in interest rates; and (v) the effect of changes in the business cycle and
downturns in the New England and national economy.
TABLE OF CONTENTS
Part I
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Part II
Item 5. Market for the Registrant's Common Stock and Related Security
Holder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 8. Financial Statements and Supplementary Data 29
Item 9. Changes in and Disagreements with Accountants and
Financial Disclosure 63
Part III
Item 10. Directors and Executive Officers of the Registrant 63
Item 11. Executive Compensation 63
Item 12. Security Ownership of Certain Beneficial Owners and Management 64
Item 13. Certain Relationships and Related Transactions 64
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 64
PART I
ITEM 1. BUSINESS
GENERAL
First Essex Bancorp, Inc.
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First Essex Bancorp, Inc. ("First Essex" or the "Company") is a Delaware
corporation whose primary activity is to act as the parent holding company for
First Essex Bank, FSB (the "Bank"). Until December 1, 1993, the business of
First Essex Bancorp, Inc. was conducted through two banking subsidiaries, First
Essex Savings Bank, a Massachusetts-chartered savings bank and First Essex
Savings Bank of New Hampshire, a Guaranty Savings Bank. The New Hampshire bank
was owned through a second tier holding company, First Essex Bancorp of New
Hampshire, Inc., which was merged into First Essex Bancorp, Inc. on December 1,
1993.
On December 30, 1996, the Company acquired all of the outstanding shares of the
common stock of Finest Financial Corp. ("Finest"). The purchase price was
composed of 1,353,998 shares of common stock issued at a price of $11.50 per
share and a total cash outlay of $16.3 million. Included in the total
acquisition cost was approximately $1.4 million of capitalized costs incurred in
connection with the acquisition. This transaction was accounted for as a
purchase and, accordingly, the consolidated statement of operations includes the
results of Finest's operations since the acquisition.
On December 30, 1996, Finest Financial Corp. ("Finest"), the parent holding
company of Pelham Bank and Trust Company ("Pelham"), a New Hampshire chartered
bank, was merged into the Company in a transaction that was accounted for as a
purchase. Pelham was simultaneously merged into the Bank.
First Essex Bank, FSB
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The Bank was originally founded under a Massachusetts legislative charter issued
in 1847. On December 1, 1993, First Essex Savings Bank converted to a federal
savings bank with a charter issued by the Office of Thrift Supervision, (the
"OTS") under the name of First Essex Bank, FSB. On the same day First Essex
Savings Bank of New Hampshire was merged into First Essex Bank, FSB. As stated
above, the Bank merged with Pelham on December 30, 1996.
At December 31, 1996, the Bank had total assets of $1.1 billion, of which
approximately $196.6 million was attributable to the acquisition of Pelham. The
Bank is principally engaged in the business of attracting deposits from the
general public and investing in residential mortgage, construction, commercial
real estate, commercial and consumer loans. The Bank also makes investments in
various investment securities to provide a source of interest and dividend
income. The Bank currently maintains fifteen full service banking offices at
various locations throughout its market area. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation (the "FDIC").
MARKET AREA
First Essex's market area is centered in the Merrimack Valley, approximately 25
miles north of Boston and five miles south of New Hampshire, at the intersection
of two major highways: Interstate Route 93, the major north-south roadway
connecting Boston with the northern Boston suburban communities and New
Hampshire, and Interstate Route 495. The Bank's principal executive offices are
located in Andover, Massachusetts, and its main banking office and two of its
branches are located in Lawrence, Massachusetts. Other branches are in the
surrounding communities of Andover, North Andover, Haverhill, Lowell and
Methuen, Massachusetts and Londonderry, Pelham, Salem and Windham, New
Hampshire. First Essex also has loan centers in Lowell and Wellesley,
Massachusetts, and in Nashua and North Hampton, New Hampshire.
CURRENT MARKET CONDITIONS
The New England region, including those portions of northeastern Massachusetts
and southern New Hampshire that constitute First Essex's market area, continues
to experience growth.
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Loan demand to finance new and existing home sales was stronger in 1996 and 1995
than in prior years. The growth in commercial loans to small and mid-size
businesses in the area has also shown strength, although the competition among
lenders for these loans is intense. First Essex was able to grow loans while
adhering to its credit quality guidelines. Automobile sales continued to show
their strength in 1996 and First Essex has been able to participate in that
growth through an indirect automobile lending program that was begun early in
1994. The general improvement in consumer confidence and the consumer's
willingness to take on additional debt has also resulted in growth in direct
lending to consumers.
REGULATION
General
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The Office of Thrift Supervision ("OTS") is the primary regulator of the Company
and the Bank. The Bank's deposits are insured up to applicable limits by the
Bank Insurance Fund ("BIF") of the FDIC. The Company and the Bank must file
reports with the OTS concerning activities and financial condition, in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with or acquisitions of other financial institutions. Periodic
examinations are conducted by the OTS to test the Company's and the Bank's
compliance with various regulatory requirements. The Bank is also a member of
the Federal Home Loan Bank ("FHLB") system, which provides a central credit
facility primarily for member institutions. The Company, as a savings and loan
holding company, is also required to file certain reports, and otherwise comply,
with the rules and regulations of the OTS and of the Securities and Exchange
Commission ("SEC") under the federal securities laws.
Business Activities
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The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit
Insurance Act (the "FDI Act"). The HOLA and the FDI Act were amended by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FDICIA, among other things, requires that federal banking regulators intervene
promptly when a depository institution experiences financial difficulties,
mandates the establishment of a risk-based deposit insurance assessment system
and requires the imposition of numerous additional safety and soundness
operational standards and restrictions. FDICIA contains provisions affecting
numerous aspects of the operations of federal savings institutions and empowers
the OTS and the FDIC, among other agencies, to promulgate regulations
implementing its provision.
Qualified Thrift Lender Test
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The HOLA requires saving institutions to meet a qualified thrift lender ("QTL")
test. Under the QTL test, as modified by FDICIA, a savings association is
required to maintain at least 65% of its "portfolio assets" (total assets less
(i) specified liquid assets up to 20% of total assets, (ii) intangibles,
including goodwill, and (iii) the value of property used to conduct the
association's business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) on a monthly basis in 9 out of every 12 months.
Limitation on Capital Distributions
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OTS regulations impose limitations upon all capital distributions, other than
stock dividends, by savings institutions. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that meets or exceeds all fully phased-in capital requirements
before and after a proposed capital distribution ("Tier 1 Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice but without the approval of the OTS, make capital
distributions during a calendar year equal to the greater of: (i) 100% of its
net income to date during the calendar year plus the amount that would reduce
by one-half its "surplus capital ratio" (the percentage by which its capital to
assets ratio exceeds the ratio of its fully phased-in capital requirements to
its assets) at the beginning of the calendar year; or (ii) 75% of its net income
for the previous four quarters. Any additional capital distributions would
require prior regulatory approval. In the event the Bank's capital fell below
its fully-phased in requirement or the OTS notified the Bank that it was in need
of more than normal supervision, the Bank's ability to make capital
distributions would be restricted. In addition, the OTS could prohibit any
proposed capital distribution by any institution if
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it determines that such distribution would constitute an unsafe or unsound
practice. Furthermore, under the OTS prompt corrective action regulations, which
took effect on December 19, 1992, the Bank generally would be prohibited from
making any capital distribution if, after the distribution, the Bank would have
(i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based
capital ratio of less than 4% or (iii) a Tier 1 core capital ratio of less than
3%. As of December 31, 1996, the Bank exceeds all fully-phased in capital
requirements.
Branching
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The HOLA and OTS regulations permit savings institutions to branch nationwide
provided the institutions meet certain asset composition tests. The OTS
authority preempts any state law purporting to regulate branching by savings
institutions. As of December 31, 1996, the Bank would be permitted to engage in
such nationwide interstate branching.
Capital Requirements
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The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures are established by regulation to ensure the capital
adequacy required of the Bank to maintain minimum amounts and ratios of total
and Tier I capital (as defined in the regulations) to risk- weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as defined).
Management believes, as of December 31, 1996, that the Company meets all capital
adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification received from the OTS
categorized the Company as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Company must
maintain the total risk-based, Tier I risk-based and Tier I average asset
ratios. There are no conditions or events since that notification that
management believes have changed the institution's category.
FDICIA required that the OTS revise risk-based capital standards, with
appropriate transition rules, to ensure that they take account of interest rate
risk, concentration of risk and the risks of nontraditional activities. Under
OTS regulation effective January 1, 1994, a savings institution with interest
rate risk exposure above a specified percentage must deduct a specified interest
rate risk component when calculating total capital for purposes of determining
whether it meets OTS risk-based capital requirements. As of December 31, 1996,
the OTS did not deem it necessary for an interest-rate risk component to be
deducted from capital in determining risk-based capital requirements.
The Company may not declare or pay cash dividends on its shares of common stock
if the effect thereof would cause stockholders' equity to be reduced below
applicable capital maintenance requirements or if such declaration and payment
would otherwise violate regulatory requirements.
The capital ratios discussed above, along with the Company's actual capital
amounts and ratios are presented in a table within footnote 15 to the
consolidated financial statements included in response to Item 8 "Financial
Statements and Supplementary Data" of this report.
INSURANCE OF DEPOSIT ACCOUNTS
As required by FDICIA, in 1993, the FDIC established a risk-based assessment
system for insured depository institutions that takes into account the risks
attributable to different categories and concentrations of assets and
liabilities, the likely amounts of any loss, and the revenue needs of the
insurance fund.
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Insurance of deposits may be terminated by the FDIC after notice and hearing,
upon finding by the FDIC that the savings institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations,
or has violated any applicable law, rule, regulation, order or condition imposed
by, or written agreement with, the FDIC. Additionally, if insurance termination
proceedings are initiated against a savings institution, the FDIC temporarily
may suspend insurance on new deposits received by an institution under certain
circumstances. Management is not aware of any activity or condition which could
result in a termination of its deposit insurance.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain
noninterest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). Because required reserves must be maintained in
the form of either vault cash, a noninterest bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As such, the Company has registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. As a unitary savings and loan holding company, the Company
generally will not be restricted under existing laws as to the types of business
activities in which it may engage, provided that the Bank continues to be a QTL.
The HOLA requires the Company to obtain regulatory approvals prior to entering
into certain transactions such as mergers with or acquisitions of other
institutions or holding companies.
LENDING ACTIVITIES
General
At December 31, 1996, the loan portfolio, before deducting the allowance for
possible loan losses, was $704.7 million, representing 66.0% of total assets and
an increase of $204.6 million over the prior year. The increase in loans
included $97.5 million of loans acquired from Finest Financial Corp ("Finest")
at the time of its acquisition by the Company.
Loan originations increased in 1996 primarily due to the stabilization of
the New England residential real estate market, and in the Massachusetts and New
Hampshire economies generally. The increase also reflects a stronger marketing
effort by the Bank in the commercial and consumer loan areas. First Essex
originates residential first mortgage loans, commercial real estate loans,
construction loans, consumer loans and commercial loans. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition."
The following table sets forth information concerning First Essex's loan
portfolio, including mortgage loans held for sale, at the dates indicated. The
balances shown in the table are net of unadvanced funds and unearned discounts
and fees. Required disclosure regarding maturity distribution is shown on pages
26 and 27.
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Years Ended December 31,
1996 1995 1994 1993 1992
------- -------- -------- -------- ------
(Dollars in Thousands)
Real Estate:
Residential $301,869 42.9% $235,204 47.0% $264,848 61.6% $203,574 70.1% $205,799 69.4%
Commercial 102,718 14.6 53,504 10.7 25,786 6.0 28,755 9.9 38,134 12.9
Construction 24,855 3.5 14,210 2.8 15,527 3.6 14,482 5.0 7,194 2.4
--------- ----- --------- ---- -------- ----- -------- ---- -------- ----
Total real estate loans 429,442 61.0 302,918 60.5 306,161 71.2 246,811 85.0 251,127 84.7
--------- ---- --------- ---- -------- ----- -------- ---- -------- ----
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Owner occupied commercial
real estate(1) 29,465 4.2 --- --- --- --- --- --- --- ---
Commercial loans 63,695 9.0 66,737 13.4 55,377 12.9 15,416 5.3 8,602 2.9
Aircraft loans 33,267 4.7 14,478 2.9 522 0.1 --- 0.0 --- 0.0
Consumer loans:
Home equity 12,088 1.7 12,558 2.5 12,943 3.0 14,745 5.1 19,319 6.5
Automobile 92,175 13.1 76,590 15.3 34,906 8.1 2,435 0.8 5,182 1.7
Other 44,527 6.3 26,770 5.4 19,902 4.7 11,100 3.8 12,404 4.2
---------- ----- --------- ---- ------- ----- --------- ---- -------- ----
Total consumer loans 148,790 21.1 115,918 23.2 67,751 15.8 28,280 9.7 36,905 12.4
--------- ---- -------- ---- ------- ----- --------- ---- -------- ----
Total loans $704,659 100.0% $500,051 100.0% $429,811 100.0% $290,507 100.0% $296,634 100.0%
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(1) During 1996, management began to report this category of loans separate from its other commercial and commercial real estate
loans. Management believes this category of loans is distinguishable from its other commercial lending products. In 1996, the
Company reclassified certain loans to this category from other more
historical classification categories.
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Residential Mortgage Loans
The Bank originates residential first mortgage loans in its market area. At
December 31, 1996, the residential mortgage loan portfolio was $301.9 million,
representing 42.9% of the loan portfolio. The Company's residential first
mortgage loan products consist of six month, one-year, three-year, five year and
seven year adjustable-rate mortgages and fixed-rate mortgages, having terms of
15 to 30 years.
Commercial Real Estate Loans
The Bank also holds loans secured by commercial real estate, such as
manufacturing, retail, apartment and office buildings. At December 31, 1996,
First Essex's commercial real estate loan portfolio had an outstanding balance
of $102.7 million, representing 14.6% of First Essex's loan portfolio.
Generally, commercial real estate loans in the portfolio have been made to
finance the acquisition or retention of income producing properties. The current
policy of First Essex is to limit commercial real estate loans primarily to
properties in eastern Massachusetts and southern New Hampshire.
Commercial real estate loans generally reprice over periods ranging from six
months to five years based on a margin over a published prime rate or other
index.
Construction Loans
Construction loans are primarily made to developers and builders for the
construction of commercial and single family properties. Construction loans have
generally been made with maturities of one year or less at a margin floating
over the published prime, subject to renewal or extension by the Bank.
Additionally, loans are made to qualified individuals for construction of
single-family owner-occupied homes that convert to permanent mortgages upon
completion of construction. At December 31, 1996, the Bank's construction loan
portfolio had an outstanding balance of $24.9 million, representing 3.5% of the
loan portfolio.
Owner-Occupied Commercial Real Estate Loans
Owner-occupied commercial real estate loans are extensions of credit to
commercial borrowers for the construction or purchase of business space,
primarily for the borrower's own use, or loans to commercial borrowers for
operating purposes in which the Bank has taken real estate occupied by the
borrower as collateral. In these instances, the cash flow of the borrower's
business is the primary source of repayment. At December 31, 1996, this
portfolio had total outstandings of $29.5 million, representing 4.2% of the
Bank's loan portfolio.
Commercial Loans
At December 31, 1996, the portfolio of commercial loans totalled $88.5 million,
representing 12.6% of the loan portfolio. Included in that total are $24.8
million of commercial aircraft loans. The Bank offers various types of
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commercial aircraft loans. The Bank offers various types of commercial loans,
which are short term or have adjustable rates at a margin above the prime rate,
including secured and unsecured demand loans, time loans, term loans, lines of
credit and working capital loans. Commercial loans are originated by the Bank's
commercial lending officers and supported by a credit, processing and
documentation staff.
Consumer Loans
The portfolio of consumer loans, consisting of automobile loans, fully or
partially secured personal loans, boat loans, aircraft loans, second mortgage
loans, home equity loans and education loans, as well as unsecured personal
loans, totalled $157.3 million, including $8.5 million of consumer aircraft
loans, at December 31, 1996, representing 22.3% of the loan portfolio.
Automobile loans include dealer indirect loans, as well as loans originated
directly in retail branches. The Bank offers a variable rate home equity line of
credit called "First Line Equity Credit". This product consists of a line of
credit, secured by a second mortgage on residential property, with a monthly
adjustable interest rate at a margin above a published prime rate.
Risks Associated with Commercial Real Estate, Commercial, Owner-Occupied
Commercial Real Estate and Construction Loans
Commercial real estate and commercial lending involve significant additional
risks compared with one-to-four family residential mortgage lending, and,
therefore, typically account for a disproportionate share of delinquent loans
and real estate owned through foreclosure. Such lending generally involves
larger loan balances to single borrowers or groups of related borrowers than
does residential lending, and repayment of the loan depends in part on the
underlying business and financial condition of the borrower and is more
susceptible to adverse future developments. If the cash flow from
income-producing property is reduced (for example, because leases are not
obtained or renewed), the borrower's ability to repay the loan may be materially
impaired. These risks can be significantly affected by considerations of supply
and demand in the market for office, manufacturing and retail space and by
general economic conditions. As a result, commercial real estate and commercial
loans are likely to be subject, to a greater extent than residential property
loans, to adverse conditions in the economy generally.
Construction loans are, in general, subject to the same risks as commercial real
estate loans, but involve additional risks as well. Such additional risks are
due to uncertainties inherent in estimating construction costs, delays arising
from labor problems, shortages of material, uncertain marketability of a
complete project and other unpredictable contingencies that make it relatively
difficult to determine accurately the total loan funds required to complete a
project or the value of the completed project. Construction loan funds are
advanced on the security of the project under construction, which is of
uncertain value prior to the completion of construction. When a construction
project encounters cost overruns, marketing or other problems, it may become
necessary, in order to sustain the project and to preserve collateral values,
for the lender to advance additional funds and to extend the maturity of its
loan. In a declining market, there is no assurance that this strategy will
successfully enable the lender to recover outstanding loan amounts and interest
due. Moreover, foreclosing on such properties results in administrative expense
and substantial delays in recovery of outstanding loan amounts and provides no
assurance that the lender will recover all monies due to it, either by
developing the property, subject to regulatory limitations and to the attendant
risks of development, or by selling the property to another developer.
Residential Loan Servicing and Purchase and Sale of Loans
The Bank has a general policy of writing residential mortgage loans to meet the
requirements for sale in the secondary market. From time to time, the Bank sells
residential mortgage loans and residential loan servicing. Such loan sales
represent a potential source of liquidity to meet lending demand and deposit
flows. See Item 7 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Asset/Liability Management."
At December 31, 1996, the Bank's loan servicing portfolio totalled $95.8
million.
NON-PERFORMING ASSETS
General
Non-performing assets consist of non-accruing loans (including loans impaired
under the Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan,"), other real estate
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owned and other foreclosed property. For further information regarding the
impairment of loans see "Provision for Possible Loan Losses" included in Item 7
- - "Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Non-Accruing Loans
It is the general practice of the Bank to discontinue accrual of interest on
loans for which payment of interest or principal is 90 days or more past due and
such other loans where collection of interest and principal is doubtful. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on non-accrual status. At December 31,
1996, the Bank's non-accruing loans totalled $4.7 million compared to $4.4
million on December 31, 1995. For further information regarding the Bank's
non-accruing loans, see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition -
Non-Performing Assets."
Restructured Loans
These are loans on which concessions have been made in light of the debtor's
financial difficulty with the objective of maximizing recovery and with respect
to which the renegotiated payment terms are being met. At December 31, 1996 and
1995, the Bank had restructured loans with principal balances of $1.0 million
outstanding. For further information regarding restructured loans, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Non-Performing Assets."
Foreclosed Property
Foreclosed property at December 31, 1996 totalled $1.9 million, compared to $1.8
million at December 31, 1995. Such properties were acquired through foreclosure.
Foreclosed property consists of real or tangible property that collateralized a
loan prior to foreclosure or repossession. These properties are carried at the
lower of cost or the estimated net realizable values. Any decreases in value
prior to sale are charged to operations.
For further information regarding the Bank's foreclosed property, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Non-Performing Assets."
INVESTMENT ACTIVITIES
The Bank maintains an investment portfolio to provide a source of interest and
dividend income and a potential source of liquidity to meet lending demand and
deposit flows. At December 31, 1996, the investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities, stock
in the Federal Home Loan Bank of Boston and stock of the Savings Bank Life
Insurance Company of Massachusetts, was $315.7 million, or 29.6% of total
assets. Investment securities totalling $62.1 million are attributable to the
acquisition of Finest.
Interest and dividend income on the investment portfolio generated 26.2% of
total interest and dividend income for the year ended December 31, 1996. See
Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Investments" for further
information regarding the investment portfolio.
The Bank's investment strategy seeks to enhance liquidity and seeks to realize
current income while preserving principal. The Bank will generally invest only
in government or corporate bonds or securities issued in the United States and
will only purchase bonds which are rated A or higher at the time of purchase.
DEPOSITS
The Bank offers a range of deposit accounts including regular passbook savings,
NOW, money market and demand deposit accounts. The Bank offers a number of
relationship products which allow customers to combine balances in checking and
savings accounts in order to avoid service and maintenance fees, and obtain free
banking services. It also includes discounts on installment loans and bonus
rates on certificates of deposit. The
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Bank also offers 60-day to 7 year term deposit certificates. Interest rates on
these certificates vary according to the term selected and are based upon
several indices, including the rates on government securities with similar
maturities. From time to time, the Bank promotes various types of accounts with
the intention of changing the maturity schedule of its liabilities.
The Bank offers its retail banking customers a wide range of deposit services
and the convenience of drive-up ATMs. The Bank is a member of the NYCE(TM),
EXCHANGE(TM), TX(TM) and CIRRUS(TM) networks. These networks allow the Bank's
depositors access to their accounts through ATMs at the Bank, other banks and
locations nationwide and worldwide.
COMPETITION
The Bank faces competition both in originating loans and in attracting deposits.
Competition in originating loans comes from a variety of sources, including, but
not limited to, other thrift institutions, commercial banks, mortgage companies,
insurance companies and consumer and commercial finance companies. The Bank
competes for loans principally on the basis of interest rates and loan fees, the
types of loans originated and the quality of services provided to borrowers. In
attracting deposits, the primary competitors are other thrift institutions,
commercial banks, mutual funds and credit unions. The ability to attract and
retain deposits depends on the ability to provide investment opportunities that
satisfy the requirements of investors with respect to rate of return, liquidity,
risk and other factors. The Bank competes for deposits on the basis of interest
rates and by offering convenient branch locations, extended business hours and
an automated teller network.
EMPLOYEES
At December 31, 1996, the Bank had 294 employees, of whom 50 were part-time.
None of the employees of the Bank are represented by a collective bargaining
group and management considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal banking subsidiary, First Essex Bank, FSB, operates
banking facilities in ten locations in northern Massachusetts, and five
locations in southern New Hampshire. The offices of the Bank are in good
physical condition with modern equipment and facilities considered adequate to
meet the banking needs of customers in the communities serviced.
The offices of the Company are located in the Bank's branch office at 71 Main
Street in Andover, Massachusetts.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its business,
none of which is believed by management to be material to the financial
condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of Stockholders was held on December 19, 1996 for the purpose
of considering and voting upon a proposal to approve and adopt the Agreement and
Plan of Reorganization dated August 5, 1996, as amended as of September 27, 1996
(the "Merger Agreement"), by and among First Essex, Finest and Pelham, and each
of the transactions contemplated thereby, including the merger (the "Merger") of
Finest with and into First Essex, upon the terms and subject to the conditions
set forth in the Merger Agreement.
An affirmative vote of the majority of holders of the outstanding shares of
First Essex Common Stock was required for approval of the Merger Agreement and
the transactions contemplated thereby. Abstentions and broker non-votes had the
same effect as votes against the Merger Agreement. At the close of business on
the record date of October 31, 1996 outstanding shares totalled 6,058,935
requiring a vote in favor of the Merger Agreement of shares totalling 3,029,468.
The number of votes cast in favor of the Merger Agreement totalled 3,207,560.
Shares voted against totalled 79,139 with abstentions of 28,739 and non-votes
totalling 2,743,497.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND
RELATED SECURITY HOLDER MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on the
National Market System of the National Association of Securities Dealers, Inc.
Automated Quotation System (NASDAQ) under the symbol FESX.
At December 31, 1996, there were 7,421,433 shares outstanding and approximately
1,190 shareholders of record. This does not reflect the number of persons or
entities who hold their stock in nominee or street name through various
brokerage firms.
The price information regarding the Company's common stock in the following
table is based on high and low closing sales prices on NASDAQ.
- -------------------------------------------------------------------------------------------
Dividend
Price Per Share Declared
HIGH LOW per Share
1996
First Quarter $11.750 $10.187 $.12
Second Quarter 11.000 10.375 .12
Third Quarter 12.000 10.000 .12
Fourth Quarter 14.500 11.625 .12
1995
First Quarter $8.750 $7.625 $.08
Second Quarter 8.750 8.000 .08
Third Quarter 11.000 8.125 .12
Fourth Quarter 12.000 10.375 .12
- -------------------------------------------------------------------------------------------
The only funds available to the Company for the payment of dividends are cash
and cash equivalents held at the holding company level, dividends from the Bank
and borrowings. In addition, bank regulatory authorities generally restrict the
amounts available for the payment of dividends by the Bank to First Essex to the
net profit of the Bank for that year, see Item 1 - "Business - Regulation -
Limitation on Capital Distributions". The Federal Reserve Act also restricts the
Bank in lending or advancing funds to First Essex unless such loans are
collateralized by specific obligations, and limits collateralized loans to 10%
of the Bank's capital stock and surplus.
The Bank is prohibited from paying cash dividends, to the extent that any such
payment would reduce its capital below required regulatory capital levels or
would impair the liquidation account established in connection with its
conversion from mutual to stock form. See Note 14 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report for further discussion.
The payment of dividends by the Bank could carry significant adverse tax
consequences. To the extent that distributions by the Bank to the holding
company exceeds the Bank's current and accumulated earnings and profits (as
computed for federal income tax purposes for taxable years beginning after
December 31, 1951), those distributions would be treated for tax purposes as
first being made out of the Bank's bad debt reserve. In that case, the Bank
would have federal taxable income equal to approximately one and one-half times
the amount of the actual shareholder distribution that is treated as made out of
the Bank's bad debt reserves.
9
ITEM 6. SELECTED FINANCIAL DATA
At December 31,
1996 1995 1994 1993 1992
------ ------ ------ ------ -----
(Dollars in thousands)
Balance Sheet Data:
Total assets $1,067,175 $808,792 $806,872 $645,873 $506,913
Loans receivable 694,121 493,499 422,574 282,760 284,875
Investment securities (1) 315,664 275,900 346,943 329,823 186,232
Foreclosed property 1,880 1,756 3,038 6,360 12,125
Deposits 690,953 491,469 456,878 398,233 412,218
Borrowed funds 274,958 245,569 279,948 185,001 40,000
Stockholders' equity 83,141 60,172 54,757 50,749 44,619
Years Ended December 31,
1996 1995 1994 1993 1992
-------- -------- -------- --------- --------
(Dollars in thousands, except per share data)
Operating Data:
Interest and
dividend income $63,545 $60,914 $ 45,057 $ 36,183 $ 37,831
Interest Expense 37,317 37,081 22,707 16,654 19,240
------- ------- ------- -------- --------
Net interest income 26,228 23,833 22,350 19,529 18,591
Provision for loan losses 1,415 770 --- --- ---
Net gain (loss) on sales
of securities 497 (13) --- --- 613
Gain on sale of mortgage loans
and mortgage servicing rights 1,352 1,431 260 730 234
Net gain on sales of
foreclosed property 109 53 141 895 943
Other income 2,416 2,290 2,301 2,465 2,252
Noninterest expenses 20,034 19,297 19,331 19,290 21,522
Income tax
expense (benefit) 40 75 (805) (2,621) 13
------- ------- ------- ------- -------
Net income $ 9,113 $ 7,452 $ 6,526 $ 6,950 $ 1,098
======= ======= ======= ======= =======
Per Share Data:
Earnings per share $ 1.47 $ 1.22 $ 1.08 $ 1.15 $ .18
Dividends declared .48 .40 .28 .11 .00
Book value at
end of period 11.20 9.99 9.10 8.44 7.42
Selected Financial Ratios:
Return on average assets 1.08% 0.91% 0.94% 1.24% 0.22%
Return on average equity 14.37 12.79 12.42 14.83 2.50
Average equity as a
percentage of average assets 7.54 7.09 7.56 8.34 8.94
Weighted average interest
rate spread 2.72 2.56 3.02 3.29 3.57
Net yield on average
earning assets 3.22 2.99 3.33 3.60 3.96
(1) Investment securities include short term investments, U.S. government and
agency obligations, mortgage-backed securities, other bonds and obligations,
stock in the Federal Home Loan Bank of Boston and stock in the Savings Bank Life
Insurance Company.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
General
The results of operations of the Company consist primarily of the
results of operations of the Bank which is the Company's sole subsidiary. Pretax
income for 1996 rose $1.6 million or 22% over 1995. The improvement was in part
due to the 2.3% increase in average earning assets combined with decreased
levels of nonperforming assets. See Item 1. "Business - Current Market
Conditions/Recent Operating Results."
Net income for the year ended December 31, 1996 totalled $9.1 million (or $1.47
per share) compared to $7.5 million (or $1.22 per share) for the same period in
1995. The increase in net income is mainly due to an increase of $2.4 million in
net interest income and higher gains in the sale of investment securities of
$510,000, offset by an increase in the provision for possible loan losses of
$645,000 and an increase in salaries and employee benefit expense of $1.1
million.
11
Analysis of Average Yields Earned and Rates Paid
The following table presents an analysis of average yields earned and rates paid
for the years indicated:
- -----------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
1996 1995 1994
--------------------------- --------------------------- ------------------------------
Interest Average Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ------ ------ ------- ------ ------ ------- ------- -----
(Dollars in thousands)
Assets
Earning Assets
Short-term investments $ 8,589 $ 451 5.25% $ 6,735 $ 342 5.08% $ 2,457 $ 107 4.35%
Investment securities 267,493 16,202 6.06 316,501 19,354 6.11 343,303 18,114 5.28
Total loans (1) 538,758 46,892 8.70 473,069 41,218 8.71 325,922 26,836 8.23
------- ------- -------- ----- --------
Total earning assets 814,840 63,545 7.80 796,305 60,914 7.65 671,682 45,057 6.71
------- ------- -------- ----- --------
Allowance for possible loan losses (6,734) (6,447) (7,332)
-------- -------- -------
Total earning assets less allowance
for possible loan losses 808,106 789,858 664,350
Other Assets 32,652 31,889 30,760
-------- -------- --------
Total Assets $840,758 $821,747 $695,110
======== ======== ========
Liabilities and Stockholders' Equity
NOW accounts 32,846 399 1.21% 28,664 325 1.13% $ 30,086 354 1.18%
Money market accounts 72,632 1,606 2.21 79,593 1,586 1.99 105,181 2,210 2.10
Savings accounts 49,822 862 1.73 51,069 816 1.60 58,514 780 1.33
Time deposits 320,649 19,079 5.95 294,473 17,117 5.81 203,500 9,080 4.46
------- ------ -------- ----- ------
Total interest bearing
deposits 475,949 21,946 4.61 453,799 19,844 4.37 397,281 12,424 3.13
Borrowed funds 259,070 15,371 5.93 274,956 17,237 6.27 218,553 10,283 4.71
------- -------- -------- ----- ------
Total interest bearing deposits
and borrowed funds 735,019 37,317 5.08 728,755 37,081 5.09 615,834 22,707 3.69
-------- -------- -------
Demand deposits 30,804 23,550 15,982
Other liabilities 11,530 11,195 10,745
-------- -------- -------
Total liabilities 777,353 763,500 642,561
Stockholders' equity 63,405 58,247 52,549
-------- -------- -------
Total liabilities and
stockholders' equity $840,758 $821,747 $695,110
======== ======== ========
Net interest income $26,228 $23,833 $22,350
======== ======= =======
Weighted average rate spread 2.72% 2.56% 3.02%
==== ===== ====
Net yield on earning assets (2) 3.22% 2.99% 3.33%
======= ======== ====
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for possible loan losses divided by
average interest earning assets.
- -----------------------------------------------------------------------------------------------------------------------------------
12
Rate/Volume Analysis
The following table presents, for the periods indicated, the changes in interest
and dividend income and the changes in interest expense attributable to changes
in interest rates and changes in the volume of interest earning assets and
interest bearing liabilities. The change attributable to both volume and rate
has been allocated proportionally to the two categories.
- --------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
1996 Compared to 1995 1995 Compared to 1994
-------------------------- -----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
Volume Rate Total Volume Rate Total
(Dollars in thousands)
Interest and dividend income:
Loans before the allowance for
possible loan losses $ 6,064 $ (390) $ 5,674 $13,409 $ 973 $14,382
Investment securities (2,970) (182) (3,152) (1,197) 2,437 1,240
Federal funds sold and short-term investments 97 12 109 214 21 235
------ ------- -------- ------- ------ -------
Total interest and dividend income 3,191 (560) 2,631 12,426 3,431 15,857
------ ------- -------- -------- ------ -------
Interest expense:
Savings deposits (48) 188 140 (595) (22) (617)
Time deposits 1,550 412 1,962 4,792 3,245 8,037
Borrowed funds (968) (898) (1,866) 3,039 3,915 6,954
------- ------ -------- ------- ------- -------
Total interest expense 534 (298) 236 7,236 7,138 14,374
------- ------- -------- ------- ------- -------
Net interest and dividend income $ 2,657 $ (262) $ 2,395 $ 5,190 $(3,707) $ 1,483
======== ====== ======== ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Net Interest Income
Net interest income increased by $2.4 million to $26.2 million for the year
ended December 31, 1996, representing a 10.0% increase from $23.8 million in
1995. The increase in net interest income is primarily due to the $18.5 million
increase (2.3%) in average earning assets along with an increase of 23 basis
points in the net yield on average earning assets. The increase in the net yield
is attributable to the declining interest cost of borrowed funds and interest
bearing deposits.
Net interest income increased by $1.5 million to $23.8 million for the year
ended December 31, 1995, representing a 6.6% increase from $22.3 million in
1994. The increase in net interest income is primarily due to the $124.6 million
increase (18.6%) in average earning assets offset by a 34 basis point decrease
in the net yield on average earning assets. The decrease in net yield is
attributable to the rising interest cost of borrowed funds and interest bearing
deposits.
Interest and Dividend Income
Interest and dividend income increased by $2.6 million (4.3%) to $63.5 million
for the year ended December 31, 1996 from $60.9 million in 1995. This increase
was primarily due to the increase in average earning assets. Average earning
assets increased from $796.3 million in 1995 to $814.8 million in 1996, a 2.3%
increase. The net yield on average earning assets rose 23 basis points from the
1995 yield of 2.99% to 3.22% in 1996.
13
Interest and dividend income increased by $15.9 million (35.2%) to $60.9 million
for the year ended December 31, 1995 from $45.1 million in 1994. This increase
was primarily due to the increase in average earning assets. Average earning
assets increased from $671.7 million in 1994 to $796.3 million in 1995, an 18.6%
increase. The average weighted yield on loans rose 48 basis points from the 1994
yield of 8.23% to 8.71% in 1995. The average weighted yield on investment
securities rose from the 1994 yield of 5.28% to 6.11% in 1995.
Interest Expense
Interest expense increased by $236,000 (0.6%) to $37.3 million for the year
ended December 31, 1996 from $37.1 million in 1995. The increase is attributable
in part to an increase of $2.1 million in the amount paid on depositors'
accounts offset by a decrease of $1.9 million paid on borrowed funds. The total
weighted cost of funds decreased slightly from a level of 5.09% in 1995 to 5.08%
in 1996.
Interest expense increased by $14.4 million (63.3%) to $37.1 million for the
year ended December 31, 1995 from $22.7 million in 1994. The main reason for the
increase was an increase of $112.9 million (18.3%) in interest bearing
liabilities utilized to support asset growth. The remainder was primarily due to
the 1.4 percentage point increase in the cost of funds. The total weighted cost
of funds increased from a level of 3.69% in 1994 to 5.09% in 1995.
Provision for Possible Loan Losses
Beginning in 1995, the Company adopted SFAS No. 114, as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114"). Under SFAS
No. 114, the Company considers a loan impaired if it is ninety days or more past
due as to principal and interest, or if management's credit risk assessment
determines that it is probable that principal and interest will not be collected
as contractually scheduled. In addition, loans which are restructured at market
rates and comparable to loans with similar risks are considered impaired only in
the year of the restructuring, so long as they continue to perform according to
the restructured terms. Excluded from the impaired category, but otherwise
considered non-accruing loans, are small balance homogeneous loans which are
ninety days or more past due. Small balance homogeneous loans include
residential mortgage loans, residential construction loans to individuals
(excluding builder construction loans) and consumer loans. The Company evaluates
a loan's level of impairment by measuring the net present value of the expected
future cash flows using the loan's original effective interest rate, or looking
at the fair value of the collateral if the loan is collateral dependent. When
the difference between the net present value of the impaired loan (or fair value
of the collateral if the loan is collateral dependent) is lower than the
recorded investment of the loan, the difference is provided to expense with a
resulting valuation allowance.
Possible losses on loans are provided for under the accrual method of
accounting. Assessing the adequacy of the allowance for possible loan losses
involves substantial uncertainties and is based upon management's evaluation of
the amount required to meet estimated losses inherent in the loan portfolio
after weighing various factors. Among the factors management may consider are
the quality of specific loans, risk characteristics of the loan portfolio
generally, the level of non-accruing loans, current economic conditions, trends
in delinquencies and charge-offs and collateral values of the underlying
security. Ultimate losses may vary significantly from the current estimates.
Losses on loans, including impaired loans, are charged against the allowance
when management believes the collectibility of principal is doubtful.
Provisions for possible loan losses totalled $1.4 million and $770,000 for the
years ended December 31, 1996 and 1995, respectively. Included in those amounts
were $659,000 and $356,000, respectively, of provisions for possible losses
related to loans impaired under SFAS No. 114. There were no provisions for
possible loan losses for the year ended December 31, 1994. Provisions result
from management's continuing internal review of the loan portfolio as well as
its judgment as to the adequacy of the reserves in light of the condition of the
regional real estate market and the economy generally. As a result of increased
loans, there is an expectation that the Bank will continue to find it necessary
to make provisions for possible loan losses in the future. See "Financial
Condition - Non-Performing Assets."
The Bank's total allowance for possible loan losses was $10.5 million (including
$4.1 million acquired from Finest) or 222.4% of non-accruing loans at December
31, 1996 compared to $6.6 million or 148.4% at December 31, 1995 and $7.2
million or 99.0% at December 31, 1994.
14
Noninterest Income
Noninterest income consists of net gains or losses from sales of securities, net
gains from sales of loans and loan servicing rights, fee and other noninterest
income.
Noninterest income increased to $4.3 million for the year ended December 31,
1996 compared to $3.7 million in 1995. The primary reason for the increase from
1995 to 1996 was an increased gain on the sale of investment securities, which
rose by $510,000 from a loss of $13,000 in 1995, to a gain of $497,000 in 1996.
Loan fees also increased by $36,000 from $477,000 in 1995 to $513,000 in 1996.
Noninterest income increased to $3.7 million for the year ended December 31,
1995 compared to $2.6 million in 1994. The primary reason for the increase from
1994 to 1995 was increased gains from sales of loans and loan servicing rights,
which rose by $1.2 million from the gain of $260,000 in 1994 to the gain of $1.4
million in 1995. Loan fees also increased by $84,000 from $393,000 in 1994 to
$477,000 in 1995.
Noninterest Expenses
Noninterest expenses increased by $681,000 (3.5%) to $19.9 million for the year
ended December 31, 1996 compared to $19.2 million in 1995. This increase is
primarily due to a $1.4 million increase in salary and employee benefits and
building and equipment costs, offset by a decrease of $606,000 and $118,000 in
other operating and foreclosed property expenses, respectively.
Noninterest expenses stayed constant at $19.2 million for the year ended
December 31, 1995 compared to 1994. Salary and employee benefits and building
and equipment costs, increased by $1.3 million, which was almost entirely offset
by a decrease of $1.2 million in foreclosed property expenses.
Salaries and employee benefits increased by $1.1 million (11.7%) to $10.1
million for the year ended December 31, 1996 from $9.0 million in 1995 and $8.1
million in 1994. The increases for both years were primarily due to costs
associated with increases in personnel of 12% in 1996 and 6% in 1995 to support
business growth.
Building and equipment costs increased $349,000 to $3.6 million for 1996
compared to $3.3 million in 1995 and $2.8 million in 1994. The increase in 1996
was due in part to costs associated with the opening during 1996 of two new
branches, one located in Salem, New Hampshire, the other at the Crosspoint
Towers in Lowell, Massachusetts.
Expenses associated with foreclosed property totalled $666,000 for the year
ended December 31, 1996 compared to $784,000 in 1995. These expenses include
$82,000 of additional write-downs of the carrying values of properties during
1996 compared to $361,000 in 1995. Other expenses associated with the ownership
of foreclosed property totalled $584,000 in 1996 compared to $423,000 in 1995.
While the regional economy and real estate market continues to recover from the
difficulties of the past several years, there is no assurance that the Bank will
not experience further write-downs in the carrying values of foreclosed
property.
Expenses associated with foreclosed property totalled $784,000 for the year
ended December 31, 1995 compared to $2.0 million in 1994. These expenses include
$361,000 of additional write-downs of the carrying values of properties during
1995 compared to $1.1 million in 1994. Other expenses associated with the
ownership of foreclosed property totalled $423,000 in 1995 compared to $934,000
in 1994.
All other operating expenses decreased in total by $606,000 (9.8%) to $5.6
million for the year ended December 31, 1996 compared to $6.2 million in 1995
and $6.1 million in 1994. The decrease is mainly due to reduction of $498,000 in
insurance expense to $192,000 for 1996 when compared to $690,000 in the prior
year.
Income Taxes
The net provision for income taxes amounted to $40,000 in 1996 compared to a
provision of $75,000 recorded in 1995. The amounts recorded in each year were
based on management's quarterly review of the operations of the Company, the
realizability of the deferred tax asset, and management's analysis of future
taxable income. Management has valued the deferred tax asset in accordance with
regulatory guidelines which resulted in the elimination, during 1996, of the
deferred tax valuation allowance that existed at December 31, 1995.
15
Management expects that during 1997 the Company will return to the position of
having a provision for income taxes that more closely aligns with statutory
rates. For further information on income taxes, see Note 8 of Notes to
Consolidated Financial Statements.
16
FINANCIAL CONDITION
Total assets amounted to $1.1 billion at December 31, 1996, an increase of
$258.4 million or 32.0% from $808.8 million at December 31, 1995. Included in
the increase for 1996 is $191.1 million of assets acquired through the purchase
and acquisition of Finest, which was consummated on December 31, 1996.
Loans
At December 31, 1996, the loan portfolio, excluding the allowance for possible
loan losses, and including mortgage loans held-for-sale, was $704.7 million,
representing 66.0% of total assets, compared to $500.1 million or 61.8% of total
assets at December 31, 1995. The increase in loans is attributable in part to
the acquisition of Finest and its $101.5 million loan portfolio. See Item 1 -
"Business - Lending Activities General" for a table setting forth the
composition of the loan portfolio of the Bank at the end of each of the past
five years.
The Bank's indirect automobile lending program resulted in $92.2 million, $76.6
million and $34.7 million of automobile loans for the years ending December 31,
1996, 1995 and 1994, respectively. Aircraft loans, an increasing lending
activity for the Bank, totalled $33.3 million in 1996 compared to $14.5 million
in 1995, and $22,000 in 1994.
Non-Performing Assets
Non-performing assets consist of non-accruing and restructured loans (including
loans impaired under SFAS No. 114), and foreclosed property. Non-performing
assets totalled $6.6 million at December 31, 1996, compared to $6.2 million at
December 31, 1995 and $10.4 million at December 31, 1994. Included in the 1996
total of $6.6 million, are $1.7 million of non-performing assets acquired from
Finest.
The Bank's general practice is to discontinue the accrual of interest on loans
(including loans impaired under SFAS No. 114) for which payment of interest or
principal is ninety days or more past due or for such other loans as considered
necessary by management if collection of interest and principal is doubtful.
When a loan is placed on non-accrual status, all previously accrued but
uncollected interest is reversed against current period interest income.
The principal balance of restructured loans was $1.0 million for both years
ended December 31, 1996 and 1995. There were no restructured loans outstanding
in 1994.
If the non-accruing loans at December 31, 1996 and 1995 had been current in
accordance with their original terms, the amount of interest income that would
have been recorded is $140,000 and $389,000, respectively. Interest income
recognized on impaired loans, using the cash basis of accounting, amounted to
approximately $244,000 for the year ended December 31, 1996 compared to
approximately $166,000 in 1995. The amount of interest that was collected and
recorded as income on non-performing loans was $350,000 and $511,000 for the
years ended December 31, 1996 and 1995 respectively.
Foreclosed property at December 31, 1996 totalled $1.9 million compared to $1.8
million at December 31, 1995 and consists mainly of real estate collateral from
loans which were foreclosed. Included in the 1996 total is $740,000 of
foreclosed property acquired from Finest at the time of the purchase.
At December 31, 1996, the recorded investment in loans that are considered to be
impaired under SFAS No. 114 totalled $1.4 million of which $1.1 million had a
related allowance for possible loan losses of $491,000. The remaining $286,000
of impaired loans did not require a related allowance for possible loan losses.
The average recorded investment in impaired loans during 1996 was approximately
$1.9 million.
The following table shows the composition of non-performing assets for the
five years ended December 31, 1996.
- -------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accruing loans:
Real estate $ 2,693 $ 2,559 $ 6,548 $ 9,743 $15,816
17
Other 1,004 814 776 1,325 1,974
Restructured loans 1,042 1,043 --- --- 4,447
------- ------- ------- ------- -------
Total non-accruing loans 4,739 4,416 7,324 11,068 22,237
Foreclosed property 1,880 1,756 3,038 6,360 12,125
------- ------- ------- ------- -------
Total non-performing assets $ 6,619 $ 6,172 $10,362 $17,428 $34,362
======= ======= ======= ======= =======
Percentage of non-performing
to total assets 0.62% 0.76% 1.28% 2.70% 6.78%
Percentage of allowance for
possible loan losses
to non-accruing loans 222.4% 148.4% 98.82% 70.00% 52.19%
- -------------------------------------------------------------------------------------------------------------------
The following table summarizes the activity of foreclosed property during the
year ended December 31, 1996:
- -------------------------------------------------------------------------------------------------------------------
Other
Residential Construction Commercial Repossessed
Real Estate Real Estate Real Estate Assets Total
(Dollars in thousands)
Balance at beginning of year $ 406 $ 40 $1,151 $ 159 $1,756
Transfer from loans 309 --- 242 1,409 1,960
Write-downs --- (15) (67) --- (82)
Sales (477) (25) (517) (1,475) (2,494)
Acquired foreclosed property - Finest 740 --- --- --- 740
------ ----- ------ ------ -----
Balance at end of year $ 978 $ 0 $ 809 $ 93 $1,880
====== ===== ====== ===== ======
- -------------------------------------------------------------------------------------------------------------------
18
Allowance for Possible Loan Losses
The allowance for loan losses is maintained at a level determined by management
to be adequate to provide for probable losses inherent in the loan portfolio
including commitments to extend credit. The allowance for loan loss is
maintained through the provision for loan losses, which is a charge to
operations. The potential for loss in the portfolio reflects the risks and
uncertainties inherent in the extension of credit.
The determination of the adequacy of the allowance of possible loan losses is
based upon management's assessment of risk elements in the portfolio, factors
affecting loan quality and assumptions about the economic environment in which
the Company operates. The process includes identification and analysis of loss
potential in various portfolio segments utilizing a credit risk grading process
and specific reviews and evaluations of significant individual problem credits.
In addition, management reviews overall portfolio quality through an analysis of
current levels and trends in charge-off, delinquency and nonaccruing loan data,
review of forecasted economic conditions and the overall banking environment.
These reviews are of necessity dependent upon estimates, appraisals and
judgments, which may change quickly because of changing economic conditions and
the Company's perception as to how these factors may affect the financial
condition of debtors.
The following table summarizes the activity in the allowance for possible loan
losses for the five years ended December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at beginning of year $6,552 $ 7,237 $ 7,747 $11,759 $18,304
Acquired allowance - Finest 4,080 --- ---- ---- ---
Provision for possible loan losses 1,415 770 ---- ---- ---
Charge offs:
Mortgage (1,148) (1,448) (1,703) (4,081) (5,323)
Construction (1) (96) (5) --- (652)
Owner-occupied commercial
real estate (1) --- --- --- --- ---
Commercial (157) (230) (248) (1,023) (788)
Consumer (1,029) (711) (155) (467) (583)
------- --------- -------- -------- -------
Total Charge-offs (2,335) (2,485) (2,111) (5,571) ( 7,346)
------- --------- -------- -------- -------
Recoveries:
Mortgage 277 234 535 649 479
Construction 6 279 240 2 7
Owner-occupied commercial
real estate (1) --- --- --- --- ---
Commercial 461 431 727 815 240
Consumer 82 86 99 93 75
------- --------- ---------- ---------- --------
Total recoveries 826 1,030 1,601 1,559 801
Net Charge-offs (1,509) (1,455) (510) ( 4,012) ( 6,545)
--------- -------- ------- -------- --------
Balance at end of year $10,538 $6,552 $ 7,237 $ 7,747 $11,759
======= ======= ======== ======== =======
Total loans at end of year $704,659 $500,051 $429,811 $290,507 $296,634
Average loans for the year 538,758 473,069 325,922 286,965 330,022
Allowance to loans ratio 1.50% 1.31% 1.68% 2.67% 3.96%
Net Charge-offs to average loans ratio 0.28% 0.30% 0.16% 1.40% 1.98%
(1) During 1996, management began to report this category of loans separate from
its other commercial and commercial real estate loans. Management believes this
category of loans is distinguishable from its other commercial lending products.
In 1996, the Company reclassified certain loans to this category from other more
historical classification categories. In making this reclassification it was
determined that no restatement of charge-offs and/or recoveries, if any, to this
new loan category would be material or meaningful.
- -----------------------------------------------------------------------------------------------------------------------
19
Investments
At December 31, 1996, the Company's investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities,
Federal Home Loan Bank ("FHLB") stock and Savings Bank Life Insurance Company of
Massachusetts stock, totalled $315.7 million or 29.6% of assets, compared to
$275.9 million or 34.1% of assets at December 31, 1995. The portfolio included
U.S. government and agency obligations having a book value of $51.9 million and
a fair value of $52.0 million and mortgage-backed securities with a book value
of $205.6 million and a fair value of $204.6 million. Interest and dividend
income on the Company's investment portfolio generated 26.2% of total interest
and dividend income for the year ended December 31, 1996. During 1996 the
investment portfolio decreased by $22.3 million, net of the effect of $62.1
million of investment securities available-for-sale acquired through the
purchase and acquisition of Finest.
To identify and control risks associated with the investment portfolio, the
Company has established policies and procedures, which include stop loss limits
and stress testing on a periodic basis.
The Company does not have any investments in off balance sheet financial
instruments, except as noted in footnote 9 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report.
The following table sets forth the composition of the investment
portfolio for the years indicated:
- ---------------------------------------------------------------------------------------------------------------
1996 1995 1994
-------- --------- ---------
(Dollars in thousands)
Short-term investments:
Interest bearing deposits $ 3,507 $ 5,086 $ 217
Federal funds sold 16,350 4,500 2,500
-------- -------- --------
Total short-term investments 19,857 9,586 2,717
Investment securities held-to-maturity:
U.S. government & agency obligations 9,978 17,080 54,271
Mortgage backed securities 94,487 118,018 209,747
Other bonds and obligations --- --- 31,039
-------- ------- --------
Total investment securities held-to-maturity 104,465 135,098 295,057
Investment securities available-for-sale:
U.S. government & agency obligations 41,962 --- ---
Mortgage-backed securities 111,062 91,781 35,200
Other bonds and obligations 21,692 23,372 ---
-------- ------- -------
Total investment securities available for sale 174,716 115,153 35,200
Stock in Federal Home Loan Bank of Boston 15,517 14,869 12,775
Stock in Savings Bank Life Insurance Company 1,194 1,194 1,194
-------- -------- --------
Total investments $315,749 $275,900 $346,943
======== ======== ========
Percent of total assets 29.6% 34.1% 43.0%
For further information regarding the Company's investment portfolio,
including information regarding amortized cost and fair value as of December 31,
1996, see notes 1, 3 and 20 to the Company's consolidated financial statements
included in response to Item 8 hereof.
- ---------------------------------------------------------------------------------------------------------------
20
Set forth below is a breakdown of yields and contractual maturities for the
amortized cost of indicated investment securities at December 31, 1996.
- ------------------------------------------------------------------------------------------------------------------------
U.S. Other
government bonds Mortgage-
and agency and backed
obligations obligations securities Total
(Dollars in thousands)
Due in 1 year or less:
Amount $ 9,519 $ 3,641 $ 1,596 $14,756
Yield 5.96% 5.61% 6.16% 5.90%
Due from 1 to 2 years:
Amount 11,985 2,999 16,014 30,998
Yield 5.98% 5.71% 4.87% 5.38%
Due from 2 to 3 years:
Amount 7,000 15,016 --- 22,016
Yield 6.67% 5.84% --- 6.10%
Due from 3 to 5 years:
Amount 19,729 --- 26,725 46,454
Yield 6.49 --- 6.21% 6.33%
Due from 5 to 10 years:
Amount 3,592 106 13,507 17,205
Yield 7.47% 6.79% 6.02% 6.33%
Due after 10 years:
Amount 100 --- 147,745 147,845
Yield 9.25% --- 6.52% 6.52%
------- ------- -------- ---------
Total:
Amount $51,925 $21,762 $205,587 $279,274
Yield 6.37% 5.79% 6.32% 6.29%
- ------------------------------------------------------------------------------------------------------------------------
21
Deposits
Deposits have historically been the Bank's primary source of funds for lending
and investment activities. Deposit flows vary significantly and are influenced
by prevailing interest rates, market conditions, economic conditions and
competition. At December 31, 1996 the Bank had total deposits of $691.0 million,
representing a net increase of $199.5 million compared to $491.5 million at
December 31, 1995. Included in the 1996 total are $162.1 million of deposits
assumed through the purchase and acquisition of Finest. During 1996, the Bank
aggressively marketed deposits resulting in increases of $32.3 million in time
deposits, and $6.2 million in other deposits.
While deposit flows are by nature unpredictable, management attempts to manage
its deposits through selective pricing. Because of the uncertainty of market
conditions, it is not possible for the Bank to predict how aggressively it will
compete for deposits in the future or the likely effect of any such decision on
deposit levels, interest expense and net interest income.
The following table sets forth the composition of average deposits and rates for
the years indicated with respect to categories exceeding 10% of total average
deposits:
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994
------ ------ -----
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Amount Rate Amount Rate Amount Rate
(Dollars in thousands)
NOW $ 32,846 1.21% $ 28,664 1.13% $ 30,086 1.18%
Money market accounts 72,632 2.21 79,593 1.99 105,181 2.10
Savings and notice accounts 49,822 1.73 51,069 1.60 58,514 1.33
Time deposits 320,649 5.95 294,473 5.81 203,500 4.46
------- -------- --------
Total interest bearing deposits 475,949 4.61 453,799 4.37 397,281 3.13
Demand deposits 30,804 23,550 15,982
--------- --------- --------
Total deposits $506,753 $477,349 $413,263
======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
At December 31, 1996, 1995 and 1994, outstanding certificates of deposits in
denominations of $100,000 and over had maturities as follows:
- ---------------------------------------------------------------------------------------------
Remaining Term to Maturity 1996 1995 1994
-------------------------- ------- ------- -------
(Dollars in thousands)
Three months or less $13,993 $ 3,265 $ 2,821
Three to six months 3,998 8,324 2,596
Six to twelve months 11,816 10,549 3,195
Over twelve months 18,530 2,067 11,246
------- ------- -------
Total $48,337 $24,205 $19,858
======= ======= =======
- ---------------------------------------------------------------------------------------------
22
Borrowed Funds
The Bank is a member of the Federal Home Loan Bank ("FHLB") and is entitled to
borrow from the FHLB by pledging certain assets. The Bank also utilizes short
term repurchase agreements, generally with maturities less than three months, as
an additional source of funds. Repurchase agreements are secured by U.S.
government and agency securities. Borrowings are an alternative source of funds
compared to deposits and totalled $275.0 million at December 31, 1996 compared
to $245.6 million and $279.9 million at December 31, 1995 and 1994,
respectively. The increase in borrowings in 1995 to 1996 was used to fund loan
growth during the year. The decrease in borrowings in 1995 was a result of an
increase in deposit accounts.
The following table summarizes the maximum and average amounts of borrowings
outstanding, the majority of which are short-term, during 1996, 1995 and 1994
together with the weighted average interest rates thereon.
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996 At December 31, 1996
--------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $278,318 $249,278 5.89% $267,275 5.74%
Repurchase Agreements 33,473 12,732 5.28 7,683 5.18
For the Year Ended December 31, 1995 At December 31, 1995
-------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $285,372 $263,298 6.22% $219,673 6.10%
Repurchase Agreements 27,019 8,432 5.50 25,896 5.72
For the Year Ended December 31, 1994 At December 31, 1994
-------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $255,489 $207,067 4.66% $225,017 6.10%
Repurchase Agreements 55,131 11,399 5.47 54,931 5.94
- ----------------------------------------------------------------------------------------------------------------------------
23
ASSET/LIABILITY MANAGEMENT
The Bank's asset/liability management strategy is designed to increase net
interest income and provide adequate earnings in expected future interest rate
environments. As part of this strategy, a balance is sought between the
repricing characteristics of its earning assets and funding sources while
maximizing the spread between interest income and expense. The Bank adjusts the
level of its liquid assets and the mix of its loans and investments based on
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
In order to achieve a better repricing balance between its assets and
liabilities, the Bank continued to originate and hold in portfolio adjustable
rate residential mortgage loans. The Bank has a general policy of writing
substantially all newly originated fixed rate residential loans to meet the
requirements for sale in the secondary market. During 1996 the Bank sold $93.4
million of residential loans. The Bank's commercial real estate, construction,
consumer and commercial business lending programs also provide opportunities to
better match the interest rate sensitivity of its loan portfolio and liabilities
due to the adjustable rate or short term repricing characteristics of these
types of loans. Total loans increased by $204.6 million during the year.
Approximately $101.5 million of that increase was as a result of the Finest
acquisition completed on December 30, 1996.
During 1996 investments increased by $39.8 million. The Finest acquisition
brought an additional $62.1 million into the portfolio. During the year and
prior to the Finest acquisition, investments declined due to maturities,
amortization, prepayments and sales. Most of this cash was redeployed to fund
the growth in the loan portfolio.
Borrowings increased by $29.4 million to fund growth in the commercial and
consumer loan portfolios which, excluding the impact of the Finest acquisition,
outstripped deposit growth during the year.
Deposits increased by $199.5 million in 1996, including $162.2 million assumed
in the Finest acquisition. An aggressive marketing program, along with the
opening of two new branches led to an increase in deposits of $37.3 million over
the course of the year and prior to the Finest acquisition.
It is management's opinion that interest rates will continue to exhibit
volatility. With this in mind, the Bank will continue to follow a strategy which
seeks to achieve a balance in the repricing characteristics of its assets and
liabilities and provide adequate earnings in all plausible interest rate
environments.
24
The following table sets forth the maturity and repricing information relating
to interest sensitive assets and liabilities at December 31, 1996. Fixed-rate
mortgage loans and mortgage-backed investments are shown in the table in the
time period corresponding to computed principal amortization based on their
respective contractual maturity. Short term investments, adjustable-rate loans,
investment securities and adjustable mortgage-backed investments are allocated
to the period in which the rates would be next adjusted. The table reflects an
"expected" prepayment assumption on residential, commercial real estate and
consumer loans and mortgage-backed investments. This prepayment assumption was
derived from both past experience and a market consensus of prepayment speeds
for similar types of loans and mortgage-backed investments. Since regular
savings accounts and NOW accounts are not subject to contractual interest rate
adjustments, such accounts have been included in the other deposits category and
are assumed to reprice within 3-5 years. The Bank believes these deposits are
less interest rate sensitive over long periods of time. Other deposits in the
181 - 365 day time period represent anniversary savings accounts which reprice
in one year.
- ----------------------------------------------------------------------------------------------------------------
December 31, 1996
1-180 181-365 1-3 3-5 5+
Days Days Years Years Years Total
(Dollars in thousands)
Interest-earning assets:
Short-term investments $ 19,772 $ --- $ --- $ --- $ --- $ 19,772
Investment securities 39,107 7,917 20,008 22,345 1,201 90,578
Mortgage-backed securities 90,777 41,676 18,590 51,197 3,074 205,314
Loans held for sale 8,915 --- --- --- --- 8,915
Loans in process 6,536 --- --- --- --- 6,536
Fixed rate loans 47,075 38,552 115,055 95,776 15,003 311,461
Adjustable rate loans 191,919 92,012 49,495 44,321 --- 377,747
--------- ------- -------- --------- ------- -------
Total rate sensitive assets 404,101 180,157 203,148 213,639 19,278 1,020,323
-------- ------- -------- --------- ------- ---------
Interest-bearing liabilities:
Money market deposit accounts 92,173 --- --- --- --- 92,173
Certificates of deposit 183,252 94,630 116,532 21,446 6,123 421,983
Other deposits --- 3,476 --- 114,552 --- 118,028
Borrowed funds 200,683 --- 62,597 8,603 3,075 274,958
-------- ------- ------- ------- -------- -------
Total rate sensitive liabilities 476,108 98,106 179,129 144,601 9,198 907,140
-------- ------- ------- ------- -------- -------
Excess (deficiency) of
interest sensitive assets
over interest sensitive
liabilities $(72,007) $82,051 $ 24,019 $ 69,038 $ 10,080 $113,181
========= ======= ======== ======== ======== ========
Cumulative excess
(deficiency) of interest
sensitive assets over
interest sensitive
liabilities $(72,007) $10,044 $ 34,063 $103,101 $113,181
========= ======= ======== ======== ========
Cumulative excess
(deficiency)
percentage of
total assets (6.75)% 0.94% 3.19% 9.66% 10.61%
- ----------------------------------------------------------------------------------------------------------------
25
The following table reflects the scheduled maturities of selected loans at
December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------
One
One Through Over
Year Five Five
or Less Years Years Total
(Dollars in thousands)
Construction loans $24,647 $ 139 $ 69 $24,855
Owner-occupied commercial real estate 5,374 10,278 13,813 29,465
Commercial loans 9,443 44,387 9,865 63,695
------- -------- ------- --------
Total $39,505 $54,814 $23,747 $118,066
======= ======= ======== ========
A summary of the above categories of loans due after one year as to the rate
variability follows (dollars in thousands):
With predetermined rates $23,369
With floating or adjustable rates 55,192
Total maturing or repricing after one year $78,561
=======
- -----------------------------------------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of liquidity are customer deposits, borrowings from
the FHLB, repurchase agreements, scheduled amortization and prepayments of loan
principal, cash flow from operations, maturities of various investments and loan
sales.
Management believes it is prudent to maintain an investment portfolio that not
only provides a source of income, but also provides a potential source of
liquidity to meet lending demand and deposit flows. The Bank adjusts the level
of its liquid assets and the mix of its loans and investments based upon
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields. At December 31,
1996, short-term investments, bonds and obligations and mortgage-backed
investments totalled $315.7 million, 4.7% of which either matures or is
estimated to be prepaid within one year. At December 31, 1995, short term
investments, bonds and obligations and mortgage backed investments totalled
$275.9 million, 8.6% of which matured within one year.
At December 31, 1996, the Bank had total outstanding borrowings of $275.0
million, 73% of which matures within one year. In 1995 the Bank had outstanding
borrowings of $245.6 million, 61% of which matured in one year.
At December 31, 1996, the Bank had outstanding commitments to loan funds under
mortgage, construction and commercial loans and home equity lines of credit,
amounting to $58.6 million, compared to $56.0 million in 1995. Management
believes the sources of liquidity previously discussed are sufficient to meet
its commitments.
Net cash provided by operating activities totalled $13.8 million in 1996
compared to $5.9 million in 1995. Net income was $9.1 million compared to a net
income of $7.5 million for the respective period. Included in these amounts were
non-cash write-downs of foreclosed properties of $82,000 in 1996 and $361,000 in
1995. The provision for possible loan losses recorded in 1996 was $1.4 million
compared to $770,000 in 1995. Net cash provided by operating activities totalled
$5.9 million in 1995 compared to $13.8 million in 1994. Net income was $7.5
million compared to a net income of $6.5 million for the respective periods.
Included in these amounts were non-cash write-downs of foreclosed properties of
$361,000 in 1995 and $1.0 million in 1994. Provisions for possible loan losses
recorded in 1995 totalled $770,000. No provision for possible loan losses was
recorded in 1994.
Net cash used for investing activities totalled $67.4 million for the year ended
December 31, 1996 compared to net cash provided of $5.8 million in 1995 and net
cash used of $162.7 million in 1994. The 1996 increase in net cash used by
investing activities over 1995 was primarily attributable to increased purchases
of investment securities and increased loan originations. The 1995 increase in
net cash used by investing activities over 1994 was primarily attributable to a
reduction in the purchase of investment securities.
26
Net cash provided by financing activities totalled $64.5 million for the year
ended December 31, 1996 compared to net cash used of $3.0 million for the
comparable period in 1995 and net cash provided of $152.4 million in 1994. Net
cash provided by the increase in borrowed funds (net of repayments) totalled
$29.4 million in 1996, compared to $34.4 million (net of repayments) of cash
used in 1995. Net cash provided by deposits totalled $37.3 million in 1996
compared to of $34.6 million in 1995. Net cash of $2.9 million was used to pay
dividends in 1996.
The Bank is in compliance with and exceeds Federal regulatory capital
requirements. The minimum standards are (i) a total risk-based capital ratio of
8%, (ii) a Tier 1 risk-based capital ratio of 4% or (iii) a Tier 1 core capital
ratio of 3%. As of December 31, 1996, the Bank exceeds all fully-phased in
capital requirements.
IMPACT OF INFLATION
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles which require
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation.
An important concept in understanding the effect of inflation on financial
institutions is the distinction between monetary and non-monetary items. In a
stable environment, monetary items are those assets and liabilities which are or
will be converted into a fixed amount of dollars regardless of changes in
prices. Examples of monetary items include cash, investment securities, loans,
deposits and borrowings. Non-monetary items are those assets and liabilities
which gain or lose general purchasing power as a result of the relationships
between specific prices for the items and price change levels. Examples of
non-monetary items include premises and equipment and real estate in
foreclosure. In the recent environment in the New England region, where real
estate values have dramatically decreased, the deflationary impact of changing
prices of real estate securing loans significantly affects a financial
institution's performance. Additionally, interest rates do not necessarily move
in the same direction, or in the same magnitude, as the prices of goods and
services as measured by the consumer price index. In a volatile interest rate
environment, liquidity and the management of the maturity structure of assets
and liabilities are critical in maintaining acceptable profitability levels.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
FIRST ESSEX BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of First Essex
Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 1996 and 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of First Essex Bancorp, Inc. and
subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 13, 1997
28
FIRST ESSEX BANCORP, INC.
CONSOLIDATED BALANCE SHEETS