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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-28389
CONNECTICUT BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-1564613
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
923 Main Street, Manchester, Connecticut 06040
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (860) 646-1700
---------------------
Securities registered pursuant to Section 12(b) of the Act:
None.
Securities registered pursuant to Section 12(g)of the Act:
Common Stock, par value $0.01 per share.
Indicate by check mark whether the registrant 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 has been subject to such
filing requirements for the past 90 days. YES X NO ______
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ___
The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of March 9, 2001 was $204,409,485.
As of March 9, 2001, there were 11,232,000 shares of the registrant's
common stock outstanding.
Documents Incorporated by Reference:
Part III of this 10-K incorporates information by reference from the
registrant's definitive proxy statement which will be filed no later than 120
days after December 31, 2000.
INDEX
PART I
Page No.
--------
Item 1. Business................................................... 1
Item 2. Properties................................................. 34
Item 3. Legal Proceedings.......................................... 36
Item 4. Submission of Matters to a Vote of Security Holders........ 37
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters............................ 37
Item 6. Selected Consolidated Financial Data....................... 38
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 40
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk....................................................... 50
Item 8. Financial Statements and Supplementary Data................ 54
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure........................ 54
PART III
Item 10. Directors and Executive Officers of the Registrant......... 54
Item 11. Executive Compensation..................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 54
Item 13. Certain Relationships and Related Transactions............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K................................................ 55
SIGNATURES
Forward Looking Statements
This Form 10-K contains forward looking statements that are based on
assumptions and describe future plans, strategies, and expectations of the Bank.
These forward looking statements are generally identified by use of the words
"believe," "expect," "intend," "anticipate," "estimate," "project," or similar
expressions. The Bank's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which could have a
material adverse effect on the operations of the Bank and the subsidiaries
include, but are not limited to, changes in interest rates, general economic
conditions, legislative/regulatory changes, monetary and fiscal policies of the
U.S. Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality and composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Bank's market area and changes in relevant accounting principles and
guidelines. These risks and uncertainties should be considered in evaluating
forward looking statements and undue reliance should not be placed on such
statements. The Bank does not undertake--and specifically disclaims any
obligation--to publicly release the result of any revisions which may be made to
any forward looking statements to reflect events or circumstances after the date
of the statements or to reflect the occurrence of anticipated or unanticipated
events.
PART I
Item 1. Business.
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Connecticut Bancshares, Inc. (the "Company"), a Delaware corporation, was
organized in October 1999 for the purpose of becoming the holding company for
Savings Bank of Manchester ("SBM"), (collectively, "the Bank"), upon the
conversion of the Bank's former parent holding company, Connecticut Bankshares,
M.H.C. ("M.H.C."), from a mutual to stock form of organization (the
"Conversion"). The Conversion was completed on March 1, 2000. In connection with
the Conversion, the Company sold 10,400,000 shares of its common stock, par
value $0.01 per share ("Common Stock") at a purchase price of $10 per share, to
depositors of the Bank in a subscription offering. In addition, the Company
issued an additional 832,000 shares, representing 8% of the shares sold in the
subscription offering, to SBM Charitable Foundation, Inc., a charitable
foundation established by the Bank. The Company used 50% of the net proceeds
from the conversion to buy all of the common stock of SBM and retained the
remaining 50% which were primarily invested in fixed income securities.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the Bank. The Company, SBM and
its wholly-owned subsidiaries are referred to herein as the Bank.
SBM was founded in 1905 as a Connecticut-chartered mutual savings bank. In
1996, SBM converted to stock form as part of M.H.C.'s mutual holding company
formation. SBM is regulated by the Connecticut Department of Banking and the
Federal Deposit Insurance Corporation. SBM's deposits are insured to the maximum
allowable amount by the Bank Insurance Fund of the Federal Deposit Insurance
Corporation. SBM has been a member of the Federal Home Loan Bank System since
1977.
The Bank is a traditional savings association that accepts retail deposits
from the general public in the areas surrounding its 23 full-service banking
offices and uses those funds, together with funds generated from operations and
borrowings, to originate residential mortgage loans, commercial loans and
consumer loans, primarily home equity loans and lines of credit. The Bank
primarily holds the loans that it originates for investment. However, the Bank
also sells loans, primarily fixed-rate mortgage loans, in the secondary market,
while generally retaining the servicing rights. The Bank also invests in
mortgage-backed securities, debt and equity securities and other permissible
investments. The Bank's revenues are derived principally from the generation of
interest and fees on loans originated and, to a lesser extent, interest and
dividends on investment and mortgage-backed securities. The Bank's primary
sources of funds are deposits, principal and interest payments on loans and
investments and mortgage-backed securities and advances from the Federal Home
Loan Bank of Boston.
Pending Acquisition
1
On February 7, 2001, the Company and First Federal Savings and Loan
Association of East Hartford ("First Federal") entered in a definitive agreement
(the "Agreement") under which the Company will acquire all of the outstanding
common stock of First Federal for cash equal to approximately $110 million.
Immediately after the completion of the acquisition, First Federal will be
merged into SBM, a wholly-owned subsidiary of the Company. The Board of
Directors of the Company expects the transaction to close in the third quarter
of 2001. The transaction is subject to approval by the First Federal
shareholders and federal and state regulatory agencies.
Under certain circumstances, if the Agreement is terminated by the Company
for the reasons set forth in the Agreement before the consummation of the
merger, First Federal may be required to pay the Company cash of $4.50 million
plus out-of-pocket expenses.
Market Area
The Bank is headquartered in Manchester, Connecticut in Hartford County.
The Bank's primary deposit gathering and lending areas are concentrated in the
communities surrounding its 23 banking offices located in Hartford, Tolland and
Windham Counties.
Hartford County is located in central Connecticut approximately two hours
from both Boston and New York City and contains the City of Hartford. The region
serves as the governmental and as a financial center of Connecticut. Hartford
County has a diversified mix of industry groups, including insurance and
financial services, manufacturing, service, government and retail. The major
employers in the area include several prominent international and national
insurance and manufacturing companies, such as Aetna, Inc., The Hartford
Financial Services Group, Inc., United Technologies Corp., Stanley Works, as
well as many regional banks and the Connecticut State Government.
Competition
The Bank faces intense competition in attracting deposits and loans in its
primary market area. Historically, the Bank's most direct competition for
deposits came from commercial and savings banks operating in its primary market
area and, to a lesser extent, from other financial institutions, such as
brokerage firms, credit unions and insurance companies. Although these entities
continue to provide a source of competition for deposits, the Bank faces
increasingly significant competition for deposits from the mutual fund industry
as customers seek alternative sources of investment for their funds. The Bank
also must compete for investors' funds which may be used to purchase short-term
money market securities and other corporate and government securities. While the
Bank faces competition for loans from the significant number of traditional
financial institutions, primarily savings banks and commercial banks in its
market area, its most significant competition comes from other financial service
providers, such as the mortgage companies and mortgage brokers operating in its
primary market area. Additionally, the Bank expects competition to increase as a
result of recent regulatory actions and legislative changes, most notably the
recent enactment of the Financial Services Modernization Act of 1999. These
changes have eased and likely will continue to ease restrictions on interstate
banking and entry into the financial services market by non-depository and non-
traditional financial services providers, including insurance companies,
securities brokerage and underwriting firms, and specialty financial services
companies such as internet-based providers.
Lending Activities
General. The types of loans that the Bank may originate are limited by
federal and state laws and regulations. Interest rates charged by the Bank on
loans are affected principally by the Bank's current asset/liability strategy,
the demand for such loans, the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by
general and economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, legislative tax policies and governmental
budgetary matters.
2
Loan Portfolio Analysis. The following table sets forth the composition of
the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio
at the dates indicated.
At December 31,
-------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------------- ------------------- -------------------- ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------------------- ------------------- -------------------- ------------------ ------------------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 586,536 58.22% $544,732 57.40% $464,623 56.85% $489,105 60.53% $457,168 61.66%
Construction (1) 33,422 3.32 40,690 4.29 35,860 4.39 23,524 2.90 16,900 2.27
Commercial and multi-family 161,579 16.04 155,085 16.34 131,717 16.11 117,622 14.55 104,364 14.07
---------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 781,537 77.58 740,507 78.03 632,200 77.35 630,251 77.98 578,432 78.00
---------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial loans 146,360 14.53 134,637 14.19 114,650 14.03 106,874 13.22 97,117 13.10
---------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer loans:
Home equity loans and lines
of credit 27,203 2.70 23,019 2.43 21,605 2.64 20,559 2.54 18,959 2.56
Other 52,358 5.20 50,794 5.35 48,917 5.98 50,553 6.26 47,071 6.34
---------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 79,561 7.90 73,813 7.78 70,522 8.62 71,112 8.80 66,030 8.90
---------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 1,007,458 100.00% 948,957 100.00% 817,372 100.00% 808,237 100.00% 741,579 100.00%
====== ====== ====== ====== ======
Allowance for loan losses (11,694) (10,617) (10,585) (9,945) (9,131)
---------- -------- -------- -------- --------
Total loans, net $ 995,764 $938,340 $806,787 $798,292 $732,448
========== ======== ======== ======== ========
(1) Includes residential and commercial real estate loans.
3
One- to Four-Family Real Estate Loans. The Bank's primary lending activity
is to originate loans secured by one- to four-family residences located in its
primary market area. At December 31, 2000, $586.54 million, or 58.22%, of the
Bank's total loans consisted of one- to four-family mortgage loans. Of the one-
to four-family loans outstanding at that date, 50.75% were fixed-rate mortgage
loans and 49.25% were adjustable-rate loans.
The Bank originates fixed-rate fully amortizing loans with maturities
ranging between ten and 30 years. Management establishes the loan interest rates
based on market conditions. The Bank offers mortgage loans that conform to
Fannie Mae and Freddie Mac guidelines, as well as jumbo loans, which are
presently loans in amounts over $275,000. Fixed-rate conforming loans are
generally originated for portfolio. However, the Bank may sell such loans from
time to time. Management periodically determines whether or not to sell loans
based on changes in prevailing market interest rates. Loans that are sold are
generally sold to Freddie Mac, with the servicing rights retained.
Currently, the Bank also offers adjustable-rate mortgage loans, with an
interest rate based on the one year Constant Maturity Treasury index, which is
adjusted annually at the outset of the loan or which is adjusted annually after
a three or five year initial fixed period and with terms of up to 30 years.
Interest rate adjustments on such loans are limited to no more than 2% during
any adjustment period and 6% over the life of the loan. Adjustable-rate loans
may possess a conversion option, whereby the borrower may opt to convert the
loan to a fixed interest rate after a predetermined period of time, generally
within the first 60 months of the loan term. Included in the Bank's adjustable-
rate mortgage loan portfolio are adjustable-rate loans which are originated at
an interest rate below the fully indexed rate. During 2000, the Bank originated
$16.43 million of these discounted adjustable-rate mortgage loans, or 1.63% of
the total loan portfolio, with an average yield of 5.89%. The time period in
which such loans will reprice to their fully indexed rate may be longer than the
Bank's other fully indexed adjustable-rate loans. However, the Bank's
experience, which cannot be guaranteed in future periods, is that these
discounted adjustable-rate loans tend to be more stable and less susceptible to
prepayment activity in a falling interest rate environment and less subject to
default in a rising interest environment.
Adjustable-rate mortgage loans help reduce the Bank's exposure to changes
in interest rates. There are, however, unquantifiable credit risks resulting
from the potential of increased costs due to changed rates to be paid by
borrowers. It is possible that during periods of rising interest rates the risk
of default on adjustable-rate mortgage loans may increase as a result of
repricing and the increased payments required to be paid by borrowers. In
addition, although adjustable-rate mortgage loans allow the Bank to adjust the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the annual and lifetime interest rate
adjustment limits. Because of these considerations, the Bank has no assurance
that yields on adjustable-rate mortgage loans will be sufficient to offset
increases in the Bank's cost of funds during periods of rising interest rates.
The Bank believes these risks, which have not had a material adverse effect on
the Bank to date, are generally less than the risks associated with holding
fixed-rate loans in its portfolio in a rising interest rate environment.
The Bank underwrites fixed- and variable-rate one- to four-family
residential mortgage loans with loan-to-value ratios of up to 97% and 95%,
respectively, provided that a borrower obtains private mortgage insurance on
loans that exceed 80% of the appraised value or sales price, whichever is less,
of the secured property. The Bank also requires fire, casualty, title, hazard
insurance and, if appropriate, flood insurance be maintained on all properties
securing real estate loans made by the Bank. An independent licensed appraiser
generally appraises all properties.
In an effort to provide financing for moderate income and first-time home
buyers, the Bank offers FHA and CHFA (Connecticut Housing Finance Authority)
loans and has its own First-Time Home Buyer loan program. These programs offer
residential mortgage loans to qualified individuals. These loans are offered
with adjustable- and fixed-rates of interest and terms of up to 30 years. Such
loans may be secured by one- to four-family residential property, in the case of
FHA and CHFA loans, and must be secured by a single family owner-occupied unit
in the case of First-Time Home Buyer loans. All of these loans are originated
using modified underwriting guidelines. FHA loans are closed in the name of SBM
and immediately sold on the secondary market to Countrywide Mortgage Company
with the loan servicing released. CHFA loans are immediately assigned after
closing to the Connecticut Housing Finance Authority with servicing rights
retained by the Bank. Countrywide Mortgage and CHFA establish their respective
rates and terms upon which such loans are offered. First-Time Home Buyer loans
are offered with a
4
discounted interest rate (approximately 50 basis points) and usually with no
application or loan origination fees. All such loans are originated in amounts
of up to 97% of the lower of the property's appraised value or the sale price.
Private mortgage insurance is required on all such loans.
The Bank also offers to its full-time employees who satisfy certain
criteria and the general underwriting standards of the Bank fixed and
adjustable-rate mortgage loans with reduced interest rates, which are currently
50 to 100 basis points below the rates offered to the Bank's other customers.
The Employee Mortgage Rate is limited to the purchase, construction or
refinancing of an employee's owner-occupied primary residence. The Employee
Mortgage Rate normally ceases upon termination of employment or if the property
no longer is the employee's primary residence. Upon termination of the Employee
Mortgage Rate, the interest rate reverts to the contract rate in effect at the
time that the loan was extended. All other terms and conditions contained in the
original mortgage and note continue to remain in effect. As of December 31,
2000, the Bank had $6.82 million of Employee Mortgage Rate loans, or 0.68% of
total loans.
Construction Loans. The Bank originates construction loans to individuals
for the construction and acquisition of personal residences. At December 31,
2000, residential construction loans amounted to $5.84 million, or 0.58% of the
Bank's total loans. At December 31, 2000, the unadvanced portion of construction
loans totalled $5.62 million.
The Bank's residential construction loans generally provide for the payment
of interest only during the construction phase, which is usually twelve months.
At the end of the construction phase, the loan converts to a permanent mortgage
loan. Loans can be made with a maximum loan-to-value ratio of 90%, provided that
the borrower obtains private mortgage insurance on the loan if the loan balance
exceeds 80% of the appraised value or sales price, whichever is less, of the
secured property. At December 31, 2000, the largest outstanding residential
construction loan commitment was for $750,000, $3,200 of which was outstanding.
This loan was performing according to its terms at December 31, 2000.
Construction loans to individuals are generally made on the same terms as the
Bank's one- to four-family mortgage loans.
Before making a commitment to fund a residential construction loan, the
Bank requires an appraisal of the property by an independent licensed appraiser.
The Bank also reviews and inspects each property before disbursing any funds
during the term of the construction loan. Loan proceeds are disbursed after each
inspection based on the percentage of completion method.
The Bank also originates residential development loans primarily to finance
the construction of single-family homes and subdivisions. At December 31, 2000,
residential development loans totalled $20.24 million, or 2.01% of the Bank's
total loans. These loans are generally offered to experienced builders with whom
the Bank has an established relationship. Residential development loans are
typically offered with terms of up to 24 months. The maximum loan-to-value limit
applicable to these loans is 80% for contract sales and 70% for speculative
properties. Construction loan proceeds are disbursed periodically in increments
as construction progresses and as inspection by an approved appraiser of the
Bank warrants. At December 31, 2000, the Bank's largest residential development
loan was a nonperforming loan for $3.68 million secured by a retirement facility
located in Central New England. That facility is part of a larger development,
that also had a loan which matured on June 30, 1999 in the amount of $563,000
secured by eight residential units. Interest payments were kept current on the
latter loan, and the latter loan was repaid in 2000. Proceeds from the sale of
units were used to reduce the amount outstanding on the overall lending
relationship by $2.05 million in 2000.
The Bank also makes construction loans for commercial development projects.
The projects include multi-family, apartment, industrial, retail and office
buildings. These loans generally have an interest-only phase during construction
and then convert to permanent financing. Disbursement of funds are at the sole
discretion of the Bank and are based on the progress of construction. The
maximum loan-to-value limit applicable to these loans is 75%. At December 31,
2000, commercial construction loans totalled $7.34 million, or 0.73%, of total
loans.
The Bank also originates land loans to local contractors and developers for
the purpose of improving the property, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 70% of the lower of the acquisition price or the appraised value
of the land and have a term
5
of up to two years with a floating interest rate based on the Bank's internal
base rate. The Bank's land loans are generally secured by property in its
primary market area. The Bank requires title insurance and, if applicable, a
hazardous waste survey reporting that the land is free of hazardous or toxic
waste.
Construction and development financing is generally considered to involve a
higher degree of credit risk than long-term financing on improved, owner-
occupied real estate. Risk of loss on a construction loan depends largely upon
the accuracy of the initial estimate of the property's value at completion of
construction compared to the estimated cost (including interest) of construction
and other assumptions. If the estimate of construction cost proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed in order to protect the value of the property.
Additionally, if the estimate of value proves to be inaccurate, the Bank may be
confronted with a project, when completed, having a value which is insufficient
to assure full repayment.
Commercial and Multi-Family Real Estate Loans. The Bank originates multi-
family and commercial real estate loans that are generally secured by five or
more unit apartment buildings and properties used for business purposes such as
small office buildings, industrial facilities or retail facilities primarily
located in the Bank's primary market area. At December 31, 2000, the Bank had
$161.58 million in commercial and multi-family real estate loans which amounted
to 16.04% of total loans. The Bank's multi-family and commercial real estate
underwriting policies provide that such real estate loans may be made in amounts
of up to 75% of the appraised value of the property provided such loan complies
with the Bank's current loans-to-one-borrower limit, which at December 31, 2000
was $36.63 million. The Bank's multi-family and commercial real estate loans may
be made with terms of up to 25 years and are offered with interest rates that
adjust periodically and are generally indexed to the one, three or five year
Constant Maturity Treasury index. In reaching its decision on whether to make a
multi-family or commercial real estate loan, the Bank considers the net
operating income of the property, the borrower's expertise, credit history and
profitability and the value of the underlying property. In addition, with
respect to commercial real estate rental properties, the Bank will also consider
the term of the lease and the quality of the tenants. The Bank has generally
required that the properties securing these real estate loans have debt service
coverage ratios (the ratio of earnings before debt service to debt service) of
at least 1.20x. Environmental surveys are generally required for commercial real
estate loans. Generally, multi-family and commercial real estate loans made to
corporations, partnerships and other business entities require personal
guarantees by the principals. The largest multi-family or commercial real estate
relationship in the Bank's portfolio was performing with $10.65 million
committed of which $7.49 million was outstanding at December 31, 2000. The
relationship was secured mainly by office and industrial buildings located in
Glastonbury, Berlin, Bloomfield and Avon, Connecticut.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties often depend on
the successful operation or management of the properties, repayment of such
loans may be affected by adverse conditions in the real estate market or the
economy. The Bank tries to minimize these risks through its underwriting
standards.
Commercial Loans. At December 31, 2000, the Bank had $146.36 million in
commercial loans which amounted to 14.53% of total loans. In addition, at such
date, the Bank had $63.19 million of unadvanced commercial lines of credit. The
Bank makes commercial business loans primarily in its market area to a variety
of professionals, sole proprietorships and small businesses. The Bank offers a
variety of commercial lending products, including term loans for fixed assets
and working capital, revolving lines of credit, letters of credit, and Small
Business Administration guaranteed loans. The maximum amount of a commercial
business loan is limited by the Bank's loans-to-one-borrower limit which at
December 31, 2000, was $36.63 million. Term loans are generally offered with
initial fixed rates of interest for one to five years and with terms of up to
ten years. Business lines of credit have adjustable rates of interest and are
payable on demand, subject to annual review and renewal. Business loans with
variable rates of interest adjust on a daily basis and are indexed to the Bank's
internal base rate.
When making commercial business loans, the Bank considers the financial
statements of the borrower, the Bank's lending history with the borrower, the
debt service capabilities of the borrower, the projected cash flows of the
business and the value of the collateral. Commercial business loans are
generally secured by a variety of collateral, primarily accounts receivable,
inventory and equipment, and are supported by personal guarantees. Depending on
the collateral used to secure the loans, commercial loan relationships are made
in amounts of up to
6
90% of the value of the collateral securing the loan. The Bank generally does
not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis of
the borrower's ability to make repayment from his or her employment or other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial loans are of higher risk and typically are made
on the basis of the borrower's ability to make repayment from the cash flow of
the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself. Further, any collateral securing such loans may depreciate over
time, may be difficult to appraise and may fluctuate in value. At December 31,
2000, the Bank's largest commercial loan relationship had $6.68 million
committed with $5.43 million outstanding and was secured by commercial real
estate located in Windham, Connecticut and operating as a mobile home park. This
loan was performing according to its original terms at December 31, 2000.
Consumer Loans. The Bank offers a variety of consumer loans, including
second mortgage loans and home equity lines of credit, both of which are secured
by owner-occupied one- to four-family residences. At December 31, 2000, second
mortgage loans and equity lines of credit totalled $55.45 million, or 5.50% of
the Bank's total loans and 69.70% of consumer loans. Additionally, at December
31, 2000, the unadvanced amounts of home equity lines of credit totalled $26.90
million. The underwriting standards employed by the Bank for second mortgage
loans and equity lines of credit include a determination of the applicant's
credit history, an assessment of the applicant's ability to meet existing
obligations and payments on the proposed loan and the value of the collateral
securing the loan. Home equity lines of credit have adjustable rates of interest
which are indexed to the prime rate as reported in The Wall Street Journal.
Interest rate adjustments on home equity lines of credit are limited to no more
than a maximum of 17%. Generally, the maximum loan-to-value ratio on home equity
lines of credit is 90%. A home equity line of credit may be drawn down by the
borrower for a period of 10 years from the date of the loan agreement. During
this period, the borrower has the option of paying, on a monthly basis, either
principal and interest or only the interest. The borrower has to pay back the
amount outstanding under the line of credit at the end of a 20 year period. The
Bank offers fixed- and adjustable-rate second mortgage loans with terms up to 20
years. The loan-to-value ratios of both fixed-rate and adjustable-rate home
equity loans are generally limited to 90%.
The Bank offers fixed-rate automobile loans for new or used vehicles with
terms of up to 72 months and loan-to-value ratios of the lesser of the purchase
price or the retail value shown in the NADA Used Car Guide. At December 31,
2000, automobile loans totalled $10.38 million, or 1.03% of the Bank's total
loans and 13.05% of consumer loans.
Other consumer loans at December 31, 2000 amounted to $13.73 million, or
1.36% of the Bank's total loans and 17.26% of consumer loans. These loans
include unsecured personal loans, collateral loans, credit card loans and
education loans. Unsecured personal loans generally have a fixed-rate, a maximum
borrowing limitation of $25,000 and a maximum term of five years. Collateral
loans are generally secured by a passbook account, a certificate of deposit or
marketable securities.
Consumer loans entail greater risk than residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles. In these cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections depend on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Loans to One Borrower. The maximum amount that the Bank may lend to one
borrower is limited by statute. At December 31, 2000, the Bank's statutory limit
on loans to one borrower was $36.63 million. At that date, the Bank's largest
amount of loans to one borrower, including the borrower's related interests, was
$10.65 million committed, of which $7.49 million was outstanding and consisted
of ten loans secured by various residential and commercial properties. These
loans were performing according to their original terms at December 31, 2000.
7
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of the Bank's total loans at December 31, 2000, excluding
the effect of future principal prepayments.
At December 31, 2000
--------------------------------------------------------------------------------
Commercial
One- and Multi-
to Four- Construction family
family (1) Real Estate Commercial Consumer Total
--------------------------------------------------------------------------------
(In thousands)
Amounts due in:
One year or less $ 24 $ 17,619 $ 1,277 $ 35,963 $ 1,311 $ 56,194
After one year:
More than one year to three years 2,336 3,659 3,247 26,155 7,877 43,274
More than three years to five years 3,538 - 4,645 26,688 15,793 50,664
More than five years to 10 years 22,074 - 34,862 29,178 17,938 104,052
More than 10 years to 15 years 75,580 2,832 49,680 10,881 9,845 148,818
More than 15 years 482,984 9,312 67,868 17,495 26,797 604,456
---------- --------- --------- ---------- ---------- -----------
Total amounts due $ 586,536 $ 33,422 $ 161,579 $ 146,360 $ 79,561 $ 1,007,458
========== ========= ========= ========== ========== ===========
(1) Includes residential and commercial real estate loans.
The following table sets forth, at December 31, 2000, the dollar amount of
loans contractually due after December 31, 2001, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2001
--------------------------------------
Fixed Adjustable Total
--------------------------------------
(In thousands)
Real estate loans:
One- to four-family $ 297,882 $ 288,630 $ 586,512
Construction (1) 5,464 10,339 15,803
Commercial and multi-family 12,221 148,081 160,302
--------- --------- ---------
Total real estate loans 315,567 447,050 762,617
Commercial loans 39,852 70,545 110,397
Consumer loans 54,572 23,678 78,250
--------- --------- ---------
Total loans $ 409,991 $ 541,273 $ 951,264
========= ========= =========
(1) Includes residential and commercial real estate loans.
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of a loan is substantially less than
its contractual term because of prepayments. In addition, due-on-sale clauses on
loans generally give the Bank the right to declare loans immediately due and
payable if, among other things, the borrower sells the real property with the
mortgage and the loan is not repaid. The average life of a mortgage loan tends
to increase, however, when current mortgage loan market rates are substantially
higher than rates on existing mortgage loans and, conversely, tends to decrease
when rates on existing mortgage loans are substantially higher than current
mortgage loan market rates.
Loan Approval Procedures and Authority. The Bank's lending activities
follow written, non-discriminatory, underwriting standards and loan origination
procedures established by the Bank's Board of Directors and management. The
Bank's policies and loan approval limits are established by management and are
approved by the Board of Directors. The Board of Directors has designated
certain individuals of the Bank and certain branch managers to consider and
approve loans within their designated authority.
8
All one- to four-family mortgage loans secured by the borrower's primary
residence in amounts of up to $500,000 and all residential construction and
second mortgage loans and home equity lines of credit in amounts of up to
$250,000 may be approved by any two designated individuals. All residential
construction and second mortgage loans and home equity lines of credit in excess
of $250,000 and up to $500,000 require the approval of the Bank's loan
committee. All residential loans in excess of $500,000 and up to $1.00 million
require the approval of the Bank's loan committee. All residential loans in
excess of $1.00 million require the approval of the Executive Committee of the
Board of Directors.
All commercial loans, including commercial real estate loans, multi-family
loans, commercial construction and development loans and commercial business
loans in amounts of up to $500,000 may be approved by any two of the designated
individuals with the appropriate authority. All commercial loans in excess of
$500,000 and up to $1.00 million require the approval of the Bank's loan
committee; and all commercial loans where an individual loan is in excess of
$1.00 million or the aggregate indebtedness exceeds $3.00 million require the
approval of the Executive Committee of the Board of Directors.
With regard to consumer loans, automobile loans in amounts of up to $50,000
and unsecured personal loans in amounts of up to $25,000 may be approved by
either one or two of the designated individuals depending on the credit score;
automobile loans in excess of $50,000 and unsecured personal loans in excess of
$25,000 must be approved by the Bank's loan committee. Collateral loans of up to
$25,000 may be approved by any branch manager.
Loan Originations, Purchases and Sales. The Bank's lending activities are
conducted by its salaried and commissioned loan personnel and through non-bank
third-party correspondents. Currently, the Bank uses 17 loan originators who
solicit and originate mortgage loans on behalf of the Bank. These loan
originators accounted for approximately three quarters of the adjustable-rate
and fixed-rate mortgage loans originated by the Bank in 2000. Loan originators
are compensated by a commission that is based on product, mortgage type, and new
or existing customer relationship. The commission currently ranges from 30 to 60
basis points of the loan amount. All loans originated by the loan originators
are underwritten in conformity with the Bank's loan underwriting policies and
procedures. At December 31, 2000, the Bank serviced $210.15 million of
residential mortgage loans for others.
From time to time, the Bank will purchase loans primarily secured by one-
to four-family residential properties located outside of the Bank's primary
market area, usually in Fairfield County, Connecticut or in Massachusetts.
Purchased loans are underwritten according to the Bank's own underwriting
criteria and procedures and are generally purchased without the accompanying
servicing rights. Amounts outstanding related to loan purchases totalled $88.22
million at December 31, 2000.
9
Substantially all of the Bank's adjustable-rate mortgage loans are
originated for inclusion in the Bank's loan portfolio. Historically, the Bank
originated fixed-rate mortgage loans for sale in the secondary market. However,
since 1998 and due to the low demand for adjustable-rate mortgage loans, the
Bank has begun to retain for its portfolio a significant portion of fixed-rate
mortgage loans. Sales are generally to Freddie Mac, with servicing rights
retained. Loan sale decisions are made by the Bank's management and are
generally based on prevailing market interest rates and the Bank's asset-
liability position.
The following table presents total loans originated, sold, purchased and
repaid during the periods indicated.
For the Year Ended December 31,
---------------------------------------
2000 1999 1998
---------------------------------------
(In thousands)
Loans at beginning of year $ 948,957 $ 817,372 $ 808,237
----------- ----------- ----------
Originations:
Real estate:
One-to four-family 81,722 128,630 160,974
Construction (1) 53,376 60,500 55,492
Commercial and multi-family 15,915 31,571 24,948
----------- ----------- ----------
Total real estate loans 151,013 220,701 241,414
Commercial 93,537 97,246 88,170
Consumer 35,485 33,926 30,684
----------- ----------- ----------
Total loans originated 280,035 351,873 360,268
Loans purchased 27,337 36,911 17,281
----------- ----------- ----------
Total loans originated and purchased 307,372 388,784 377,549
----------- ----------- ----------
Deduct:
Principal loan repayments and prepayments 228,245 236,869 274,246
Loan sales 19,989 18,646 91,917
Charge-offs 433 1,360 1,087
Transfers to other real estate owned 204 324 1,164
----------- ----------- ----------
Total deductions 248,871 257,199 368,414
----------- ----------- ----------
Net increase in loans 58,501 131,585 9,135
----------- ----------- ----------
Loans at end of year $ 1,007,458 $ 948,957 $ 817,372
=========== =========== ==========
(1) Includes residential and commercial real estate loans.
Loan Commitments. The Bank issues loan commitments to prospective
borrowers on the condition that certain events occur. Commitments are made in
writing on specified terms and conditions and are generally honored for up to 60
days from approval. At December 31, 2000, the Bank had loan commitments and
unadvanced loans and lines of credit totalling $176.67 million.
Loan Fees. In addition to interest earned on loans, the Bank receives
income from fees derived from loan originations, loan modifications, late
payments and for miscellaneous services related to its loans. Income from these
activities varies from period to period depending upon the volume and type of
loans made and competitive conditions. On loans originated by third-party
originators, the Bank may pay a premium to compensate an originator for loans
where the borrower is paying a higher rate on the loan.
The Bank charges loan origination fees which are calculated as a
percentage of the amount borrowed. As required by applicable accounting
principles, loan origination fees, discount points and certain loan origination
costs are deferred and recognized over the contractual remaining lives of the
related loans on a level yield basis. At December 31, 2000, the Bank had
approximately $1.20 million of net deferred loan fees. The Bank amortized
approximately $301,000 of net deferred loan fees during the year ended December
31, 2000.
10
Nonperforming Assets, Delinquencies and Impaired Loans. All loan
payments are due on the first day of each month. When a borrower fails to make a
required loan payment, the Bank attempts to cure the deficiency by contacting
the borrower and seeking the payment. A late notice is mailed on the 16/th/ day
of the month. In most cases, deficiencies are cured promptly. If a delinquency
continues beyond the 30/th/ day of the month, the account is referred to an in-
house collector. The Bank generally prefers to work with borrowers to resolve
problems, but the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
On a monthly basis, management informs the Board of Directors of the
amount of loans delinquent for more than 30 days, all loans in foreclosure, and
all foreclosed and repossessed property that the Bank owns. The Bank ceases
accruing interest on mortgage loans when principal or interest payments are
delinquent 90 days or more unless management determines that the loan principal
and interest is fully secured and in the process of collection. Once the accrual
of interest on a loan is discontinued, all interest previously accrued is
reversed against current period interest income once management determines that
interest is uncollectible.
On January 1, 1995, the Bank adopted SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan," as amended by SFAS No. 118 "Accounting by
Creditors for Impairment of a Loan--an amendment to SFAS No. 114." At December
31, 2000 and 1999, the Bank had a $6.77 million and $11.49 million,
respectively, recorded investment in impaired loans all of which had no specific
allowances.
At December 31, 2000, the Bank's largest residential development loan
was a nonperforming loan for $3.68 million secured by a retirement facility
located in Central New England. That facility is part of a larger development,
that also had a loan which matured on June 30, 1999 in the amount of $563,000
secured by eight residential units. Interest payments were kept current on the
latter loan, and the latter loan was repaid in 2000. Proceeds from the sale of
units were used to reduce the amount outstanding on the overall lending
relationship by $2.05 million in 2000.
The following table sets forth information regarding nonperforming
loans, troubled debt restructurings and other real estate owned at the dates
indicated.
At December 31,
----------------------------------------------------
2000 1999 1998 1997 1996
----------------------------------------------------
(Dollars in thousands)
Nonperforming loans:
One- to four-family real estate $ 485 $ 501 $ 456 $ 1,732 $ 5,181
Commercial and multi-family real estate 3,685 10,513 388 408 1,076
Commercial 2,528 454 665 680 992
Consumer 74 17 15 15 29
-------- -------- -------- -------- --------
Total nonperforming loans 6,772 11,485 1,524 2,835 7,278
Other real estate owned 125 604 1,759 4,708 5,482
-------- -------- -------- -------- --------
Total nonperforming assets 6,897 12,089 3,283 7,543 12,760
Troubled debt restructurings - - - - -
-------- -------- -------- -------- --------
Total nonperforming assets and troubled
debt restructurings $ 6,897 $ 12,089 $ 3,283 $ 7,543 $ 12,760
======== ======== ======== ======== ========
Total nonperforming loans and troubled
debt restructurings as a percentage
of total loans 0.67% 1.21% 0.19% 0.35% 0.98%
Total nonperforming assets and troubled
debt restructurings as a percentage
of total assets 0.49% 0.98% 0.30% 0.73% 1.32%
Interest income that would have been recorded for the years ended December
31, 2000, 1999 and 1998 had nonaccruing loans been current according to their
original terms amounted to approximately $568,000, $635,000 and $136,000,
respectively. No interest related to these loans was included in interest income
in either year.
11
The following tables set forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
At December 31, 2000 At December 31, 1999
------------------------------------------ -------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
---------- --------------- ---------- ---------------
Principal Principal Principal Principal
Number Balance of Number Balance of Number Balance of Number Balance of
of Loans Loans of Loans Loans of Loans Loans of Loans Loans
------------------------------------------ -------------------------------------------
(Dollars in thousands)
Real estate loans:
One-to four-family 2 $ 42 6 $ 301 1 $ 32 3 $ 227
Commercial and multi-family - - - - - - - -
--------- -------- -------- -------- --------- -------- -------- -------
Total real estate loans 2 42 6 301 1 32 3 227
--------- -------- -------- -------- --------- -------- -------- -------
Commercial loans 7 310 3 139 5 223 3 124
--------- -------- -------- -------- --------- -------- --------- -------
Consumer loans:
Home equity loans and lines of credit - - - - - - - -
Other 7 16 7 64 3 5 7 7
--------- -------- -------- -------- --------- -------- -------- -------
Total consumer loans 7 16 7 64 3 5 7 7
--------- -------- -------- -------- --------- -------- -------- -------
Total 16 $ 368 16 $ 504 9 $ 260 13 $ 358
========= ======== ======== ======== ======== ======== ======== =======
Delinquent loans to total loans 0.04% 0.05% 0.03% 0.04%
======== ======== ======== =======
At December 31, 1998
--------------------------------------------------------------
60-89 Day 90 Days or More
--------- ---------------
Principal Principal
Number Balance of Number Balance of
of Loans Loans of Loans Loans
---------------------------------------------------------------
(Dollars in thousands)
Real estate loans:
One-to four-family 1 $ 1 4 $ 151
Commercial and multi-family - - 1 279
--------- -------- -------- --------
Total real estate loans 1 1 5 430
--------- -------- -------- --------
Commercial loans 7 137 6 294
--------- -------- -------- --------
Consumer loans:
Home equity loans and lines of credit 1 15 - -
Other 5 7 3 16
--------- -------- -------- --------
Total consumer loans 6 22 3 16
--------- -------- -------- --------
Total 14 $ 160 14 $ 740
========= ======== ======== ========
Delinquent loans to total loans 0.02% 0.09%
======== ========
Real Estate Owned. Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until sold. When property is acquired, it is recorded at fair market value at
the date of foreclosure, establishing a new cost basis. Holding costs and
declines in fair value after acquisition are expensed. At December 31, 2000, the
Bank had $125,000 of real estate owned consisting of a one- to four-family
residence.
Asset Classification. Banking regulators have adopted various regulations
and practices regarding problem assets of savings institutions. Under such
regulations, federal and state examiners have authority to identify problem
assets during examinations and, if appropriate, require their classification.
There are three classifications for problem assets: substandard, doubtful
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that its continued status as an asset of the institution is
not warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover probable losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do
12
not qualify as regulatory capital. Assets that do not currently expose the
insured institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are designated "special
mention." The Bank performs an internal analysis of its loan portfolio and
assets to classify such loans and assets similar to the manner in which such
loans and assets are classified by the federal banking regulators. In addition,
the Bank regularly analyzes the losses inherent in its loan portfolio and its
nonperforming loans in determining the appropriate level of the allowance for
loan losses.
Allowance for Loan Losses. In originating loans, the Bank recognizes that
losses will be experienced on loans and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan, general economic conditions and, in the case
of a secured loan, the quality of the security for the loan. The Bank maintains
an allowance for loan losses to absorb losses inherent in the loan portfolio.
The allowance for loan losses represents management's estimate of probable
losses based on information available as of the date of the financial
statements. The allowance for loan losses is based on management's evaluation of
the collectibility of the loan portfolio, including past loan loss experience,
known and inherent risks in the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values, and economic
conditions.
The loan portfolio and other credit exposures are regularly reviewed by
management to evaluate the adequacy of the allowance for loan losses. The
methodology for assessing the appropriateness of the allowance includes
comparison to actual losses, peer group comparisons, industry data and economic
conditions. In addition, the regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses
and may require the Bank to make additional provisions for estimated losses
based upon judgments different from those of management.
In assessing the allowance for loan losses, loss factors are applied to
various pools of outstanding loans and certain unused commitments. The Bank
segregates the loan portfolio according to risk characteristics (i.e., mortgage
loans, home equity, consumer). Loss factors are derived using the Bank's
historical loss experience and may be adjusted for significant factors that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date.
In addition, management assesses the allowance using factors that cannot be
associated with specific credit or loan categories. These factors include
management's subjective evaluation of local and national economic and business
conditions, portfolio concentration and changes in the character and size of the
loan portfolio. The allowance methodology reflects management's objective that
the overall allowance appropriately reflects a margin for the imprecision
necessarily inherent in estimates of expected credit losses.
At December 31, 2000, the Bank had an allowance for loan losses of $11.69
million which represented 1.16% of total loans and 172.68% of nonperforming
loans. Although management believes that it uses the best information available
to establish the allowance for loan losses, future adjustments to the allowance
for loan losses may be necessary and results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses consistent with generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase its
allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
increases will not be necessary should the quality of any loans deteriorate as a
result of the factors discussed above. Any material increase in the allowance
for loan losses may adversely affect the Bank's financial condition and results
of operations.
13
The following table presents an analysis of the Bank's allowance for loan
losses at and for the periods indicated.
At or For the Year Ended December 31,
-----------------------------------------------------
2000 1999 1998 1997 1996
-----------------------------------------------------
(Dollars in thousands)
Allowance for loan losses, beginning of year $ 10,617 $ 10,585 $ 9,945 $ 9,131 $ 8,484
-------- --------- --------- --------- ---------
Charged-off loans:
One- to four-family real estate 84 110 340 299 695
Commercial and multi-family real estate 14 790 112 133 326
Commercial 244 337 483 311 366
Consumer 91 123 152 203 375
-------- --------- --------- --------- ---------
Total charged-off loans 433 1,360 1,087 946 1,762
-------- --------- --------- --------- ---------
Recoveries on loans previously charged off:
One- to four-family real estate 153 55 146 215 38
Commercial and multi-family real estate 80 98 12 10 18
Commercial 26 96 283 229 939
Consumer 51 43 86 106 214
-------- --------- --------- --------- ---------
Total recoveries 310 292 527 560 1,209
-------- --------- --------- --------- ---------
Net loans charged-off 123 1,068 560 386 553
-------- --------- --------- --------- ---------
Provision for loan losses 1,200 1,100 1,200 1,200 1,200
-------- --------- --------- --------- ---------
Allowance for loan losses, end of year $ 11,694 $ 10,617 $ 10,585 $ 9,945 $ 9,131
======== ========= ========= ========= =========
Net loans charged-off to average interest-earning loans 0.01% 0.12% 0.07% 0.05% 0.08%
Allowance for loan losses to total loans 1.16 1.12 1.30 1.23 1.23
Allowance for loan losses to nonperforming loans and 172.68 92.44 694.55 350.79 125.46
troubled debt restructurings
Net loans charged-off to allowance for loan losses 1.05 10.06 5.29 3.88 6.06
Recoveries to charge-offs 71.59 21.47 48.48 59.20 68.62
14
The following table presents the approximate allocation of the
allowance for loan losses by loan categories at the dates indicated and the
percentage of such amounts to the total allowance and to total loans. Management
believes that the allowance can be allocated by category only on an approximate
basis. The allocation of the allowance to each category is not indicative of
future losses and does not restrict the use of any of the allowance to absorb
losses in any category.
At December 31,
-----------------------------------------------------------------------------------------------------------
2000 1999 1998
------------------------------------ ---------------------------------- -------------------------------------
Percent of Percent of Percent of
Allowance Percent Allowance Percent Allowance Percent
in Each of Loans in Each of Loans in Each of Loans
Category in Each Category in Each Category in Each
to Total Category to to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------------------------------------ ---------------------------------- -------------------------------------
(Dollars in thousands)
Real estate $ 6,221 53% 78% $ 5,198 49% 78% $ 4,995 47% 77%
Commercial 4,470 38 14 4,473 42 14 4,714 45 14
Consumer 1,003 9 8 946 9 8 876 8 9
-------- ----- ---- ------- ----- ------ ------- ------- -----
Total allowance
for loan losses 11,694 100% 100% 10,617 100% 100% 10,585 100% 100%
======= ===== ==== ======= ===== ====== ======= ======= =====
-----------------------------------------------------------------------------
1997 1996
-------------------------------------- -------------------------------------
Percent of Percent of
Allowance Percent Allowance Percent
in Each of Loans in Each of Loans
Category in Each Category in Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
-------------------------------------- -------------------------------------
Real estate $ 4,310 43% 78% $3,531 39% 78%
Commercial 4,913 50 13 4,958 54 13
Consumer 722 7 9 642 7 9
------- ----- ------- ------- ---- ----
Total allowance
for loan losses $ 9,945 100% 100% $9,131 100% 100%
======= ===== ======= ======= ==== ====
15
Investment Activities
General. Under Connecticut law, the Bank has authority to purchase a
wide range of investment securities. As a result of recent changes in federal
banking laws, however, financial institutions such as SBM may not engage as
principals in any activities that are not permissible for a national bank,
unless the Federal Deposit Insurance Corporation has determined that the
investments would pose no significant risk to the Bank Insurance Fund and that
SBM is in compliance with applicable capital standards. In 1993, the Regional
Director of the Federal Deposit Insurance Corporation approved a request by SBM
to invest in certain listed stocks and/or registered stocks subject to certain
conditions.
The Bank's Board of Directors has the overall responsibility for the
Bank's investment portfolio, including approval of the Bank's investment policy,
appointment of the Bank's investment adviser and approval of the Bank's
investment transactions. All investment transactions are reviewed by the Board
on a monthly basis. The Bank's President and/or Chief Financial Officer, or
their designees, are authorized to make investment decisions consistent with the
Bank's investment policy and the recommendations of the Bank's investment
adviser and the Board's Investment Committee. The Investment Committee meets
quarterly with the President and Chief Financial Officer in order to review and
determine investment strategies.
The Bank's investment policy is designed to complement the Bank's
lending activities, provide an alternative source of income through interest,
dividends and capital gains, diversify the Bank's assets and improve liquidity
while minimizing the Bank's tax liability. Investment decisions are made in
accordance with the Bank's investment policy and are based upon the quality of a
particular investment, its inherent risks, the composition of the balance sheet,
market expectations, the Bank's liquidity, income and collateral needs and how
the investment fits within the Bank's interest rate risk strategy. Although the
Bank utilizes the investment advisory services of a Boston-based investment
firm, management is ultimately and completely responsible for all investment
decisions.
The Bank's investment policy divides investments into two categories,
fixed income and equity portfolios. The primary objective of the fixed income
portfolio is to maintain an adequate source of liquidity sufficient to meet
regulatory and operating requirements, and to safeguard against deposit
outflows, reduced loan amortization and increased loan demand. The fixed income
portfolio primarily includes debt issues, including mortgage-backed and
asset-backed securities. Substantially all of the Bank's mortgage-backed
securities are issued or guaranteed by agencies of the U.S. Government.
Accordingly, they carry lower credit risk than mortgage-backed securities of a
private issuer. Asset-backed securities are typically collateralized by the cash
flow from a pool of auto loans, credit card receivables, consumer loans and
other similar obligations.
The Bank's investment policy permits the Bank to be a party to
financial instruments with off-balance sheet risk in the normal course of
business in order to manage interest rate risk. The Bank's derivative position
is reviewed by the Investment Committee on a quarterly basis. The investment
policy authorizes the Bank to be involved in and purchase various types of
derivative transactions and products including interest rate swap, cap and floor
agreements. At December 31, 1999, the Bank was a party to one interest rate cap
agreement with a notional principal amount of $25 million. Under the terms of
the cap agreement, the Bank paid a premium totalling $123,000. The cap was sold
during first quarter of 2000 resulting in a net gain of $72,000. At December 31,
2000, the Bank was not party to any interest rate swap, cap, or other derivative
agreement.
The marketable equity securities portfolio has the objective of
producing capital appreciation through long-term investment. Safety of principal
and prudent risk taking are of paramount importance. The total market value of
the marketable equity securities portfolio, excluding Federal Home Loan Bank
stock, is limited by the investment policy to 50% of the SBM's Tier 1 capital.
At December 31, 2000, the market value of the marketable equity securities
portfolio was $49.14 million or 28.43% of the SBM's Tier 1 capital. At December
31, 2000, the net unrealized gains associated with the marketable equity
securities portfolio were $13.92 million. In future periods and subject to
market conditions and other factors, the Bank intends to increase its marketable
equity securities portfolio through periodic purchases of high quality equity
investments. Emphasis will be placed on companies with established records of
growth and financial strength.
16
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" requires that investments be categorized as "held to maturity,"
"trading securities" or "available for sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as "held to maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as "held
to maturity." Debt and equity securities held for current resale are classified
as "trading securities." These securities are reported at fair value, and
unrealized gains and losses on the securities would be included in earnings. The
Bank does not currently use or maintain a trading account or have any
investments classified as held to maturity. Debt and equity securities not
classified as either "held to maturity" or "trading securities" are classified
as "available for sale." These securities are reported at fair value, and
unrealized gains and losses on the securities are excluded from earnings and
reported, net of deferred taxes, as a separate component of capital. As
permitted by SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," the Bank adopted the provisions of SFAS No. 133 on January 1, 2000,
earlier than required, and reclassified all held to maturity investments to
available for sale.
All of the Bank's debt securities and mortgage-backed and asset-backed
securities carry market risk insofar as increases in market rates of interest
may cause a decrease in their market value. They also carry prepayment risk
insofar as they may be called or repaid before maturity in times of low market
interest rates, so that the Bank may have to invest the funds at a lower
interest rate. The marketable equity securities portfolio also carries equity
price risk in that, if equity prices decline due to unfavorable market
conditions or other factors, SBM's capital would decrease.
17
The following table presents the amortized cost and fair value of the
Bank's securities, by type of security, at the dates indicated.
At December 31,
----------------------------------------------------------------------
2000 1999 1998
----------------------- ---------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---------- --------- ---------- --------- --------- ---------
(In thousands)
Debt securities held to maturity:
Asset-backed securities $ - $ - $ 17,481 $ 17,418 $ 23,204 $ 23,386
U.S. Government and agency obligations - - - - 3,506 3,524
Corporate securities - - 3,105 2,950 3,145 3,246
--------- -------- ---------- --------- ---------- --------
Total - - 20,586 20,368 29,855 30,156
--------- -------- ---------- --------- ---------- --------
Debt securities available for sale:
Asset-backed securities 32,717 33,816 - - - -
U.S. Government and agency obligations 82,068 85,254 82,486 81,328 70,563 71,703
Corporate securities 58,313 59,212 33,870 33,345 40,128 40,420
--------- -------- ---------- --------- ---------- --------
Total 173,098 178,282 116,356 114,673 110,691 112,123
--------- -------- ---------- --------- ---------- --------
Equity securities available for sale:
Marketable equity securities 35,221 49,144 32,273 50,545 29,427 42,773
Other equity securities 432 432 432 432 396 396
--------- -------- ---------- --------- ---------- --------
Total 35,363 49,576 32,705 50,977 29,823 43,169
--------- -------- ---------- --------- ---------- --------
Total debt and equity securities 208,751 227,858 169,647 186,018 170,369 185,448
--------- -------- ---------- --------- ---------- --------
Mortgage-backed securities:
Mortgage-backed securities available
for sale 79,079 80,223 16,741 16,204 12,832 12,859
Mortgage-backed securities held to
maturity - - 25,474 24,630 22,742 22,898
--------- -------- ---------- --------- ---------- --------
Total mortgage-backed securities 79,079 80,223 42,215 40,834 35,574 35,757
--------- -------- ---------- --------- ---------- --------
Total investment securities $ 287,830 $308,081 $ 211,862 $ 226,852 $ 205,943 $221,205
========= ======== ========== ========= ========== ========
18
At December 31, 2000, the Bank did not own any investment or
mortgage-backed securities of a single issuer, other than U.S. Government and
agency securities, which had an aggregate book value in excess of 10% of SBM's
capital at that date.
The following presents the activity in the investment securities and
mortgage-backed securities portfolios for the periods indicated.
For the Year Ended December 31,
---------------------------------
2000 1999 1998
---------------------------------
(In thousands)
Mortgage-backed and asset-backed securities (1):
Mortgage-backed and asset-backed securities, beginning of year $ 59,159 $ 58,805 $ 58,068
Purchases:
Asset-backed securities - held to maturity - - 5,069
Asset-backed securities - available for sale 25,136 - -
Mortgage-backed securities - held to maturity - 6,876 12,235
Mortgage-backed securities - available for sale 57,220 7,278 -
Sales:
Mortgage-backed securities - available for sale (14,256) - -
Asset-backed securities - available for sale (5,418) - -
Repayments and prepayments (10,713) (13,249) (16,510)
Increase in net premium 132 13 25
Change in unrealized net gain on securities available for sale 2,779 (564) (82)
-------- -------- --------
Net increase in mortgage-backed and asset-backed securities 54,880 354 737
-------- -------- --------
Mortgage-backed and asset-backed securities, end of year 114,039 59,159 58,805
-------- -------- --------
Investment securities (1):
Investment securities, beginning of year 168,755 161,943 123,804
Purchases:
Investment securities - available for sale 127,592 49,875 61,694
Sales:
Investment securities - available for sale (72,566) (18,530) (18,132)
Maturities:
Investment securities - held to maturity - (3,535) (3,500)
Investment securities - available for sale (31,774) (21,778) (5,000)
Increase (decrease) in net premium 615 (1,031) 17
Change in unrealized net gain on securities available for sale 1,420 1,811 3,060
-------- -------- --------
Net increase in investment securities 25,287 6,812 38,139
-------- -------- --------
Investment securities, end of year 194,042 168,755 161,943
-------- -------- --------
Total mortgage-backed, asset-backed and investment securities, end
of year $308,081 $227,914 $220,748
======== ======== ========
(1) Available for sale securities are presented at market value and held to
maturity securities are presented at amortized cost.
19
The following table presents certain information regarding the carrying
194,042 value, weighted average yields and maturities or periods to repricing of
the Bank's debt securities at December 31, 2000.
At December 31, 2000
-----------------------------------------------------------------------
More than One Year More than Five Years
One Year or Less to Five Years to Ten Years
----------------------- ---------------------- -----------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-----------------------------------------------------------------------
(Dollars in thousands)
Available for sale securities:
U.S. Government and agency obligations $ 10,408 6.18% $ 51,358 6.57% $ 23,488 6.18%
Corporate securities 5,477 7.07 42,593 6.44 8,193 7.87
Asset-backed securities - - 16,981 7.04 12,232 6.81
Mortgage-backed securities - - - - 1,324 7.00
---------- --------- --------- -------- -------- --------
Total debt securities at fair value $ 15,885 6.49% $ 110,932 6.59% $ 45,237 6.68%
========== ========= ========
---------------------------------------------
More than Ten Years Total
---------------------- ---------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-----------------------------------------------
Available for sale securities:
U.S. Government and agency obligations $ - -% $ 85,254 6.41%
Corporate securities 2,949 5.85 59,212 6.67
Asset-backed securities 4,603 6.83 33,816 6.93
Mortgage-backed securities 78,899 7.46 80,223 7.45
-------- -------- ---------- --------
Total debt securities at fair value $ 86,451 7.37% $ 258,505 6.86%
======== =========
20
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. SBM may use
borrowings from the Federal Home Loan Bank of Boston to compensate for
reductions in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors reside in
Connecticut. The Bank offers a wide variety of deposit accounts with a range of
interest rates and terms. The Bank's deposit accounts consist of interest-
bearing checking, noninterest-bearing checking, regular savings, money market
savings and certificates of deposit. The maturities of the Bank's certificate of
deposit accounts range from seven days to five years. In addition, the Bank
offers retirement accounts, including IRAs and Keogh accounts and simplified
employee pension plan accounts. The Bank also offers commercial business
products to small businesses operating within its primary market area. Deposit
account terms vary with the principal differences being the minimum balance
deposit, early withdrawal penalties, limits on the number of transactions and
the interest rate. The Bank reviews its deposit mix and pricing on a weekly
basis.
The Bank believes it offers competitive interest rates on its deposit
products. The Bank determines the rates paid based on a number of factors,
including rates paid by competitors, the Bank's need for funds and cost of
funds, borrowing costs and movements of market interest rates. While certificate
accounts in excess of $100,000 are accepted by the Bank, and may receive
preferential rates, the Bank does not actively seek such deposits as they are
more difficult to retain than core deposits. The Bank does not utilize brokers
to obtain deposits and at December 31, 2000, had no brokered deposits.
In the unlikely event SBM is liquidated, eligible depositors as of a
specific record date will be entitled to full payment of their deposit accounts
before any payment is made to the Company as the sole stockholder of the SBM.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Year Ended December 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
(In thousands)
Beginning balance $ 906,591 $ 855,117 $ 827,667
Increase (decrease) before interest credited (6,329) 20,565 (4,969)
Interest credited 33,108 30,909 32,419
----------- ----------- -----------
Net increase 26,779 51,474 27,450
----------- ----------- -----------
Ending balance $ 933,370 $ 906,591 $ 855,117
=========== =========== ===========
At December 31, 2000, the Bank had $57.76 million in certificate of deposit
accounts in amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
--------------- --------- ---------
(Dollars in thousands)
Three months or less $ 6,005 4.93%
Over 3 months through 6 months 18,567 5.77
Over 6 months through 12 months 19,209 6.38
Over 12 months 13,981 6.17
---------
Total $ 57,762
=========
21
The following table presents information concerning average balances and
weighted average interest rates for the periods indicated.
For the Year Ended December 31,
---------------------------------------------------------------------------------------------------------------
2000 1999 1998
------------------------------------ ------------------------------------ ---------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------------------------------------ ------------------------------------ ---------------------------------
(Dollars in thousands)
Savings accounts $ 223,700 24.8% 2.28% $ 226,477 26.0% 2.26% $ 215,769 25.8% 2.36%
Money market
accounts 73,576 8.1 4.24 51,088 5.8 3.52 33,146 4.0 2.87
NOW accounts 115,819 12.8 1.19 105,916 12.1 1.42 94,394 11.2 1.38
Certificates of
deposit 432,624 47.9 5.47 444,550 51.0 5.06 463,226 55.3 5.45
Demand deposits 57,871 6.4 - 44,358 5.1 - 30,985 3.7 -
---------- --------- ---------- -------- ---------- --------
Total $ 903,590 100.0% 3.68% $ 872,389 100.0% 3.54% $ 837,520 100.0% 3.90%
========== ========= ========== ======== ========== ========
Certificates of Deposit by Rates and Maturities. The following table
presents by various rate categories, the amount of certificate accounts
outstanding at the dates indicated and the periods to maturity of the
certificate accounts outstanding at December 31, 2000.
Period to Maturity from December 31, 2000 Total at December 31,
------------------------------------------------------ ---------------------------------
Two to
Less than One to Two Three Over Three
One Year Years Years Years 2000 1999 1998
------------------------------------------------------------------------------------------
(In thousands)
0.00 - 2.00% $ 42 $ - $ - $ - $ 42 $ 18 $ 21
2.01 - 4.00% 1,375 - - - 1,375 2,329 2,598
4.01 - 5.00% 80,460 1,313 1,094 5,718 88,585 207,163 222,709
5.01 - 6.00% 50,276 24,265 18,249 6,735 99,525 195,403 178,662
6.01 - 7.00% 199,699 13,921 3,546 33,146 250,312 39,129 32,907
7.01 - 8.00% - - - - - 6,305 9,227
8.01 - 9.00% - - - - - - 15
-------- --------- --------- -------- --------- -------- ---------
Total $331,852 $ 39,499 $ 22,889 $ 45,599 $ 439,839 $450,347 $ 446,139
======== ========= ========= ======== ========= ======== =========
Borrowings. SBM may use advances from the Federal Home Loan Bank of Boston
to supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The Federal Home Loan Bank of Boston functions as a central
reserve bank providing credit for savings banks and certain other member
financial institutions. As a member of the Federal Home Loan Bank of Boston, SBM
is required to own capital stock in the Federal Home Loan Bank of Boston and is
authorized to apply for advances on the security of the capital stock and
certain of its mortgage loans and other assets, principally securities that are
obligations of, or guaranteed by, the U.S. Government or its agencies, provided
certain creditworthiness standards have been met. Advances are made under
several different credit programs. Each credit program has its own interest rate
and range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 2000, SBM
had the ability to borrow a total of approximately $447.29 million from the
Federal Home Loan Bank of Boston. Of the total maximum borrowing capacity SBM
had $100.00 million outstanding at December 31, 2000.
22
Federal banking laws and regulations prohibit a bank from paying interest
on commercial checking accounts. However, SBM offers to its commercial customers
a transactional repurchase agreement, a form of non-deposit borrowing by SBM,
that is designed as a mechanism to offer business customers the functional
equivalent of a commercial checking account that pays interest. This account,
overseen by an outside agent, is not a FDIC-insured deposit account, but is
backed by a security interest in U.S. Government and agency securities at a
ratio of approximately 1.10 to 1.00. At December 31, 2000, SBM had such accounts
with balances aggregating $105.73 million, which are included in short-term
borrowed funds, backed by a security interest of $133.43 million or a ratio of
1.26 to 1.00.
The following table presents certain information regarding SBM's Federal
Home Loan Bank advances and short-term borrowed funds at the dates or for the
periods indicated.
At or For the Year Ended December 31,
-------------------------------------
2000 1999 1998
-------------------------------------
(Dollars in thousands)
Average balance outstanding:
Federal Home Loan Bank advances $105,692 $ 58,761 $36,534
Short-term borrowed funds 110,520 89,133 76,523
Maximum amount outstanding at any month-end during the
period:
Federal Home Loan Bank advances 124,000 95,962 45,000
Short-term borrowed funds 119,821 104,575 87,790
Balance outstanding at end of period:
Federal Home Loan Bank advances 100,000 84,000 45,000
Short-term borrowed funds 106,493 95,814 79,545
Weighted average interest rate during the period:
Federal Home Loan Bank advances 6.39% 6.09% 6.31%
Short-term borrowed funds 3.31 3.06 3.00
Weighted average interest rate at end of period:
Federal Home Loan Bank advances 6.15 6.03 6.21
Short-term borrowed funds 3.20 3.12 2.84
Subsidiary Activities
The following are descriptions of SBM's wholly owned subsidiaries, which
are indirectly owned by the Company.
SBM, Ltd. SBM, Ltd. was organized in February 1983 for the purpose of
acquiring and holding real estate acquired by the Bank. In 1990, the purpose
changed to acquire, hold and dispose of real estate acquired through
foreclosure. At December 31, 2000, SBM, Ltd. held no properties and had no
assets.
923 Main, Inc. 923 Main was incorporated in December 1994 for the purpose
of maintaining an ownership interest in a third party registered broker-dealer,
Infinex Financial Group. Infinex maintains an office at the Bank and offers to
customers a complete range of nondeposit investment products, including mutual
funds, debt, equity and government securities, retirement accounts, insurance
products and fixed and variable annuities. The Bank receives a portion of the
commissions generated by Infinex from sales to customers. For the years ended
December 31, 2000 and 1999, the Bank received fees of $1.38 million and $1.16
million, respectively, through its relationship with Infinex.
23
Savings Bank of Manchester Mortgage Company, Inc. SBM Mortgage was
established in January 1999 to service and hold loans secured by real property.
SBM Mortgage was established and is managed to qualify as a passive investment
company for Connecticut income tax purposes. Income earned by a qualifying
passive investment company is exempt from Connecticut income tax. Accordingly,
no state income taxes were provided in 1999 or 2000.
Savings Bank of Manchester Foundation, Inc.
In 1998, SBM established a private charitable foundation, Savings Bank
of Manchester Foundation, Inc. This foundation, which is not a subsidiary of the
Company or SBM, provides grants to individuals and not-for-profit organizations
within the communities that the Bank serves. In 1998, SBM contributed marketable
equity securities with a cost basis and fair market value of $700,000 and $3.00
million, respectively, at the date of contribution and transfer. At December 31,
2000, the foundation had assets of approximately $3.19 million. The foundation's
four member Board of Trustees consists of current directors, officers and
employees of the Bank. The Bank intends to maintain the foundation, but does not
expect to make any further contributions to the foundation in the future.
SBM Charitable Foundation, Inc.
During 2000, the Bank established a second private charitable
foundation, SBM Charitable Foundation, Inc. This foundation, which is not a
subsidiary of the Company or SBM, provides grants to individuals and
not-for-profit organizations within the communities that the Bank serves. In
2000, in connection with the Company's conversion to stock form, the Company
contributed 832,000 shares of company stock with a cost basis and fair market
value of $8.32 million, at the date of contribution and transfer. At December
31, 2000, the foundation had assets of approximately $15.18 million, consisting
primarily of the company stock. The foundation's thirteen member Board of
Directors consists of current directors, officers and employees of the Bank. The
Bank intends to maintain the foundation, but does not expect to make any further
contributions to the foundation in the future.
REGULATION AND SUPERVISION
General
As a savings bank chartered by the State of Connecticut, SBM is
extensively regulated under state law by the Connecticut Banking Commissioner
("Commissioner") with respect to many aspects of its banking activities. In
addition, as a bank whose deposits are insured by the Federal Deposit Insurance
Corporation ("FDIC") through the Bank Insurance Fund ("BIF"), SBM must pay
deposit insurance assessments and is examined and supervised by the FDIC. These
laws and regulations have been established primarily for the protection of
depositors, customers and borrowers of SBM, not its stockholders.
The Bank is also required to file reports with, and otherwise comply
with the rules and regulations of, the Office of Thrift Supervision ("OTS"), the
Commissioner, and the Securities and Exchange Commission ("SEC") under the
federal securities laws. The following discussion of the laws and regulations
material to the operations of the Company and SBM is a summary and is qualified
in its entirety by reference to such laws and regulations.
SBM and the Company, as a savings and loan holding company, are
extensively regulated and supervised. Regulations, which affect the Bank on a
daily basis, may be changed at any time, and the interpretation of the relevant
law and regulations may also change because of new interpretations by the
authorities who interpret those laws and regulations. Any change in the
regulatory structure or the applicable statutes or regulations, whether by the
Commissioner, the State of Connecticut, the OTS, the FDIC or the U.S. Congress,
could have a material impact on the Company and SBM.
24
Connecticut Banking Laws and Supervision
The Commissioner regulates SBM's internal organization as well as its
deposit, lending and investment activities. The approval of the Commissioner is
required for, among other things, the establishment of branch offices and
business combination transactions. The Commissioner conducts periodic
examinations of SBM. The FDIC also regulates many of the areas regulated by the
Commissioner and federal law may limit some of the authority provided to SBM by
Connecticut law.
Lending Activities. Connecticut banking laws grant banks broad lending
authority. With certain limited exceptions, however, total secured and unsecured
loans made to any one obligor under this statutory authority may not exceed 10%
and 15%, respectively, of the bank's equity capital and reserves for loan and
lease losses.
A savings bank may pay cash dividends out of its net profits. For
purposes of this restriction, "net profits " means the remainder of all earnings
from current operations. Further, the total amount of all dividends declared by
a savings bank in any calendar year may not exceed the sum of the bank's net
profits for the year in question combined with its retained net profits from the
preceding two calendar years. Additionally, earnings appropriated to reserves
for loan losses and deducted for federal income tax purposes are not available
for cash dividends without the payment of taxes at then current income tax rates
on the amount used. Federal law also prevents an institution from paying
dividends or making other capital distributions if doing so would cause it to
become "undercapitalized." The FDIC may limit a savings bank's ability to pay
dividends. No dividends may be paid to the Bank's stockholders if such dividends
would reduce stockholders' equity below the amount of the liquidation account
required by the Connecticut conversion regulations.
Branching Activities. Any Connecticut-chartered bank meeting certain
statutory requirements may, with the Commissioner's approval, establish and
operate branches in any town or towns within the state and establish mobile
branches.
Investment Activities. Connecticut law requires the board of directors
of each Connecticut bank to adopt annually an investment policy to govern the
types of investments the bank makes, and to periodically review the bank's
adherence to its investment policy. The investment policy must establish
standards for the making of prudent investments and procedures for divesting
investments no longer deemed consistent with the bank's investment policy. In
recent years, Connecticut law has expanded bank investment activities.
Connecticut banks may invest in debt securities and debt mutual funds
without regard to any other liability to the Connecticut bank of the maker or
issuer of the debt securities and debt mutual funds, if the debt securities and
debt mutual funds are rated in the three highest rating categories or otherwise
deemed to be a prudent investment, and so long as the total amount of debt
securities and debt mutual funds of any one issuer will not exceed 25% of the
bank's total equity capital and reserves for loan and lease losses and the total
amount of all its investments in debt securities and debt mutual funds will not
exceed 25% of its assets. In addition, a Connecticut bank may invest in certain
government and agency obligations according to the same standards as debt
securities and debt mutual funds except without any percentage limitation.
Similarly, Connecticut banks may invest in equity securities and equity
mutual funds without regard to any other liability to the Connecticut bank of
the issuer of equity securities and equity mutual funds, so long as the total
amount of equity securities and equity mutual funds of any one issuer will not
exceed 25% of the bank's total equity capital and reserves for loan and lease
losses and the total amount of the bank's investment in all equity securities
and equity mutual funds will not exceed 25% of its assets.
Powers. In recent years, Connecticut law has expanded bank powers.
Connecticut law permits Connecticut banks to sell insurance and fixed and
variable rate annuities if licensed to do so by the Connecticut Insurance
Commissioner. Connecticut law authorizes a new form of Connecticut bank known as
an uninsured bank. An uninsured bank has the same powers as banks except that it
does not accept retail deposits and is not required to insure deposits with the
FDIC. With the prior approval of the Commissioner, Connecticut banks are also
authorized to engage in a broad range of activities related to the business of
banking, or that are financial in nature or that are permitted under the Bank
Holding Company Act ("BHCA") or the Home Owners' Loan Act ("HOLA"), both
25
federal statutes, or the regulations promulgated as a result of these statutes.
Connecticut banks are also authorized to engage in any activity permitted for a
national bank or a federal savings association upon filing notice with the
Commissioner unless the Commissioner disapproves the activity.
Recent Legislation. Connecticut legislation enacted in 2000 has
expanded the authority of the Commissioner. The Commissioner now has the
authority to waive provisions of Connecticut's regulations governing mutual to
stock conversions that are inconsistent with the regulations of the OTS.
Assessments. Connecticut banks may be required to pay annual
assessments to the Connecticut Department of Banking to fund the department's
operations. The general assessments are paid pro rata based upon a bank's asset
size. No assessments were paid by SBM for the year ended December 31, 2000.
Enforcement. Under Connecticut law, the Commissioner has extensive
enforcement authority over Connecticut banks and, under certain circumstances,
affiliated parties, insiders, and agents. The Commissioner's enforcement
authority includes: cease and desist orders, fines, receivership,
conservatorship, removal of officers and directors, emergency closures,
dissolution, and liquidation.
Federal Regulations
Capital Requirements. Under FDIC regulations, federally insured
state-chartered banks that are not members of the Federal Reserve System ("state
non-member banks"), such as SBM, are required to comply with minimum leverage
capital requirements. For an institution determined by the FDIC to not be
anticipating or experiencing significant growth and to be in general a strong
banking organization, rated composite 1 under the Uniform Financial Institutions
Ranking System (the rating system) established by the Federal Financial
Institutions Examination Council, the minimum capital leverage requirement is a
ratio of Tier 1 capital to total assets of 3%. For all other institutions, the
minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of
common stockholders' equity, noncumulative perpetual preferred stock (including
any related surplus) and minority investments in certain subsidiaries, less
intangible assets (except for certain servicing rights and credit card
relationships).
The FDIC regulations require state non-member banks to maintain certain
levels of regulatory capital in relation to regulatory risk-weighted assets. The
ratio of regulatory capital to regulatory risk-weighted assets is referred to as
the bank's "risk-based capital ratio." Risk-based capital ratios are determined
by allocating assets and specified off-balance sheet items to four risk-weighted
categories ranging from 0% to 100%, with higher levels of capital being required
for the categories perceived as representing greater risk. For example, under
the FDIC's risk-weighting system, cash and securities backed by the full faith
and credit of the U.S. government are given a 0% risk weight, loans secured by
one- to four-family residential properties generally have a 50% risk weight and
commercial loans have a risk weighting of 100%.
State non-member banks must maintain a minimum ratio of total capital
to risk-weighted assets of at least 8%, of which at least one-half must be Tier
1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary
capital items, which include allowances for loan losses in an amount of up to
1.25% of risk-weighted assets, cumulative preferred stock and certain other
capital instruments, and a portion of the net unrealized gain on equity
securities. The includable amount of Tier 2 capital cannot exceed the amount of
the institution's Tier 1 capital.
The Federal Deposit Insurance Corporation Improvement Act (the
"FDICIA") required each federal banking agency to revise its risk-based capital
standards for insured institutions to ensure that those standards take adequate
account of interest-rate risk, concentration of credit risk, and the risk of
nontraditional activities, as well as to reflect the actual performance and
expected risk of loss on multi-family residential loans. The FDIC, along with
the other federal banking agencies, has adopted a regulation providing that the
agencies will take into account the exposure of a bank's capital and economic
value to changes in interest rate risk in assessing a bank's capital adequacy.
As a savings and loan holding company regulated by the OTS, the Company
is not, under current law,
26
subject to any separate regulatory capital requirements.
Standards for Safety and Soundness. As required by statute, the federal
banking agencies adopted final regulations and Interagency Guidelines
Establishing Standards for Safety and Soundness to implement safety and
soundness standards. The guidelines set forth the safety and soundness standards
that the federal banking agencies use to identify and address problems at
insured depository institutions before capital becomes impaired. The guidelines
address internal controls and information systems, internal audit system, credit
underwriting, loan documentation, interest rate risk exposure, asset growth,
asset quality, earnings and compensation, and fees and benefits. If the
appropriate federal banking agency determines that an institution fails to meet
any standard prescribed by the guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard.
Investment Activities
Since the enactment of the FDICIA, all state-chartered FDIC insured
banks, including savings banks, have generally been limited to activities as
principal and equity investments of the type and in the amount authorized for
national banks, notwithstanding state law. The FDICIA and the FDIC permit
exceptions to these limitations. For example, state chartered banks, such as
SBM, may, with FDIC approval, continue to exercise state authority to invest in
common or preferred stocks listed on a national securities exchange or the
Nasdaq National Market and in the shares of an investment company registered
under the Investment Company Act of 1940, as amended. In addition, the FDIC is
authorized to permit such institutions to engage in state authorized activities
or investments that do not meet this standard (other than non-subsidiary equity
investments) for institutions that meet all applicable capital requirements if
it is determined that such activities or investments do not pose a significant
risk to the BIF. The FDIC has adopted revisions to its regulations governing the
procedures for institutions seeking approval to engage in such activities or
investments. All non-subsidiary equity investments, unless otherwise authorized
or approved by the FDIC, must have been divested by December 19, 1996, under a
FDIC-approved divestiture plan, unless such investments were grandfathered by
the FDIC. SBM received grandfathered authority from the FDIC in March 1993 to
invest in listed stocks and/or registered shares. However, the maximum
permissible investment is 100% of Tier 1 capital, as specified by the FDIC's
regulations, or the maximum amount permitted by Connecticut law, whichever is
less. Such grandfathered authority may be terminated upon the FDIC's
determination that such investments pose a safety and soundness risk to SBM or
if SBM converts its charter or undergoes a change in control. As of December 31,
2000, SBM had $49.58 million of securities which were held under such
grandfathering authority. The Gramm-Leach-Bliley Act of 1999 (the "GLB Act")
specifies that a nonmember bank may control a subsidiary that engages in
activities as principal that would only be permitted for a national bank to
conduct in a "financial subsidiary" if the bank meets specified conditions and
deducts its investment in the subsidiary for regulatory capital purposes.
Interstate Branching
Beginning June 1, 1997, the Interstate Branching Act (the "IBA")
permitted the responsible federal banking agencies to approve merger
transactions between banks located in different states, regardless of whether
the merger would be prohibited under the law of the two states. The IBA also
permitted a state to "opt in" to the provisions of the IBA before June 1, 1997,
and permitted a state to "opt out" of the provisions of the IBA by adopting
appropriate legislation before that date. In 1995, Connecticut affirmatively
"opted-in" to the provisions of the IBA. Accordingly, beginning June 1, 1997,
the IBA permitted a bank, such as SBM, to acquire branches in a state other than
Connecticut unless the other state had opted out of the IBA. The IBA also
authorizes de novo branching into another state if the host state enacts a law
expressly permitting out of state banks to establish such branches within its
borders.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to banks that do not
meet minimum capital requirements. For these purposes, the law establishes five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
27
The FDIC has adopted regulations to implement the prompt corrective
action legislation. An institution is deemed to be "well capitalized" if it has
a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater and a leverage ratio of 5% or greater. An institution is
"adequately capitalized" if it has a total risk-based capital ratio of 8% or
greater, a Tier 1 risk-based capital ratio of 4% or greater, and generally a
leverage ratio of 4% or greater. An institution is "undercapitalized" if it has
a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital
ratio of less than 4%, or generally a leverage ratio of less than 4%. An
institution is deemed to be "significantly undercapitalized" if it has a total
risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of
less than 3%, or a leverage ratio of less than 3%. An institution is considered
to be "critically undercapitalized" if it has a ratio of tangible equity (as
defined in the regulations) to total assets that is equal to or less than 2%. As
of December 31, 2000, SBM was a "well capitalized" institution.
"Undercapitalized" banks must adhere to growth, capital distribution
(including dividend) and other limitations and are required to submit a capital
restoration plan. A bank's compliance with such plan is required to be
guaranteed by any company that controls the undercapitalized institution in an
amount equal to the lesser of 5% of the institution's total assets when deemed
undercapitalized or the amount necessary to achieve the status of adequately
capitalized. If an "undercapitalized" bank fails to submit an acceptable plan,
it is treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" banks must comply with one or more of a number of additional
restrictions, including but not limited to an order by the FDIC to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cease receipt of deposits from correspondent banks or dismiss
directors or officers, and restrictions on interest rates paid on deposits,
compensation of executive officers and capital distributions by the parent
holding company. "Critically undercapitalized" institutions are subject to
additional measures including, subject to a narrow exception, the appointment of
a receiver or conservator within 270 days after it obtains such status.
Transactions with Affiliates
Under current federal law, transactions between depository institutions
and their affiliates are governed by Sections 23A and 23B of the Federal Reserve
Act (the "FRA"). In a holding company context, at a minimum, the parent holding
company of a savings bank and any companies which are controlled by such parent
holding company are affiliates of the savings bank. Generally, Section 23A
limits the extent to which the savings bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to 10% of such savings bank's
capital stock and surplus, and contains an aggregate limit on all such
transactions with all affiliates to 20% of capital stock and surplus. The term
"covered transaction" includes, among other things, the making of loans or other
extensions of credit to an affiliate and the purchase of assets from an
affiliate. Section 23A also establishes specific collateral requirements for
loans or extensions of credit to, or guarantees, acceptances on letters of
credit issued on behalf of an affiliate. Section 23B requires that covered
transactions and a broad list of other specified transactions be on terms
substantially the same, or no less favorable, to the savings bank or its
subsidiary as similar transactions with nonaffiliates.
Further, Section 22(h) of the FRA restricts an institution with respect
to loans to directors, executive officers, and principal stockholders
("insiders"). Under Section 22(h), loans to insiders and their related interests
may not exceed, together with all other outstanding loans to such persons and
affiliated entities, the institution's total capital and surplus. Loans to
insiders above specified amounts must receive the prior approval of the board of
directors. Further, under Section 22(h), loans to directors, executive officers
and principal shareholders must be made on terms substantially the same as
offered in comparable transactions to other persons, except that such insiders
may receive preferential loans made under a benefit or compensation program that
is widely available to the bank's employees and does not give preference to the
insider over the employees. Section 22(g) of the FRA places additional
limitations on loans to executive officers.
Enforcement
The FDIC has extensive enforcement authority over insured savings
banks, including SBM. This enforcement authority includes, among other things,
the ability to assess civil money penalties, to issue cease and desist orders
and to remove directors and officers. In general, these enforcement actions may
be initiated in response
28
to violations of laws and regulations and unsafe or unsound practices.
The FDIC has authority under Federal law to appoint a conservator or
receiver for an insured bank under limited circumstances. The FDIC is required,
with certain exceptions, to appoint a receiver or conservator for an insured
state non-member bank if that bank was "critically undercapitalized" on average
during the calendar quarter beginning 270 days after the date on which the
institution became "critically undercapitalized." The FDIC may also appoint
itself as conservator or receiver for an insured state non-member institution
under specific circumstances on the basis of the institution's financial
condition or upon the occurrence of other events, including: (1) insolvency; (2)
substantial dissipation of assets or earnings through violations of law or
unsafe or unsound practices; (3) existence of an unsafe or unsound condition to
transact business; and (4) insufficient capital, or the incurring of losses that
will deplete substantially all of the institution's capital with no reasonable
prospect of replenishment without federal assistance.
Insurance of Deposit Accounts
The FDIC has adopted a risk-based insurance assessment system. The FDIC
assigns an institution to one of three capital categories based on the
institution's financial condition consisting of (1) well capitalized, (2)
adequately capitalized or (3) undercapitalized, and one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information which the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is
assigned. Assessment rates for insurance fund deposits currently range from 0
basis points for the strongest institution to 27 basis points for the weakest.
BIF members are also required to assist in the repayment of bonds issued by the
Financing Corporation in the late 1980's to recapitalize the Federal Savings and
Loan Insurance Corporation. For the year ended December 31, 2000, the total FDIC
assessment was $187,000. The FDIC is authorized to raise the assessment rates.
The FDIC has exercised this authority several times in the past and may raise
insurance premiums in the future. If such action is taken by the FDIC, it could
have an adverse effect on the earnings of SBM.
The FDIC may terminate insurance of deposits if it finds that the
institution is in an unsafe or unsound condition to continue operations, has
engaged in unsafe or unsound practices, or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC. The management of SBM
does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
Federal Reserve System
The FRB regulations require depository institutions to maintain
non-interest-earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). The FRB regulations generally require that
reserves be maintained against aggregate transaction accounts as follows: for
that portion of transaction accounts aggregating $42.8 million or less (which
may be adjusted by the FRB) the reserve requirement is 3%; and for accounts
greater than $42.8 million, the reserve requirement is $1.28 million plus 10%
(which may be adjusted by the FRB between 8% and 14%) against that portion of
total transaction accounts in excess of $42.8 million. The first $5.5 million of
otherwise reservable balances (which may be adjusted by the FRB) are exempted
from the reserve requirements. SBM is in compliance with these requirements.
Federal Home Loan Bank System
SBM is a member of the Federal Home Loan Bank System, which consists of
12 regional Federal Home Loan Banks. The FHLB provides a central credit facility
primarily for member institutions. SBM, as a member of the FHLB of Boston, is
required to acquire and hold shares of capital stock in the FHLB of Boston in an
amount at least equal to 1% of the aggregate principal amount of its unpaid
residential mortgage loans and similar obligations at the beginning of each
year, or 1/20 of its advances (borrowings) from the FHLB of Boston, whichever is
greater. SBM was in compliance with this requirement with an investment in FHLB
of Boston stock at December 31, 2000 of $6.65 million. At December 31, 2000, SBM
had $100.00 million in FHLB of Boston advances.
29
The Federal Home Loan Banks are required to provide funds for certain
purposes including contributing funds for affordable housing programs. These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and result in the Federal Home Loan Banks imposing a
higher rate of interest on advances to their members. For the years ended
December 31, 2000 and 1999, cash dividends from the FHLB of Boston to SBM
amounted to approximately $460,000 and $383,000, respectively. Further, there
can be no assurance that the impact of recent or future legislation on the
Federal Home Loan Banks will not also cause a decrease in the value of the FHLB
stock held by SBM.
Holding Company Regulation
Federal law allows a state savings bank that qualifies as a "Qualified
Thrift Lender," discussed below, to elect to be treated as a savings association
for purposes of the savings and loan holding company provisions of the HOLA.
Such election allows its holding company to be regulated as a savings and loan
holding company by the OTS rather than as a bank holding company by the FRB. SBM
has made such election and the Company is a nondiversified savings and loan
holding company within the meaning of the HOLA. The Company is registered with
the OTS and has adhered to the OTS' regulations and reporting requirements. In
addition, the OTS may examine and supervise the Company and the OTS has
enforcement authority over the Company and its non-savings institution
subsidiaries. Among other things, this authority permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to the subsidiary
savings institution. Additionally, SBM is required to notify the OTS at least 30
days before declaring any dividend to the Company. By regulation, the OTS may
restrict or prohibit the Company from paying dividends.
The Company is a unitary savings and loan holding company under federal
law because SBM is its only insured subsidiary immediately after the Conversion.
Formerly, a unitary savings and loan holding company was not restricted as to
the types of business activities in which it could engage, provided that its
subsidiary savings association continued to be a qualified thrift lender. The
GLB Act, however, restricts unitary savings and loan holding companies not
existing or applied for before May 4, 1999 to activities permissible for a
financial holding company as defined under the legislation, including insurance
and securities activities, and those permitted for a multiple savings and loan
holding company as described below. The Company is subject to these activities
restrictions. Upon any non-supervisory acquisition by the Company of another
savings association as a separate subsidiary, the Company would become a
multiple savings and loan holding company. The HOLA limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the BHCA, provided the prior approval of the OTS is
obtained, and to other activities authorized by OTS regulation. Multiple savings
and loan holding companies are generally prohibited from acquiring or retaining
more than 5% of a non-subsidiary company engaged in activities other than those
permitted by the HOLA.
The HOLA prohibits a savings and loan holding company from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
association or savings and loan holding company or from acquiring such an
institution or company by merger, consolidation or purchase of its assets,
without prior written approval of the OTS. In evaluating applications by holding
companies to acquire savings associations, the OTS considers the financial and
managerial resources and future prospects of the Company and the institution
involved, the effect of the acquisition on the risk to the insurance funds, the
convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, except: (1) interstate supervisory acquisitions by
savings and loan holding companies; and (2) the acquisition of a savings
institution in another state if the laws of the state of the target savings
institution specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the OTS
(rather than as a bank holding company by the FRB), SBM must qualify as a
Qualified Thrift Lender ("QTL"). To qualify as a QTL, the Bank must maintain
compliance with the test for a "domestic building and loan association," as
defined in the Internal Revenue Code, or with a QTL Test. Under the QTL Test, a
savings institution is required to maintain at least 65% of its "portfolio
assets" (total assets less: (1) specified liquid assets up to 20% of total
assets; (2) intangibles,
30
including goodwill; and (3) the value of property used to conduct business) in
certain "qualified thrift investments" (primarily residential mortgages and
related investments, including certain mortgage-backed and related securities)
in at least 9 months out of each 12 month period. As of December 31, 2000 SBM
maintained in excess of 75% of its portfolio assets in qualified thrift
investments. SBM also met the QTL test in each of the last 12 months and,
therefore, met the QTL Test.
Connecticut Holding Company Regulations. Under Connecticut banking law,
no person may acquire beneficial ownership of more than 10% of any class of
voting securities of a Connecticut-chartered bank, or any bank holding company
of such a bank, without prior notification of, and lack of disapproval by, the
Commissioner. Similar restrictions apply to any person who holds in excess of
10% of any such class and desires to increase its holdings to 25% or more of
such class. The Commissioner will evaluate the effect of the acquisition on the
financial condition of the bank or bank holding company. The Commissioner will
also disapprove the acquisition if the bank or holding company to be acquired
has been in existence for less than five years, unless the Commissioner waives
this requirement, or if the acquisition would result in the acquirer controlling
30% or more of the total amount of deposits in insured depository institutions
in Connecticut.
Federal Securities Laws
Upon the completion of the Conversion in March, 2000, the Company's
common stock became registered with the SEC under the Exchange Act. The Company
now observes the reporting, proxy solicitation, insider trading restrictions and
other requirements under the Securities Exchange Act of 1934.
The registration under the Securities Act of 1933 of shares of the
common stock issued in the Conversion did not cover the resale of such shares.
Shares of the common stock purchased by persons who are not affiliates of the
Company may be resold without registration. The resale restrictions of Rule 144
under the Securities Act govern shares purchased by an affiliate of the Company.
If the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's sale
to be aggregated with those of other persons) would be able to sell in the
public market, without registration, a number of shares not to exceed, in any
three-month period, the greater of (1) 1% of the outstanding shares of the
Company or (2) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under specific circumstances.
31
FEDERAL AND STATE TAXATION OF INCOME
Federal Income Taxation
General. The Company and SBM report their income on a calendar year
basis using the accrual method of accounting. The federal income tax laws apply
to the Company and SBM in the same manner as to other corporations with some
exceptions, including particularly SBM's reserve for bad debts discussed below.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to SBM
or the Company. The Bank's federal income tax returns have been either audited
or closed under the statute of limitations through tax year 1996. For its 2000
tax year, the Bank's maximum federal income tax rate was 35%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for nonqualifying
loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts and the percentage of taxable income method for tax
years beginning after 1995 and require savings institutions to recapture or take
into income certain portions of their accumulated bad debt reserves.
Approximately $12.56 million of SBM's accumulated bad debt reserves would not be
recaptured into taxable income unless SBM makes a "non-dividend distribution" to
the Company as described below.
Distributions. If SBM makes "non-dividend distributions" to the
Company, they will be considered to have been made from SBM's unrecaptured tax
bad debt reserves, including the balance of its reserves as of December 31,
1987, to the extent of the "non-dividend distributions," and then from SBM's
supplemental reserve for losses on loans, to the extent of those reserves, and
an amount based on the amount distributed, but not more than the amount of those
reserves, will be included in SBM's taxable income. Non-dividend distributions
include distributions in excess of SBM's current and accumulated earnings and
profits, as calculated for federal income tax purposes, distributions in
redemption of stock, and distributions in partial or complete liquidation.
Dividends paid out of SBM's current or accumulated earnings and profits will not
be so included in SBM's taxable income.
The amount of additional taxable income triggered by a non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Therefore, if SBM makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
the distribution not in excess of the amount of the reserves would be includable
in income for federal income tax purposes, assuming a 35% federal corporate
income tax rate. SBM does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserves.
Connecticut Taxation
The Bank is subject to the Connecticut corporation business tax. The
Bank is eligible to file a combined Connecticut corporation business tax return
and will pay the regular corporation business tax (income tax).
The Connecticut corporation business tax is based on the federal
taxable income before net operating loss and special deductions of the Bank and
makes certain modifications to federal taxable income to arrive at Connecticut
taxable income. Connecticut taxable income is multiplied by the state tax rate
(7.5% for 2000 and thereafter) to arrive at Connecticut income tax.
In May 1998, the State of Connecticut enacted legislation permitting
the formation of passive investment company subsidiaries by financial
institutions. This legislation exempts qualifying passive investment companies
from the Connecticut corporation business tax and excludes dividends paid from a
passive investment company
32
from the taxable income of the parent financial institution. SBM's formation of
a passive investment company in January 1999 eliminated the state income tax
expense of the Bank for 1999 and 2000. The Bank expects the passive investment
company will eliminate substantially all state income taxes of the Bank going
forward.
33
Item 2. Properties.
- ------------------
Properties
The Bank currently conducts its business through its main office
located in Manchester, Connecticut, and 22 other full-service banking offices.
The Bank believes that its facilities are adequate to meet its present and
immediately foreseeable needs.
Net Book Value
of Property
Leased, or Leasehold
Licensed Original Year Date of Lease/ Improvements
or Leased License at December 31,
Location Owned or Acquired Expiration 2000
- -------- ----- ----------- ---------- --------------
(In thousands)
Main Branch and Executive Office:
923 Main Street Owned 1932 -- $ 1,318
Manchester, CT 06040
Branch Offices:
285 East Center Street Leased 1956 2011 99
Manchester, CT 06040
220 North Main Street Leased 1970 2005 102
Manchester, CT 06040
241 West Middle Turnpike /(1)/ 1983 2023 160
Manchester, CT 06040
955 Sullivan Avenue /(1)/ 1965 2010 539
South Windsor, CT 06074
477 Connecticut Boulevard Leased 1996 2006 83
East Hartford, CT 06108
236 Spencer Street Leased 1974 2004 -
Manchester, CT 06040
1 Main Street Leased 1975 2010 -
East Hartford, CT 06118
62 Buckland Street Leased 1990 2009 90
Manchester, CT 06040
Eastford Center, County Road Leased 1985 2004 -
Eastford, CT 06242
122A Prospect Hill Road Leased 1985 2004 -
East Windsor, CT 06088
6 Storrs Road Leased 1986 2015 75
Mansfield, CT 06250
200 Merrow Road Leased 1989 2004 57
Tolland, CT 06084
1320 Manchester Road /(1)/ 1987 2007 258
Glastonbury, CT 06033
435 Hartford Turnpike Leased 1988 2003 89
Vernon, CT 06066
1078 N. Main Street Leased 1990 2010 -
Dayville (Killingly), CT 06241
Route 66
34
Net Book Value
of Property
Leased, or Leasehold
Licensed Original Year Date of Lease/ Improvements
or Leased License at December 31,
Location Owned or Acquired Expiration 2000
- -------- ----- ----------- ---------- --------------
(In thousands)
Columbia, CT 06237 Owned 1991 -- $ 235
1671 Boston Turnpike, Route 44 Leased 1993 2013 74
Coventry, CT 06238
574 & 596 Middle Turnpike Owned 1995 -- 760
Storrs, CT 06268
49 Hazard Avenue Leased 1995 2007 91
Enfield, CT 06082
2133 Poquonock Avenue Leased 1996 2006 160
Windsor, CT 06095
44-48 Wells Road Leased 1996 2008 114
Wethersfield, CT 06109
55 South Main Street Leased 1997 2016 215
West Hartford, CT 06107
ATM Facilities:
Rt. 6 Leased 1974 2004 -
Andover, CT 06232
Junction Routes 44 & 74 Leased 1976 2001 -
Ashford, CT 06278
Rt. 44A, 663 Boston Turnpike Leased 1968 2001 -
Bolton, CT 06043
700 Burnside Ave. Leased 1966 (4) -
East Hartford, CT 06108
60 Bidwell Street Licensed/(2)/ 1990 /(2)/ -
Manchester, CT 06040
Buckland Hills Mall Leased 1992 2004 -
Manchester, CT 06040
31 Union Street Licensed/(2)/ 1995 /(2)/ -
Rockville, CT 06066
469 Hartford Rd Leased 1970 2002 -
Manchester, CT 06040
71 Haynes Street Licensed/(2)/ 1989 /(2)/ -
Manchester, CT 06040
Administrative Offices:
469 Hartford Road Leased 1970 2002 20
Manchester, CT 06040
50-56 Cottage Street Owned 1986 -- 455
Manchester, CT 06040
881 Main Street Leased 1984 2001 118
Manchester, CT 06040
35
Net Book Value
of Property
Leased, or Leasehold
Licensed Original Year Date of Lease/ Improvements
or Leased License at December 31,
Location Owned or Acquired Expiration 2000
- -------- ----- ----------- ---------- --------------
(In thousands)
935 Main Street Owned /(3)/ - $ 2,846
Manchester, CT 06040
935 Main Street Leased 1997 2006 85
Units B102 & B102A
Manchester, CT 06040
945 Main Street Leased 1999 2001 -
Unit 102A
Manchester, CT 06040
945 Main Street Owned 1997 -- 132
Unit 305
Manchester, CT 06040
945 Main Street Owned 1998 -- 74
Unit 309
Manchester, CT 06040
35-43 Oak Street Owned 1995 -- 724
Manchester, CT 06040
681 Main Street Leased 1997 /(4)/ -
Plantsville, CT 06479 ------------
$ 8,973
============
(1) The Bank owns the building and leases the land and only owns the building
as long as the lease is in effect.
(2) The Bank maintains a license to possess the property. Generally, the
holder of a license has less property rights than the possessor of a
leasehold interest. The license has no expiration date.
(3) The Bank owns seventeen commercial condominiums, which were all acquired
at various times between 1990 and 2000.
(4) The Bank possesses this property on a month-to-month basis.
Item 3. Legal Proceedings.
- -------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties in
which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
36
Item 4. Submission of Matters to a Vote of Security Holders.
- ------------------------------------------------------------
None.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
- -------------------------------------------------------------------------
Matters.
- -------
The Company's Common Stock has been traded on the Nasdaq National
Market under the symbol "SBMC". The stock began trading on March 2, 2000. The
following table indicates the high and the low last sale prices of the Common
Stock for the past year as reported by the Nasdaq National Market.
Quarter Ended High Low
------------------------------------ -------- --------
March 31, 2000 (since March 1, 2000) $ 10.81 $ 9.81
June 30, 2000 14.69 10.75
September 30, 2000 18.94 15.00
December 31, 2000 18.94 16.50
As of March 9, 2001, the most recent practicable date, the closing
price of the Company's Common Stock as reported by Nasdaq, was $21.00 per share
and the Company had approximately 5,350 holders of record.
The Company has not paid any dividends to date. The Board of Directors
of the Company has the authority to declare dividends on the Common Stock,
subject to statutory and regulatory requirements. In the future, the Board of
Directors intends to consider a policy of paying cash or stock dividends on the
Common Stock. However, no decision has been made with respect to the payment of
dividends. Declarations of dividends by the Board of Directors, if any, will
depend upon a number of factors, including investment opportunities available to
the Company or SBM, capital requirements, regulatory limitations, the Company's
and SBM's financial condition and results of operations, tax considerations and
general economic conditions. No assurances can be given, however, that any
dividends will be paid or, if commenced, will continue to be paid.
The Company is subject to the requirements of Delaware law, which
generally limits dividends to an amount equal to the excess of the net assets of
the Company (the amount by which total assets exceed total liabilities) over its
statutory capital or, if there is no excess, to its net profits for the current
and/or immediately preceding fiscal year.
37
Item 6. Selected Consolidated Financial Data.
- --------------------------------------------
The Bank has derived the following selected consolidated financial and
other data of the Bank in part from the Bank's consolidated financial statements
and notes appearing elsewhere in this Form 10-K.
At December 31,
-------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------
(In thousands)
Selected Consolidated Financial Data:
Total assets...................................... $1,403,311 $1,227,798 $1,108,287 $ 1,033,086 $968,252
Cash and cash equivalents......................... 64,797 26,678 45,048 14,660 22,850
Loans, net........................................ 995,764 938,340 806,787 798,292 732,448
Securities held to maturity:
Mortgage-backed securities..................... - 25,474 22,742 14,409 8,047
Other investment securities.................... - 20,586 29,855 35,874 39,518
---------- ---------- ---------- ----------- --------
Total securities held to maturity........... - 46,060 52,597 50,283 47,565
---------- ---------- ---------- ----------- --------
Securities available for sale:
Mortgage-backed securities..................... 80,223 16,204 12,859 17,985 24,570
U.S. Government and agency obligations......... 85,254 81,328 71,703 48,767 35,907
Marketable equity securities................... 49,144 50,545 42,773 40,635 37,797
Other securities............................... 93,460 33,777 40,816 24,202 32,987
---------- ---------- ---------- ----------- --------
Total securities available for sale......... 308,081 181,854 168,151 131,589 131,261
---------- ---------- ---------- ----------- --------
Deposits.......................................... 933,370 906,591 855,117 827,667 792,833
Short-term borrowed funds......................... 106,493 95,814 79,545 71,179 58,747
Advances from Federal Home Loan Bank.............. 100,000 84,000 45,000 17,987 15,000
Stockholders' equity.............................. 232,539 123,223 112,807 101,191 88,535
Premises and equipment, net....................... 13,197 14,436 15,621 15,709 11,369
Nonperforming assets (1).......................... 6,897 12,089 3,283 7,543 12,760
For the Year Ended December 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
------------------------------------------------------------------
Selected Operating Data:
Total interest and dividend income................ $ 95,092 $ 78,834 $ 76,858 $ 73,931 $ 69,973
Total interest expense............................ 43,842 37,374 37,200 35,856 34,714
---------- ---------- ---------- ----------- --------
Net interest income............................ 51,250 41,460 39,658 38,075 35,259
Provision for loan losses......................... 1,200 1,100 1,200 1,200 1,200
---------- ---------- ---------- ----------- --------
Net interest income after provision for loan
losses...................................... 50,050 40,360 38,458 36,875 34,059
---------- ---------- ---------- ----------- --------
Noninterest income:
Gains on sales of securities, net.............. 445 1,372 2,621 4,007 842
Other.......................................... 9,824 8,034 9,539 7,460 8,155
---------- ---------- ---------- ----------- --------
Total noninterest income.................... 10,269 9,406 12,160 11,467 8,997
---------- ---------- ---------- ----------- --------
Noninterest expense............................... 49,277 36,586 37,092 31,556 27,772
---------- ---------- ---------- ----------- --------
Income before provision for income taxes....... 11,042 13,180 13,526 16,786 15,284
Provision for income taxes........................ 3,659 4,426 4,208 6,584 5,853
---------- ---------- ---------- ----------- --------
Net income..................................... $ 7,383 $ 8,754 $ 9,318 $ 10,202 $ 9,431
========== ========== ========== =========== ========
38
At or For the Year Ended December 31,
--------------------------------------------------
2000 1999 1998 1997 1996
--------------------------------------------------
Selected Operating Ratios and Other Data (2):
Performance Ratios:
Average yield on interest-earning assets..................... 7.26% 7.09% 7.54% 7.75% 7.69%
Average rate paid on interest-bearing liabilities............ 4.11 3.81 4.02 4.11 4.15
Average interest rate spread (3)............................. 3.15 3.28 3.52 3.64 3.54
Net interest margin (4)...................................... 3.91 3.73 3.89 3.96 3.85
Interest-earning assets to interest-bearing liabilities...... 126.27 113.61 110.29 109.47 108.62
Net interest income after provision for
loan losses to noninterest expense........................ 101.57 110.32 103.68 116.86 122.64
Noninterest expense as a percentage of average assets........ 3.65 3.18 3.46 3.15 2.92
Return on average assets..................................... 0.55 0.76 0.87 1.02 0.99
Return on average capital.................................... 3.59 7.53 8.71 10.75 11.38
Ratio of average capital to average assets................... 15.24 10.11 9.99 9.48 8.70
Regulatory Capital Ratios (2):
Leverage capital ratio....................................... 12.82 9.10 9.33 8.98 8.41
Total risk-based capital ratio............................... 19.63 13.96 13.89 13.67 13.09
Asset Quality Ratios (2):
Nonperforming loans and troubled debt restructurings
as a percentage of total loans (5)........................ 0.67 1.21 0.19 0.35 0.98
Nonperforming assets and troubled debt restructurings
as a percentage of total assets........................... 0.49 0.98 0.29 0.73 1.32
Allowance for loan losses as a percentage of total loans..... 1.16 1.12 1.30 1.23 1.23
Allowance for loan losses as a percentage of nonperforming
loans and troubled debt restructurings.................... 172.68 92.44 694.55 350.79 125.46
Net loans charged-off to average interest-earning loans...... 0.01 0.12 0.07 0.05 0.08
Full service offices at end of period........................ 23 23 23 23 22
(1) Nonperforming assets consist of nonperforming loans, troubled debt
restructurings and other real estate owned.
(2) Asset Quality and Regulatory Capital Ratios are end of period ratios.
Except for end of period ratios, all ratios are based on average monthly
balances during the indicated periods and are annualized for interim
periods.
(3) Average interest rate spread represents the difference between the average
yield on interest-earning assets and the average rate paid on
interest-bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
(5) Nonperforming loans consist of nonperforming loans and loans 90 days or
more past due and accruing interest.
39
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations.
- -------------
The following discussion should be read in conjunction with the
"Selected Consolidated Financial Data" and the Consolidated Financial Statements
and related Notes appearing elsewhere in this Form 10-K.
General
The Company has only one subsidiary, SBM. The Bank's results of
operations depend primarily on net interest income, which is the difference
between the interest income earned on its interest-earning assets, such as loans
and securities, and the interest expense on its interest-bearing liabilities,
such as deposits and borrowings. The Bank also generates noninterest income
primarily from fees charged on customers' accounts and fees earned on activities
such as investment services provided through a third party registered
broker-dealer. Gains on the sales of securities is another source of noninterest
income. The Bank's noninterest expenses primarily consist of employee
compensation and benefits, occupancy expense, advertising and other operating
expenses. The Bank's results of operations are also affected by general economic
and competitive conditions, notably changes in market interest rates, government
policies and regulations. SBM exceeded all of its regulatory capital
requirements at December 31, 2000.
Pending Acquisition
On February 7, 2001, the Bank and First Federal entered in an Agreement
under which the Bank will acquire all of the outstanding common stock of First
Federal for cash equal to approximately $110.00 million. Immediately after the
completion of the acquisition, First Federal will be merged into SBM. The Board
of Directors of the Company expects the transaction to close in the third
quarter of 2001. The transaction is subject to approval by First Federal
shareholders and federal and state regulatory agencies.
Under certain circumstances, if the Agreement is terminated by the Bank
for the reasons set forth in the Agreement before the consummation of the
merger, First Federal may be required to pay the Bank cash of $4.50 million plus
out-of-pocket expenses.
40
Operating Strategy
The Bank is an independent, community-oriented savings bank, delivering
quality customer service and offering a wide range of deposit, loan and
investment products to its customers. In recent years, the Bank's strategy has
been to enhance profitability by emphasizing the origination of commercial real
estate and business loans, increasing sources of noninterest income and by
improving operating efficiencies while managing its capital position and
limiting its credit and interest rate risk exposure. To accomplish these
objectives, the Bank has sought to:
. Operate as a full service community bank.
. Provide superior customer service and innovative products by
expanding delivery systems through the opening of new branch
offices, offering a bank-issued credit card and debit card
services, establishing Internet banking and a call center that
provides interest rate information for deposit and loan products
and other customer services.
. Increase fee income by providing merchant credit card processing
services.
. Originate high quality commercial real estate and commercial
business loans which increase the yields earned on its overall loan
portfolio, without incurring unacceptable credit risk.
. Control credit risk by focusing on the origination of single-
family, owner-occupied residential mortgage loans and consumer
loans, consisting primarily of home equity loans and lines of
credit.
. Monitor and control interest rate risk primarily by selling longer-
term fixed-rate loans as market interest rate conditions dictate,
by investing in shorter-term mortgage-backed securities and by
selectively using off-balance sheet hedging transactions.
. Invest funds in excess of loan demand primarily in mortgage-backed
securities, investment grade debt and equity mutual funds.
. Invest in technological enhancements to increase productivity and
efficiency.
Comparison of Financial Condition at December 31, 2000 and 1999
Total assets increased $175.51 million, or 14.27%, to $1.40 billion at
December 31, 2000 as compared to $1.23 billion at December 31, 1999. The
increase was due primarily to a $80.17 million increase in securities, a $58.50
million increase in the loan portfolio, and a $38.12 million increase in cash
and cash equivalents of which $37.89 million of the increase was in short-term
investments. The growth in assets was funded primarily by the net proceeds from
the Company's public offering in March 2000, and increases in deposits of $26.78
million, Federal Home Loan Bank advances of $16.00 million, and short-term
borrowed funds of $10.68 million. The increase in securities and short-term
investments reflect management's strategy of investing the net proceeds from the
public offering as well as implementing its funds management and asset liability
policies. Gross loans increased due to strong loan demand in most sectors of the
loan portfolio. The Bank continues to offer an increased array of loan products
to an expanded market area using aggressive marketing efforts.
Deposits totalled $933.37 million at December 31, 2000, an increase of
$26.78 million, or 2.95%, compared to $906.59 million at December 31, 1999. The
deposit growth reflects an increase of $18.80 million, or 16.68%, in NOW
accounts, a $17.98 million, or 35.04%, increase in demand deposits and a $10.51
million, or 2.33%, decrease in certificates of deposit. The substantial
increases in NOW accounts and demand deposits reflect aggressive marketing of
both retail and commercial deposit accounts as well as the Bank's commitment to
controlling interest costs by not necessarily increasing rates on certificates
of deposits. In addition, the Bank continues to market a short-term commercial
transactional repurchase agreement (repo) account to commercial businesses.
These repo accounts increased $11.11 million, or 11.74%, from $94.62 million as
of December 31, 1999
41
to $105.73 million as of December 31, 2000.
Nonperforming assets totaled $6.90 million at December 31, 2000
compared to $12.09 million at December 31, 1999, representing an decrease of
$5.19 million, or 42.93%. The decrease is primarily due to the full repayment of
a nonperforming commercial real estate loan for $4.29 million during April 2000.
Nonperforming loans and troubled debt restructurings as a percentage of total
gross loans decreased to 0.67% at December 31, 2000 from 1.21% at December 31,
1999. Nonperforming assets and troubled debt restructurings as a percentage of
total assets decreased to 0.49% at December 31, 2000 from 0.98% at December 31,
1999. Other real estate owned declined $479,000, or 79.30%, from $604,000 as of
December 31, 1999 to $125,000 as of December 31, 2000 due to property sales.
Total capital increased $109.32 million, or 88.72%, to $232.54 million
at December 31, 2000 compared to $123.22 million at December 31, 1999. The
increase was primarily due to the proceeds after expenses from the public
offering of $90.51 million, common stock issued to SBM Charitable Foundation,
Inc. of $8.32 million, net income of $7.38 million and an increase of $2.25
million in accumulated other comprehensive income related to unrealized gains on
available for sale securities at December 31, 2000.
Comparison of Operating Results for the Years Ended December 31, 2000 and 1999
Net Income. Net income decreased by $1.37 million, or 15.66%, to $7.38
million for 2000 from $8.75 million for 1999. Net income for the year 2000 was
reduced by an expense of $8.32 million ($5.41 million after tax) relating to the
Bank's establishment of SBM Charitable Foundation, Inc. in March 2000 in
connection with the Bank's conversion from the mutual holding company form of
organization to the stock holding company form or organization. Due to the
timing of the conversion, earnings per share for the twelve months ended
December 31, 2000 and prior periods are not presented. Earnings per diluted
share were $0.59 for the ten months ended December 31, 2000.
Operating earnings, which exclude securities gains and the previously
discussed expense of $8.32 million net of related tax effect, were significantly
higher than the prior year's levels. Operating earnings, net of tax, for the
year ended December 31, 2000 were $12.50 million, a $4.64 million, or 59.03%,
increase compared to $7.86 million for the year ended December 31, 1999. Net
interest income after provision for loan losses increased $9.69 million, or
24.01%, to $50.05 million for 2000 compared to $40.36 million for 1999. Service
charges and fees and other noninterest income increased $2.11 million, or
28.21%, from $7.48 million for 1999 to $9.59 million for 2000. Noninterest
expense, excluding the foundation expense of $8.32 million in 2000, increased
$4.37 million, or 11.94%, to $40.96 million for 2000 from $36.59 million for
1999.
Net Interest Income. Net interest income increased $9.79 million, or
23.61%, to $51.25 million for 2000 from $41.46 million for 1999. The increase
was primarily a result of higher interest income from an increase in the level
of interest earning assets, primarily funded by the net proceeds from the public
offering. Loan and investment yields also increased in 2000 as compared to 1999.
These increases were partially offset by higher levels of FHLB advances and
short-term borrowed funds, and an increased cost of funds. Interest and dividend
income increased $16.26 million, or 20.63%, to $95.09 million for 2000 from
$78.83 million for 1999. The average yield on interest earning assets increased
17 basis points to 7.26% in 2000 from 7.09% in 1999, primarily due to an
increase in general market interest rates. Interest income on loans increased
$9.73 million, or 14.65%, to $76.16 million for 2000 compared to $66.43 million
for 1999. The increase was primarily due to a $111.93 million increase in the
average balance of loans outstanding, as well as a 12 basis point increase in
the average yield on loans primarily due to a higher interest rate environment.
Interest and dividend income from investment securities and other
interest-bearing assets increased $6.52 million, or 52.54%, to $18.93 million
for 2000 compared to $12.41 million for 1999. The increase in interest and
dividend income from investment securities and other interest-bearing assets was
due to an increase in the average balance of $86.39 million, or 37.22%, to
$318.52 million for the year ended December 31, 2000, as more funds were
available for investment due to the net proceeds received from the public
offering. Investment and other interest-bearing asset yields increased 59 basis
points in 2000 as compared to 1999 due to an increase in general market interest
rates.
Interest expense increased $6.47 million, or 17.31%, to $43.84 million
for 2000 from $37.37 million for
42
1999. The increase reflects an increase in expense on advances from Federal Home
Loan Bank of $3.17 million, deposits of $2.37 million and short-term borrowed
funds of $923,000. Interest expense on advances from Federal Home Loan Bank
increased primarily due to increased average volumes of $46.93 million as well
as higher costs of 30 basis points. Interest expense on deposits and escrow
increased primarily due to higher costs of certificates of deposit of 41 basis
points and savings and money market accounts of 28 basis points. Interest
expense on short-term borrowed funds, primarily represented by commercial
transactional repurchase agreements, increased primarily due to increased
average volumes of $21.39 million as well as higher costs of 25 basis points.
The average cost of funds for the Bank increased 30 basis points from 3.81% in
1999 to 4.11% in 2000, mainly due to higher general market interest rates.
Provision for Loan Losses. The provision for loan losses was $1.20
million for 2000 compared to $1.10 million for 1999. The allowance for loan
losses was 1.16% of total loans and 172.68% of nonperforming loans at December
31, 2000 compared to 1.12% and 92.44%, respectively, at December 31, 1999. The
increase in the allowance for loan losses as a percentage of nonperforming loans
is primarily due to the full repayment of a nonperforming commercial real estate
loan for $4.29 million during April 2000.
The Bank's management assesses the adequacy of the allowance for loan
losses based on known and inherent risks in the loan portfolio and upon
management's continuing analysis of the quality of the loan portfolio. While
management believes that, based on information currently available, the Bank's
allowance for loan losses is sufficient to cover probable losses inherent in its
loan portfolio at this time, no assurances can be given that the Bank's level of
allowance for loan losses will be sufficient to cover loan losses incurred by
the Bank or that future adjustments to the allowance for loan losses will not be
necessary if economic and other conditions differ substantially from the
economic and other conditions used by management to determine the current level
of the allowance for loan losses. Management may increase its level of allowance
for loan losses as a percentage of total loans and nonperforming loans if the
level of commercial, multi-family, construction or consumer lending as a
percentage of total loan portfolio increases. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require the Bank to
provide additions to the allowance based on judgments different from those of
management.
Noninterest Income. Noninterest income increased $863,000, or 9.17%, to
$10.27 million for 2000 as compared to $9.41 million for 1999. Fee income from
service charges and account fees was $7.65 million in 2000 compared to $5.87
million for 1999. The increase in fee income and service charges is primarily
due to the introduction of debit cards and increases in merchant services and
individual account fees. Other fee income increased from $1.62 million in 1999
to $1.94 million in 2000 and reflects increases in fees earned from brokerage
services. Gains on sales of securities and mortgage loans declined $927,000 and
$314,000 respectively, as management chose to retain higher yielding securities
and loans rather than sell them and obtain one-time gains.
Noninterest Expense. Noninterest expense increased $12.69 million, or
34.68%, to $49.28 million for 2000 from $36.59 million for 1999. The increase is
primarily due to a contribution of securities to SBM Charitable Foundation, Inc.
of $8.32 million in 2000. Other increases in noninterest expense include $1.69
million, or 39.30%, for pension and other employee benefits, $1.09 million, or
7.17%, for salaries, and $1.02 million, or 26.91%, for fees and services.
Pension and other employee benefits increased due to new qualified and
non-qualified benefit plans formed in connection with the public offering.
Salaries increased due to annual wage increases and additional staffing
necessary for a public entity. Fees and services increased due to director,
legal and other fees of the new public holding company, other legal fees and
debit card service fees.
43
Provision for Income Taxes. The provision for income taxes decreased
$767,000, or 17.31%, to $3.66 million for 2000 from $4.43 million for 1999. The
effective tax rates were 33.14% for 2000 and 33.58% for 1999. The decrease in
tax expense is due to a decrease in taxable income.
Comparison of Operating Results for the Years Ended December 31, 1999
and 1998
Net Income. Net income decreased by $564,000, or 6.05%, to $8.75
million for 1999 from $9.32 million for 1998. The decrease was primarily
attributable to reduced gains on the sale of mortgages and securities. Net
interest income after provision for loan losses increased $1.90 million, or
4.94%, to $40.36 million for 1999 compared to $38.46 million for 1998. Service
charges and fees and other noninterest income increased slightly from $7.12
million to $7.48 million for 1999. Noninterest expense decreased $506,000 or
1.36%, to $36.59 million for 1999 from $37.09 million for 1998. Noninterest
expense for 1998 included a $3.00 million expense relating to the establishment
of Savings Bank of Manchester Foundation, Inc. in June 1998. Excluding the
effect of this charge, noninterest expense would have increased in 1999 by $2.49
million, or 7.30%, primarily due to an increase in salaries expense in 1999.
Net Interest Income. Net interest income increased by $1.80 million, or
4.54%, to $41.46 million for 1999 from $39.66 million for 1998. This increase
was primarily a result of higher interest income from an increase in the level
of average interest-earning assets and a decrease in the average rate paid on
interest-bearing liabilities due to a lower interest rate environment,
particularly during the early part of 1999. Interest and dividend income
increased $1.97 million, or 2.56%, to $78.83 million for 1999 from $76.86
million for 1998. The average yield on interest-earning assets declined 45 basis
points to 7.09% in 1999 from 7.54% in 1998 primarily due to a decline in market
interest rates. Interest income on loans increased $1.92 million, or 2.98%, to
$66.43 million for 1999, compared to $64.51 million for the prior year. This
increase was due to a $76.18 million increase in the average balance of loans
outstanding, partially offset by a 47 basis point decrease in the average yield
on loans primarily due to a lower interest rate environment. Interest and
dividend income from investment securities increased $62,000, or 0.50%, from
$12.35 million for 1998 to $12.41 million for 1999. The increase in interest and
dividend income from investment securities was primarily due to an increase in
yield in mortgage-backed securities of 9 basis points.
Interest expense increased $174,000, or 0.47%, to $37.37 million for
1999 from $37.20 million for 1998. The increase is due to an increase in expense
for FHLB advances of $1.27 million, and short-term borrowed funds of $432,000,
partially offset by a decrease in expense for deposits and escrow of $1.53
million. FHLB advances increased due to higher average advances of $22.23
million, partially offset by lower interest cost of 22 basis points. Short-term
borrowed funds, represented primarily by commercial transactional repurchase
agreements increased due to $12.61 million higher average agreements and higher
interest cost of 6 basis points. Interest expense on deposits and escrow
decreased due to a lower cost of funds of 29 basis points. Bankwide cost of
funds decreased 21 basis points from 4.02% in 1998 to 3.81% in 1999.
Provision for Loan Losses. The provision for loan losses was $1.10
million for 1999 compared to $1.20 million for 1998. For 1999, management
decreased the provision by 50% for the first half of the year, reflecting
improved delinquency trends during 1998 and early 1999. The addition of two
large commercial real estate relationships to nonaccrual status by September
1999 required an additional provision during the last two quarters of 1999. The
allowance for loan losses was 1.12% of total loans and 92.44% of nonperforming
loans at December 31, 1999 compared to 1.30% and 694.55% respectively, at
December 31, 1998. The changes reflect the addition of two large commercial real
estate relationships to nonperforming loan status during 1999.
Noninterest Income. Noninterest income totalled $9.41 million and
$12.16 million for 1999 and 1998, respectively. The decline was due to the
combined effect of decreased securities gains and reduced gains from the sale of
mortgages to the secondary market. The decline in securities gains is due to the
gains realized in 1998 relating to the formation of Savings Bank of Manchester
Foundation, Inc. and the contribution of appreciated securities to the
foundation. The decreased gains from the sale of mortgages to the secondary
market reflect management's decision to retain fixed rate mortgages in order to
grow the loan portfolio. During 1999, the Bank sold $19.20 million of loans in
the secondary market, realizing gains of $551,000, compared with sales of $94.33
million in 1998, which generated gains of $2.42 million. Fee income from service
charges and account fees was
44
$5.87 million in 1999 compared with $5.45 million in 1998. Other fee income
declined slightly from $1.68 million in 1998 to $1.62 million in 1999 and
reflects fees earned from brokerage services and rental income properties in
other real estate owned. Other real estate owned declined from $1.76 million at
the end of 1998 to $604,000 at the end of 1999.
Noninterest Expense. Noninterest expense decreased $506,000, or 1.36%,
to $36.59 million for 1999 from $37.09 million for 1998. The decrease is
attributable to the expense in 1998 relating to the charitable contribution of
$3.00 million of appreciated securities to Savings Bank of Manchester
Foundation, Inc. Excluding this charitable contribution, 1998 noninterest
expense would have been $34.09 million and the increase in 1999 would have been
$2.49 million, or 7.30%. Increases in noninterest expense include $1.10 million,
or 7.81%, for salaries, $575,000, or 17.86%, for fees and services, and
$338,000, or 8.54%, for pension and other employee benefits. These increases
reflect an increase in commercial lending staff, continued development of the
Merchant Services Center program, the Year 2000 project, and increased benefit
costs. Marketing expenses increased $120,000, or 7.23%, due to a new television
advertising program.
Provision for Income Taxes. The provision for income taxes increased
$218,000 to $4.43 million for 1999, compared to $4.21 million for 1998. During
1998, the Bank created Savings Bank of Manchester Foundation, Inc. and donated
appreciated securities to the foundation, resulting in a lower 1998 effective
tax rate. During 1999, the Bank formed the Savings Bank of Manchester Mortgage
Company, Inc. which eliminated the Bank's Connecticut state income tax liability
for 1999. The effective tax rates were 33.58% and 31.11% for 1999 and 1998,
respectively.
45
Average Blances, Interest and Average Yields/Cost
The following table presents certain information for the periods indicated
regarding average balances of assets and liabilities, as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and the resulting
average yields and costs. The yields and costs for the periods indicated are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. Average balances were
derived from average daily balances. The yields and rates include fees which are
considered adjustments to yields.
For the Year Ended December 31,
------------------------------------------------------------------------------------------
2000 1999 1998
----------------------------- ----------------------------- ------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------------------------- ----------------------------- ------------------------------
(Dollars in thousands)
Interest-earning assets:
Loans (1):
Real estate $ 773,358 $ 57,200 $ 7.40% $ 684,617 $ 50,086 7.32% $ 621,751 $ 48,338 7.77%
Consumer 76,588 6,321 8.25 71,537 5,653 7.90 71,132 5,780 8.13
Commercial 141,212 12,642 8.95 123,071 10,686 8.68 110,158 10,393 9.43
---------- --------- -------- ---------- --------- ------- ---------- --------- --------
Total loans 991,158 76,163 7.68 879,225 66,425 7.56 803,041 64,511 8.03
---------- --------- -------- ---------- --------- ------- ---------- --------- --------
Mortgage-backed securities (2) 62,083 4,499 7.25 36,295 2,460 6.78 35,762 2,392 6.69
Investment securities (3):
U.S. Government and agency
obligations 89,215 5,572 6.25 74,233 4,344 5.85 65,637 3,813 5.81
Corporate securities 51,833 3,584 6.91 35,890 2,348 6.54 34,960 2,266 6.48
Marketable equity securities 45,612 1,017 2.23 44,513 999 2.24 42,066 1,373 3.26
Other equity securities 432 - - 419 - - 302 - -
Asset-backed securities 28,258 1,796 6.36 20,244 1,265 6.25 25,419 1,650 6.49
Other interest-bearing assets:
Federal Home Loan Bank stock 6,477 460 7.10 5,909 383 6.48 5,831 369 6.33
Federal funds sold 34,607 2,001 5.78 14,625 610 4.17 6,846 484 5.03
---------- --------- -------- ---------- --------- ------- ---------- --------- --------
Total interest-earning assets 1,309,675 $ 95,092 7.26% 1,111,353 $ 78,834 7.09% 1,019,864 $ 76,858 7.54%
========= ========= =========
Noninterest-earning assets 38,575 38,733 59,199
---------- ---------- ----------
Total assets $1,348,250 $1,150,086 $1,079,063
========== ========== ==========
Interest-bearing liabilities:
Deposits:
NOW accounts $ 115,819 $ 1,378 1.19% $ 105,916 $ 1,507 1.42% $ 94,394 $ 1,299 1.38%
Savings and money market
accounts 297,276 8,225 2.77 277,565 6,919 2.49 248,915 5,982 2.40
Certificates of deposit 432,624 23,672 5.47 444,550 22,482 5.06 463,226 25,138 5.43
Escrow deposits 6,069 163 2.69 5,684 158 2.78 5,092 176 3.46
---------- --------- -------- ---------- --------- ------- ---------- --------- --------
Total interest-bearing
deposits 851,788 33,438 3.93 833,715 31,066 3.73 811,627 32,595 4.02
Short-term borrowed funds 110,520 3,653 3.31 89,133 2,730 3.06 76,523 2,298 3.00
Advances from Federal Home
Loan Bank 105,692 6,751 6.39 58,761 3,578 6.09 36,534 2,307 6.31
---------- --------- -------- ---------- --------- ------- ---------- --------- --------
Total interest-bearing
liabilities 1,068,000 $ 43,842 4.11% 981,609 $ 37,374 3.81% 924,684 $ 37,200 4.02%
========= ========= =========
Noninterest-bearing liabilities 74,828 52,175 47,865
---------- ---------- ----------
Total liabilities 1,142,828 1,033,784 972,549
Stockholder's equity 205,422 116,302 106,514
---------- ---------- ----------
Total liabilities and
stockholder's equity $1,348,250 $1,150,086 $1,079,063
========== ========== ==========
Net interest-earning assets $ 241,675 $ 129,744 $ 95,180
========== ========== ==========
Net interest income $ 51,250 $ 41,460 $ 39,658
========= ========= ==========
Interest rate spread (4) 3.15% 3.28% 3.52%
Net interest margin (5) 3.91% 3.73% 3.89%
Ratio of interest-earning assets
to interest-bearing liabilities 122.63% 113.22% 110.17%
(1) Balances are net of undisbursed proceeds of construction loans in process
and include nonperforming loans.
(2) Includes mortgage-backed securities available for sale at market value and
held to maturity at amortized cost.
(3) Includes investment securities available for sale at market and held to
maturity at cost.
(4) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of interest-
bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
46
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on
the interest income and interest expense of the Bank. The rate column shows the
effects attributable to changes in rate (changes in rate multiplied by prior
volume). The volume column shows the effects attributable to changes in volume
(changes in volume multiplied by prior volume). For purposes of this table,
changes attributable to changes in both rate and volume, which cannot be
segregated, are shown in the rate/volume column.
2000 Compared to 1999 1999 Compared to 1998
-------------------------------------- --------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
-------------------------------------- --------------------------------------
Rate Volume Rate/Volume Net Rate Volume Rate/Volume Net
---- ------ ----------- --- ---- ------ ----------- ---
(In thousands) (In thousands)
Interest-earning assets:
Loans:
Real estate $ 550 $ 6,493 $ 71 $ 7,114 $ (28) $ 49 $ 1,727 $ 1,748
Consumer 251 399 18 668 (164) 33 4 (127)
Commercial 332 1,575 49 1,956 (826) 1,218 (99) 293
------- ------- ------- ------- ------- ------- ------- -------
Total loans 1,133 8,467 138 9,738 (1,018) 1,300 1,632 1,914
Mortgage-backed securities 170 1,748 121 2,039 32 36 - 68
Investment securities 715 3,315 451 4,481 (493) 699 (212) (6)
------- ------- ------- ------- ------- ------- ------- -------
Total interest-earning assets 2,018 13,530 710 16,258 (1,479) 2,035 1,420 1,976
------- ------- ------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits:
NOW accounts (247) 141 (23) (129) - 2 206 208
Savings accounts 761 491 54 1,306 224 688 25 937
Certificates of deposit 1,843 (604) (49) 1,190 (1,714) (1,014) 72 (2,656)
Other (5) 10 - 5 (35) 20 (3) (18)
------- ------- ------- ------- ------- ------- ------- -------
Total deposits 2,352 38 (18) 2,372 (1,525) (304) 300 (1,529)
Short-term borrowed funds 216 655 52 923 46 378 8 432
Advances from Federal Home Loan Bank 175 2,858 140 3,173 (80) 1,403 (52) 1,271
------- ------- ------- ------- ------- ------- ------- -------
Total interest-bearing liabilities 2,743 3,551 174 6,468 (1,559) 1,477 256 174
------- ------- ------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income $ (725) $ 9,979 $ 536 $ 9,790 $ 80 $ 558 $ 1,164 $ 1,802
======= ======= ======= ======= ======= ======= ======= =======
47
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial
obligations of a short-term nature. The Bank further defines liquidity as the
ability to respond to the needs of depositors and borrowers as well as
maintaining the flexibility to take advantage of investment opportunities.
Primary sources of funds consist of deposit inflows, loan repayments,
maturities, paydowns, and sales of investment and mortgage-backed securities and
borrowings from the Federal Home Loan Bank of Boston. While maturities and
scheduled amortization of loans and securities are predictable sources of funds,
deposit outflows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition.
The Bank's primary investing activities are (1) originating residential
one-to four-family mortgage loans and, to a lesser extent, commercial business
and real estate loans, multi-family loans, single-family construction loans,
home equity loans and lines of credit and consumer loans and (2) investing in
mortgage-backed securities, asset-backed securities, U.S. Government and agency
obligations, corporate equity securities and debt obligations. These activities
are funded primarily by proceeds from the public offering, principal and
interest payments on loans, maturities of securities, deposit growth and Federal
Home Loan Bank of Boston advances. The Company received net proceeds (after
expenses) from the issuance of stock in connection with the conversion of $90.51
million. The Company used 50% of the net proceeds from the conversion to buy all
of the common stock of SBM and retained the remaining 50%, which amount was
primarily invested in fixed income securities. During the years ended December
31, 2000 and 1999, the Bank purchased and originated loans totaling $307.37
million and $388.78 million, respectively. During the years ended December 31,
2000 and 1999, the Bank purchased mortgage-backed securities, asset-backed
securities, U.S. Government and agency obligations, corporate equity securities
and debt obligations of $209.95 million and $64.03 million, respectively. The
Bank experienced a net increase in total deposits of $26.78 million and $51.47
million for the years ended December 31, 2000 and 1999, respectively, primarily
as a result of retail and commercial programs designed to attract deposits.
Deposit flows are affected by the overall level of interest rates, the interest
rates and products offered by the Bank and its local competitors and other
factors. Principal payments on loans, maturities of securities, and net Federal
Home Loan Bank advances were $228.25 million, $31.77 million, and $16.00
million, respectively, for the year ended December 31, 2000. Principal payments
on loans, maturities of securities, and net Federal Home Loan Bank advances were
$236.87 million, $25.31 million, and $39.00 million, respectively, for the year
ended December 31, 1999. The Bank closely monitors its liquidity position on a
daily basis. If the Bank should require funds beyond its ability to generate
them internally, additional sources of funds are available through Federal Home
Loan Bank advances and through repurchase agreement borrowing facilities.
Outstanding commitments for all loans and unadvanced construction loans
and lines of credit totalled $176.67 million at December 31, 2000. Management of
the Bank anticipates that it will have sufficient funds available to meet its
current loan commitments. Certificates of deposit that are scheduled to mature
in one year or less from December 31, 2000 totalled $331.85 million. The Bank
relies primarily on competitive rates, customer service, and long-standing
relationships with customers to retain deposits. Occasionally, the Bank will
also offer special competitive promotions to its customers to increase retention
and promote deposit growth. Based upon the Bank's historical experience with
deposit retention, management believes that, although it is not possible to
predict future terms and conditions upon renewal, a significant portion of such
deposits will remain with the Bank.
SBM must satisfy various regulatory capital requirements administered
by the federal banking agencies including a risk-based capital measure. The
risk-based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet assets
and off-balance sheet items to broad risk categories. At December 31, 2000, SBM
exceeded all of its regulatory capital requirements with leverage capital of
$172.85 million, or 12.82% of average assets, which is above the required level
of $53.93 million, or 4.00%, and risk-based capital of $184.54 million, or
19.63% of risk weighted assets, which is above the required level of $75.22
million, or 8.00%. SBM is considered "well capitalized" under regulatory
guidelines.
On February 7, 2001, the Bank and First Federal entered into a
definitive agreement under which the Bank would acquire all of the outstanding
common stock of First Federal for cash equal to approximately $110 million.
Immediately after the completion of the acquisition, First Federal will be
merged into SBM. The Board of
48
Directors of the Company expects the transaction to close in the third quarter
of 2001. The transaction is subject to approval by First Federal shareholders
and federal and state regulatory agencies. Management expects the effect of the
transaction on the liquidity and capital of the Bank to be significant.
Management will continue to plan for and monitor the liquidity and capital of
the Bank as the transaction closing date draws nearer. Management is considering
several options to fund the acquisition.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in
this Form 10-K have been prepared in conformity with accounting principles
generally accepted in the United States, which require the 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. Unlike many industrial companies, substantially all of the assets and
liabilities of the Bank are monetary in nature. As a result, interest rates have
a more significant impact on the Bank's performance than the general level of
inflation. Over short periods of time, interest rates may not necessarily move
in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
In September 2000, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125".
SFAS No. 140 replaces SFAS No. 125. Certain requirements related to SFAS No. 140
are effective beginning March 31, 2001. The Bank does not expect that these
additional requirements will have an effect on the Bank's consolidated financial
position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the statement of operations and
requires that an entity formally document, designate and assess the
effectiveness of transactions that receive hedge accounting. The Bank early
adopted SFAS No. 133, as amended by SFAS No. 137, "Accounting for Derivatives
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133" and SFAS No. 138, "Accounting for Certain Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 -
An Amendment of FASB Statement No. 133" on January 1, 2000. In connection with
the adoption, the Bank reclassified all held to maturity investments to
available for sale as allowed by SFAS No. 133. As of December 31, 2000, the Bank
did not have any derivative instruments.
On December 3, 1999, the SEC released Staff Accounting Bulletin ("SAB")
No. 101, "Revenue Recognition in Financial Statements." The guidelines set forth
in SAB No. 101 stipulate that revenue should not be recognized until it is
realized or realizable and earned. The Bank adopted SAB No. 101 on January 1,
2000 without effect on the Bank's consolidated financial condition or results of
operations since the Bank's previous revenue recognition policies complied with
SAB No. 101.
Effective January 1, 1999, the Bank adopted SFAS No. 134 "Accounting
for Mortgage-Backed Securities Retained after the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of SFAS No.
65." This statement requires that after the securitization of mortgage loans
held for sale, an entity engaged in mortgage banking activities shall classify
the resulting mortgage-backed securities or other retained interests based on
its ability and intent to sell or hold those investments. The adoption did not
have any effect on the Bank's consolidated financial condition or results of
operations.
49
Item 7A. Quantitative and Qualitative disclosure About Market Risk
- ------------------------------------------------------------------
Qualitative Aspects of Market Risk
The Bank's most significant form of market risk is interest rate risk.
The principal objectives of the Bank's interest rate risk management are to
evaluate the interest rate risk inherent in certain balance sheet account,
determine the level of risk appropriate given its business strategy, operating
environment, capital and liquidity requirements and performance objectives, and
manage the risk consistent with its established policies. The Bank has an
Asset/Liability Committee, responsible for reviewing its asset/liability
policies and interest rate risk position, which meets quarterly and reports
trends and interest rate risk position to the Executive Committee of the board
of Directors and the Board of Directors. The extent of the movement of interest
rates is an uncertainty that could have a negative impact on the earnings of the
Bank. In recent years, the Bank has managed interest rate risk by:
(1) emphasizing the origination of adjustable-rate loans and selling
longer term fixed-rate loans as market interest rate conditions
dictate;
(2) originating variable rate commercial real estate loans and prime
rate commercial business loans;
(3) emphasizing shorter-term consumer loans including home equity
lines of credit indexed to the prime rate, as reported in The
Wall Street Journal;
(4) maintaining a high quality securities portfolio that provides
adequate liquidity and flexibility to take advantage of
opportunities that may arise from fluctuations in market
interest rates, the overall maturity and duration of which is
monitored in relation to the repricing of its loan portfolio;
(5) promoting lower cost liability accounts such as demand deposits
and business repurchase accounts; and
(6) using Federal Home Loan Bank advances to better structure
maturities of its interest rate sensitive liabilities.
SBM's market risk also includes equity price risk. SBM's marketable
equity securities portfolio had gross unrealized gains of $15.20 million and
gross unrealized losses of $1.28 million at December 31, 2000 which are
included, net of taxes, in accumulated other comprehensive income, a separate
component of the SBM's capital. If equity security prices decline due to
unfavorable market conditions or other factors, SBM's capital would decrease.
The Bank's investment policy authorizes it to be a party to financial
instruments with off-balance sheet risk in the normal course of business to
reduce its exposure to fluctuations in interest rates. These financial
instruments include interest rate cap agreements. Interest rate cap agreements
generally involve the payment of a premium in return for cash receipts if
interest rates rise above or fall below a specified interest rate level.
Payments are based on a notional principal amount. Caps generally are not
readily available for time periods longer than five years. The Bank's objective
in using interest rate caps is to reduce risk associated with adverse rate
volatility while enabling the Bank to benefit from favorable interest rate
movements. All counter-parties to cap arrangements must be preapproved by the
Bank's Executive Committee and reported to its Investment Committee. At December
31, 2000, the Bank had no derivative instruments.
Quantitative Aspects of Market Risk
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring a bank's interest rate sensitivity "gap." An asset or liability is
said to be interest rate sensitive within a specific time period if it will
mature or reprice within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that same time period. At December 31,
2000, the Bank's one-year gap position, the difference between the amount of
interest-earning assets maturing or repricing within one year and interest-
bearing liabilities maturing or repricing
50
within one year, was 3.67%. A gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
Accordingly, during a period of rising interest rates, an institution with a
positive gap position would be in a better position to invest in higher yielding
assets which, consequently, may result in the yield on its assets increasing at
a pace more closely matching the increase in the cost of its interest-bearing
liabilities than if it had a negative gap. During a period of falling interest
rates, an institution with a positive gap would tend to have its assets
repricing at a faster rate than one with a negative gap which, consequently, may
tend to restrain the growth of, or reduce, its net interest income.
The following table sets forth the amount of interest-earning assets
and interest-bearing liabilities outstanding at December 31, 2000, which are
anticipated by the Bank, based upon certain assumptions, to reprice or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of term to repricing or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at December
31, 2000, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within a series of time intervals. For residential
adjustable-rate, and fixed-rate loans, prepayment rates were assumed to range
from 8% to 24% annually. Mortgage-backed securities were assumed to prepay at a
rate of 11% annually. Investment securities, which include callable federal
agency obligations, are presented based on stated maturities. Money market
accounts were assumed to reprice at 40%, 30%, 20%, 10% and 0%, respectively, for
each of the following periods: one year, one to two years, two to three years,
three to five years, and over five years. Savings accounts were assumed to
reprice at 10%, 10%, 10%, 20% and 50%, respectively, for each of the following
periods: one year, one to two years, two to three years, three to five years,
and over five years. NOW accounts were assumed to reprice at 15%, 15%, 15%, 30%,
and 25%, respectively, for each of the following periods: one year, one to two
years, two to three years, three to five years, and over five years. Short term
borrowed funds were assumed to reprice at 40%, 30%, 20%, 10%, and 0%,
respectively, for each of the following periods: one year, one to two years, two
to three years, three to five years, and over five years. Prepayment rates can
have a significant impact on the Bank's estimated gap. While the Bank believes
such assumptions to be reasonable, there can be no assurance that assumed
prepayment rates and repricing rates will approximate actual future loan
repayment and deposit withdrawal activity.
51
At December 31, 2000
-----------------------------------------------------------------------------------------------
More than More than More than
One Year One Year to Two Years to Three Years to More than Total Fair
or Less Two Years Three Years Five Years Five Years Amount Value
-----------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest-earning assets:
Securities (1):
Investment securities (2) $ 66,107 $ 20,041 $ 26,850 $ 69,541 $ 36,635 $ 219,174 $ 219,174
Mortgage-backed
securities 15,089 13,259 10,656 14,111 27,108 80,223 80,223
Equity securities (3) 23,971 1,300 200 - 30,759 56,230 56,230
--------- --------- --------- ---------- ---------- ---------- ----------
Total securities 105,167 34,600 37,706 83,652 94,502 355,627 355,627
Loans 451,690 128,381 106,338 144,226 176,823 1,007,458 992,174
--------- --------- --------- ---------- ---------- ---------- ----------
Total interest-earning
assets $ 556,857 $ 162,981 $ 144,044 $ 227,878 $ 271,325 $1,363,085 $1,347,801
========= ========= ========= ========== ========== ========== ==========
Interest-bearing liabilities:
Money market accounts $ 29,520 $ 22,140 $ 14,760 $ 7,379 $ - $ 73,799 $ 73,799
Savings accounts 21,890 21,890 21,890 43,780 109,451 218,901 218,901
Mortgagors' escrow
accounts 8,896 - - - - 8,896 8,896
NOW accounts 19,730 19,730 19,730 39,460 32,886 131,536 131,536
Certificates of deposit 332,659 38,946 22,649 45,585 - 439,839 443,205
Advances from Federal Home
Loan Bank 50,000 20,000 - 30,000 - 100,000 100,197
Short-term borrowed funds 42,597 31,948 21,299 10,649 - 106,493 106,493
--------- --------- --------- ---------- ---------- ---------- ----------
Total interest-bearing
liabilities $ 505,292 $ 154,654 $ 100,328 $ 176,853 $ 142,337 $1,079,464 $1,083,027
========= ========= ========= ========== ========== ========== ==========
Interest-earning assets
less interest-bearing
liabilities $ 51,565 $ 8,327 $ 43,716 $ 51,025 $ 128,988 $ 283,621
Cumulative interest-rate gap $ 51,565 $ 59,892 $ 103,608 $ 154,633 $ 283,621
Cumulative interest-rate
gap as a percentage of
total assets 3.67% 4.27% 7.38% 11.02% 20.21%
Cumulative interest-rate
gap as a percentage
of total interest
earning assets 3.78% 4.39% 7.60% 11.34% 20.81%
Cumulative interest-earning
assets as a percentage of
cumulative interest-bearing
liabilities 110.20% 109.08% 113.63% 116.50% 126.27%
Cumulative interest-
earning assets $ 556,857 $ 719,838 $ 863,882 $1,091,760 $1,363,085
Cumulative interest-
bearing liabilities $ 505,292 $ 659,946 $ 760,274 $ 937,127 $1,079,464
(1) Includes available for sale at market value.
(2) Includes federal funds sold.
(3) Includes Federal Home Loan Bank stock.
52
As of December 31, 2000, the Bank's estimated exposure as a percentage of
estimated net interest income for the next twelve and twenty-four month periods
is as follows:
Percentage Change in Estimated
Net Interest Income Over
---------------------------------------
12 months 24 months
--------------- --------------
200 basis point increase in rates 0.45% 1.73%
200 basis point decrease in rates (2.18%) (6.38%)
Based on the scenario above, net income would be adversely affected
(within the Bank's internal guidelines) in both the twelve and twenty-four month
periods in a declining rate environment and positively affected (within the
Bank's internal guidelines) in both the twelve and twenty-four month periods in
a rising rate environment. For each percentage point change in net interest
income, the effect on net income would be $361,000, assuming a 35% tax rate.
53
Item 8. Financial Statements and Supplementary Data.
- ----------------------------------------------------
For a listing of consolidated financial statements which are included in this
document see page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure.
- --------------------
None.
PART III
Item 10. Directors of the Registrant.
- ------------------------------------
Information regarding directors and Section 16(a) Compliance is
incorporated herein by reference from the Sections entitled "Proposal 1-Election
of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" of
the Company's definitive proxy statement which will be filed no later than 120
days after December 31, 2000.
Item 11. Executive Compensation
- -------------------------------
Incorporated herein by reference from the Sections entitled "Proposal 1 -
Election of Directors - Directors' Compensation" and "Executive Compensation" of
the Company's definitive proxy statement which will be filed no later than 120
days after December 31, 2000.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- -----------------------------------------------------------------------
Incorporated herein by reference from the Section entitled "Stock
Ownership" of the Company's definitive proxy statement which will be filed no
later than 120 days after December 31, 2000.
Item 13. Certain Relationships and Related Transactions
- -------------------------------------------------------
Incorporated herein by reference from the section entitled "Transactions
with Management" of the Company's definitive proxy statement which will be filed
no later than 120 days after December 31, 2000.
54
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- --------------------------------------------------------------------------
(a)(1) Financial Statements
For a listing of consolidated financial statements which are included
in this document see Page F-1.
(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated
Financial Statements or notes thereto.
(b) Reports on Form 8-K filed during the last quarter of 2000
None.
(c) Exhibits Required by Securities and Exchange Commission Regulation S-K
Exhibit
Number
------
2.1 Amended Provisional Plan of Conversion for Connecticut
Bancshares, M.H.C. and The Savings Bank of Manchester
(including the Amended and Restated Stock Articles of
Incorporation and Bylaws of the Savings Bank of Manchester).
(1)
3.1 Certificate of Incorporation of Connecticut Bancshares, Inc.
(1)
3.2 Amended and Restated Bylaws of Connecticut Bancshares, Inc.
(2)
10.1 Connecticut Bancshares, Inc. 2000 Stock-Based Incentive Plan
(3)
10.2 Employment Agreement between The Savings Bank of Manchester
and Richard P. Meduski (4)
10.3 Employment Agreement between The Savings Bank of Manchester
and Charles L. Pike (4)
10.4 Employment Agreement between The Savings Bank of Manchester
and Douglas K. Anderson (4)
10.5 Employment Agreement between The Savings Bank of Manchester
and Roger A. Somerville (4)
10.6 Employment Agreement between Connecticut Bancshares, Inc. and
Richard P. Meduski (4)
10.7 Employment Agreement between Connecticut Bancshares, Inc. and
Charles L. Pike (4)
10.8 Employment Agreement between Connecticut Bancshares, Inc. and
Douglas K. Anderson (4)
10.9 Employment Agreement between Connecticut Bancshares, Inc. and
Roger A. Somerville (4)
21.0 Subsidiaries Information Incorporated Herein By Reference to
Part 1 - Subsidiaries
23.0 Consent of Independent Auditors (filed herewith)
-----------------------------
(1) Incorporated by reference into this document from the Exhibits
filed with the Registration Statement on Form S-1, and any
amendments thereto, Registration No. 333-90865.
(2) Incorporated by reference into this document from the
Quarterly Report on Form 10-Q filed on August 14, 2000.
(3) Incorporated by reference into this document from the
Registrant's Proxy Statement dated August 18, 2000 and filed
August 18, 2000.
(4) Incorporated by reference into this document from the 1999
Annual Report on Form 10-K filed on March 30, 2000.
55
CONFORMED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Connecticut Bancshares, Inc.
By: /s/ Richard P. Meduski March 30, 2001
---------------------------
Richard P. Meduski
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Richard P. Meduski President, Chief Executive Officer March 30, 2001
- ---------------------------
Richard P. Meduski and Director
(principal executive officer)
/s/ Michael J. Hartl Senior Vice President and Chief March 30, 2001
- ---------------------------
Michael J. Hartl Financial Officer
(principal accounting and
financial officer)
/s/ Laurence P. Rubinow Director and Chairman of the Board March 30, 2001
- ---------------------------
Laurence P. Rubinow
/s/ A. Paul Berte Director March 30, 2001
- ----------------------------
A. Paul Berte
/s/ Timothy J. Devanney Director March 30, 2001
- ---------------------------
Timothy J. Devanney
/s/ M. Adler Dobkin Director March 30, 2001
- ---------------------------
M. Adler Dobkin
/s/ Sheila B. Flanagan Director March 30, 2001
- ---------------------------
Sheila B. Flanagan
/s/ John D. LaBelle, Jr. Director March 30, 2001
- ---------------------------
John D. LaBelle, Jr.
/s/ Eric A. Marziali Director March 30, 2001
- ---------------------------
Eric A. Marziali
/s/ Jon L. Norris Director March 30, 2001
- ----------------------------
Jon L. Norris
/s/ William D. O'Neill Director March 30, 2001
- ----------------------------
William D. O'Neill
/s/ John G. Sommers Director March 30, 2001
- ----------------------------
John G. Sommers
/s/ Thomas E. Toomey Director March 30, 2001
- ----------------------------
Thomas E. Toomey
/s/ Gregory S. Wolff Director March 30, 2001
- ----------------------------
Gregory S. Wolff
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Index
Page
Report of Independent Public Accountants F-2
Consolidated Statements of Condition
As of December 31, 2000 and 1999 F-3
Consolidated Statements of Operations
For the Years Ended December 31, 2000, 1999 and 1998 F-4
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2000, 1999 and 1998 F-5
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2000, 1999 and 1998 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Public Accountants
To the Board of Directors of
Connecticut Bancshares, Inc.:
We have audited the accompanying consolidated statements of condition of
Connecticut Bancshares, Inc. (a Connecticut stock holding company) and its
subsidiary, The Savings Bank of Manchester (collectively, the Bank), as of
December 31, 2000 and 1999, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2000. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Connecticut
Bancshares, Inc. and subsidiary as of December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
/s/ Arthur Andersen
Hartford, Connecticut
January 19, 2001 (except with respect to the
matter discussed in Note 16, as to
which the date is February 7, 2001)
F-2
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Condition
As of December 31, 2000 and 1999
(In thousands, except share amounts)
ASSETS 2000 1999
Cash and cash equivalents $ 64,797 $ 26,678
Securities available for sale (cost of $287,830 at December 31, 2000
and $165,802 at December 31, 1999) 308,081 181,854
Securities held to maturity (market value of $44,998 at December 31,
1999) - 46,060
Loans held for sale 290 38
Loans, net 995,764 938,340
Federal Home Loan Bank stock, at cost 6,654 5,909
Premises and equipment, net 13,197 14,436
Accrued interest receivable 8,747 6,900
Other real estate owned 125 604
Intangible assets 1,967 2,398
Other assets 3,689 4,581
------------ ------------
Total assets $ 1,403,311 $ 1,227,798
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 933,370 $ 906,591
Short-term borrowed funds 106,493 95,814
Mortgagors' escrow accounts 8,896 8,674
Advances from Federal Home Loan Bank 100,000 84,000
Current and deferred income taxes 419 509
Accrued benefits and other liabilities 21,594 8,987
------------ ------------
Total liabilities 1,170,772 1,104,575
------------ ------------
Commitments and contingencies (Notes 9 and 12)
Stockholders' equity:
Common stock ($.01 par value; 45,000,000 authorized shares;
11,232,000 and 0 shares issued and outstanding
at December 31, 2000 and 1999, respectively) 112 -
Additional paid-in capital 108,257 -
Retained earnings 119,691 112,308
ESOP unearned compensation (8,685) -
Accumulated other comprehensive income 13,164 10,915
------------ ------------
Total stockholders' equity 232,539 123,223
------------ ------------
Total liabilities and stockholders' equity $ 1,403,311 $ 1,227,798
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
For the Years Ended December 31, 2000, 1999 and 1998
(In thousands, except share amounts)
2000 1999 1998
Interest and dividend income:
Interest income on loans $ 76,163 $ 66,425 $ 64,511
Interest and dividends on securities 18,929 12,409 12,347
----------- ---------- ---------
Total interest and dividend income 95,092 78,834 76,858
----------- ---------- ---------
Interest expense:
Interest on deposits 33,438 31,066 32,595
Interest on Advances from Federal Home Loan Bank 6,751 3,578 2,307
Interest on short-term borrowed funds 3,653 2,730 2,298
----------- ---------- ---------
Total interest expense 43,842 37,374 37,200
----------- ---------- ---------
Net interest income 51,250 41,460 39,658
Provision for loan losses 1,200 1,100 1,200
----------- ---------- ---------
Net interest income after provision for loan losses 50,050 40,360 38,458
----------- ---------- ---------
Noninterest income:
Service charges and fees 7,649 5,866 5,448
Gains on sales of securities, net 445 1,372 2,621
Gains on mortgage loan sales, net 237 551 2,415
Other 1,938 1,617 1,676
----------- ---------- ---------
Total noninterest income 10,269 9,406 12,160
----------- ---------- ---------
Noninterest expense:
Salaries 16,289 15,195 14,091
Pension and other employee benefits 5,987 4,297 3,959
Occupancy, net 3,006 3,232 3,162
Fees and services 4,809 3,790 3,215
Furniture and equipment 2,956 2,962 2,852
Marketing 1,676 1,784 1,664
Foreclosed real estate expense 233 277 385
Net gains on sales of other real estate owned (36) (64) (324)
Securities contributed to Savings Bank of Manchester
Foundation, Inc. and SBM Charitable Foundation, Inc. 8,316 - 3,000
Other operating expenses 6,041 5,113 5,088
----------- ---------- ---------
Total noninterest expense 49,277 36,586 37,092
----------- ---------- ---------
Income before provision for income taxes 11,042 13,180 13,526
Provision for income taxes 3,659 4,426 4,208
----------- ---------- ---------
Net income $ 7,383 $ 8,754 $ 9,318
=========== ========== =========
For the Period from
March 1, 2000 to
December 31, 2000 1999 1998
Earnings per share (see Note 1):
Basic $ 0.59 N/A N/A
Diluted $ 0.59 N/A N/A
Weighted average shares outstanding:
Basic 10,367,476 N/A N/A
Diluted 10,368,049 N/A N/A
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2000, 1999 and 1998
(In thousands)
Additional ESOP
Common Stock Paid-In Retained Unearned
Shares Amount Capital Earnings Compensation
BALANCE, December 31, 1997 - $ - $ - $ 94,236 $ -
------------ --------- ---------- ----------- -----------
Comprehensive income:
Net Income - - - 9,318 -
Change in unrealized gain on securities
available for sale, net of taxes - - - - -
------------ --------- ---------- ----------- -----------
Total comprehensive income - - - 9,318 -
------------ --------- ---------- ----------- -----------
BALANCE, December 31, 1998 - - - 103,554 -
------------ --------- ---------- ----------- -----------
Comprehensive income:
Net Income - - - 8,754 -
Change in unrealized gain on securities
available for sale, net of taxes - - - - -
------------ --------- ---------- ----------- -----------
Total comprehensive income - - - 8,754 -
------------ --------- ---------- ----------- -----------
BALANCE, December 31, 1999 - - - 112,308 -
------------ --------- ---------- ----------- -----------
Proceeds from issuance of
common stock in connection
with conversion, after expenses
of approximately $4,300 10,400,000 104 99,714 - (9,305)
------------ --------- ---------- ----------- -----------
Common stock issued to SBM
Charitable Foundation, Inc. 832,000 8 8,308 - -
------------ --------- ---------- ----------- -----------
Change in ESOP unearned compensation - - 235 - 620
------------ --------- ---------- ----------- -----------
Comprehensive income:
Net Income - - - 7,383 -
Change in unrealized gain on securities
available for sale, net of taxes - - - - -
------------ --------- ---------- ----------- -----------
Total comprehensive income - - - 7,383 -
------------ --------- ---------- ----------- -----------
BALANCE, December 31, 2000 11,232,000 $ 112 $ 108,257 $ 119,691 $ (8,685)
============= ========= ========== =========== ===========
Accumulated
Other
Comprehensive
Income Total
BALANCE, December 31, 1997 $ 6,955 $ 101,191
----------- -----------
Comprehensive income:
Net Income - 9,318
Change in unrealized gain on securities
available for sale, net of taxes 2,298 2,298
----------- -----------
Total comprehensive income 2,298 11,616
----------- -----------
BALANCE, December 31, 1998 9,253 112,807
----------- -----------
Comprehensive income:
Net Income - 8,754
Change in unrealized gain on securities
available for sale, net of taxes 1,662 1,662
----------- -----------
Total comprehensive income 1,662 10,416
----------- -----------
BALANCE, December 31, 1999 10,915 123,223
----------- -----------
Proceeds from issuance of
common stock in connection
with conversion, after expenses
of approximately $4,300 - 90,513
----------- -----------
Common stock issued to SBM
Charitable Foundation, Inc. - 8,316
----------- -----------
Change in ESOP unearned compensation - 855
----------- -----------
Comprehensive income:
Net Income - 7,383
Change in unrealized gain on securities
available for sale, net of taxes 2,249 2,249
----------- -----------
Total comprehensive income 2,249 9,632
----------- -----------
BALANCE, December 31, 2000 $ 13,164 $ 232,539
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2000, 1999 and 1998
(In thousands)
2000 1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,383 $ 8,754 $ 9,318
Adjustments to reconcile net income to net cash provided by
operating activities:
Securities contributed to SBM Charitable Foundation, Inc. 8,316 - -
Provision for loan losses 1,200 1,100 1,200
Depreciation 2,559 2,658 2,295
Provision for loss on other real estate owned 39 214 385
Deferred income tax (benefit) provision (3,520) 61 495
Amortization/accretion -
Premium on deposits 432 432 407
Premium on loans and bonds 741 654 538
Net gains on sales of other real estate owned (36) (64) (324)
Gains on sale of securities, net (445) (1,372) (2,621)
Net gains on mortgage loan sales (237) (551) (2,415)
Change in ESOP unearned compensation 855 - -
Changes in operating assets and liabilities -
Accrued interest receivable (1,847) (465) 289
Other assets 892 (1,552) (1,007)
Other liabilities 12,607 1,815 807
------------- ------------- ------------
Net cash provided by operating activities 28,939 11,684 9,367
------------- ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan originations and purchases, net of repayments (79,127) (151,915) (103,303)
Proceeds from sales of loans 20,226 19,197 94,332
Proceeds from maturities of held to maturity securities - 3,535 3,500
Proceeds from maturities of available for sale securities 31,774 21,778 5,000
Proceeds from sales of available for sale securities 92,685 19,081 20,753
Purchases of held to maturity securities - (6,876) (17,304)
Purchases of Federal Home Loan Bank stock (745) - -
Purchases of available for sale securities (209,948) (57,153) (61,694)
Proceeds from principal payments of mortgage-backed
securities 10,713 13,249 16,510
Proceeds from sales of other real estate owned 686 1,481 3,503
Purchases of premises and equipment (1,277) (1,372) (3,192)
-------------- ------------- ------------
Net cash used in investing activities (135,013) (138,995) (41,895)
-------------- ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 90,513 - -
Net increase in savings, money market, NOW and
demand deposits 37,287 47,266 57,077
Net (decrease) increase in certificates of deposit (10,508) 4,208 (29,627)
Net increase in short-term borrowed funds 10,679 16,269 379
Increase in mortgagors' escrow accounts 222 2,198 87
Increase in advances from Federal Home Loan Bank 16,000 39,000 35,000
------------- ------------- ------------
Net cash provided by financing activities 144,193 108,941 62,916
------------- ------------- ------------
Net increase (decrease) in cash and cash
equivalents 38,119 (18,370) 30,388
CASH AND CASH EQUIVALENTS, beginning of year 26,678 45,048 14,660
------------- ------------- ------------
CASH AND CASH EQUIVALENTS, end of year $ 64,797 $ 26,678 $ 45,048
============= ============= ============
SUPPLEMENTAL INFORMATION:
Cash paid for -
Interest and dividends $ 44,316 $ 37,312 $ 37,214
Income taxes 5,700 4,522 5,025
Non-cash transactions -
Transfers from loans to other real estate owned 204 324 1,164
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999 and 1998
(1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
The accompanying consolidated financial statements include the accounts of
Connecticut Bancshares, Inc. ("Connecticut Bancshares or the Company"),
successor to Connecticut Bancshares, M.H.C. ("MHC"), and its wholly-owned
subsidiary, The Savings Bank of Manchester ("SBM"), and its wholly-owned
subsidiaries, SBM, Ltd., 923 Main, Inc. and Savings Bank of Manchester
Mortgage Company, Inc. ("SBM Mortgage"). Collectively, all of the
aforementioned entities are referred to herein as the Bank. SBM Mortgage, a
passive investment company for Connecticut income tax purposes, was
established in January 1999 to service and hold loans secured by real
property. SBM Mortgage is included in the consolidated financial statements
as of December 31, 1999 and 2000 and for the years then ended. As discussed
in Note 2, MHC adopted a Plan of Conversion pursuant to which, in March
2000, MHC merged into SBM, with SBM being the surviving corporation, and
SBM continuing as a state-chartered stock savings bank and a wholly-owned
subsidiary of the Company. All material intercompany balances and
transactions have been eliminated in consolidation.
In 1998, the Bank contributed securities with a fair market value of
approximately $3 million to the newly formed Savings Bank of Manchester
Foundation, Inc. (the "Foundation"), a not-for-profit organization. The
Foundation was formed to provide charitable contributions for the
surrounding community. In connection with the contribution, the Bank
realized a gain of approximately $2.3 million on the transfer of
securities.
Business
The Company does not transact any material business other than through the
Bank. The Company used 50% of the net proceeds from the conversion to buy
all of the common stock of SBM and retained the remaining 50% (see Note 2),
which primarily were invested in fixed income securities. The Bank, with
its main office located in Manchester, Connecticut, operates through
twenty-three branches located primarily in eastern Connecticut. The Bank's
primary source of income is interest received on loans to customers, which
include small and middle market businesses and individuals residing within
the Bank's service area.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as of
the date of the financial statements and the reported amounts of income and
expenses during the reporting periods. Operating results in the future
could vary from the amounts derived from management's estimates and
assumptions. A material estimate that is particularly susceptible to
changes in the near term relates to the determination of the allowance for
loan losses (see Note 5).
Cash flows
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks.
F-7
Earnings per share
Basic earnings per share is computed based upon the weighted average shares
outstanding during the period presented. Diluted earnings per share is
computed based upon the weighted average shares outstanding during the
period presented, including the impact of outstanding options, determined
under the treasury stock method. Earnings per share data is not presented
in these consolidated financial statements prior to March 1, 2000 since
shares of common stock were not issued until March 1, 2000; therefore, per
share information for prior periods is not meaningful.
The following table sets forth the calculation of basic and diluted
earnings per share for the period from March 1, 2000 to December 31, 2000
(dollars in thousands):
For the Period from
March 1, 2000 to
December 31,
2000
Net income $ 6,118
=============
Weighted average shares outstanding:
Weighted average shares outstanding 11,232,000
Less: unearned ESOP shares (864,524)
-------------
Basic shares 10,367,476
Dilutive effect of outstanding stock options 573
-------------
Diluted shares 10,368,049
=============
Earnings per share:
Basic $ 0.59
============
Diluted $ 0.59
============
Investment and mortgage-backed securities
Investments are classified into one of three categories and accounted for
as follows:
Category Accounting Treatment
Trading, representing debt, equity Reported at fair value, with unrealized
and mortgage-backed securities gains and losses included in noninterest
which are held for resale in the near term income
Held to maturity, representing debt and Reported at amortized cost
mortgage-backed securities for which
the Bank has the positive intent and
ability to hold to maturity
Available for sale, representing debt, Reported at fair value, with unrealized
equity and mortgage-backed securities gains and losses, net of tax, reported as
not classified as trading or held to a separate component of accumulated
maturity other comprehensive income
F-8
Any security that experiences a decline in value that management believes
is other than temporary is reduced to its net realizable value by a charge
to noninterest income. Realized gains and losses from the sale of
investments are recorded on the trade date by specific identification of
the security sold.
Loans held for sale
Loans held for sale are valued at the lower of acquisition cost (less
principal payments received) or estimated market value. Market is
determined by reference to outstanding commitments from investors
calculated on an individual loan basis. Net unrealized losses are
recognized in a valuation allowance established by charges to noninterest
income.
Loans
Loans are stated at their principal amounts outstanding net of unearned
income. Interest on loans is recorded as income based on rates applied to
principal amounts outstanding. Some installment and commercial loans are
made on a discounted basis, and the unearned discount is recorded in income
by use of a method that approximates the effective interest method.
Interest on loans is credited to income as earned based on contractual
rates applied to principal amounts outstanding. The accrual of interest is
discontinued when payments are 90 days or more delinquent, and when a
reasonable doubt exists as to the collectibility of the principal or
interest. When interest accruals are discontinued, previously recognized
accrued interest income is charged against earnings. When a loan becomes 90
days or more past due, interest income is recognized on the cash basis,
only if in management's judgment all principal is expected to be collected.
Loan origination fees and certain direct loan origination costs are
capitalized, and the net fee or cost is recognized in interest income using
the effective interest method over the contractual life of the loans. When
loans are prepaid, sold or participated out, the unamortized portion of
deferred fees and related origination costs are recognized as income at
that time. As of December 31, 2000 and 1999, net deferred loan fees were
approximately $1,203,000 and $1,301,000, respectively.
The allowance for loan losses is established through a provision charged to
expense. Loans are charged against the allowance for loan losses when
management believes the collectibility of principal is unlikely. The
allowance represents an amount, which, in management's judgment, will be
adequate to absorb losses on existing loans that may become uncollectible.
Management's judgment in determining the adequacy of the allowance is based
on the evaluation of individual performing and impaired loans, risk
characteristics of the loan portfolios, assessment of current economic and
real estate market conditions, estimates of the current value of underlying
collateral, past and current loan loss experience and other relevant
factors.
The Bank has identified certain loans as impaired based upon management's
belief it is probable that the borrower will be unable to pay all principal
and interest amounts in accordance with the loan agreement's contractual
terms. The Bank is required to account for the time value of money when
determining the adequacy of the Bank's allowance for loan losses for
certain impaired loans.
Certain impaired loans are required to be measured based on the present
value of expected future cash flows discounted at the loan's original
effective interest rate. As a practical expedient, impairment also may be
measured based on the loan's observable market price or the fair value of
the collateral if the loan is collateral dependent. When the measure of the
impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Interest payments
received on impaired loans are recorded as interest income unless
collection of the remaining recorded investment is doubtful, at which time
payments received are recorded as reductions of principal.
F-9
Premises and equipment
Depreciation of premises and equipment and amortization of leasehold
improvements are computed using the straight-line basis over the estimated
useful lives of the assets (5-39 years) or in the case of leasehold
improvements, the lease term if shorter.
Intangible assets
In 1997, the Bank acquired certain assets of a branch in West Hartford,
Connecticut. The premium of $250,000, for lease rights acquired, is being
amortized over the remaining term of the lease (10 years) using the
straight-line method.
In 1995, the Bank acquired certain fixed assets and assumed certain deposit
liabilities of two branches in Storrs and Enfield, Connecticut. In
consideration of the assumption of certain deposit liabilities, the Bank
received cash and other assets. The resultant premium of approximately
$4,062,000 is being amortized over 10 years using the straight-line method.
Other real estate owned
Other real estate owned, comprised of real estate acquired through
foreclosure or acceptance of a deed in lieu of foreclosure, is carried at
the lower of cost or fair market value, net of estimated costs to sell.
Property is transferred to other real estate owned at the lower of cost or
fair market value, with any excess over cost charged to the allowance for
loan losses. Any further decline in value based on subsequent changes to
estimated fair market value or any loss upon ultimate disposition of the
property is charged to other real estate owned expenses.
Mortgage servicing rights
The Bank applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," (as amended by SFAS
No. 127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125 (an amendment of FASB Statement No. 125)"), which
requires that the cost of mortgage servicing rights be amortized in
proportion to, and over the period of, estimated net servicing revenues.
Impairment of mortgage servicing rights is assessed based on the fair value
of those rights. Fair values are estimated using discounted cash flows
based on a current market interest rate. The amount of impairment
recognized is the amount by which the capitalized mortgage servicing rights
for a stratum exceed their fair value.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. The
adoption of this statement had no effect on the Bank's consolidated
financial condition or results of operations.
When participating interests in loans sold have an average contractual
interest rate, adjusted for normal servicing fees, that differs from the
agreed yield to the purchaser, gains or losses are recognized equal to the
present value of such differential over the estimated remaining life of
such loans. The resulting "deferred servicing revenue" is amortized over
the estimated life using a method approximating the effective interest
method.
F-10
Quoted market prices are not available for the servicing receivables. Thus,
the servicing receivables and the amortization thereon periodically are
evaluated in relation to estimated future servicing revenues, taking into
consideration changes in interest rates, current prepayment rates and
expected future cash flows. The Bank evaluates the carrying value of the
servicing receivables by estimating the future servicing income of the
servicing receivables based on management's best estimate of remaining loan
lives and discounted at the original discount rate.
Short-term borrowed funds
Short-term borrowings are comprised of uninsured accounts which are
secured by investment securities.
Income taxes
Items of income and expense recognized in different time periods for
financial reporting purposes and for purposes of computing income taxes
currently payable (temporary differences) give rise to deferred income
taxes which are reflected in the financial statements. A deferred tax
liability or asset is recognized for the estimated future tax effects,
based upon enacted law, attributed to temporary differences. If applicable,
the deferred tax asset is reduced by the amount of any tax benefits that,
based on available evidence, are not likely to be realized.
Stock-based compensation
The Bank accounts for stock-based compensation for employees under
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees", and elected the disclosure-only alternative under
SFAS No. 123, "Accounting for Stock-Based Compensation."
Related party transactions
Directors and officers of the Bank and their associates have been customers
of, and have had transactions with the Bank, and management expects that
such persons will continue to have such transactions in the future. All
deposit accounts, loans, services and commitments comprising such
transactions were made in the ordinary course of business, on substantially
the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other customers who
are not directors or officers and, in the opinion of management, the
transactions did not involve more than normal risks of collectibility,
favored treatment or terms, or present other unfavorable features (see Note
5 for further details regarding related party transactions).
Comprehensive income
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
separately reporting comprehensive income and its components. Components of
comprehensive income represent changes in equity resulting from
transactions and other events and circumstances from non-owner sources.
Comprehensive income for the years ended December 31, 2000, 1999 and 1998
is as follows (in thousands):
2000 1999 1998
Net income $ 7,383 $ 8,754 $ 9,318
Unrealized gains on securities:
Change in unrealized holding gains
arising during the period, net of tax 2,538 2,554 4,002
Less: reclassification adjustment
for gains included in net income, net of tax (289) (892) (1,704)
---------- ---------- ----------
Comprehensive income $ 9,632 $ 10,416 $ 11,616
========== ========== ==========
F-11
Segment information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires public companies to report certain financial
information about significant revenue-producing segments of the business
for which such information is available and utilized by the chief operating
decision-maker. Specific information to be reported for individual
operating segments includes a measure of profit and loss, certain revenue
and expense items and total assets. As a community-oriented financial
institution, substantially all of the Bank's operations involve the
delivery of loan and deposit products to customers. Management makes
operating decisions and assesses performance based on an ongoing review of
these community-banking operations, which constitutes the Bank's only
operating segment for financial reporting purposes under SFAS No. 131.
Recent accounting pronouncements
In September 2000, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities - a Replacement of FASB Statement No.
125." SFAS No. 140 replaces SFAS No. 125. Certain disclosure provisions
required by SFAS No. 140 were effective immediately and are included
herein. Additional requirements related to SFAS No. 140 are effective
beginning March 31, 2001. The Bank does not expect that these additional
requirements will have an effect on the Bank's consolidated financial
position or results of operations.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement
establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes
in the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the statement of income and requires that an
entity formally document, designate and assess the effectiveness of
transactions that receive hedge accounting.
The Bank early adopted SFAS No. 133, as amended by SFAS No. 137,
"Accounting for Derivatives and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 and SFAS No. 138, "Accounting for
Certain Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - An Amendment of FASB Statement
No. 133", on January 1, 2000. In connection with the adoption, the Bank
reclassified all held to maturity investments to available for sale as
allowed by SFAS No. 133. In March 2000, the Bank realized approximately
$72,000 on the sale of an interest rate cap, which amount is included in
other noninterest income in the accompanying consolidated statement of
operations for the year ended December 31, 2000. As of December 31, 2000,
the Bank did not have any other derivative instruments.
On December 3, 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." The guidelines set forth in SAB No. 101 stipulate that revenue
should not be recognized until it is realized or realizable and earned. The
Bank adopted SAB No. 101 on January 1, 2000 without effect on the Bank's
consolidated financial condition or results of operations since the Bank's
previous revenue recognition policies complied with SAB No. 101.
Effective January 1, 1999 the Bank adopted SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of SFAS
No. 65." This statement requires that after the securitization of mortgage
loans held for sale, an entity engaged in mortgage banking activities shall
classify the resulting mortgage-backed securities or other retained
interests based on its ability and intent to sell or hold those
investments. The adoption did not have any effect on the Bank's
consolidated financial condition or results of operations.
F-12
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(2) CONVERSION TO STOCK FORM OF OWNERSHIP
On August 30, 1999, the Boards of Directors of MHC and SBM adopted a Plan
of Conversion and, on October 6, 1999 and October 26, 1999, unanimously
amended the Plan of Conversion (as amended, the Plan), pursuant to which,
on March 1, 2000, MHC converted from the mutual holding company form to the
stock holding company form. All of the outstanding common stock of SBM was
sold to the Company which issued and sold its stock pursuant to the Plan.
The net proceeds of the offering were $90.5 million, after expenses of
approximately $4.3 million. All of the stock of the Company sold in the
conversion was offered to eligible account holders, employee benefit plans
of the Bank and certain other eligible subscribers in subscription and
direct community offerings pursuant to subscription rights in order of
priority as set forth in the Plan. Additionally, the Bank established an
Employee Stock Ownership Plan ("ESOP") for the benefit of eligible
employees, which became effective upon the conversion (See Note 9).
The Plan provided for the establishment of an additional charitable
foundation, SBM Charitable Foundation, Inc. (the "New Foundation") in
connection with the conversion. The New Foundation was funded with a
contribution of 832,000 common shares, or an amount equal to 8% of the
common stock sold in the conversion. This contribution resulted in the
recognition of an expense of $8.3 million in March 2000, related to the
fair value of the shares contributed, which is reflected as such in the
accompanying consolidated statement of operations for the year ended
December 31, 2000. The New Foundation is dedicated to charitable purposes
within the Bank's local community, including community development
activities.
Effective upon the conversion, the Company entered into employment and
change in control agreements with certain executives and certain eligible
employees of the Company and the Bank. The agreements include, among other
things, provisions for minimum annual compensation and certain lump-sum
severance payments in the event of a "change in control."
The Bank's deposit accounts continue to be insured by the FDIC and were not
affected by the conversion. In accordance with the Plan, upon the
completion of the conversion, the Bank established a special "liquidation
account" for the benefit of eligible account holders and in an amount equal
to the equity capital of the Bank less any subordinated debt approved as
bona fide capital of the Bank, as of the date of its latest statement of
condition contained in the final prospectus used in connection with the
conversion. The date was September 30, 1999 and the amount established was
$117.6 million. The liquidation account which totaled $61.4 million at
December 31, 2000 is reduced annually by an amount proportionate to the
decrease in eligible deposit accounts. Eligible account holders continuing
to maintain deposit accounts at the Bank are entitled, on a complete
liquidation of the Bank after the conversion, to an interest in the
liquidation account prior to any payment to the stockholders of the Bank.
The Bank's retained earnings are substantially restricted with respect to
payment of dividends to stockholders due to the liquidation account. The
liquidation account will terminate on the tenth anniversary of the
consummation date of the conversion.
The primary source of funds for the Company to pay dividends is in the form
of dividends received from SBM. Neither the Company nor SBM may declare or
pay dividends on, or repurchase any of its shares of common stock, if the
effect thereof would cause stockholders' equity to be reduced below either
the balance required for the liquidation account or applicable regulatory
capital maintenance requirements, or if such declaration, payment or
repurchase would otherwise violate regulatory requirements.
F-13
(3) REGULATORY MATTERS
SBM 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 Bank's consolidated financial statements. The regulations
require SBM to meet specific capital adequacy guidelines that involve
quantitative measures of assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. SBM's capital
amounts and classification are also subject to qualitative judgments by the
banking regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require SBM to maintain minimum capital ratios (set forth in the table
below) of Tier I leverage capital (as defined in the regulations) to total
average assets (as defined), and minimum ratios of Tier I and total capital
(as defined) to risk weighted assets (as defined). To be considered
adequately capitalized (as defined) under the regulatory framework from
Prompt Corrective Action, SBM must maintain minimum Tier I leverage, Tier I
risk-based and total risk-based ratios as set forth in the table.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") categorizes banks based on capital levels and triggers certain
mandatory and discretionary supervisory responses for institutions that
fall below certain capital levels. A bank generally is categorized as "well
capitalized" if it maintains a leverage capital ratio of at least 5%, a
Tier I risk-based capital ratio of at least 6% and a total risk-based
capital ratio of at least 10%, and it is not subject to a written
agreement, order or capital directive.
As of December 31, 2000 and 1999, management believes that SBM met all
capital adequacy requirements to which it is subject. As of the most recent
notification from the Federal Deposit Insurance Corporation, SBM was
categorized as well capitalized under the regulatory framework for Prompt
Corrective Action, and the highest capital category, as defined in the
FDICIA regulations. Management believes that there are no events or
conditions which have occurred subsequent to the notification that would
change its category.
Actual capital amounts and ratios for SBM were (dollars in thousands):
To Be Well Capitalized Under
----------- Capital Adequacy ----------- Prompt Corrective Action
Required Actual Required
Amount (Ratio) Amount (Ratio) Amount (Ratio)
December 31, 2000:
Tier I Capital (to Total
Average Assets) $ 53,926 (4.0%) $ 172,847 (12.8%) $ 67,407 (5.0%)
Tier I Capital (to Risk
Weighted Assets) 37,609 (4.0%) 172,847 (18.4%) 56,414 (6.0%)
Total Capital (to
Risk Weighted
Assets) 75,218 (8.0%) 184,541 (19.6%) 94,023 (10.0%)
December 31, 1999:
Tier I Capital (to Total
Average Assets) $ 48,189 (4.0%) $ 109,652 (9.1%) $ 60,236 (5.0%)
Tier I Capital (to Risk
Weighted Assets) 34,463 (4.0%) 109,652 (12.7%) 51,694 (6.0%)
Total Capital (to Risk
Weighted Assets) 68,925 (8.0%) 120,269 (14.0%) 86,157 (10.0%)
F-14
(4) INVESTMENT SECURITIES
As of December 31, 2000 and 1999, the amortized cost and market value of
investment securities were (in thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
December 31, 2000
Available for Sale:
U.S. Government and
agency obligations $ 82,068 $ 3,187 $ (1) $ 85,254
Corporate securities 58,313 1,114 (215) 59,212
Marketable equity securities 35,221 15,200 (1,277) 49,144
Mortgage-backed securities 79,079 1,356 (212) 80,223
Asset-backed securities 32,717 1,100 (1) 33,816
Other equity securities 432 - - 432
------------ ------------ ---------- -------------
Total $ 287,830 $ 21,957 $ (1,706) $ 308,081
============ ============ =========== =============
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
December 31, 1999
Available for Sale:
U.S. Government and
agency obligations $ 82,486 $ 13 $ (1,171) $ 81,328
Corporate securities 33,870 6 (531) 33,345
Marketable equity securities 32,273 19,428 (1,156) 50,545
Mortgage-backed securities 16,741 128 (665) 16,204
Other equity securities 432 - - 432
------------ ------------ ---------- -------------
Total $ 165,802 $ 19,575 $ (3,523) $ 181,854
============ ============ ========== =============
Held to Maturity:
U.S. Government and
agency obligations $ - $ - $ - $ -
Corporate securities 3,105 - (155) 2,950
Asset-backed securities 17,481 191 (254) 17,418
Mortgage-backed securities 25,474 20 (864) 24,630
------------ ------------ ---------- -------------
Total $ 46,060 $ 211 $ (1,273) $ 44,998
============ ============ ========== =============
As of December 31, 2000, the amortized cost and market values of debt
securities, by contractual maturity, are shown below (in thousands).
Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
F-15
-------As of December 31, 2000------
Amortized Market
Cost Value
Due in one year or less $ 16,892 $ 16,904
Due after one year through five years 107,662 110,932
Due after five years through ten years 41,143 42,894
Due after ten years 7,401 7,552
----------- -----------
Mortgage-backed securities 79,079 80,223
----------- -----------
Total $ 252,177 $ 258,505
=========== ===========
For the years ended December 31, 2000 and 1999, proceeds from the sales
of available for sale securities were approximately $92,240,000 and
$19,081,000, respectively. Gross gains of approximately $2,733,000 and
$1,922,000, respectively, and gross losses of approximately $2,288,000
and $550,000, respectively, were realized on those sales for the years
ended December 31, 2000 and 1999.
As of December 31, 2000 and 1999, investment securities with a book
value of approximately $130,297,000 and $103,627,000 were pledged as
security for short-term borrowed funds, U.S. Treasury tax and loan
payments and municipal deposits held by the Bank, respectively.
(5) LOANS
As of December 31, 2000 and 1999, the Bank's residential mortgage loan
portfolio was entirely secured by one- to four-family homes, located
primarily in central and eastern Connecticut. The commercial mortgage
loan portfolio was secured primarily by multi-family, commercial and
manufacturing properties located in Connecticut and surrounding states.
A variety of different assets, including business assets, rental income
properties, and manufacturing and commercial properties, secured a
majority of the commercial loans. The composition of the Bank's loan
portfolio as of December 31, 2000 and 1999 is as follows (in thousands):
2000 1999
One-to four-family residential mortgages $ 586,536 $ 544,732
Construction mortgages 33,422 40,690
Commercial and multi-family mortgages 161,579 155,085
Commercial business loans 146,360 134,637
Installment loans 79,561 73,813
----------- -----------
Total loans 1,007,458 948,957
Less - Allowance for loan losses (11,694) (10,617)
----------- -----------
Total loans, net $ 995,764 $ 938,340
=========== ===========
The Bank services certain loans that it has sold without recourse to
third parties. The aggregate amount of loans serviced for others
approximated $210,149,000, $210,158,000 and $218,660,000 as of December
31, 2000, 1999 and 1998, respectively. Income from servicing loans for
others was approximately $544,000, $576,000 and $503,000 for the years
ended December 31, 2000, 1999 and 1998, respectively. Mortgage servicing
rights of approximately $2,555,000, $2,550,000 and $2,480,000 were
capitalized as of December 31, 2000, 1999 and 1998, respectively.
Amortization of mortgage servicing rights was approximately $387,000,
$425,000 and $276,000 for the years ended December 31, 2000, 1999 and
1998, respectively.
F-16
As of December 31, 2000 and 1999, loans to related parties totaled
approximately $6,300,000 and $15,800,000, respectively. For the year
ended December 31, 2000, new loans of approximately $1,156,000 were
granted to these parties and payments of approximately $185,000 were
received. Related parties include directors and officers of the Bank,
their respective affiliates in which they have a controlling interest and
their immediate family members. For the years ended December 31, 2000 and
1999, all loans to related parties were performing.
Allowance for loan losses
The allowance for loan losses is maintained at a level determined by
management to be the best estimate of losses incurred in the loan
portfolio. The allowance is increased or decreased by provisions or
credits charged to operations, which represent an estimate of losses that
occurred during the period and a correction of estimates of losses
recorded in prior periods. Confirmed losses, net of recoveries, are
charged directly to the allowance and the loans are written down.
The determination of the adequacy of loan losses by management is based
on an assessment of risk elements in the portfolio, identified factors
affecting specific loans and available information about the current
economic environment in which the Bank and its borrowers operates.
Management reviews overall portfolio quality through an analysis of
current levels and trends in chargeoffs, delinquency and nonaccruing loan
data and the credit risk profile of each component of the portfolio.
The allowance for loan losses consists of a formula allowance for various
loan portfolio classifications and a valuation allowance for loans
identified as impaired, if necessary. The allowance is an estimate, and
ultimate losses may vary from current estimates. Changes in the estimate
are recorded in the results of operations in the period in which they
become known, along with provisions for estimated losses incurred during
that period.
A loan is considered to be impaired when it is probable that a creditor
will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Impaired loans, as defined, may be measured
based on the present value of expected future cash flows, discounted at
the loan's original effective interest rate or on the loan's observable
market price or the fair value of the collateral if the loan is
collateral-dependent. When the measurement of the impaired loan is less
than the recorded investment in the loan, the impairment is recorded
through a valuation allowance.
For the years ended December 31, 2000, 1999 and 1998, an analysis of the
allowance for loan losses is as follows (in thousands):
2000 1999 1998
Balance, beginning of period $ 10,617 $ 10,585 $ 9,945
Provision for loan losses 1,200 1,100 1,200
Loans charged off (433) (1,360) (1,087)
Recoveries 310 292 527
--------- ---------- ----------
Balance, end of period $ 11,694 $ 10,617 $ 10,585
========= ========== ==========
(6) NONPERFORMING ASSETS
Nonperforming assets include loans for which the Bank does not accrue
interest ("nonaccrual loans"), loans 90 days past due and still accruing
interest and other real estate owned. Nonaccrual loans and loans 90 days
past due and still accruing interest represent the Bank's impaired loans.
For the years ended December 31, 2000, 1999 and 1998, the average
recorded investment in impaired loans was approximately $9,390,000,
$6,417,000 and $2,200,000, respectively. As of December 31, 2000 and
1999, nonperforming assets were (in thousands):
F-17
2000 1999
Nonaccrual loans $ 6,268 $ 11,130
Loans 90 days past due and accruing interest 504 355
Other real estate owned 125 604
---------- ----------
Total nonperforming assets $ 6,897 $ 12,089
========== ==========
For the years ended December 31, 2000, 1999 and 1998, had interest
income been accrued on nonaccrual loans at contractual rates, interest
income would have increased by approximately $568,000, $635,000 and
$136,000, respectively. For the years ended December 31, 2000, 1999 and
1998, interest income on impaired loans of approximately $60,000,
$125,000 and $80,000, respectively, was recognized. As of years ended
December 31, 2000, 1999 and 1998, no significant additional funds were
committed to customers whose loans were nonperforming.
As of December 31, 2000 and 1999, the Bank had impaired loans of
approximately $6,773,000 and $11,485,000, respectively, for which a
valuation allowance of $771,000 and $1,430,000, respectively, was
required. For the years ended December 31, 2000 and 1999, $269,000 and
$700,000 was charged off on nonaccrual loans, respectively. For the year
ended December 31, 1998, no chargeoffs occurred on impaired loans.
(7) DEPOSITS
As of December 31, 2000 and 1999, deposits consisted of the following
(in thousands):
2000 1999
Certificates of Deposit:
One to twelve-month certificates $ 94,481 $ 210,597
One to five year certificates 287,596 179,261
Time certificates in denominations of $100,000 or more 57,762 60,489
----------- -----------
439,839 450,347
----------- -----------
Savings accounts 218,901 223,656
Money market accounts 73,799 68,532
NOW accounts 131,536 112,741
Demand deposits 69,295 51,315
----------- -----------
Total deposits $ 933,370 $ 906,591
=========== ===========
For the years ended December 31, 2000, 1999 and 1998, interest expense
on time deposits in denominations greater than $100,000 was
approximately $3,078,000, $2,587,000 and $2,921,000, respectively.
F-18
(8) ADVANCES FROM FEDERAL HOME LOAN BANK AND SHORT-TERM BORROWED FUNDS
As of December 31, 2000 and 1999, SBM had the following borrowings from
Federal Home Loan Bank of Boston (FHLB) (dollars in thousands):
Interest
Rate Maturity Date 2000 1999
5.83% March 23, 2000 $ - $ 44,000
5.76% April 5, 2000 - 10,000
6.67% April 25, 2001 20,000 -
6.51% April 25, 2001 10,000 -
5.96% September 26, 2001 20,000 -
5.80% June 26, 2002 20,000 -
6.05% May 2, 2005 30,000 30,000
----------- -----------
Total advances from Federal Home Loan Bank $ 100,000 $ 84,000
=========== ===========
SBM's FHLB stock collateralizes these advances. In addition, mortgage
loans and otherwise unencumbered investment securities qualified as
collateral available to the FHLB were pledged to secure these advances,
unused credit lines and letters of credit issued by the FHLB. As of
December 31, 2000, SBM had the ability to borrow a total of
approximately $447.29 million from FHLB.
SBM maintains a line of credit of $34,000,000 with the FHLB which
accrues interest at variable rates determined by the FHLB on a daily
basis. Amounts drawn against the line of credit are due within one day
of withdrawal; however, such amounts are automatically renewed provided
that SBM has sufficient cash balances deposited with the FHLB.
Borrowings under the line of credit are secured by U.S. Government
treasury and/or agency bonds. There were no outstanding borrowings on
the FHLB line of credit at December 31, 2000 or 1999. The Bank also
maintains a $15,000,000 line of credit with a correspondent bank. No
amounts were outstanding on the correspondent line as of December 31,
2000 or 1999.
Short-term borrowed funds primarily represents commercial transactional
repurchase accounts (business checking accounts, which are not Federal
Deposit Insurance Corporation insured).
(9) PENSION PLANS
The Bank has a non-contributory defined benefit pension plan ("the
Plan") covering substantially all employees. The benefits are based on
years of service and average compensation, as defined in the Plan. The
Bank's funding policy is to contribute annually the maximum amount
allowed by federal tax regulations.
The following table sets forth the change in benefit obligation, change
in plan assets and the funded status of the Bank's pension plan for the
years ended December 31, 2000 and 1999. The table also provides a
reconciliation of the plan's funded status and the amounts recognized in
the Bank's consolidated statements of condition (in thousands):
2000 1999
Change in benefit obligation:
Benefit obligation, beginning of year $ 17,835 $ 18,082
Service cost 1,363 1,416
Interest cost 1,321 1,161
Actuarial gain (1,236) (2,376)
Benefits paid (483) (448)
------------- -----------
Benefit obligation, end of year 18,800 17,835
------------ -----------
F-19
2000 1999
Change in plan assets:
Fair value of plan assets, beginning of year 19,526 17,163
Actual return on plan assets 2,879 2,811
Employer contribution 97 -
Benefits paid (483) (448)
------------ -----------
Fair value of plan assets, end of year 22,019 19,526
------------ -----------
Funded status 3,219 1,691
Unrecognized transition asset (194) (271)
Unrecognized prior service cost 99 107
Unrecognized contributions - 97
Unrecognized net actuarial gain (8,113) (5,538)
------------ -----------
Accrued benefit cost $ (4,989) $ (3,914)
============ ===========
The components of net periodic pension cost for the years ended December
31, 2000, 1999 and 1998 were as follows (in thousands):
2000 1999 1998
Service cost $ 1,363 $ 1,416 $ 989
Interest cost 1,321 1,161 980
Expected return on plan assets (1,454) (1,297) (1,119)
Recognized net gain (87) - -
Amortization and deferral (69) (69) (69)
---------- ---------- ----------
Net periodic pension cost $ 1,074 $ 1,211 $ 781
========== ========== ==========
Significant actuarial assumptions used in determining the actuarial
present value of the projected benefit obligation and the net periodic
pension cost were as follows:
2000 1999 1998
Discount rate 7.75% 7.5% 6.5%
Rate of increase in compensation levels 4.5 4.5 4.5
Long-term rate of return on assets 8.5 8.5 8.0
The Bank has entered into supplemental retirement agreements with certain
officers and outside directors. The following table sets forth the change
in benefit obligation and the funded status of the obligations for the
years ended December 31, 2000 and 1999. The table also provides a
reconciliation of the obligation's funded status and the amounts
recognized in the Bank's consolidated statements of condition (in
thousands):
F-20
2000 1999
Change in benefit obligation:
Benefit obligation, beginning of year $ 717 $ 613
Service cost 203 41
Interest cost 206 40
Plan amendments 1,966 -
Actuarial loss 73 23
Benefits paid - -
------------ -----------
Benefit obligation, end of year 3,165 717
Plan assets - -
------------ -----------
Funded status (3,165) (717)
Unrecognized prior service cost 1,940 258
Unrecognized net actuarial gain 147 75
Other (1,291) -
------------ -----------
Accrued benefit cost $ (2,369) $ (384)
============ ===========
The components of net periodic pension cost for the years ended December
31, 2000, 1999 and 1998 were as follows (in thousands):
2000 1999 1998
Service cost $ 203 $ 41 $ 36
Interest cost 206 40 37
Amortization and deferral 285 27 27
---------- ---------- ----------
Net periodic pension cost $ 694 $ 108 $ 100
========== ========== ==========
Significant actuarial assumptions used in determining the actuarial
present value of the projected benefit obligation and the net periodic
pension cost were as follows:
2000 1999 1998
Discount rate 7.75% 7.50% 6.50%
Rate of increase in compensation levels 4.00 and 4.50 4.00 4.00
In addition to providing pension benefits, the Bank provides certain
health care benefits for retired employees (the Health Care Plan). Only
employees retiring before January 1, 1989 are eligible for these
benefits, provided they attain age 55 while working for the Bank. In
addition, all employees who have attained age 55 and have ten years of
vested service are covered under the Health Care Plan until age 65.
Effective January 1, 1993, the Bank began to accrue for the estimated
costs of these benefits through charges to expense during the years that
the employees earn these benefits. The following table reconciles the
Health Care Plan's funded status to the accrued obligation as of December
31, 2000 and 1999 (in thousands):
F-21
2000 1999
Accumulated postretirement benefit obligation:
Retirees $ 490 $ 454
Other fully eligible participants 209 137
Other active participants 465 403
--------- ---------
1,164 994
Unrecognized actuarial gain 418 576
Unrecognized prior service cost (155) (168)
--------- ---------
Prepaid postretirement cost $ 1,427 $ 1,402
========= =========
For the years ended December 31, 2000, 1999 and 1998, net postretirement
health care cost included the following components (in thousands):
2000 1999 1998
Service cost $ 69 $ 64 $ 39
Interest cost 71 61 75
Amortization and deferral (16) (17) (9)
------- ------- -------
$ 124 $ 108 $ 105
======= ======= =======
Significant actuarial assumptions used in determining the actuarial
present value of the projected benefit obligation and the net
postretirement health care cost are as follows:
2000 1999 1998
Discount rate 7.75% 7.5% 6.5%
Rate of increase in compensation levels 4.5 4.0 4.0
The health care cost trend rate used to measure the accumulated
postretirement benefit obligation is 7.0% as of December 31, 2000.
Increasing the health care cost trend rate by 1% would increase the
accumulated postretirement benefit cost by approximately $70,000, and
the net postretirement benefit cost by approximately $17,000, (pretax)
annually as of December 31, 2000.
In connection with the Plan of Conversion, the Bank established an ESOP
which acquired 8%, or 898,560, of the shares which were issued in the
conversion at a price of $10.36 per share. The purchase of the shares by
the ESOP was funded by a loan of $9,305,000 from the Company. The loan
is to be repaid in fifteen equal annual installments of principal and
interest of $1,122,622. Interest on the loan is fixed at 8.75%. ESOP
expense for the year ended December 31, 2000 was $855,000. ESOP expense
is based on the market value of the Company's common stock at the time
shares are allocated to employees, which may differ from the $10.36 cost
of those shares.
F-22
(10) INCOME TAXES
For the years ended December 31, 2000, 1999 and 1998, the provision
(benefit) for income taxes consisted of the following (in thousands):
2000 1999 1998
Current tax provision:
Federal $ 7,179 $ 4,365 $ 3,156
State - - 557
--------- -------- ---------
Total current 7,179 4,365 3,713
--------- -------- ---------
Deferred tax provision (benefit):
Federal (3,520) 61 421
State - - 74
--------- -------- ---------
Total deferred (3,520) 61 495
--------- -------- ---------
Total provision for income taxes $ 3,659 $ 4,426 $ 4,208
========= ======== =========
As of December 31, 2000 and 1999, the components of the net deferred
income tax asset (liability) included in current and deferred income
taxes in the accompanying consolidated statements of condition were (in
thousands):
December 31,
2000 1999
Deferred tax assets:
Allowance for loan losses $ 4,093 $ 3,716
Charitable contributions 2,155 72
Benefits 2,856 2,006
Branch premiums 275 224
Payments and interest on nonaccrual loans 741 562
Accretion on bonds sold 263 158
Other 30 44
---------- ----------
10,413 6,782
---------- ----------
Deferred tax liabilities:
Unrealized gain on available for sale securities (7,087) (5,137)
Accretion on bonds held (473) (317)
Premises and equipment (510) (633)
Mortgage serving rights (894) (892)
Other (1,043) (967)
---------- ----------
(10,007) (7,946)
---------- ----------
Net deferred tax asset (liability) $ 406 $ (1,164)
========== ==========
Effective for taxable years commencing after December 31, 1998, financial
service companies are permitted to establish in the State of Connecticut
a passive investment company ("PIC") to hold and manage loans secured by
real property. Income earned by the PIC is exempt from Connecticut
corporation business tax and dividends received by the financial service
company from the PIC are not taxable. In 1999, SBM established a PIC, as
a wholly-owned subsidiary, and transferred a portion of its real estate
mortgage portfolio from SBM to the PIC.
F-23
During 1999, the deferred state tax assets for which the valuation
allowance was established were written off upon the transfer to the PIC,
and the valuation allowance was eliminated. Prior to 1999, all state
deferred tax assets were reserved for due to uncertainty of realization.
For the years ended December 31, 2000, 1999 and 1998, the provision for
income taxes differed from the amount computed by applying the statutory
federal income tax rate (35%) to income before provision for income taxes
for the following reasons (in thousands):
2000 1999 1998
Tax provision at statutory rate $ 3,865 $ 4,613 $ 4,734
Increase (decrease) in tax resulting from:
State income taxes, net of federal tax benefit - - 817
Gain on contribution of securities to
Savings Bank of Manchester Foundation, Inc. - - (921)
Dividends received deduction (249) (245) (409)
Change in valuation allowance - - (420)
Other, net 43 58 407
-------- ---------- ----------
$ 3,659 $ 4,426 $ 4,208
======== ========== ==========
As of December 31, 2000, the Bank's allowance for loan losses for federal
income tax return purposes was approximately $12,560,000. If any portion
of this allowance is used for purposes other than to absorb loan losses
and write-downs of other real estate owned, such amounts will become
subject to income tax at the then current tax rate. Management does not
anticipate that capital will be used in such a way so as to require the
payment of taxes on taxable income resulting from the recapture of the
tax allowance. As a result, in accordance with SFAS No. 109, no provision
for such tax has been recorded in the accompanying consolidated financial
statements.
(11) STOCK-BASED COMPENSATION
In connection with the conversion to stock form of ownership (see Note
2), the Company established the Connecticut Bancshares, Inc. 2000
Stock-Based Incentive Plan (the "Stock Plan") to attract and retain
qualified personnel in key positions and to provide employees with an
interest in the Company as an incentive to contribute to its success. The
Stock Plan authorizes the granting of options to purchase common stock of
the Company and awards of restricted shares of common stock. All
employees and non-employee directors of the Company are eligible to
receive awards under the Stock Plan. The Stock Plan is administered by a
committee (the Committee). Subject to certain regulatory conditions, the
Committee has the authority to determine the amount of options granted to
any individual and the dates on which each option will become
exercisable. The exercise price of all options is determined by the
Committee but is at least 100% of the fair market value of the underlying
common stock at the time of the grant. In addition, subject to certain
regulatory conditions, the Committee has the authority to determine the
amounts of restricted stock awards granted to any individual and the
dates on which restricted stock awards granted will vest or any other
conditions which must be satisfied before vesting. On December 15, 2000,
the Bank granted options to purchase 1,017,776 shares of common stock at
an exercise price of $17.625 per share, the fair value on the date of
grant. The options expire 10 years from the date of grant and vest over 5
years. At December 31, 2000, no options were exercisable. As of December
31, 2000, no shares of restricted stock had been granted.
The Company applies APB No. 25 and related Interpretations in accounting
for the Stock Plan. Accordingly, no compensation cost has been recognized
for the Stock Plan. Had compensation cost for the Company's Stock Plan
been determined consistent with SFAS No. 123, the Company's pro forma net
income and basic and diluted net income per share for the ten months
ended December 31, 2000, would have been $6,078,000, $0.59 and $0.59,
respectively.
F-24
The fair value on the grant date of $7.28 was estimated using the Black-
Scholes option pricing model with the following assumptions:
2000
Risk free interest rate 5.24%
Expected life 7 years
Expected volatility 26.25%
Dividend yield -
(12) SELECTED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following table presents quarterly consolidated financial information
for the Bank for 2000 and 1999 (in thousands):
-------------------2000------------------ -----------------1999-----------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Interest and dividend
income $ 25,113 $ 24,512 $ 23,722 $ 21,745 $ 20,720 $ 19,931 $ 19,153 $ 19,030
Interest expense 11,381 11,281 10,829 10,351 10,216 9,465 8,972 8,721
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income 13,732 13,231 12,893 11,394 10,504 10,466 10,181 10,309
Provision for loan losses 375 375 225 225 150 650 150 150
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income after
provision for loan losses 13,357 12,856 12,668 11,169 10,354 9,816 10,031 10,159
Noninterest income 3,911 3,417 2,424 517(1) 3,536 1,350 2,088 2,432
Noninterest expense 10,810 10,002 10,259 18,206(2) 10,072 9,377 9,386 7,751
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before
(provision for) benefit
from income taxes 6,458 6,271 4,833 (6,520) 3,818 1,789 2,733 4,840
(Provision for) benefit from
income taxes (2,139) (2,073) (1,599) 2,152 (1,430) (573) (874) (1,549)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 4,319 $ 4,198 $ 3,234 $ (4,368) $ 2,388 $ 1,216 $ 1,859 $ 3,291
======== ======== ======== ======== ======== ======== ======== ========
(1) Includes losses on sales of securities, net of $1,755,000.
(2) Includes expense of $8,316,000 related to securities contributed
to SBM Charitable Foundation, Inc.
(13) COMMITMENTS AND CONTINGENCIES
Cash and due from banks withdrawal and usage reserve requirements
The Bank is required to maintain reserves against its transaction
accounts and non-personal time deposits. As of December 31, 2000 and
1999, cash and due from banks withdrawal/usage reserve requirements of
approximately $2,144,000 and $11,060,000, respectively, existed as a
result of Federal Reserve requirements to maintain certain average
balances.
F-25
Lease commitments
The Bank leases certain of its premises and equipment under lease
agreements which expire at various dates through June 2010. The Bank has
the option to renew certain of the leases at fair rental values. Rental
expense was approximately $1,134,000, $1,132,000 and $1,120,000 for the
years ended December 31, 2000, 1999 and 1998, respectively.
As of December 31, 2000, minimum rental commitments under noncancellable
operating leases were (in thousands):
Year
2001 $ 904,311
2002 902,620
2003 873,694
2004 807,759
2005 735,040
Thereafter 3,438,405
-------------
$ 7,661,829
=============
Loan commitments and letters of credit
The Bank is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments included commitments to extend
credit of approximately $176,670,000 and $155,180,000 as of December 31,
2000 and 1999, respectively, and standby letters of credit of
approximately $7,361,000 and $6,216,000 as of December 31, 2000 and 1999,
respectively.
These consolidated financial instruments involve, to varying degrees,
elements of credit and interest rate risk. The Bank's exposure to credit
loss in the event of non-performance by the other party to the financial
instrument is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments as it does
for existing loans. Management believes that the Bank controls the credit
risk of these financial instruments through credit approvals, lending
limits, monitoring procedures and the receipt of collateral when deemed
necessary.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments
could expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. Bank management
evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Bank, upon
extension of credit is based on management's credit evaluation of the
customer. Collateral held varies but may include income producing
commercial properties, accounts receivable, inventory and property, plant
and equipment.
Standby letters of credit are conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party. The credit
risk involved in issuing letters of credit is essentially the same as
that involved in existing loan facilities to customers. The Bank holds
real estate and marketable securities as collateral supporting those
commitments for which collateral is deemed necessary.
F-26
Interest rate cap agreement
At December 31, 1999, SBM was party to an interest rate cap agreement
with a notional principal amount of $25 million. Under the terms of the
cap agreement, SBM paid a premium totalling $123,000 which was included
in other assets and was amortized over the three years term of the
agreement. Amortization for the year ended December 31, 1999 totaled
$38,000 and is recorded as an interest expense on advances. In March
2000, the Bank realized a gain of approximately $72,000 on the sale of
the interest rate cap.
(14) PARENT COMPANY FINANCIAL INFORMATION
Summarized information relative to the statements of condition as of
December 31, 2000 and 1999 and statements of operations and cash flows
for the years ended December 31, 2000, 1999 and 1998 of Connecticut
Bancshares, Inc. (parent company only) are presented as follows (in
thousands):
Statements of Condition 2000 1999
Assets:
Cash and cash equivalents $ 7,572 $ 50
Investment in SBM 187,471 123,173
Securities available for sale 36,495 -
Current and deferred income taxes 2,304 -
Accrued interest receivable 325 -
----------- -----------
Total assets $ 234,167 $ 123,223
=========== ===========
Liabilities and stockholders' equity:
Other liabilities $ 1,628 $ -
----------- -----------
Total liabilities 1,628 -
----------- -----------
Stockholders' equity 232,539 123,223
----------- -----------
Total liabilities and stockholders' equity $ 234,167 $ 123,223
=========== ===========
F-27
Statements of Operations 2000 1999 1998
Interest and dividend income:
Interest and dividend income on investment securities $ 1,744 $ - $ -
----------- --------- -----------
Total interest and dividend income 1,744 - -
----------- --------- -----------
Noninterest income:
Gains on sales of securities, net 19 - -
----------- --------- -----------
Total noninterest income 19 - -
----------- --------- -----------
Noninterest expense:
Pension and other employee benefits 856 - -
Fees and services 636 - -
Securities contributed to SBM Charitable Foundation, Inc. 8,316 - -
Other operating expenses 77 - -
----------- --------- -----------
Total noninterest expense 9,885 - -
----------- --------- -----------
Loss before income tax benefit and equity in
undistributed earnings in SBM (8,122) - -
Benefit from income taxes 2,692 - -
----------- --------- -----------
Loss before equity in undistributed earnings of SBM (5,430) - -
Equity in undistributed earnings of SBM 12,813 8,754 9,318
----------- --------- -----------
Net income $ 7,383 $ 8,754 $ 9,318
=========== ========= ===========
F-28
Statements of Cash Flows 2000 1999 1998
Cash Flows from Operating Activities:
Net income $ 7,383 $ 8,754 $ 9,318
Adjustments to reconcile net income to net cash used in
operating activities:
Securities contributed to SBM Charitable Foundation, Inc. 8,316 - -
Deferred income tax benefit (6,538) - -
Accretion on bonds, net (456) - -
Gain on sales of securities, net (19) - -
Changes in operating assets and liabilities -
Accrued interest receivable (325) - -
Other liabilities 1,628 - -
Equity in undistributed earnings of SBM (12,813) (8,754) (9,318)
---------- ---------- ----------
Net cash used in operating activities (2,824) - -
---------- ---------- ----------
Cash Flows from Investing Activities:
Proceeds from maturities of available for sale securities 5,000 - -
Proceeds from sale of available for sale securities 983 - -
Investment in SBM (45,257) - -
Purchases of available for sale securities (40,950) - -
Proceeds from principal payments from available for
sale securities 57 - -
---------- ---------- ----------
Net cash used in investing activities (80,167) - -
---------- ---------- ----------
Cash Flows from Financing Activities:
Net proceeds from issuance of common stock 90,513 - -
---------- ---------- ----------
Net cash provided by financing activities 90,513 - -
---------- ---------- ----------
Net increase in cash and cash equivalents 7,522 - -
Cash and cash equivalents, beginning of year 50 50 50
---------- ---------- ----------
Cash and cash equivalents, end of year $ 7,572 $ 50 $ 50
========== ========== ==========
(15) DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires entities to disclose the estimated fair value of financial
instruments, both assets and liabilities recognized and not recognized in
the consolidated statements of condition, for which it is practicable to
estimate fair value.
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable
to estimate that value.
Cash and due from banks and accrued interest receivable
The carrying amount is a reasonable estimate of fair value.
F-29
Securities
For marketable equity securities and other securities held for investment
purposes, fair values are based on quoted market prices or dealer quotes,
if available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans held for sale
The fair value of residential mortgage loans held for sale is estimated
using quoted market prices provided by government agencies.
Loans
The fair value of the net loan portfolio is estimated by discounting the
loans' future cash flows using the prevailing interest rates as of
year-end at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
The book and fair values of unrecognized commitments to extend credit and
standby letters of credit were not significant as of December 31, 2000
and 1999.
Deposits
The fair value of savings, NOW, demand and certain money market deposits
is the amount payable on demand as of year-end. The fair value of
certificates of deposit is estimated by discounting the future cash flows
using the rates offered for deposits of similar remaining maturities as
of yearend.
Advances from Federal Home Loan Bank
The fair value of the advances is based on the estimated costs to prepay
the debt (prior to maturity) as of year-end.
Values not determined
SFAS No. 107 excludes certain financial, as well as non-financial,
instruments from its disclosure requirements, including premises and
equipment, the intangible value of the Bank's portfolio of loans serviced
(both for itself and for others) and related servicing network, and the
intangible value inherent in the Bank's deposit relationships (i.e., core
deposits), among other assets and liabilities. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the
Bank.
F-30
As of December 31, 2000 and 1999, the estimated fair values and recorded
book balances of the Bank's financial instruments were (in thousands):
-----------2000---------- -----------1999---------
Recorded Recorded
Book Fair Book Fair
Balance Value Balance Value
Assets:
Cash and cash equivalents $ 64,797 $ 64,797 $ 26,678 $ 26,678
Securities available for sale 308,081 308,081 181,854 181,854
Securities held to maturity - - 46,060 44,998
Loans held for sale 290 290 38 38
Loans, net 995,764 980,480 938,340 931,372
Federal Home Loan Bank stock 6,654 6,654 5,909 5,909
Accrued interest receivable 8,747 8,747 6,900 6,900
Liabilities:
Deposits -
Savings $ 218,901 $ 218,901 $ 223,656 $ 223,656
Money market 73,799 73,799 68,532 68,532
Certificates of deposit 439,839 443,205 450,347 451,238
NOW 131,536 131,536 112,741 112,741
Demand 69,295 69,295 51,315 51,315
Short-term borrowed funds 106,493 106,493 95,814 95,814
Mortgagors' escrow accounts 8,896 8,896 8,674 8,674
Advances from Federal Home Loan Bank 100,000 100,197 84,000 82,054
At December 31, 1999, the Bank had an interest rate cap with a notional
value of $25,000,000 and a book asset value of $85,000 representing the
unamortized portion of the premium paid for the cap, which is included in
other assets in the accompanying consolidated statements of condition.
The interest rate cap had an estimated market value of $143,000 at
December 31, 1999.
(16) SUBSEQUENT EVENT
On February 7, 2001, the Bank and First Federal Savings and Loan
Association of East Hartford ("First Federal") entered into a definitive
agreement (the "Agreement") under which the Bank will acquire all of the
outstanding common stock of First Federal for cash equal to approximately
$110.00 million. Immediately after the completion of the acquisition,
First Federal will be merged into The Savings Bank of Manchester, a
wholly-owned subsidiary of the Company. The Board of Directors of the
Company expects the transaction to close in the third quarter of 2001.
The transaction is subject to approval by First Federal shareholders and
federal and state regulatory agencies.
Under certain circumstances, if the Agreement is terminated by the Bank
for the reasons set forth in the Agreement before the consummation of the
merger, First Federal may be required to pay the Bank cash of $4.5
million plus out-of-pocket expenses.
F-31