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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the fiscal year ended December 31, 2004
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-23129
NORTHWAY FINANCIAL, INC.
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(Exact name of registrant as specified in its charter)
New Hampshire 04-3368579
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9 Main Street
Berlin, New Hampshire 03570
--------------------- -----
Address of principal executive offices (Zip Code)
(603) 752-1171
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(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.00
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
The number of shares of voting and nonvoting common stock, par value
$1.00 per share, held by nonaffiliates of the registrant as of June 30, 2004
was 1,278,868 shares with an aggregate market value, computed by reference to
the last reported sales price on the NASDAQ National Market on such date, of
$44,696,437. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for purposes of this calculation,
this classification is not to be interpreted as an admission of such status.
At March 25, 2005, there were 1,507,574 shares of common stock
outstanding, par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2005 Annual Meeting of
Stockholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of
Part III.
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NORTHWAY FINANCIAL, INC.
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1 Business .................................................... 1
ITEM 2 Properties .................................................. 10
ITEM 3 Legal Proceedings ........................................... 10
ITEM 4 Submission of Matters to a Vote of Security Holders ......... 10
PART II
ITEM 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ........... 10
ITEM 6 Selected Financial Data ..................................... 11
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................... 12
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk .. 26
ITEM 8 Financial Statements and Supplementary Data ................. 27
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure .................................... 55
ITEM 9A Controls and Procedures ..................................... 55
PART III
ITEM 10 Directors and Executive Officers of the Registrant .......... 55
ITEM 11 Executive Compensation ...................................... 55
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters .................. 55
ITEM 13 Certain Relationships and Related Transactions .............. 55
ITEM 14 Principal Accountant Fees and Services ...................... 55
ITEM 15 Exhibits, Financial Statement Schedules and Reports on
Form 8-K .................................................... 56
Signatures .............................................. 57
FORWARD-LOOKING STATEMENTS
Certain statements in this report are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements may include, but are not limited to, projections of
revenue, income or loss, plans for future operations and acquisitions,
projections based on assumptions regarding market and liquidity risk, and plans
related to products or services of Northway Financial, Inc. ("Northway") and
its subsidiaries (the "Company", see description of business below). Such
forward-looking statements are subject to known and unknown risks,
uncertainties and contingencies, many of which are beyond the control of the
Company. To the extent any such risks, uncertainties and contingencies are
realized, the Company's actual results, performance or achievements could
differ materially from anticipated results, performance or achievements.
Factors that might affect such forward-looking statements include, among other
factors, the factors described under the caption "Risk Factors" in Item 1 of
this report, overall economic and business conditions, economic and business
conditions in the Company's market areas, interest rate fluctuations, the
demand for the Company's products and services, competitive factors in the
industries in which the Company competes, changes in government regulations,
and the timing, impact and other uncertainties of future acquisitions.
In addition to the factors described above, the following are some additional
factors that could cause our financial performance to differ from any
forward-looking statement contained herein: i) changes in interest rates over
the past year and the relative relationship between the various interest rate
indices that the Company uses; ii) a determination in the financial market
affecting the valuation of securities held in the Company's investment
portfolio; (iii) a change in product mix attributable to changing interest
rates, customer preferences or competition; iv) a significant portion of the
Company's loan customers are in the hospitality business and therefore could be
affected by a slower economy, adverse weather conditions and/or rising gasoline
prices; and v) the effectiveness of advertising, marketing and promotional
programs.
The words "believe," "expect," "anticipate," "intend," "estimate," "project" or
the negative of such terms and other similar expressions which are predications
of or indicate future events and trends and which do not relate to historical
matters identify forward-looking statements. Reliance should not be placed on
forward-looking statements because they involve known or unknown risks,
uncertainties or other factors, which may cause the actual results, performance
or achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements. The Company expressly disclaims any obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
Though the Company has attempted to list comprehensively the factors which
might affect forward-looking statements, the Company wishes to caution you that
other factors may in the future prove to be important in affecting the
Company's results of operations. New factors emerge from time to time and it is
not possible for management to anticipate all of such factors, nor can it
assess the impact of each such factor, or combination of factors, which may
cause actual results to differ materially from forward-looking statements.
PART 1
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Northway Financial, Inc. was incorporated on March 7, 1997, under the laws of
the State of New Hampshire, for the purpose of becoming the holding company of
The Berlin City Bank, a New Hampshire chartered bank headquartered in Berlin,
New Hampshire ("BCB"), pursuant to a reorganization transaction (the "BCB
Reorganization") by and among the Company, BCB, and a subsidiary of BCB, and,
thereafter, effecting the merger (the "Merger") by and among the Company, BCB,
Pemi Bancorp, Inc. ("PEMI"), and PEMI's wholly owned subsidiary, The
Pemigewasset National Bank of Plymouth, New Hampshire, a national bank
headquartered in Plymouth, New Hampshire ("PNB"). The BCB Reorganization and
the Merger became effective on September 30, 1997. As of such date, BCB and PNB
(collectively the "Banks"), became wholly owned subsidiaries of the Company.
Unless the context otherwise requires, references herein to the "Company"
include Northway Financial, Inc. and its consolidated subsidiaries.
The Company derives substantially all of its revenue and income from the
furnishing of bank and bank-related services, principally to individuals and
small and medium-sized companies in New Hampshire. BCB and PNB operate as
typical community banking institutions and do not engage in any specialized
finance or capital market activities. The Company functions primarily as the
holder of stock of its subsidiaries and assists the management of its
subsidiaries as appropriate.
The Company is subject to regulation by the New Hampshire Bank Commissioner
(the "Commissioner"), the Federal Deposit Insurance Corporation (the "FDIC"),
the Comptroller of the Currency of the United States (the "OCC"), and the Board
of Governors of the Federal Reserve System. See "Supervision and Regulation."
BCB, which was first organized in 1891, and PNB, which was first organized in
1881, are engaged in a general commercial banking business and offer commercial
and construction loans, real estate mortgages, consumer loans, including
personal secured and unsecured loans, and lines of credit.
During 1998, the Company, through the BCB subsidiary, established an indirect
lending business unit in Concord, New Hampshire. As of July 31, 2004 this line
of business accounted for approximately 30% of the Company's loan portfolio. On
August 25, 2004, the Company announced its exit from the indirect automobile
lending line of business. Effective August 31, 2004, the Company ceased
accepting applications from its dealer network. BCB will continue to service
the existing portfolio of approximately 13,000 loans. The decision to exit this
line of business was predicated on the low interest rate environment and
competitive pressures of the past eighteen months. Over the next twenty-four
months, cash flows from the existing portfolio are expected to be redeployed
into commercial loans, residential mortgage loans, consumer loans such as home
equity loans and automobile loans, and the Company's investment portfolio.
The Banks accept savings, time, demand, NOW and money market deposit accounts,
and offer a variety of banking services including safe deposit boxes, credit
card accounts, official checks and money orders, overdraft lines of credit and
wire transfer services.
Northway is a legal entity separate and distinct from its subsidiaries. The
right of Northway to participate in any distribution of assets or earnings of
any subsidiary is subject to the prior claims of creditors of the subsidiary,
except to the extent that claims, if any, of Northway itself as a creditor may
be recognized. See "Supervision and Regulation".
The following information concerning the Company's investment activities,
lending activities, asset quality and allowance for loan losses should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," appearing under Item 7 of this report and
the Company's Consolidated Financial Statements and Notes thereto.
INVESTMENT ACTIVITIES
The following table presents the carrying amount of the Company's securities
available-for-sale as of December 31, 2004, 2003 and 2002 (dollars in
thousands):
2004 2003 2002
-------- ------- -------
US Treasury and other
US government agency securities $ 54,563 $37,840 $36,188
Mortgage-backed securities (1) 29,301 2,903 12,646
Marketable equity securities 1,931 2,766 2,377
Corporate bonds 12,287 21,983 33,848
State and political subdivision
bonds and notes 3,051 2,590 2,717
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Total securities $101,133 $68,082 $87,776
======== ======= =======
(1) Includes collateralized mortgage obligations
The following table sets forth the amortized cost of the Company's investment
in debt securities maturing within stated periods and their related weighted
average yields, reported on a tax equivalent basis, as of December 31, 2004
(dollars in thousands):
Maturities
- --------------------------------------------------------------------------------
One to Five to Over Total
Within five ten ten amortized
one year years years years cost
-------- ----- ----- ----- ----
Available-for-sale:
US Treasury and other
US government agency
securities $1,999 $47,915 $5,000 $ - $54,914
Mortgage-backed
securities(1) 2 1,158 120 28,177 29,457
Corporate bonds - 9,983 2,018 - 12,001
State and political
subdivision bonds
and notes 1,129 498 819 520 2,966
------ ------- ------ ------- -------
Total amortized cost $3,130 $59,554 $7,957 $28,697 $99,338
====== ======= ====== ======= =======
Market value $3,130 $59,591 $7,961 $28,520 $99,202
====== ======= ====== ======= =======
Weighted average yield 2.71% 3.95% 5.43% 4.64% 4.23%
(1) Includes collateralized mortgage obligations
LENDING ACTIVITIES
The following table sets forth information with respect to the composition of
the Company's loan portfolio, excluding loans held for sale, as of December 31,
2004, 2003, 2002, 2001 and 2000 (dollars in thousands):
December 31,
-------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Real estate:
Residential $147,333 $129,493 $114,526 $109,261 $129,805
Commercial 130,334 120,366 111,941 111,642 100,608
Construction 5,366 3,851 6,330 1,581 5,752
Commercial 27,013 24,528 23,885 22,727 22,270
Installment 29,345 30,291 40,169 28,210 28,177
Indirect installment 116,520 150,807 139,477 120,761 98,919
Other 18,901 14,530 9,652 6,303 7,881
-------- -------- -------- -------- --------
Total loans 474,812 473,866 445,980 400,485 393,412
-------- -------- -------- -------- --------
Less:
Unearned income 106 247 207 169 154
Allowance for loan losses 5,204 5,036 4,920 4,642 4,354
-------- -------- -------- -------- --------
Total unearned income and
allowance for loan losses 5,310 5,283 5,127 4,811 4,508
-------- -------- -------- -------- --------
Net loans $469,502 $468,583 $440,853 $395,674 $388,904
======== ======== ======== ======== ========
The following table presents the maturity distribution of the Company's
real estate construction and commercial loans at December 31, 2004
(dollars in thousands):
Percent of
Amount Total
------ ----------
Within one year $13,361 41.26%
One to five years 9,092 28.08
Over five years 9,926 30.66
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$32,379 100.00%
======= ======
The Company's real estate construction and commercial loans due after one year
at December 31, 2004 were comprised of the following (dollars in thousands):
Amount
Fixed interest rate $ 7,995
Adjustable interest rate 11,023
-------
$19,018
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The following table reflects activity in the Company's allowance for loan
losses for the years ended December 31, 2004, 2003, 2002, 2001 and 2000
(dollars in thousands):
Years ended December 31,
--------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Balance at the beginning
of period $5,036 $4,920 $4,642 $4,354 $4,887
------ ------ ------ ------ ------
Charge-offs:
Real estate 56 - 83 110 213
Commercial 28 120 12 95 1,006
Installment loans to
individuals 581 750 729 529 424
------ ------ ------ ------ ------
Total 665 870 824 734 1,643
------ ------ ------ ------ ------
Recoveries:
Real estate 162 25 64 35 32
Commercial 16 11 4 - -
Installment loans to
individuals 160 145 134 87 96
Credit card - - - - 2
------ ------ ------ ------ ------
Total 338 181 202 122 130
------ ------ ------ ------ ------
Net charge-offs 327 689 622 612 1,513
Provision charged to expense 495 805 900 900 980
------ ------ ------ ------ ------
Balance at the end of period $5,204 $5,036 $4,920 $4,642 $4,354
====== ====== ====== ====== ======
Ratio of net charge-offs to
average loans 0.07% 0.15% 0.15% 0.15% 0.39%
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The following table sets forth the breakdown of the Company's allowance for
loan losses in the Company's portfolio by category of loan and the percentage
of loans in each category to total loans in the respective portfolios at the
dates indicated (dollars in thousands):
December 31,
-------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------- ------------------- ------------------ -------------------- ------------------
Percent of Percent of Percent of Percent of Percent of
loans in each loans in each loans in each loans in each loans in each
category to category to category to category to category to
Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
Real estate:
Residential $ 644 31.0% 624 27.3 598 25.9 585 27.2 1,160 32.9
Commercial &
construction 1,892 28.6 1,724 26.2 2,008 26.7 1,621 28.3 1,009 27.0
Commercial 174 5.7 155 5.2 216 5.4 208 5.7 719 5.7
Installment 2,398 30.7 2,505 38.2 2,084 40.6 1,719 37.2 1,440 32.4
Other 96 4.0 28 3.1 14 1.4 17 1.6 26 2.0
Unallocated -- N/A -- N/A -- N/A 492 N/A -- N/A
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$5,204 100.0% $5,036 100.0% $4,920 100.0% $4,642 100.0% $4,354 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
DEPOSITS
See "Financial Statements and Supplementary Data" in Item 8 of this report.
SUPERVISION AND REGULATION
The business in which the Company is engaged is subject to extensive
supervision, regulation and examination by various bank regulatory authorities
and other governmental agencies. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, and depositors in particular,
rather than the specific protection of stockholders of a bank or its parent
company.
Set forth below is a brief description of certain laws and regulations that
relate to the regulation of the Company. To the extent the following material
describes statutory or regulatory provisions, it is qualified in its entirety
by reference to the particular statute or regulation.
Regulation of the Company
General. As a registered bank holding company, the Company is subject to
regulation under the Bank Holding Company Act of 1956, as amended ("BHCA") and
to inspection, examination and supervision by the Board of Governors of the
Federal Reserve System ("FRB"). The Company is also subject to the laws of the
State of New Hampshire.
The FRB has the authority to issue orders to bank holding companies to cease
and desist from unsound banking practices and violations of conditions imposed
by, or violations of agreements with, the FRB. The FRB is also empowered to
assess civil money penalties against companies or individuals who violate the
BHCA or orders or regulations thereunder, to order termination of non-banking
activities of non-banking subsidiaries of bank holding companies, and to order
termination of ownership and control of a non-banking subsidiary by a bank
holding company. Under the BHCA, the Company may not generally engage in
activities or acquire more than 5% of any class of voting securities of any
company engaged in activities other than banking or activities that are closely
related to banking. Under certain circumstances, the Company may be required to
give notice to or seek approval of the FRB before engaging in activities other
than banking.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"). Riegle-Neal permits adequately capitalized and adequately
managed bank holding companies, as determined by the FRB, to acquire banks in
any state subject to certain concentration limits and other conditions.
Riegle-Neal also generally authorizes the interstate merger of banks. In
addition, among other things, Riegle-Neal permits banks to establish new
branches on an interstate basis provided that the law of the host state
specifically authorizes such action. However, as a bank holding company, the
Company is required to obtain prior FRB approval before acquiring more than 5%
of a class of voting securities, or substantially all of the assets of a bank
holding company, bank or savings association.
Control Acquisitions. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company, such as
the Company, unless the FRB has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the FRB, the
acquisition of 10% or more of a class of voting securities of a bank holding
company with a class of securities registered under Section 12 of the
Securities Exchange Act of 1934, as amended, would, under the circumstances set
forth in the presumption, constitute acquisition of control of the bank holding
company. In addition, a company is required to obtain the approval of the FRB
under the BHCA before acquiring 25% (5% in the case of an acquirer that is a
bank holding company) or more of any class of outstanding voting securities of
a bank holding company, or otherwise obtaining control or a "controlling
influence" over that bank holding company.
Bank Holding Company Dividends. The FRB has authority to prohibit bank holding
companies from paying dividends if such payment is deemed to be unsafe or
unsound. The FRB has indicated generally that it may be an unsafe or unsound
practice for bank holding companies to pay dividends unless the bank holding
company's net income over the preceding year is sufficient to fund the
dividends and the expected rate of earnings retention is consistent with the
organization's capital needs, asset quality and overall financial condition.
The Company depends in part upon dividends received from its subsidiary banks
to fund its activities. As described below, the Federal Deposit Insurance
Corporation ("FDIC") and the Banks' regulatory agencies may regulate the amount
of dividends payable by the subsidiary banks. The inability of the Bank to pay
a dividend may have an adverse effect on the Company.
Regulation of the Banks
General. PNB is a national banking association, organized under the National
Bank Act. As such, its primary regulatory authority is the OCC. The OCC
regularly examines national banks and their operations. In addition, operations
of national banks are subject to federal statutes and regulations. Such
statutes and regulations relate to required capital and reserves, investments,
loans, mergers, payment of dividends, issuance of securities and many other
aspects of operations. Capital requirements applicable to PNB are substantially
similar to those adopted by the FRB regarding bank holding companies as
described above.
The OCC's approval is required for a national bank to pay dividends if the
total dividends declared by a national bank in any year will exceed the total
of its net profits for that year combined with its retained net profits for the
preceding two years, less any required transfer to surplus. The OCC has the
authority to approve or disapprove mergers, consolidations, the establishment
of branches and similar corporate actions. The OCC also has the power to
prevent a national bank from engaging in unsafe or unsound practices or
violating applicable laws in conducting its business.
Under the Gramm-Leach-Bliley Act (1999) ("GLBA"), the OCC permits national
banks, to the extent permitted under state law, to engage in certain new
activities which are permissible for subsidiaries of a financial holding
company. Further, it expressly preserves the ability of national banks to
retain all existing subsidiaries.
PNB is also subject to applicable provisions of New Hampshire law to the extent
that such laws do not conflict with, or are not otherwise preempted by federal
banking law.
BCB is organized under New Hampshire law and is subject to the regulations of
the Commissioner and the FDIC, including requirements and restrictions related
to the maintenance of adequate levels of capital, the payment of dividends,
investments, the nature and amount of loans which can be originated and the
rate of interest that can be charged thereon, and other activities. Capital
requirements applicable to BCB are substantially similar to those adopted by
the FRB regarding bank holding companies as described above.
Insurance of Accounts and FDIC Regulation. The Banks pay deposit insurance
premiums to the FDIC based on an assessment rate established by the FDIC for
Bank Insurance Fund-member institutions. The FDIC has established a risk-based
premium system under which the FDIC classifies institutions based on their
capital ratios and on other relevant factors and generally assesses higher
rates on those institutions that tend to pose greater risks to the federal
deposit insurance funds. The Federal Deposit Insurance Act ("FDIA") does not
require the FDIC to charge all banks deposit insurance premiums when the ratio
of deposit insurance reserves to insured deposits is maintained above specified
levels. However, as a result of general economic conditions and bank failures,
it is possible that the ratio of deposit insurance reserves to insured deposits
could fall below the minimum ratio that FDIA requires, which would result in
the FDIC setting deposit insurance assessment rates sufficient to increase
deposit insurance reserves to the required ratio. We cannot predict whether the
FDIC will be required to increase deposit insurance assessments on the Banks
above their current levels.
Bank Holding Company Support of Subsidiary Banks. Under FRB policy, a bank
holding company is expected to act as a source of financial and managerial
strength to each of its subsidiary banks and to commit resources to their
support. This support may be required at times when the bank holding company
may not have the resources to provide it. Similarly, under the cross-guarantee
provisions of FDIA, the FDIC can hold any FDIC-insured depository institution
liable for any loss suffered or anticipated by the FDIC in connection with (1)
the "default" of a commonly controlled FDIC-insured depository institution; or
(2) any assistance provided by the FDIC to a commonly controlled FDIC-insured
depository institution "in danger of default." Both BCB and PNB are
FDIC-insured depository institutions.
Regulatory Capital Requirements. The FRB and the FDIC have issued substantially
similar risk-based and leverage capital guidelines applicable to United States
banking organizations. In addition, these regulatory agencies may from time to
time require that a banking organization maintain capital above the minimum
levels, whether because of its financial condition or actual or anticipated
growth.
The FRB risk-based guidelines define a three-tier capital framework. Tier 1
capital includes common stockholders' equity and qualifying preferred stock,
less goodwill and other adjustments. Tier 2 capital consists of preferred stock
not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts
of subordinated debt, other qualifying term debt and the allowance for loan
losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes
subordinated debt that is unsecured, fully paid, has an original maturity of at
least two years, is not redeemable before maturity without prior approval by
the FRB and includes a lock-in clause precluding payment of either interest or
principal if the payment would cause the issuing bank's risk-based capital
ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier
2 capital less investments in unconsolidated subsidiaries represents qualifying
total capital. Risk-based capital ratios are calculated by dividing Tier 1 and
total capital by risk-weighted assets. Assets and off-balance sheet exposures
are assigned to one of four categories of risk-weights, based primarily on
relative credit risk. The minimum Tier 1 capital ratio is four percent and the
minimum total capital ratio is eight percent. The Company's tier 1 calculation
equals 11.80% and its total capital ratio is 13.94%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average
total assets. Although the stated minimum ratio is 100 to 200 basis points
above three percent, banking organizations are required to maintain a ratio of
at least five percent to be classified as "well capitalized". The Company's
leverage ratio is 8.43%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
among other things, identifies five capital categories for insured depository
institutions (well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized) and requires
the federal bank regulatory agencies to implement systems for "prompt
corrective action" for insured depository institutions that do not meet minimum
capital requirements within such categories. FDICIA imposes progressively more
restrictive constraints on operations, management and capital distributions,
depending on the category in which an institution is classified. Failure to
meet the capital guidelines could also subject a banking institution to capital
raising requirements. An "undercapitalized" bank must develop a capital
restoration plan and its parent holding company must guarantee that bank's
compliance with the plan. The liability of the parent holding company under any
such guarantee is limited to the lesser of five percent of the bank's assets at
the time it became "undercapitalized" or the amount needed to comply with the
plan. Furthermore, in the event of the bankruptcy of the parent holding
company, such guarantee would take priority over the parent's general unsecured
creditors. In addition, FDICIA requires the various regulatory agencies to
prescribe certain non-capital standards for safety and soundness relating
generally to operations and management, asset quality and executive
compensation and permits regulatory action against a financial institution that
does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations
that define the five capital categories identified by FDICIA, using the total
risk-based capital, Tier 1 risk-based capital and leverage capital ratios as
the relevant capital measures. Such regulations establish various degrees of
corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 risk-based capital ratio of at least six percent, a total
risk-based capital ratio of at least ten percent and a leverage ratio of at
least five percent and not be subject to a capital directive order. Regulators
also must take into consideration (a) concentrations of credit risk; (b)
interest rate risk (when the interest rate sensitivity of an institution's
assets does not match the sensitivity of its liabilities or its
off-balance-sheet position); and (c) risks from non-traditional activities, as
well as an institution's ability to manage those risks, when determining the
adequacy of an institution's capital. This evaluation will be made as a part of
the institution's regular safety and soundness examination. In addition, the
Company, and any Bank with significant trading activity, must incorporate a
measure for market risk in their regulatory capital calculations. As of
December 31, 2004, the most recent notification from the FDIC categorized both
Banks as "well capitalized".
U.S. bank regulatory authorities and international bank supervisory
organizations, principally the Basel Committee on Banking Supervision ("Basel
Committee"), have proposed changes to the risk-based capital adequacy
framework, which ultimately could affect the appropriate capital guidelines,
including changes (such as those relating to lending to registered
broker-dealers) that are of particular relevance to banks, such as the Banks,
that engage in significant securities activities. Among other things, the Basel
Committee rules, which were proposed formally for public comment in May 2003
and are expected to become effective around early 2007, would add operational
risk as a third component to the denominator of the risk-capital calculation,
which currently includes only credit and market risks.
The Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
lenders to identify the communities served by the institution's offices and
other deposit taking facilities and to make loans and investments and provide
services that meet the credit needs of these communities. Regulatory agencies
examine each of the Banks and rate such institutions' compliance with CRA as
"Outstanding," "Satisfactory," "Needs to Improve," or "Substantial
Noncompliance." Failure of an institution to receive at least a "Satisfactory"
rating could inhibit such institution or its holding company from undertaking
certain activities, including engaging in activities newly permitted as a
financial holding company under the GLBA and acquisitions of other financial
institutions. The FRB must take into account the record of performance of banks
in meeting the credit needs of the entire community served, including low-and
moderate-income neighborhoods. New Hampshire also has enacted substantially
similar community reinvestment requirements. PNB has achieved a rating of
"outstanding" and BCB a rating of "satisfactory" on their most recent
examinations.
Customer Information Security and Privacy. The FDIC and other bank regulatory
agencies have adopted final guidelines for establishing standards for
safeguarding nonpublic personal information about customers that implement
provisions of GLBA, which establishes a comprehensive framework to permit
affiliations among commercial banks, insurance companies, securities firms, and
other financial service providers by revising and expanding the BHCA framework.
Specifically, the Information Security Guidelines established by the GLBA
require each financial institution, under the supervision and ongoing oversight
of its board of directors or an appropriate committee thereof, to develop,
implement and maintain a comprehensive written information security program
designed to ensure the security and confidentiality of customer information, to
protect against anticipated threats or hazards to the security or integrity of
such information; and to protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to any
customer.
The GLBA requires financial institutions to implement policies and procedures
regarding the disclosure of nonpublic personal information about consumers to
nonaffiliated third parties. In general, the statute requires financial
institutions to explain to consumers their policies and procedures regarding
the disclosure of such nonpublic personal information, and, unless otherwise
required or permitted by law, financial institutions are prohibited from
disclosing such information except as provided in their policies and
procedures.
USA PATRIOT Act. The USA PATRIOT Act of 2001 (The "USA PATRIOT Act"), designed
to deny terrorists and others the ability to obtain anonymous access to the
U.S. financial system, has significant implications for depository
institutions, broker-dealers and other businesses involved in the transfer of
money. The USA PATRIOT Act, together with the implementing regulations of
various federal regulatory agencies, have caused financial institutions,
including banks, to adopt and implement additional, or amend existing, policies
and procedures with respect to, among other things, anti-money laundering
compliance, suspicious activity and currency transaction reporting, customer
identity verification and customer risk analysis. The statute and its
underlying regulations also permit information sharing for counter-terrorist
purposes between federal law enforcement agencies and financial institutions,
as well as among financial institutions, subject to certain conditions, and
require the FRB (and other federal banking agencies) to evaluate the
effectiveness of an applicant in combating money laundering activities when
considering applications filed under Section 3 of the BHCA or under the Bank
Merger Act. Management believes that the Company is in compliance with all the
requirements prescribed by the USA PATRIOT Act and all applicable final
implementing regulations.
COMPETITION
The banking industry in the United States, which includes commercial banks,
savings and loan associations, mutual savings banks, capital stock savings
banks, credit unions, and bank and savings and loan holding companies, is part
of the broader financial services industry which includes insurance companies,
mutual funds, and the brokerage industry, among others. In recent years,
intense market demands and economic pressures have eroded once clearly defined
industry classifications and have forced financial services institutions to
diversify their services, increase returns on deposits, and become more
cost-effective as a result of competition with one another and with new types
of financial services companies, including non-bank competitors.
The Company's banking subsidiaries face significant competition in their
respective markets from commercial banks, savings banks, credit unions,
consumer finance companies, insurance companies, "non-bank banks," mutual
funds, government agencies, investment management companies, investment
advisors, brokers and investment bankers. In addition, increasing consolidation
within the banking and financial services industry, as well as increased
competition from larger regional and out-of-state banking organizations and
non-bank providers of various financial services, may adversely affect the
Company's ability to achieve its financial goals. Federal banking laws permit
adequately capitalized bank holding companies to venture across state lines to
offer banking services through bank subsidiaries to a wider geographic market.
Consequently, it is possible for large organizations to enter many new markets
including the markets served by the Company. Certain of these competitors, by
virtue of their size and resources, may enjoy certain efficiencies and
competitive advantages over the Company in pricing, delivery, and marketing of
their products and services. The Company's long-term success depends on the
ability of the Company's banking subsidiaries to compete successfully with
other financial institutions in their service areas. It is not possible to
assess what impact these changes in the regulatory environment will have on the
Company. Many of these large competitors have significantly more financial
resources, larger market share and greater name recognition in the market areas
served by the Company and its banking subsidiaries.
BCB and PNB compete in this environment by providing a broad range of financial
services, competitive interest rates and a personal level of service that,
combined, tend to retain the loyalty of its customers in its market areas
against competitors with far larger resources. To a lesser extent, convenience
of branch locations and hours of operations are also considered competitive
advantages of the Banks.
RISK FACTORS
The discussions set forth below contain certain statements that may be
considered "forward-looking statements." Forward-looking statements involve
unknown risks, uncertainties and other factors that may cause the Company's
actual results to materially differ from those projected in the forward-looking
statements. For further information regarding forward-looking statements, you
should review the discussion under the caption "FORWARD-LOOKING STATEMENTS" on
page 1 of this report.
Recent accounting changes could give rise to adverse changes in the regulatory
capital treatment of junior subordinated debentures, including currently
outstanding junior subordinated debentures of the Company which, in turn, could
adversely affect the Company's regulatory capital position. In January 2003,
the Financial Accounting Standards Board ("FASB") issued FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN 46") that addresses
the consolidation rules to be applied to "variable interest entities" as
defined in FIN 46. FIN 46, which applies to certain variable interest entities
as of February 1, 2003 and to all variable interest entities as of December 14,
2003, provides that certain variable interest entities should not be treated as
consolidated subsidiaries. Northway Capital Trust I and Northway Capital Trust
II, the Company's Delaware statutory business trusts, may constitute variable
interest entities. Historically, issuer trusts, such as Northway Capital Trust
I and Northway Capital Trust II that issued junior subordinated debentures have
been consolidated by their parent companies. In addition, junior subordinated
debentures have been treated as eligible for Tier 1 capital treatment by bank
holding companies under the FRB's rules and regulations relating to minority
interests in equity accounts of consolidated subsidiaries. Accordingly, the
Company has consolidated its existing issuer trusts in preparing its
consolidated financial statements in the past, and the Company's outstanding
junior subordinated debentures have been treated as Tier 1 capital.
On December 24, 2003, FASB issued a revision to FIN 46 ("FIN46R"), to clarify
some of the provisions of FIN 46. Based on FIN46R, the Company deconsolidated
its existing issuer trusts as of December 31, 2003, and restated their
historical financial statements. The adoption of FIN46R results in the
reclassification of the redeemable junior subordinated debentures from
mezzanine capital to other liabilities as well as the reclassification of
interest cost from minority interest to interest expense.
This deconsolidation could result in a change to the regulatory capital
treatment of junior subordinated debentures issued by the Company and other
U.S. bank holding companies. Specifically, it is possible that since the issuer
trusts would no longer be consolidated by the Company the junior subordinated
debentures issued by each such issuer trust would not be considered a minority
interest in equity accounts of a consolidated subsidiary and therefore not be
accorded Tier 1 capital treatment by the FRB. Trust preferred securities have
historically been eligible for Tier 1 capital treatment by bank holding
companies under FRB rules and regulations relating to minority interests in
equity accounts of consolidated subsidiaries. Following the issuance of FIN 46,
including the consolidation rules with respect to variable interest entities,
the FRB requested public comment on a proposed rule that would limit trust
preferred securities in the Tier 1 capital of bank holding companies, but with
stricter limits and clearer qualitative standards. After considering the public
comments, the FRB issued a final rule on March 1, 2005, which provides that
after a five-year transition period ending on March 31, 2009, the aggregate
amount of the trust preferred securities and certain other capital elements
would be limited to 25% of Tier 1 capital elements, net of goodwill and
intangibles. As of December 31, 2004, assuming the aggregate amount of the
trust preferred securities is limited to 25% of Tier 1 capital, the Company
would still exceed the regulatory required minimums for capital adequacy
purposes.
The Company could be adversely impacted by changes in applicable regulations.
The Company is subject to extensive federal and state laws and regulations and
is subject to supervision, regulation and examination by various federal and
state bank regulatory agencies. The restrictions imposed by such laws and
regulations limit the manner in which the Company and its bank subsidiaries may
conduct business and obtain financing. There can be no assurance that any
modification of these laws and regulations, or new legislation that may be
enacted, in the future will not make compliance more difficult or expensive,
restrict the Company's ability to originate, broker or sell loans or otherwise
adversely affect the operations of the Company. See "Supervision and
Regulation" on page 5 of this report.
The Company's business is largely dependent upon the hospitality industry. A
number of the Company's loan customers are in the hospitality industry. The
hospitality industry is dependent on personal discretionary spending levels. As
a result, the hospitality industry may be adversely impacted by economic
trends, including recession and increased unemployment. Additionally,
unforeseen events including acts of terrorism, war, increases in fuel prices,
travel-related accidents and unusual weather patterns also may adversely affect
the hospitality industry. As a result, the Company's business also is likely to
be adversely affected by those events.
Interest rate volatility may adversely impact the Company's results of
operations. The principal component of the Company's income stream is net
interest and dividend income. Net interest and dividend income is the
difference between interest and fee income on earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities,
such as deposits and borrowed funds. The Company's net interest and dividend
income may be significantly affected by changes in market interest rates. A
decrease in interest rates could reduce the Company's net interest and dividend
income as the difference between interest and fee income and interest expense
decreases. An increase in interest rates could also negatively impact the
Company's results of operations by reducing borrowers' ability to repay their
current loan obligations, resulting in increased loan defaults, foreclosures
and write-offs and could necessitate increases to the Company's allowance for
loan losses. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 of this report.
The Company's allowance for loan losses may not be adequate to cover actual
losses. The Company makes various assumptions and judgments about the
collectibility of its loan portfolio and provides an allowance for potential
loan losses based on several factors. If the Company's assumptions are
incorrect, its allowance for loan losses may be insufficient to cover its
actual losses, which would have an adverse effect on the Company's results of
operations, and may cause the Company to increase the allowance in the future.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this report.
Changes in the securities market may adversely impact the Company's results of
operations. In recent years the securities market has experienced a significant
downturn and will likely continue to experience volatility as a result of,
among other things, global economic and political conditions. Continued
declines in equity prices, as well as declines in the performance of certain
sectors or specific companies, may result in a corresponding decline in the
value of Company-held securities. The decline in the value of Company-held
securities may decrease the Company's earnings. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Item 7 of
this report.
EMPLOYEES
As of December 31, 2004 the Company has 246 full-time equivalent employees. The
Company considers its employee relations to be good.
WEBSITE ACCESS TO COMPANY REPORTS
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports are available
free of charge on the Company's website at www.northwayfinancialinc.com as soon
as reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission. Also, copies of the
Company's annual report will be made available, free of charge, upon written
request.
ITEM 2. PROPERTIES
The Company operates 20 branch offices, one commercial lending and
administration facility and one consumer loan origination facility that are
located in the central and northern New Hampshire communities of Berlin, Conway
(five offices), Gorham (two offices), Groveton, Littleton, West Ossipee, West
Plymouth, Plymouth, Campton, Ashland, North Woodstock, Tilton, Franklin,
Laconia, Belmont, Pittsfield and Concord. Fifteen of these offices are located
on properties the Company owns. The Company leases six of its branches and the
consumer loan origination facility. Two facilities are leased as tenants at
will while the remaining five facilities are leased under contracts that expire
between June 30, 2005 and December 12, 2008. Furthermore, two of the leases
have an option to renew for an additional five years. Seventeen of the
Company's branches have drive-up facilities and all are equipped with automated
teller machines.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor are any of its subsidiaries the subject of,
any material pending legal proceedings, other than ordinary routine litigation
incidental to the business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on The Nasdaq Stock Market, Inc.'s
National Market under the symbol "NWFI". The following table sets forth, for
the periods indicated, the high and low closing sale prices for the common
stock, as reported by The Nasdaq National Market, and the dividends paid on the
common stock:
Price Per Share
---------------------- Dividends
Low High Per Share
----- ------ ---------
2004 4th Quarter $31.30 $34.96 $0.17
3rd Quarter 29.30 35.12 0.17
2nd Quarter 33.50 38.60 0.17
1st Quarter 34.03 38.00 0.17
2003 4th Quarter $29.99 $35.49 $0.17
3rd Quarter 29.10 30.97 0.17
2nd Quarter 28.01 30.65 0.17
1st Quarter 28.81 31.25 0.17
The Company intends to continue to pay dividends on a quarterly basis subject
to, among other things, the financial condition and earnings of the Company,
capital requirements, and other factors, including applicable governmental
regulations. No dividends will be payable unless declared by the Board of
Directors and then only to the extent funds are legally available for the
payment of such dividends.
On March 4, 2005, the closing sales price of the common stock on the Nasdaq
National Market was $35.41 per share. As of such date, there were approximately
1,150 holders of record of the Company common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth the selected consolidated financial information of the Company for the five years in the period
ended December 31, 2004. This selected consolidated financial information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" appearing under Item 7 of this report and "Financial
Statements and Supplementary Data" appearing under Item 8 of this report.
At or for the years ended December 31, 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Balance Sheet Data:
Total assets $638,418 $609,216 $598,945 $513,939 $485,144
Securities available-for-sale, at fair value 101,133 68,082 87,776 55,564 50,288
Securities held-to-maturity -- -- -- -- 2,752
Loans, net of unearned income 474,706 473,619 445,773 400,316 393,258
Allowance for loan losses 5,204 5,036 4,920 4,642 4,354
Other real estate owned -- -- 175 22 25
Unidentifiable intangible assets -- -- -- 8,080 5,098
Goodwill 10,152 10,152 10,152 - -
Core deposit intangible 2,949 3,903 4,857 - -
Deposits 475,359 463,307 476,194 412,840 391,772
Long-term debt 98,620 87,620 66,620 48,028 35,528
Stockholders' equity 49,510 47,872 44,266 43,339 41,562
Income Statement Data:
Net interest and dividend income $ 22,846 $ 23,050 $ 21,664 $ 20,721 $ 21,253
Provision for loan losses 495 805 900 900 980
Noninterest income 5,097 5,375 3,396 2,909 2,692
Noninterest expense 22,394 22,136 20,035 17,149 16,699
Net income 3,388 3,617 2,598 3,873 4,159
Per Common Share Data:
Net income - basic $ 2.26 $ 2.40 $ 1.71 $ 2.55 $ 2.61
Net income - assuming dilution 2.24 2.39 1.71 2.54 2.61
Cash dividends declared 0.68 0.68 0.68 0.68 0.60
Book value 32.93 31.92 29.19 28.68 26.74
Tangible book value 24.02 22.30 19.07 23.16 23.41
Selected Ratios:
Return on average assets 0.54% 0.59% 0.49% 0.78% 0.86%
Return on average equity 6.97 7.82 5.86 9.14 10.29
Dividend payout 30.10 28.28 39.65 26.54 22.96
Average equity to average assets 7.75 7.61 8.33 8.58 8.31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of this discussion is to focus on significant changes in the
financial condition and results of operations of the Company. It is intended to
supplement and highlight information contained in the accompanying consolidated
financial statements and the selected financial data presented elsewhere in
this report. The discussion set forth below contains certain statements that
may be considered "forward-looking statements." Forward-looking statements
involve risks, uncertainties and other factors that may cause the Company's
actual results to materially differ from those projected in the
forwarding-looking statements. For further information regarding
forward-looking statements, you should review the discussion under the caption
"FORWARD-LOOKING STATEMENTS" on page 1 of this report.
OVERVIEW OF PERFORMANCE
The Company derives substantially all of its revenue and income from community
bank-related activities. The Banks operate as typical community banking
institutions and do not engage in any specialized finance or capital markets
activities. Northway functions primarily as the holder of stock of its
subsidiaries and assists in the management of the operations of its
subsidiaries as appropriate.
The principal components of the Company's income sources are net interest and
dividend income. Net interest and dividend income is the difference between
interest and fee income received on income earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities,
such as deposits and borrowed funds. Our other sources of income include
revenues from fee-based services, such as debit card and ATM fees and sales of
securities.
Economic and industry factors that could cause the Company's financial
performance to differ from expected results include changes in applicable
federal and state regulations, changes in the hospitality industry on which the
Company's business is largely dependent, interest rate volatility, significant
changes in loan losses which may affect the Company's allowance for loan losses
and the related provision for loan losses, and changes in the securities market
that would affect the performance of the Company's investment portfolio.
Management evaluates each of these factors on an ongoing basis to determine
their impact and to effect any strategies necessary to mitigate these risks.
The Company reported net income of $3,388,000, or $2.26 per common share, in
2004 compared to net income of $3,617,000, or $2.40 per common share, in 2003
and $2,598,000, or $1.71 per common share, in 2002. Return on average equity
was 6.97% in 2004, compared to 7.82% in 2003 and 5.86% in 2002. Return on
average assets was 0.54% in 2004, compared to 0.59% in 2003 and 0.49% in 2002.
During 2004, the Company recorded a decrease in interest and dividend income of
$1,230,000, as a decrease in the average yield on earning assets of 0.40% was
only partially offset by an increase in average earning assets of $18,885,000.
This was partially offset by the fact that the continuation of a low interest
rate environment provided the Company further opportunity to reduce its average
cost of interest bearing liabilities. During 2004, the cost of interest bearing
liabilities decreased 0.25%, resulting in a decrease in interest expense of
$1,026,000. The Company recorded a reduction in the provision for loan losses
of $310,000 as the total provision for 2004 was $495,000 compared to $805,000
for 2003. The decrease in the provision for loan losses was the result of an
ongoing review of the adequacy of the allowance for loan losses. Noninterest
income, excluding securities gains, increased $491,000 from last year. This
reflects, in part, the impact of a new non-deposit product line introduced
earlier in 2004, in addition to our continuing efforts to maximize all
components of noninterest income, including the introduction of Bounce
Protection(TM) in 2004. Less favorable market conditions for investment
securities resulted in lower securities gains for the year than in 2003, as
realized gains decreased $769,000 to $753,000. Noninterest expense increased
$258,000 to $22,394,000 in 2004 compared to $22,136,000 in 2003 due primarily
to an increase in salaries and benefits expense.
During 2003, the Company took advantage of the improved market conditions for
investment securities and realized securities gains totaling $1,522,000
compared to $151,000 for the prior year. The low interest rate environment
resulted in significant mortgage refinancing activity. The Company decided to
sell a portion of this loan volume in the secondary market based on the
Company's underwriting standards. The result of these sales was an increase in
gain on sale of loans of $163,000 to $422,000 in 2003. The current low interest
rate environment also provided the Company an opportunity to reduce its average
cost of interest bearing liabilities by 0.59%. In addition, this rate
environment allowed the Company to increase its average outstanding borrowings
at very attractive rates and use the proceeds to fund increases in both average
loans and investments.
NET INTEREST AND DIVIDEND INCOME ANALYSIS
Fluctuations in interest rates as well as changes in volume and mix of income
earning assets and interest-bearing liabilities can materially impact net
interest and dividend income, the principal source of our income. The
discussion of net interest and dividend income is presented on a taxable
equivalent basis, unless otherwise noted, to facilitate performance comparisons
among various taxable and tax-exempt assets.
The table below under the caption "Consolidated Average Balances, Interest and
Dividend Income/Expense and Average Yields/Rates," presents the average
balances, income earned or interest paid, and average yields earned or rates
paid on our assets and liabilities for the years ended December 31, 2004, 2003,
and 2002.
Net interest and dividend income for 2004 decreased $162,000, or 1%, compared
to 2003. Interest and dividend income decreased $1,188,000, or 4%, in 2004
compared to 2003. The continued suppression of market interest rates during
2004 resulted in a 0.39% decrease in the yield on average earning assets. A
0.48% decrease in the yield on loans was partially offset by an increase in
average loan balances of $17,105,000. This resulted in a net decrease of
$1,294,000, or 5%, in interest and fees on loans. The decrease in interest and
fees on loans was partially offset by an increase in interest and dividend
income on securities of $100,000, which was the result of an increase in
average balances of $6,450,000 partially offset by a decrease in average yield
of 0.22%.
Interest expense decreased $1,026,000, or 12%, in 2004 compared to 2003. The
decrease in interest expense was due primarily to a 0.25% decrease in rates
paid on interest bearing liabilities partially offset by an increase in average
balances of $11,061,000. The increase in average balances is primarily the
result of increases in average Federal Home Loan Bank ("FHLB") advances of
$17,473,000. Total average deposits, including noninterest bearing DDA,
decreased $1,373,000 but a shift in the mix of deposits resulted in a decrease
in time deposits of $20,791,000 partially offset by higher average balances in
demand deposits, NOW accounts and savings accounts, which are all lower cost
sources of funds for the Company.
Net interest and dividend income for 2003 increased $1,466,000, or 7%, compared
to 2002. Interest and dividend income increased $85,000 in 2003 compared to
2002. This was due to an increase in average earning assets of $66,220,000
which increase was partially offset by a 0.74% decrease in the yield on average
earning assets. Interest income and fees on loans increased $124,000 which
increase was primarily due to an increase in the average balance of $57,193,000
partially offset by a decrease in the average yield of 0.81%. Furthermore,
interest and dividend income on securities increased $114,000 as an increase in
average securities of $12,846,000 was partially offset by a decrease in the
average yield on securities of 0.69%. These increases in interest and dividend
income were partially offset by a decrease in interest income on federal funds
sold of $153,000 as the average balance decreased $3,818,000 and was
accompanied by a decrease in the average yield of 0.65%.
Interest expense decreased $1,381,000, or 14%, in 2003 compared to 2002. The
decrease in net interest expense was due primarily to a 0.59% decrease in the
average rate paid on interest bearing liabilities partially offset by an
increase in average interest bearing liability balances of $65,798,000. The
decrease in the rate paid on interest bearing liabilities was a function of
both the acquisition of long-term debt at attractive rates as well as a
decision by management to lower rates on interest bearing deposits. The
increase in the average liability balance is the result of increases in average
FHLB advances of $16,570,000 as the Company took advantage of the current low
rate environment to borrow $28,000,000 in medium-term advances at an average
rate of 2.74%. Furthermore, the average balance in junior subordinated
debentures increased $8,971,000 as a result of the inclusion of this debt,
which was issued during 2002, for the full 2003 fiscal year as compared to six
months in fiscal 2002. Average interest bearing deposits increased $40,527,000
due primarily to the fact that deposits acquired in October 2002 were recorded
for the full 2003 fiscal year.
The trend in net interest and dividend income is commonly evaluated in terms of
average rates using net interest margin and interest rate spread. The net
interest margin is computed by dividing fully taxable equivalent net interest
and dividend income by average total earning assets. This ratio represents the
difference between the average yield returned on average earning assets and the
average rate paid for all funds used to support those earning assets, including
both interest bearing and noninterest bearing sources of funds. The net
interest margin decreased 0.17% to 3.99% in 2004 after having decreased 0.26%
to 4.16% in 2003. The decrease in the net interest margin for 2004 was a direct
result of the decrease in the yield on earning assets, which decrease was only
partially offset by the decrease in the cost of funds.
The interest rate spread measures the difference between the average yield on
earning assets and the average rate paid on interest bearing liabilities. The
interest rate spread eliminates the impact of noninterest bearing funds and
gives a direct perspective on the effect of interest rate fluctuations. During
2004, the net interest rate spread decreased 0.14% to 3.78% as the yield on
earning assets declined 0.39% and was only partially offset by a decrease in
the cost of interest bearing liabilities of 0.25%. During 2003, the net
interest rate spread decreased 0.15% to 3.92% as the yield on earning assets
declined 0.74% and was only partially offset by a decrease in the cost of
interest bearing liabilities of 0.59%.
See the tables below under the captions "Consolidated Average Balances,
Interest and Dividend Income/Expense and Average Yields/Rates" and
"Consolidated Rate/Volume Variance Analysis" for more information.
CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND AVERAGE YIELDS/RATES
($000 Omitted)
For the Year Ended December 31,
2004 2003 2002
------------------------------ ----------------------------- ------------------------------
Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
--------- --------- --------- --------- --------- --------- --------- --------- ----------
Assets
Interest earning assets:
Federal funds sold $ 10,564 $ 125 1.18% $ 15,153 $ 118 0.78% $ 18,971 $ 271 1.43%
Interest bearing deposits 143 1 0.70 224 2 0.89 225 2 0.89
Securities (1) (2) 86,236 3,684 4.27 79,786 3,584 4.49 66,940 3,470 5.18
Loans, net (3) (4) 483,865 26,821 5.54 466,760 28,115 6.02 409,567 27,991 6.83
------- ------- -------- ------- -------- -------
Total interest earning
assets (5) 580,808 30,631 5.27 561,923 31,819 5.66 495,703 31,734 6.40
------- ------- -------
Cash and due from banks 15,637 14,907 14,597
Allowance for loan losses (5,104) (4,983) (4,794)
Premises and equipment, net 13,444 12,447 12,064
Other assets 22,574 23,753 14,960
-------- -------- --------
Total assets $627,359 $608,047 $532,530
======== ======== ========
Liabilities
Interest bearing liabilities:
Regular savings $ 85,319 220 0.26 $ 80,741 338 0.42 $ 70,559 712 1.01
NOW and super NOW 97,170 334 0.34 87,212 285 0.33 66,742 273 0.41
Money market accounts 65,286 460 0.70 66,159 495 0.75 54,676 894 1.64
Certificates of deposit 140,614 2,136 1.52 161,405 3,304 2.05 163,013 4,650 2.85
Securities sold under
agreements to repurchase 8,611 87 1.01 7,895 123 1.56 8,165 136 1.67
FHLB advances 80,744 3,115 3.86 63,271 2,876 4.55 46,701 2,508 5.37
Junior subordinated
debentures 20,620 1,079 5.23 20,620 1,036 5.02 11,649 665 5.71
------- ------ ------- ------ ------- ----
Total interest bearing
liabilities 498,364 7,431 1.49 487,303 8,457 1.74 421,505 9,838 2.33
------- ------- -------- ------- -------- -------
Noninterest bearing deposits 76,915 71,160 64,513
Other liabilities 3,475 3,307 2,180
-------- -------- --------
Total liabilities 578,754 561,770 488,198
Stockholders' equity 48,605 46,277 44,332
------ ------ ------
Total liabilities and
stockholders' Equity $627,359 $608,047 $532,530
======== ======== ========
Net interest and dividend
income(6) $23,200 $23,362 $21,896
======= ======= =======
Interest rate spread (7) 3.78% 3.92% 4.07%
Net interest margin (8) 3.99% 4.16% 4.42%
(1) Reported on a tax equivalent basis. Reported interest on securities of $3,582,000, $3,470,000 and $3,297,000 was adjusted by
$102,000, $114,000 and $173,000, for 2004, 2003 and 2002, respectively, to reflect the tax equivalent adjustment.
(2) Average balances are calculated using the adjusted cost basis.
(3) Reported on a tax equivalent basis. Reported interest and fees on loans of $26,569,000, $27,917,000 and $27,912,000 was
adjusted by $252,000, $198,000 and $79,000 for 2004, 2003 and 2002, respectively, to reflect the tax equivalent adjustment.
(4) Net of unearned income. Includes loans held for sale and nonperforming loans.
(5) Reported on a tax equivalent basis. Reported interest and dividend income of $30,277,000, $31,507,000 and $31,482,000 was
adjusted by $354,000, $312,000 and $252,000 for 2004, 2003 and 2002, respectively, to reflect the tax equivalent adjustment.
(6) Reported on a tax equivalent basis. Reported net interest and dividend income of $22,846,000, $23,050,000 and $21,644,000 was
adjusted by $354,000, $312,000 and $252,000 for 2004, 2003 and 2002, respectively, to reflect the tax equivalent adjustment.
(7) Interest rate spread equals the yield on interest earning assets minus the rate paid on interest bearing liabilities.
(8) The net interest margin equals net interest income divided by total average interest earning assets.
CONSOLIDATED RATE/VOLUME VARIANCE ANALYSIS(1)
($000 Omitted)
2004 Compared to 2003 2003 Compared to 2002
Increase (Decrease) Due to Change In Increase (Decrease) Due to Change In
------------------------------------------- ------------------------------------------
Volume Rate Mix Total Volume Rate Mix Total
------ ---- --- ----- ------ ---- --- -----
Interest and dividend income:
Federal funds sold $ (36) $ 61 $ (18) $ 7 $ (55) $ (123) $ 25 $ (153)
Interest bearing deposits (1) -- -- (1) -- -- -- --
Securities 290 (176) (14) 100 666 (463) (89) 114
Loans 1,030 (2,242) (82) (1,294) 3,909 (3,321) (464) 124
------- ------- ------- ------- ------- ------- ------- -------
Total interest and
dividend income 1,283 (2,357) (114) (1,188) 4,520 (3,907) (528) 85
------- ------- ------- ------- ------- ------- ------- -------
Interest expense:
Regular savings 19 (130) (7) (118) 103 (417) (60) (374)
NOW and super NOW 32 15 2 49 83 (55) (16) 12
Money market accounts (6) (29) -- (35) 188 (485) (102) (399)
Certificates of deposit (426) (852) 110 (1,168) (46) (1,313) 13 (1,346)
Securities sold under
agreements to repurchase 11 (43) (4) (36) (4) (9) -- (13)
FHLB advances 794 (435) (120) 239 890 (385) (137) 368
Junior subordinated debentures -- 43 -- 43 512 (80) (61) 371
------- ------- ------- ------- ------- ------- ------- -------
Total interest expense 424 (1,431) (19) (1,026) 1,726 (2,744) (363) (1,381)
------- ------- ------- ------- ------- ------- ------- -------
Net interest and dividend income $ 859 $ (926) $ (95) $ (162) $ 2,794 $(1,163) $ (165) $ 1,466
======= ======= ======= ======= ======= ======= ======= =======
(1) Reported on a tax equivalent basis.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents the annual cost of providing an
allowance for losses inherent in the loan portfolio. The size of the provision
for each year is determined by management based upon many factors, including
loan growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's assessment of loan portfolio quality, the value of
collateral and general economic factors.
The provision for loan losses was $495,000 in 2004, a decrease of $310,000 from
the provision recorded in 2003. The 2003 provision of $805,000 decreased
$95,000 from the provision recorded in 2002. The provision for each of the
three years was based upon a review of the adequacy of the allowance for loan
losses, which is conducted on a quarterly basis. These reviews are based upon
many factors including the risk characteristics of the portfolio, trends in
loan delinquencies, and an assessment of existing economic conditions. In
addition, various regulatory agencies, as part of their examination process,
review the banks' allowances for loan losses and such review may result in
changes to the allowance based on judgments different from those of management.
The decrease in the 2004 provision was due in part to a reduction in average
impaired loans of $1,100,000 as well as the fact that the Company realized
significant recoveries during 2004, which allowed the company to maintain its
coverage ratio. The decrease in the 2003 provision was due in large part to the
recording of $70,000 to other expense for a provision for losses related to
unfunded loan commitments such as unused lines of credit and unused portions of
home-equity loans. This provision had previously been calculated as part of the
allowance for loan losses.
Although management utilizes its best judgment in providing for losses, there
can be no assurance that the Company will not have to change its provision for
loan losses in subsequent periods. Management will continue to monitor the
allowance for loan losses and modify the provision to the allowance for loan
losses as appropriate. For additional information regarding estimates in the
assessment of the allowance for loan losses see "Application of Critical
Accounting Policies" below.
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities, including fee-based services and income
earned through securities sales.
The following table sets forth the components of the Company's noninterest
income:
($000 Omitted)
Years Ended December 31,
----------------------------
2004 2003 2002
------ ------ ------
Service charges and fees on deposit accounts $2,229 $1,673 $1,473
Gain on sales of securities
available-for-sale, net 753 1,522 151
Gain on sales of loans, net 374 422 259
Other 1,741 1,758 1,513
------ ------ ------
Total noninterest income $5,097 $5,375 $3,396
====== ====== ======
Fee income from service charges and fees on deposit accounts increased 33% in
2004, 14% in 2003 and 26% in 2002. The improvement in 2004 is due principally
to increases in overdraft fee income as the Company introduced new fee
schedules in December 2003. In addition, the Company introduced Bounce
Protection(TM), an overdraft privilege program, in April 2004 and this has led
to increased overdraft income. The improvement in 2003 is due principally to
increases in overdraft fee income and service charge income resulting from the
full year impact of the branch acquisitions completed in October 2002. The
improvement in 2002 is due principally to the introduction of new overdrawn
account procedures and fee schedules introduced in January 2002 as well as the
impact of the branch purchases during the fourth quarter 2002.
Net gains on sales of securities were $753,000 in 2004 compared to $1,522,000
in 2003 and $151,000 in 2002. Securities gains in 2004 and 2003 were the result
of improved market conditions for investment securities. Securities gains, net,
in 2004 included $253,000 of net gains on sales of equity securities compared
to net losses of $147,000 in 2003 and net losses of $410,000 in 2002. Net gains
on the sales of debt securities totaled $500,000 in 2004 compared to $1,669,000
in 2003 and $561,000 in 2002.
Gains on sales of loans, net, decreased $48,000 in 2004 compared to 2003. Gains
on sales of mortgage loans decreased $228,000 as the Company opted to retain a
greater portion of fixed rate mortgages in portfolio in 2004 compared to 2003.
This was partially offset by the fact that during 2004, the Company sold a
portfolio of commercial loans guaranteed by the Small Business Administration
for a gain of $178,000. The low interest rate environment in 2003 resulted in
significant mortgage refinancing activity. Therefore, during 2003 the Company
decided to sell a portion of this loan volume in the secondary market based on
our underwriting standards. The result of these sales was an increase in gain
on sale of loans of $163,000 to $422,000 in 2003. During 2002, the Company
recorded a gain on sale of loans of $259,000 which resulted from the sale of
mortgage loans to the secondary market.
Other noninterest income (sources of which include debit card interchange fees,
credit card merchant and fee income, automated teller machine fees, loan fees,
safe deposit fees and commissions on alternative investment products) decreased
$17,000, or 1%, to $1,741,000 in 2004 following an increase of $245,000, or
16%, to $1,758,000 in 2003 and $339,000, or 29%, to $1,513,000 in 2002. The
decrease in 2004 was due to the fact that in 2003 the Company recognized
approximately $191,000 in other loan fees resulting from transactions with
Federal Home Loan Mortgage Corporation ("FHLMC"). This decrease was partially
offset by the introduction of alternative investment products offered by the
Company, which increased fee income by approximately $126,000. The increase in
2003 compared to 2002 was due primarily to the increase in other loan fees.
NONINTEREST EXPENSE
Total noninterest expense increased $258,000, or 1%, during 2004 following an
increase of $2,101,000, or 10%, during 2003 and an increase of $2,866,000, or
17%, during 2002. The increase in expenses during 2004 is due primarily to an
increase in salaries and employee benefits. The increase in expenses during
2003 is due in large part to the full year impact of the October 2002 branch
purchases, which contributed to the overall in increase in salaries and
benefits expense, office occupancy and equipment expense and increased expenses
associated with the amortization of core deposit intangibles. The increase in
expenses during 2002 is due in large part to the $910,000 write-down of equity
securities, expenses related to the acquisition of three branches during the
fourth quarter, staff additions and technology initiatives.
The following table sets forth information relating to the Company's
noninterest expense during the periods indicated:
($000 Omitted)
Years Ended December 31,
2004 2003 2002
------- ------- -------
Salaries and employee benefits $11,981 $11,426 $ 9,758
Office occupancy and equipment 3,731 3,753 3,298
Amortization of core deposit
intangible 954 954 476
Write-down of equity securities
available-for-sale -- 184 910
Professional fees 1,234 1,166 1,096
Stationery and supplies 429 556 596
Telephone 595 571 505
Postage and shipping 348 378 378
ATM expense 295 442 366
Other 2,827 2,706 2,652
------- ------- -------
Total noninterest expense $22,394 $22,136 $20,035
======= ======= =======
Salaries and employee benefits increased $555,000, or 5%, from 2003 to 2004 and
$1,668,000 or 17%, from 2002 to 2003. These increases reflect staff additions
in connection with the expansion of the retail franchise, increased lending
activities and normal salary and wage increases. Also, during 2004 and 2003,
the Company recorded a liability to deferred compensation related to a
Supplemental Employee Retirement Plan ("SERP"). Refer to Note 14 to the
Consolidated Financial Statements for a further discussion regarding the SERP.
Office occupancy and equipment expense decreased $22,000 from 2003 to 2004
after increasing $455,000, or 14%, from 2002 to 2003. The 2003 increase was due
to increases in depreciation expense associated with technology purchases made
in the latter part of 2002 as well as the expansion of the retail franchise.
The amortization of core deposit intangibles, net, remained unchanged from 2003
to 2004 after increasing $478,000 from 2002 to 2003 due to the full year impact
of the October 2002 branch purchases.
During 2004, the Company recorded no write-down of equity securities compared
to $184,000 in 2003 and $910,000 in 2002. During 2003, five equity securities
were determined to be other than temporarily impaired due to sustained weakness
in their sector as well as weaknesses related to the individual companies.
During 2002, the sustained overall weakness in the equity market as well as
significant declines in certain sectors and specific companies within those
sectors, resulted in the Company determining that the market values of certain
of its marketable equity securities were other than temporarily impaired. As a
result, during 2002 the Company recorded a write-down of equity securities of
$910,000.
INCOME TAX EXPENSE
The Company recognized $1,666,000, $1,867,000 and $1,507,000 in income tax
expense for the years ended December 31, 2004, 2003 and 2002, respectively. The
effective tax rate was 33.0% for 2004, 34.1% for 2003 and 36.7% for 2002. For
additional information relating to income taxes, see Note 13 to the
Consolidated Financial Statements.
ASSETS
Total assets increased $29,202,000, or 5%, to $638,418,000 at December 31, 2004
compared to $609,216,000 at December 31, 2003. The following is a summary of
significant balance sheet changes.
($000 Omitted)
Years Ended December 31,
--------------------------------------------
2004 2003 Change % Change
-------- -------- ------- ---
Total assets $638,418 $609,216 $29,202 4.8%
Earning assets 592,971 562,311 30,660 5.5
Federal funds sold 10,975 16,470 (5,495) (33.4)
Securities available-for-sale, at
fair value (1) 107,013 73,152 33,861 46.3
Loans, net of unearned income 474,706 473,619 1,087 0.2
Deposits 475,359 463,307 12,052 2.6
Borrowings 109,888 95,021 14,867 15.7
Stockholders' equity 49,510 47,872 1,638 3.4
(1) Includes Federal Home Loan Bank stock and Federal Reserve Bank stock.
The increase in earning assets of $30,660,000 was due primarily to an increase
in securities available-for-sale partially offset by a decrease in federal
funds sold. The increase in earning assets was funded by an increase in both
deposits and borrowings.
SECURITIES AVAILABLE-FOR-SALE
The Company's securities are classified into one of two categories based on
management's intent to hold the securities: (i) "held-to-maturity" securities,
or (ii) securities "available-for-sale." Securities designated to be
held-to-maturity are reported at amortized cost. Securities classified as
available-for-sale are required to be reported at fair value with unrealized
gains and losses, net of taxes, excluded from earnings and shown separately as
a component of stockholders' equity. At December 31, 2004 and 2003 the Company
had no securities designated as held-to-maturity.
The following table summarizes the Company's securities portfolio at December
31, 2004 and 2003, showing amortized cost and fair value for each category:
($000 Omitted)
December 31,
------------------------------------------------
2004 2003
----------------- ------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ---- --------- ----
Securities available-for-sale:
US Treasury and US government
agencies $ 54,914 $ 54,563 $37,945 $37,840
Mortgage-backed securities 29,447 29,291 2,803 2,888
Collateralized mortgage
obligations 10 10 15 15
Marketable equity securities 1,827 1,931 2,589 2,766
Corporate bonds 12,001 12,287 20,857 21,983
State and political subdivisions 2,966 3,051 2,432 2,590
-------- -------- ------- -------
Total securities available-for-sale $101,165 $101,133 $66,641 $68,082
======== ======== ======= =======
Total securities increased $33,051,000 during 2004 to $101,133,000. One of the
primary functions of the investment portfolio is to provide liquidity to the
Company. During 2004, the Company deployed a leverage strategy whereby
$20,000,000 in FHLB advances were offset by the purchase of mortgage-backed
securities providing the Company an attractive spread. The remainder of the
increase in securities was due to the increase in deposits.
The net unrealized loss on securities available-for-sale was $32,000 at
December 31, 2004 compared to a net unrealized gain of $1,441,000 at December
31, 2003. At December 31, 2004, the net unrealized loss on debt securities was
$136,000 and the net unrealized gain on marketable equity securities was
$104,000. At December 31, 2003, the net unrealized gain on debt securities was
$1,264,000 and the net unrealized gain on marketable equity securities was
$177,000. The net unrealized gain on debt securities for 2003 is primarily the
result of the low interest rate environment during 2003, which resulted in an
appreciation in value of existing debt holdings.
Due to the decline in the performance of securities in certain sectors and
specific companies within those sectors, the Company determined, through the
evaluations described in Note 1 to the Consolidated Financial Statements, that
the market values of certain of its marketable equity securities were other
than temporarily impaired. As a result, during 2003 net losses on sales of
marketable equity securities amounted to $147,000 and write-downs of marketable
equity securities amounted to $184,000. During 2002 net losses on sales of
marketable equity securities amounted to $410,000 and write-downs of marketable
equity securities amounted to $910,000.
At December 31, 2004, the Company's investment in equity securities totaled
$1,931,000. This amount is net of a market value adjustment of $104,000, of
which the full amount was reflected as a gain in accumulated other
comprehensive loss in stockholders' equity.
The Company has a general policy of purchasing investment grade securities and
U.S. government securities to minimize credit risk. All securities, however,
carry interest rate risk, which affect their market values such that as market
yields increase, the value of the Company's securities decline and vice versa.
Additionally, mortgage-backed securities carry prepayment risk whereby expected
yields may not be achieved due to the inability to reinvest proceeds from
prepayment at comparable yields. Moreover, such mortgage-backed securities may
not benefit from price appreciation in periods of declining rates to the same
extent as the remainder of the portfolio.
A portion of the securities portfolio is pledged to secure public deposits,
short-term securities sold under agreements to repurchase and treasury, tax and
loan accounts. Refer to Note 3 to the Consolidated Financial Statements for a
further discussion of pledging of securities.
LOANS
Gross loans remained relatively unchanged in 2004, increasing $946,000 due
primarily to increases in residential real estate, commercial real estate and
commercial loans, partially offset by a decrease in indirect installment loans.
At December 31, 2003 loans increased 6% with the most significant increases
occurring in residential real estate, commercial real estate and indirect
installment loans. The following table presents the composition of the loan
portfolio as of December 31, 2004 and 2003:
($000 Omitted)
Percent Percent
2004 of Total 2003 of Total
-------- ----- -------- -----
Real estate:
Residential $147,333 31.0% $129,493 27.3%
Commercial 130,334 27.5 120,366 25.4
Construction 5,366 1.1 3,851 0.8
Commercial 27,013 5.7 24,528 5.2
Installment 29,345 6.2 30,291 6.4
Indirect installment 116,520 24.5 150,807 31.8
Other 18,901 4.0 14,530 3.1
-------- ----- -------- -----
$474,812 100.0% $473,866 100.0%
======== ===== ======== =====
The loan portfolio mix shifted during the year. Indirect installment loans,
which are fixed-rate loans secured by automobiles originated through automobile
dealers with an average term of 60 months, comprised 24.5% of the loan
portfolio at December 31, 2004 as compared to 31.8% at the end of 2003.
Effective August 31, 2004, the Company discontinued the origination of indirect
installment loans; therefore, this portfolio will continue to amortize going
forward. Residential real estate loans increased to account for 31.0% of the
portfolio from 27.3% at December 31, 2003 due in part to the decision to retain
high credit quality fixed-rate mortgages in the portfolio rather than sell in
the secondary market.
Commercial real estate loans consist of loans secured by income producing
commercial real estate and commercial loans consist of loans that are either
unsecured or are secured by inventories, receivables or other corporate assets,
and some are additionally secured by a guarantee of the federal Small Business
Administration. Commercial real estate and commercial loans increased by
$12,453,000 in 2004 as compared to 2003. The Company continues to emphasize
commercial real estate and commercial loans in order to enhance earnings and
maintain the balance of its portfolio.
Residential real estate loans increased by $17,840,000 in 2004, a 14% increase
from 2003, compared to an increase of $14,967,000, or 13%, in 2003 compared to
2002. The Company originates both fixed-rate and adjustable-rate residential
loans for its portfolio. Some fixed-rate residential loans are originated for
sale to investors in the secondary market. The increase in residential real
estate loans in 2004 and 2003 resulted primarily from the Company's decision to
retain a greater percentage of fixed-rate residential mortgage loans.
During 2004, installment loan balances decreased $946,000, or 3%, from 2003,
compared to a decrease of $9,878,000, or 25%, in 2003 compared to 2002.
Indirect installment loans decreased by $34,287,000, or 23%, in 2004 compared
to an increase of $11,330,000, or 8%, in 2003. As previously mentioned,
indirect installment originations ceased on August 31, 2004.
NONPERFORMING ASSETS
Nonperforming assets were $2,949,000, or 0.46% of total assets, at December 31,
2004 compared to $4,180,000, or 0.69% of total assets, at December 31, 2003, a
decrease of $1,321,000, or 29%. Nonperforming assets are comprised primarily of
nonaccrual loans, other chattels owned and real estate acquired by foreclosure
or a similar conveyance of title. The accrual of interest on a loan is
discontinued when there is reasonable doubt as to its collectibility or
whenever the payment of principal or interest is more than 90 days past due.
However, there are loans within this nonaccrual classification that provide
periodic payments, but which have a weakness with respect to the collateral
securing the loan.
At December 31, 2004, nonaccrual loans totaled $2,867,000, or 0.60% of total
loans, compared to $4,089,000, or 0.86% of total loans, in 2003. There was no
other real estate owned at either December 31, 2004 or 2003. Other chattels
owned decreased $9,000 to $82,000 at December 31, 2004 compared to $91,000 at
December 31, 2003.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan losses to absorb losses inherent in
the existing loan portfolio. When a loan, or portion thereof, is considered
uncollectible, it is charged against the allowance. Recoveries of amounts
previously charged-off are added to the allowance when collected. The adequacy
of the allowance for loan losses is evaluated on a regular basis by management.
Factors considered in evaluating the adequacy of the allowance include previous
loss experience, current economic conditions and their effect on borrowers and
the market area in general, and the performance of individual credits in
relation to the contract terms. In addition various federal and state
regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of the Company's allowance for loan losses.
For additional information regarding estimates in the assessment of the
allowance for loan losses see "Application of Critical Accounting
Policies-Allowance for Loan Losses" below.
The Company's allowance for loan losses increased $168,000 from December 31,
2003 to $5,204,000, or 1.10% of total loans, at December 31, 2004.
The following table sets forth the composition of the allowance for loan losses
for the periods indicated:
($000 Omitted)
Years Ended December 31,
--------------------------------
2004 2003 2002
------ ------- --------
Beginning allowance $5,036 $4,920 $4,642
Provision for loan losses 495 805 900
Loans charged-off (665) (870) (824)
Recoveries of loans previously
charged-off 338 181 202
------- ------- -------
Net charge-offs (327) (689) (622)
------- ------- -------
Ending allowance $ 5,204 $ 5,036 $ 4,920
======= ======= =======
Allowance as a percentage of loans
outstanding 1.10% 1.06% 1.10%
Allowance as a percentage of
nonperforming loans 181.51 123.16 135.95
Net charge-offs as a percentage of
average loans 0.07 0.15 0.15
DEPOSITS
Total deposits at December 31, 2004 were $475,359,000, an increase of
$12,052,000, or 3%, compared to $463,307,000 at December 31, 2003. The increase
in deposits was due primarily to an increase in demand deposits, NOW accounts
and regular savings partially offset by a decrease in time deposits.
The following table sets forth the components of deposits for the periods
indicated:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Demand $ 78,669 $ 69,599
Regular savings, NOW and money market 263,685 244,766
Time 133,005 148,942
-------- --------
Total deposits $475,359 $463,307
======== ========
At December 31, 2004, time deposits of $100,000 or more are scheduled to mature
as follows:
($000 Omitted)
3 months or less $ 4,360
Over 3 to 6 months 2,868
Over 6 to 12 months 4,109
Over 12 months 7,598
-------
$18,935
=======
BORROWINGS
At December 31, 2004 short-term borrowings consisted of securities sold under
agreements to repurchase of $11,268,000 compared to $7,401,000 for 2003.
Long-term debt in 2004 consists of FHLB term advances of $78,000,000 as well as
$20,620,000 of junior subordinated debentures, compared to $67,000,000 of FHLB
term advances and $20,620,000 of junior subordinated debentures in 2003. Seven
of the long-term term FHLB advances are callable quarterly with call dates in
January, February and March 2005. The increase in FHLB advances is the result
of new advances totaling $20,000,000, which was partially offset by the
maturity of $9,000,000 in advances.
Junior subordinated debentures consist of two issues of floating rate trust
preferred securities acquired during April and July 2002 in the amount of
$7,217,000 and $13,403,000, respectively, due in 2032. These trust preferred
securities were offered for the purpose of providing capital to the subsidiary
banks to ensure adequate capital following the recent branch acquisitions and
for general corporate purposes. As of December 31, 2004, of the $20,620,000
principal amount outstanding, $16,338,000 qualified as Tier 1 capital and
$4,282,000 was allocated to Tier 2 capital.
See Notes 8 and 9 to the Consolidated Financial Statements for additional
information regarding the Company's borrowings.
The following table sets forth certain information concerning the Company's
borrowings at the dates indicated:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Short-term borrowings $ 11,268 $ 7,401
Long-term debt 98,620 87,620
-------- --------
$109,888 $ 95,021
======== ========
At December 31, 2004, long-term debt is scheduled to mature as follows:
($000 Omitted)
Less than one year $ 2,000
One to three years 44,000
Three to five years 23,000
Over five years 29,620
-------
$98,620
=======
OFF-BALANCE SHEET ARRANGEMENTS
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans and standby letters of
credit. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby
letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, 2004
and 2003 totaled $48,199,000 and $45,276,000, respectively.
See Note 15 to the Consolidated Financial Statements for additional information
regarding off-balance sheet arrangements.
CAPITAL
The Company's stockholders' equity serves to support growth and provide
depositors and other creditors protection against loss. Equity capital
represents the stockholders' investment in the Company. Management strives to
maintain an optimal level of capital on which an attractive return to the
stockholders will be realized over both the short-term and long-term, while
serving depositors' and creditors' needs.
The Company must also observe the minimum requirements enforced by the federal
banking regulators. There are three capital requirements that banks and bank
holding companies must meet: Tier 1 capital, total capital (combination of Tier
1 capital and Tier 2 capital), and leverage (Tier 1 capital to average assets)
ratios. Tier 1 capital consists of stockholders' equity, net of intangible
assets as well as a portion of junior subordinated debentures. Tier 2 capital
consists of a limited amount of allowance for loan losses and the portion of
junior subordinated debentures not allocated to Tier 1 capital. Tier 1 capital,
total capital and leverage ratios do not include any adjustments for unrealized
gains and losses relating to securities available-for-sale except net
unrealized losses relating to marketable equity securities. The minimum
requirements for the leverage ratio, risk-based Tier 1 capital and risk-based
total capital are 4%, 4% and 8%, respectively. As of December 31, 2004 and
2003, both Banks were "well capitalized" as defined under FDIC regulations.
The following table sets forth the Company's risk-based capital and
leverage ratios:
($000 Omitted)
December 31,
-------------------------
2004 2003
-------- --------
Risk-adjusted assets $446,807 $453,272
Tier 1 capital (to average assets) 8.43% 7.22%
Tier 1 capital (to risk weighted assets) 11.80 9.66
Total capital (to risk weighted assets) 13.94 12.81
Total stockholders' equity includes a $691,000 negative adjustment for
accumulated other comprehensive loss, net of tax, at December 31, 2004 and a
$149,000 adjustment for accumulated other comprehensive income, net of tax, at
December 31, 2003. At December 31, 2004, this adjustment was comprised of a net
unrealized loss on securities available-for-sale of $18,000, net of taxes, and
an unfunded pension accumulated benefit obligation of $673,000, net of taxes.
While the Company continues to contribute the maximum amount permitted by law
to its pension plan, the discount rate used to calculate the future value of
such contribution and the poor asset performance of investment securities has
resulted in the unfunded pension accumulated benefit obligation. For additional
information regarding estimates see "Application of Critical Accounting
Policies" below.
The Company intends to continue to pay dividends on a quarterly basis subject
to the financial condition and earnings of the Company, capital requirements,
and other factors, including applicable governmental regulations. No dividends
will be payable unless declared by the Board of Directors and then only to the
extent funds are legally available for the payment of such dividends.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 1 of the
Consolidated Financial Statements. As disclosed in Note 1, the preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions about future
events that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ significantly from those
estimates. The Company believes that the following discussion addresses the
Company's most critical accounting policies, which are those that are most
important to the portrayal of the Company's financial condition and results of
operations and require management's most difficult, subjective and complex
judgments.
Allowance for Loan Losses. Allowance for loan losses are estimated at the
individual Banks based on estimates of losses related to customer loan
balances. In establishing the appropriate provisions for customer loan
balances, the Company makes assumptions with respect to their future
collectibility. The Company's assumptions are based on an individual assessment
of the customer's credit quality as well as subjective factors and trends,
including the credit rating of the loans. Generally, these individual credit
assessments occur prior to the inception of the credit exposure and at regular
reviews during the life of the exposure and consider (a) the customer's ability
to meet and sustain their financial commitments; (b) a customer's current and
projected financial condition; (c) the positive or negative effects of the
current and projected industry outlook; and (d) the economy in general. Once
the Company considers all of these factors, a determination is made as to the
probability of default. An appropriate provision is made, which takes into
account the severity of the likely loss on the outstanding loan balances based
on the Company's experience in collecting these amounts. The Company's level of
allowance for loan losses fluctuates depending upon all of the factors
mentioned above.
Goodwill and Core Deposit Intangible. Effective January 1, 2002, the Company
adopted Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"),
"Goodwill and Other Intangible Assets." Under SFAS No. 142, the Company is
required to perform annual impairment tests of its goodwill and intangible
assets and more frequently in certain circumstances. The Company has elected to
test for goodwill and intangible asset impairment in the fourth quarter of each
year. In that goodwill is carried on the books of the Banks and the Company
owns 100% of their outstanding stock, there is no market value for their common
stock. The Company utilizes a multiple of earnings approach in analyzing the
valuation of goodwill. Core deposit intangibles are carried on the books of the
Banks as well. The valuation of core deposit intangibles incorporate deposits
acquired compared with current deposit levels, considers deposit outflow
assumptions made at acquisition as well as other factors.
The most recent impairment test of goodwill and core deposit intangible assets
indicated that no adjustment was required. The Company cannot predict the
occurrence of certain future events that might adversely affect the reported
value of goodwill and core deposit intangible that totaled $10,152,000 and
$2,949,000, respectively, at December 31 2004. Such events include, but are not
limited to, strategic decisions made in response to economic and competitive
conditions, the impact of the economic environment on the Company's customer
base, or the impact of changes in federal and state laws and regulations.
Pension Benefits. The Company maintains a trusteed non-contributory pension
plan (the "Plan") covering substantially all full-time employees. Several
statistical and other factors, which attempt to anticipate future events, are
used in calculating the expense and liability related to the Plan. Key factors
include assumptions about the expected rates of return on plan assets and
discount rates. The Company considers market conditions, including changes in
investment returns and interest rates, in making these assumptions.
The Company determines the expected long-term rate of return on plan assets
based on the building block method, which consists of aggregating the expected
rates of return for each component of the plan's asset mix. Plan assets are
comprised primarily of mutual funds including bond funds, US equity funds,
international equity funds, real estate funds and short-term money market
funds. The Company uses historic plan asset returns combined with current
market conditions to estimate the rate of return. The expected rate of return
on plan assets is a long-term assumption and generally does not change
annually. The discount rate reflects the market rate for high-quality fixed
income debt instruments on the Company's annual measurement date (December 31)
and is subject to change each year.
Unrecognized actuarial gains and losses are being recognized over approximately
a 17-year period, which represents the expected remaining service life of the
employee group. Unrecognized actuarial gains and losses arise from several
factors including experience and assumption changes in the obligations and from
the difference between expected returns and actual returns on plan assets.
These unrecognized losses will be systematically recognized as an increase in
future net periodic pension expense in accordance with FAS 87, "Employers'
Accounting for Pensions."
The actuarial assumptions used by the Company in determining its pension
benefits may differ materially from actual results due to changing market and
economic conditions, higher or lower withdrawal rates or longer or shorter life
spans of the participants. While the Company believes that the assumptions used
are appropriate, differences in actual experience or changes in assumptions may
materially affect the Company's financial position or results of operations.
Mortgage Servicing Rights (MSR or MSRs). Servicing assets are recognized as
separate assets when rights are acquired through purchase or through sale of
financial assets. Capitalized servicing rights are reported in other assets and
are amortized into noninterest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, such as interest rates and original loan
terms (primarily 15 and 30 year). Fair value is determined using prices for
similar assets with similar characteristics, when available, or based upon
discounted cash flows using market-based assumptions. In periods of falling
market interest rates, accelerated loan prepayment speeds can adversely impact
the fair value of these mortgage-servicing rights relative to their book value.
In the event that the fair value of these assets were to increase in the
future, the Company can recognize the increased fair value to the extent of the
impairment allowance but cannot recognize an asset in excess of its amortized
book value. When the book value of an individual stratum exceeds its fair
value, an impairment reserve must be recognized. Future changes in management's
assessment of the impairment of these servicing assets, as a result of changes
in observable market data relating to market interest rates, loan prepayment
speeds, and other factors, could impact the Company's financial condition and
results of operations either positively or adversely.
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates and prices, such as interest rates, foreign currency
exchange rates, commodity prices and equity prices. The Company's primary
market risk exposure is interest rate risk. The ongoing monitoring and
management of this risk is an important component of the Company's
asset/liability management process which is governed by policies established by
the Company's Boards of Directors that are reviewed and approved annually. The
Board of Directors delegates responsibility for carrying out the
asset/liability management policies to the Company's Asset Liability Committee
("ALCO"). In this capacity ALCO develops guidelines and strategies impacting
the Company's asset/liability management-related activities based upon
estimated market risk sensitivity, policy limits and overall market interest
rate levels/trends.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change, the interest income and interest
expenses associated with the Company's financial instruments also change,
thereby impacting net interest income ("NII"), the primary component of the
Company's earnings. ALCO utilizes the results of a detailed and dynamic
simulation model to quantify the estimated exposure of NII to sustained
interest rate changes. While ALCO routinely monitors simulated NII sensitivity
over a rolling 2-year horizon, it also utilizes additional tools to monitor
potential longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all interest-earning
assets and interest-bearing liabilities reflected on the Company's balance
sheet. The Company uses computer simulations to determine the impact on net
interest income of various interest rate scenarios, balance sheet trends and
strategies. These simulations incorporate assumptions about balance sheet
dynamics such as loan and deposit growth, loan and deposit pricing, changes in
funding mix, and asset and liability repricing and maturity characteristics.
Simulations based on numerous assumptions are run under various interest rate
scenarios to determine the impact on net interest income and capital. From
these scenarios, interest rate risk is quantified and appropriate strategies
are developed and implemented.
This sensitivity analysis is compared to ALCO policy limits which specify a
maximum tolerance level for NII exposure over a 1-year horizon given both an
immediate 300 basis point, or 3%, upward and downward shift in interest rates.
Given the current level of interest rates, the Company has modeled an upward
shift in rates of 300 basis points and a downward shift in rates of 100 basis
points. Using an immediate rate shock simulation where interest rates increase
300 basis points, the December 31, 2004 earnings simulation model projects that
net interest income for the twelve months ending December 31, 2005 would
decrease by an amount equal to approximately 1.67%. In addition, utilizing an
immediate rate shock simulation where interest rates decrease 100 basis points,
the December 31, 2004 earnings simulation model projects that net interest
income for the twelve months ending December 31, 2005 would decrease by an
amount equal to approximately 2.63%.
Using an immediate rate shock simulation where interest rates increase 300
basis points, the December 31, 2004 earnings simulation model projected that
net interest income for the twelve months ending December 31, 2006 would
increase by an amount equal to approximately 0.47%. In addition, utilizing an
immediate rate shock simulation where interest rates decrease 100 basis points,
the December 31, 2004 earnings simulation model projected that net interest
income for the twelve months ending December 31, 2006 would decrease by an
amount equal to approximately 5.45%. The projected results are within Company's
ALCO policy limits for both years.
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including,
among others, the nature and timing of interest rate levels, yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, and reinvestment/replacement of asset and liability
cashflows. The assumptions differed in each of the periods included in the
sensitivity analysis above. While assumptions are developed based upon current
economic and local market conditions, the Company cannot make any assurances as
to the predictive nature of these assumptions, including how customer
preferences or competitor influences might change.
The most significant factors affecting the changes in market risk exposure
during 2004 compared to 2003 were the continuation of the low interest rate
environment, changes in the yield curve for investment securities, the increase
in the aggregate principal amount in fixed-rate loans extended by the Banks,
the aggregate increase in securities available-for-sale, the increase in total
deposits, and the increase in long-term debt.
LIQUIDITY RISK
Liquidity risk management involves the Company's ability to raise funds in
order to meet its existing and anticipated financial obligations. These
obligations are the withdrawal of deposits on demand or at contractual
maturity, the repayment of debt as it matures, the ability to fund new and
existing loan commitments and the ability to take advantage of new business
opportunities. Liquidity may be provided through amortization, maturity or sale
of assets such as loans and securities available-for-sale, liability sources
such as increased deposits, utilization of the FHLB credit facility, purchased
or other borrowed funds, and access to the capital markets. Liquidity targets
are subject to change based on economic and market conditions and are
controlled and monitored by ALCO. At the bank level, liquidity is managed by
measuring the net amount of marketable assets after deducting pledged assets,
plus lines of credit, primarily with the FHLB, which are available to fund
liquidity requirements. Management then measures the adequacy of that aggregate
amount relative to the aggregate amount of liabilities deemed to be sensitive
or volatile. These include brokered deposits, deposits in excess of $100,000,
term deposits with short maturities, and credit commitments outstanding.
Additionally, the Company requires cash for various operating needs including
dividends to stockholders, the purchase of treasury stock, capital injections
to the Banks, and the payment of general corporate expenses. The primary
sources of liquidity for the Company are dividends from the Banks and
reimbursement for services performed on behalf of the banks. Additionally, the
Company may utilize outside sources of funding such as the issuance of the
trust preferred securities during 2002.
Cash and cash equivalents decreased by $6,316,000 during 2004. Cash used for
investing activities totaled $38,450,000 with lending activities utilizing
$1,112,000 and investment purchases using $34,671,000. Cash provided by
financing activities totaled $26,009,000. This cash consisted of an increase in
deposits of $12,052,000, an increase in repurchase agreements of $3,867,000 and
$20,000,000 from FHLB advances partially offset by the repayment of maturing
FHLB advances in the amount of $9,000,000. The net cash provided by operating
activities totaled $6,125,000 and consisted primarily of net income of
$3,388,000 and a decrease in other assets and other liabilities, net.
CAPITAL EXPENDITURES AND COMMITMENTS
During 2004, the Company incurred approximately $2,267,000 in capital
expenditures. The expenditures included approximately $938,000 for the
improvement of the commercial lending and administration facility in North
Conway, New Hampshire and approximately $220,000 office furnishings for the
facility. Approximately $142,000 was expended for an upgrade to the AS400
computer system. The remaining expenditures were for normal replacement of, or
upgrades in, existing property and equipment.
During 2003, the Company incurred approximately $1,810,000 in capital
expenditures. The expenditures included approximately $846,000 for the purchase
and improvement of a commercial lending and administration facility in North
Conway, New Hampshire. Approximately $307,000 was expended for the
reengineering of the operations department of the Berlin main office facility,
which included both construction and furniture costs. The remaining
expenditures were for normal replacement of, or upgrades in, existing property
and equipment.
The Company's estimated capital expenditures for 2005 total $1,250,000. The
Company has budgeted approximately $250,000 for customer relationship
management (CRM) software, $138,000 for call center expansion, and $118,000 for
upgrades to the mortgage processing system. The remaining expenditures will be
incurred for normal replacement of, or upgrades to, existing property and
equipment. These expenditures are expected to be funded through normal Company
cash flows.
CONTRACTUAL OBLIGATIONS
The table below contains information on the Company's contractual obligations
as of the fiscal year ended December 31, 2004:
($000 Omitted)
Less Than 1-3 3-5 More than
Contractual Obligations Total One Year Years Years Five Years
FHLB Advances $78,000 $2,000 $44,000 $23,000 $ 9,000
Junior subordinated
debentures 20,620 -- -- -- 20,620
-------------------------------------------------
Total $98,620 $2,000 $44,000 $23,000 $29,620
=================================================
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market
risk is included in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing under Item 7 of this report and
is hereby incorporated by reference in this Item 7A.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF INCOME
($000 Omitted, Except Per Share Data)
FOR THE YEAR ENDED DECEMBER 31, 2004 2003 2002
- -------------------------------------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $26,569 $27,917 $27,912
Interest on debt securities available-for-sale:
Taxable 3,201 3,075 2,781
Tax-exempt 142 158 275
Dividends 239 237 241
Interest on federal funds sold 125 118 271
Interest on interest bearing deposits 1 2 2
- -------------------------------------------------------------------------------------------------------------
Total interest and dividend income 30,277 31,507 31,482
- -------------------------------------------------------------------------------------------------------------
Interest expense
Interest on deposits 3,150 4,422 6,528
Interest on short-term borrowings 110 126 141
Interest on long-term debt 4,171 3,909 3,169
- -------------------------------------------------------------------------------------------------------------
Total interest expense 7,431 8,457 9,838
- -------------------------------------------------------------------------------------------------------------
Net interest and dividend income 22,846 23,050 21,644
Provision for loan losses 495 805 900
- -------------------------------------------------------------------------------------------------------------
Net interest and dividend income after provision for loan losses 22,351 22,245 20,744
- -------------------------------------------------------------------------------------------------------------
Noninterest income
Service charges and fees on deposit accounts 2,229 1,673 1,473
Gain on sales of securities available-for-sale, net 753 1,522 151
Gain on sales of loans, net 374 422 259
Other 1,741 1,758 1,513
- -------------------------------------------------------------------------------------------------------------
Total noninterest income 5,097 5,375 3,396
- -------------------------------------------------------------------------------------------------------------
Noninterest expense
Salaries and employee benefits 11,981 11,426 9,758
Office occupancy and equipment 3,731 3,753 3,298
Amortization of core deposit intangible 954 954 476
Write-down of equity securities -- 184 910
Other 5,728 5,819 5,593
- -------------------------------------------------------------------------------------------------------------
Total noninterest expense 22,394 22,136 20,035
- -------------------------------------------------------------------------------------------------------------
Income before income tax expense 5,054 5,484 4,105
Income tax expense 1,666 1,867 1,507
- -------------------------------------------------------------------------------------------------------------
Net income $ 3,388 $ 3,617 $ 2,598
- -------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 2.26 $ 2.40 $ 1.71
Earnings per common share assuming dilution $ 2.24 $ 2.39 $ 1.71
- -------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED BALANCE SHEETS
($000 Omitted)
AS OF DECEMBER 31, 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents
Cash and due from banks and interest bearing deposits $13,794 $14,615
Federal funds sold 10,975 16,470
- ----------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 24,769 31,085
- ----------------------------------------------------------------------------------------------------------------------------
Securities available-for-sale, at fair value 101,133 68,082
Federal Home Loan Bank stock 5,515 4,705
Federal Reserve Bank stock 365 365
Loans held-for-sale 311 511
Loans, net before allowance for loan losses 474,706 473,619
Less: allowance for loan losses 5,204 5,036
- ----------------------------------------------------------------------------------------------------------------------------
Net loans 469,502 468,583
- ----------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 13,701 12,858
Goodwill 10,152 10,152
Core deposit intangible, net 2,949 3,903
Other assets 10,021 8,972
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $638,418 $609,216
- ----------------------------------------------------------------------------------------------------------------------------
Liabilities
Deposits
Demand $78,669 $69,599
Regular savings, NOW and money market deposit accounts 263,685 244,766
Certificates of deposit (in denominations of $100,000 or more) 18,935 22,708
Other time 114,070 126,234
- ----------------------------------------------------------------------------------------------------------------------------
Total deposits 475,359 463,307
- ----------------------------------------------------------------------------------------------------------------------------
Short-term borrowings 11,268 7,401
Other liabilities 3,661 3,016
Long-term debt 98,620 87,620
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 588,908 561,344
- ----------------------------------------------------------------------------------------------------------------------------
Stockholders' equity
Preferred stock, $1.00 par value; 1,000,000 shares authorized; none issued - -
Common stock, $1.00 par value; 9,000,000 shares authorized; 1,731,969 issued and 1,503,574
outstanding in 2004 and 1,499,574 outstanding in 2003 1,732 1,732
Additional paid in capital 2,075 2,088
Retained earnings 52,484 50,116
Treasury stock (228,395 shares at December 31, 2004 and 232,395 shares at December 31, 2003) (6,090) (6,213)
Accumulated other comprehensive (loss) income, net of tax (691) 149
- ----------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 49,510 47,872
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $638,418 $609,216
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($000 Omitted)
Accumulated
Additional Other Total
Common Paid In Retained Treasury Comprehensive Stockholders'
Stock Capital Earnings Stock Income (Loss)(1) Equity
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1,732 $2,101 $45,955 $(5,864) $ (585) $43,339
Net income - 2002 -- -- 2,598 -- -- 2,598
Net change in unrealized loss on
securities available-for-sale, net of tax -- -- -- -- 345 345
Net change in unfunded pension accumulated
benefit obligation, net of tax -- -- -- -- (1,126) (1,126)
Exercise of stock options, net of tax benefit -- (13) -- 153 -- 140
Cash dividends declared ($0.68 per share) -- -- (1,030) -- -- (1,030)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,732 2,088 47,523 (5,711) (1,366) 44,266
Net income - 2003 -- -- 3,617 -- -- 3,617
Net change in unrealized loss on
securities available-for-sale, net of tax -- -- -- -- 1,110 1,110
Net change in unfunded pension accumulated
benefit obligation, net of tax -- -- -- -- 405 405
Treasury stock purchased -- -- -- (502) -- (502)
Cash dividends declared ($0.68 per share) -- -- (1,024) -- -- (1,024)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 1,732 2,088 50,116 (6,213) 149 47,872
Net income - 2004 -- -- 3,388 -- -- 3,388
Net change in unrealized gain on
securities available-for-sale, net of tax -- -- -- -- (888) (888)
Net change in unfunded pension accumulated
benefit obligation, net of tax -- -- -- -- 48 48
Exercise of stock options, net of tax benefit -- (13) -- 123 -- 110
Treasury stock purchased -- -- -- -- -- -
Cash dividends declared ($0.68 per share) -- -- (1,020) -- -- (1,020)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $1,732 $2,075 $52,484 $(6,090) $ (691) $49,510
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Accumulated other comprehensive loss as of December 31, 2004 consists of net unrealized holding losses on available-for-sale
securities of $18, net of tax, and net unrealized holding losses on unfunded pension accumulated benefit obligation of $673,
net of tax. Accumulated other comprehensive gain as of December 31, 2003 consists of net unrealized holding gains on
available-for-sale securities of $870, net of tax, and net unrealized holding losses on unfunded pension accumulated benefit
obligation of $721, net of tax. Accumulated other comprehensive loss as of December 31, 2002 consists of net unrealized
holding losses on available-for-sale securities of $240, net of tax, and net unrealized holding losses on unfunded pension
accumulated benefit obligation of $1,126, net of tax.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($000 Omitted)
FOR THE YEAR ENDED DECEMBER 31, 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $3,388 $3,617 $2,598
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income
Net unrealized (losses) gains on securities available-for-sale (720) 2,662 322
Reclassification adjustment for realized (gains) losses in net income (753) (1,338) 759
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized (losses) gains on securities (1,473) 1,324 1,081
Minimum pension liability adjustment 74 615 (1,707)
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (1,399) 1,939 (626)
Income tax (benefit) expense (559) 424 155
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax (840) 1,515 (781)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $2,548 $5,132 $1,817
- -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000 Omitted)
FOR THE YEAR ENDED DECEMBER 31, 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 3,388 $ 3,617 $ 2,598
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 495 805 900
Depreciation and amortization 2,369 2,381 1,791
Deferred income tax expense (benefit) 43 (249) 195
Write-down of equity securities - 184 910
Gain on sales of securities available-for-sale, net (753) (1,522) (151)
Loss (gain) on sale, disposal and write-down of premises and equipment 9 28 (18)
Amortization of premiums and accretion of discounts on securities, net 90 408 246
(Decrease) increase in unearned income, net (141) 40 38
Accretion of discount on loans acquired (160) (106) (18)
Loss (gain) on sales of other real estate owned and other personal property, net 9 (58) 5
Net decrease in loans held-for-sale 200 158 1,357
Other liabilities assumed net of (other assets acquired) in branch transactions - - (66)
Net change in other assets and other liabilities 576 1,488 (3,051)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 6,125 7,174 4,736
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale 16,964 24,520 16,709
Proceeds from maturities of securities available-for-sale 25,690 76,716 30,043
Purchases of securities available-for-sale (76,515) (80,314) (78,888)
Purchases of Federal Home Loan Bank stock (810) (73) -
Purchases of Federal Reserve Bank stock - (285) -
Loan originations and principal collections, net (7,142) (28,494) (27,111)
Recoveries of previously charged-off loans 338 181 202
Loans acquired in branch transactions - - (20,192)
Proceeds from sale of commercial loans 5,088 - -
Proceeds from sales of and payments received on other real estate owned - 285 60
Proceeds from sales of and payments received on other personal property 604 822 794
Premises and equipment acquired in branch transactions - - (519)
Additions to premises and equipment (2,267) (1,810) (1,796)
Purchase of company owned life insurance policies (400) (800) -
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (38,450) (9,252) (80,698)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase (decrease) in deposits 12,052 (12,887) 8,422
Deposits assumed in branch transactions, net of assumption premiums - - 47,527
Advances from FHLB 20,000 28,000 1,000
Repayment of FHLB advances (9,000) (7,000) (3,028)
Net increase (decrease) in securities sold under agreements to repurchase 3,867 (850) 96
Exercise of stock options, net of tax benefit 110 - 140
Purchases of treasury stock - (502) -
Issuance of in junior subordinated debentures - - 20,620
Cash dividends paid (1,020) (1,024) (1,030)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 26,009 5,737 73,747
- -----------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (6,316) 3,659 (2,215)
Cash and cash equivalents at beginning of year 31,085 27,426 29,641
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 24,769 $ 31,085 $ 27,426
- -----------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flows:
Interest paid $7,519 $8,617 $9,876
Income taxes paid 2,090 1,610 1,743
Loans transferred to other real estate owned - 46 200
Loans transferred to other personal property 603 824 802
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company is a bank holding company formed in 1997 under the laws of New
Hampshire and is registered under the Bank Holding Company Act of 1956. The
Company's only business activity has been to own all of the shares of, and
provide management, capital and operational support to, The Berlin City Bank
("BCB") and The Pemigewasset National Bank of Plymouth, New Hampshire ("PNB")
and its Delaware statutory business trusts Northway Capital Trust I and
Northway Capital Trust II. The Company's headquarters are in Berlin, New
Hampshire. The banking subsidiaries are engaged principally in the business of
attracting deposits from the general public and investing those deposits in
securities, commercial loans, real estate loans, and consumer loans.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the consolidation.
Northway Capital Trust I and Northway Capital Trust II, subsidiaries of the
Company, were formed to sell capital securities to the public through a third
party trust pool. In accordance with FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"), the subsidiaries have not been
included in the consolidated financial statements.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices within the banking industry.
In preparing the financial statements, management is required to make estimates
and judgments that affect the reported amounts of assets and liabilities as of
the dates of the consolidated balance sheets, and income and expense for the
periods. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to change in the near-term relate to the
determination of the allowance for loan losses.
RECLASSIFICATIONS
Certain amounts in the prior years' financial statements have been reclassified
to conform with the current year's presentation.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, cash and cash equivalents include
cash and due from banks, federal funds sold and interest bearing deposits.
SECURITIES
Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized cost; if
debt and equity securities are bought and held principally for the purpose of
selling in the near term they would be classified as trading and reported at
fair value, with unrealized gains and losses included in earnings; and debt and
equity securities not classified as either held-to-maturity or trading are
classified as available-for-sale and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity, net of estimated income taxes. At this time, the Company
has not established a trading account.
Premiums and discounts are amortized and accreted primarily on the level yield
method over the contractual life of the securities adjusted for expected
prepayments.
If a decline in the fair value below the adjusted cost basis of an investment
is judged to be other than temporary, the cost basis of the investment is
written down to fair value as the new cost basis and the amount of the
write-down is included in noninterest expense.
Gains and losses on sales of securities available-for-sale are recognized at
the time of the sale on a specific identification basis.
LOANS HELD-FOR-SALE
Loans held-for-sale are generally identified as such at origination and are
stated at the lower of aggregate cost or market. Market value is based on
outstanding investor commitments. When loans are sold, a gain or loss is
recognized to the extent that the sale proceeds exceed or are less than the
carrying value of the loans. Gains and losses are determined using the specific
identification method. All loans sold are without recourse to the Company.
LOANS
Loans are carried at the principal amounts outstanding, net of any unearned
income, premiums on originated loans and discounts on acquired loans. Unearned
income includes loan origination fees, net of direct loan origination costs.
This income is deferred and recognized as adjustments to loan income over the
contractual life of the related notes using a method the result of which
approximates that of the interest method.
Loans are placed on nonaccrual when payment of principal or interest is
considered to be in doubt or is past due 90 days or more. The Company may
choose to place a loan on nonaccrual status due to payment delinquency or
uncertain collectibility, while not classifying the loan as impaired, if (i) it
is probable that the Company will collect all amounts due in accordance with
the contractual terms of the loan or (ii) the loan is not a commercial,
commercial real estate or an individually significant mortgage or consumer
loan. Previously accrued income on nonaccrual loans that has not been collected
is reversed from current income, and subsequent cash receipts are recorded as
income. Loans are returned to accrual status when collection of all contractual
principal and interest is reasonably assured and there has been sustained
repayment performance.
The Company's loans are primarily secured by real estate in New Hampshire. In
addition, other real estate owned is located in this market. Accordingly, the
ultimate collectibility of a substantial portion of the Company's loan
portfolio and the recovery of other real estate owned are susceptible to
changing conditions in this market.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level considered adequate by
management on the basis of many factors including the risk characteristics of
the portfolio, trends in loan delinquencies and an assessment of existing
economic conditions. Additions to the allowance are charged to earnings;
realized losses, net of recoveries, are charged directly to the allowance.
While management uses available information in establishing the allowance for
loan losses, future additions to the allowance may be necessary if economic
conditions differ substantially from the estimates used in making the
evaluations. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Banks' allowances for loan
losses. Such agencies may require the Banks to recognize additions to the
allowance based on judgments different from those of management.
Commercial, commercial real estate and individually significant mortgage and
consumer loans are considered impaired, and are placed on nonaccrual, when it
is probable that the Company will not be able to collect all amounts due
according to the contractual terms of the loan agreement. Mortgage and consumer
loans, which are not individually significant, are measured for impairment
collectively. Loans that experience insignificant payment delays and
insignificant shortfalls in payment amounts generally are not classified as
impaired. The amount of impairment for all impaired loans is determined by the
difference between the present value of the expected cash flows related to the
loan, using the original contractual interest rate, and its recorded value, or,
as a practical expedient in the case of collateralized loans, the difference
between the fair value of the collateral and the recorded amount of the loan.
When foreclosure is probable, impairment is measured based on the fair value of
the collateral.
SERVICING ASSETS
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Capitalized servicing
rights are reported in other assets and are amortized into noninterest income
in proportion to, and over the period of, the estimated future net servicing
income of the underlying financial assets. Servicing assets are evaluated for
impairment based upon the fair value of the rights as compared to amortized
cost. Impairment is determined by stratifying rights by predominant
characteristics, such as interest rates and terms. Fair value is determined
using prices for similar assets with similar characteristics, when available,
or based upon discounted cash flows using market-based assumptions. Impairment
is recognized through a valuation allowance for an individual stratum, to the
extent that fair value is less than the capitalized amount for the stratum.
OTHER REAL ESTATE OWNED
Other real estate owned is comprised of properties acquired either through
foreclosure proceedings or acceptance of a deed in lieu of foreclosure, and for
which the Company has taken physical possession. The Company classifies loans
as repossessed or foreclosed if the Company receives physical possession of the
debtor's assets, regardless of whether or not foreclosure proceedings take
place.
Assets acquired through foreclosure or a similar conveyance of title are
initially recorded at the lower of the carrying value of the loan or the fair
value, less estimated costs to sell, of the property constructively or actually
received. Gains and losses upon disposition are reflected in the statement of
income as realized.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the estimated useful
lives of the respective assets. Estimated lives are 39 years for buildings, ten
to fifteen years for building improvements and three to seven years for
furniture and equipment.
Amortization of leasehold improvements is accumulated on a straight-line basis
over the lesser of the term of the respective lease or the asset's useful life,
not to exceed ten years.
ADVERTISING
The Company directly expenses costs associated with advertising as they are
incurred.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
the respective tax bases and operating loss and tax credit carry forwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
STOCK-BASED COMPENSATION
At December 31, 2004, the Company has a stock-based employee compensation plan
which is described more fully in Note 14. The Company accounts for this plan
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under this plan had an exercise price equal to the market value
of the underlying common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123 (revised 2004),
"Share-Based Payment", to stock-based employee compensation.
($000 Omitted, except per share data)
2004 2003 2002
------ ------ ------
Net income As reported $3,388 $3,617 $2,598
Deduct: Total stock-based employee compensation
expense determined under fair value based
methods awards, net of related tax effects -- 39 39
------ ------ ------
Pro forma $3,388 $3,578 $2,559
Earnings per common share As reported $ 2.26 $ 2.40 $ 1.71
Pro forma 2.26 2.37 1.68
Earnings per common share As reported $ 2.24 $ 2.39 $ 1.71
(assuming dilution) Pro forma 2.24 2.36 1.68
EARNINGS PER SHARE
Basic earnings per share ("EPS") excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted EPS, if applicable, reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
Earnings per common share have been computed based on the following:
($000 Omitted)
Years Ended December 31,
--------------------------------
2004 2003 2002
------- ------- -------
Net income $3,388 $3,617 $2,598
Less: Preferred stock dividends -- -- --
------- ------- -------
Net income applicable to common stock $3,388 $3,617 $2,598
======= ======= =======
Average number of common shares outstanding 1,500.1 1,504.4 1,515.1
Effect of dilutive options 11.6 7.8 6.0
------- ------- -------
Average number of common shares
outstanding used to calculate diluted
earnings per common share 1,511.7 1,512.2 1,521.1
======= ======= =======
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"), which amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement (a) clarifies under what circumstances
a contract with an initial net investment meets the characteristic of a
derivative, (b) clarifies when a derivative contains a financing component, (c)
amends the definition of an underlying to conform to language used in FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (d)
amends certain other existing pronouncements. The provisions of SFAS No. 149
are effective for contracts entered into or modified after June 30, 2003. There
was no substantial impact on the Company's consolidated financial statements on
adoption of this Statement.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). This Statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that certain financial
instruments that were previously classified as equity must be classified as a
liability. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. This Statement did not have any material effect on the Company's
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), in an effort to expand upon and
strengthen existing accounting guidance that addresses when a company should
include in its financial statements the assets, liabilities and activities of
another entity. In December 2003, the FASB revised Interpretation No. 46, also
referred to as Interpretation 46 (R) ("FIN 46(R)"). The objective of this
interpretation is not to restrict the use of variable interest entities but to
improve financial reporting by companies involved with variable interest
entities. Until now, one company generally has included another entity in its
consolidated financial statements only if it controlled the entity through
voting interests. This interpretation changes that, by requiring a variable
interest entity to be consolidated by a company only if that company is subject
to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns
or both. The Company is required to apply FIN 46, as revised, to all entities
subject to it no later than the end of the first fiscal year or interim period
ending after March 15, 2004. However, prior to the required application of FIN
46, as revised, the Company shall apply FIN 46 or FIN 46 (R) to those entities
that are considered to be special-purpose entities as of the end of the first
reporting period ending after December 15, 2003. The adoption of this
interpretation did not have a material effect on the Company's consolidated
financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits - an amendment of
SFAS No. 87, SFAS No. 88 and SFAS No. 106" ("SFAS No. 132 (revised 2003)").
This Statement revises employers' disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans required by SFAS No. 87, "Employers' Accounting for Pensions,"
SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits," and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." This
Statement retains the disclosure requirements contained in SFAS No. 132,
"Employers' Disclosures About Pensions and Other Postretirement Benefits,"
which it replaces. It requires additional disclosures to those in the original
Statement 132 about assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension plans and other defined benefit postretirement
plans. This Statement is effective for financial statements with fiscal years
ending after December 15, 2003 and interim periods beginning after December 15,
2003. Adoption of this Statement did not have a material impact on the
Company's consolidated financial statements.
In December 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 03-3 ("SOP 03-3") "Accounting for
Certain Loans or Debt Securities Acquired in a Transfer." SOP 03-3 requires
loans acquired through a transfer, such as a business combination, where there
are differences in expected cash flows and contractual cash flows due in part
to credit quality be recognized at their fair value. The excess of contractual
cash flows over expected cash flows is not to be recognized as an adjustment of
yield, loss accrual, or valuation allowance. Valuation allowances cannot be
created nor "carried over" in the initial accounting for loans acquired in a
transfer on loans subject to SFAS 114, "Accounting by Creditors for Impairment
of a Loan." This SOP is effective for loans acquired in fiscal years beginning
after December 15, 2004, with early adoption encouraged. The Company does not
believe the adoption of SOP 03-3 will have a material impact on the Company's
financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"). This Statement revises FASB Statement No. 123,
"Accounting for Stock Based Compensation" and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and its related implementation
guidance. SFAS 123R requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements. It establishes
fair value as the measurement objective in accounting for share-based payment
arrangements and requires all entities to apply a fair-value based measurement
method in accounting for share-based payment transactions with employees except
for equity instruments held by employee share ownership plans. This Statement
is effective for the Company as of the beginning of the first interim or annual
reporting period that begins after June 15, 2005. The Company does not believe
the adoption of this Statement will have a material impact on the Company's
financial position or results of operations.
NOTE 2 CASH AND DUE FROM BANKS
Cash and due from banks at December 31, 2004 and 2003 includes $3,753,000 and
$3,588,000, respectively, which is subject to withdrawals and usage
restrictions to satisfy the reserve requirements of the Federal Reserve Bank.
NOTE 3 SECURITIES AVAILABLE-FOR-SALE
The amortized cost, gains in accumulated other comprehensive income, losses in
accumulated other comprehensive income and fair value of securities at December
31, 2004 and 2003 follows:
($000 Omitted)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ----
December 31, 2004
US Treasury and other US
government agency securities $ 54,914 $ 1 $ 352 $54,563
Marketable equity securities 1,827 136 32 1,931
Mortgage-backed securities 29,447 92 248 29,291
Collateralized mortgage
obligations 10 - - 10
Corporate bonds 12,001 293 7 12,287
State and political
subdivision bonds and notes 2,966 85 - 3,051
-------- ------ ------- --------
$101,165 $ 607 $ 639 $101,133
======== ====== ======= ========
($000 Omitted)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ----
December 31, 2003
US Treasury and other
US government agency
securities $37,945 $ 74 $179 $37,840
Marketable equity securities 2,589 251 74 2,766
Mortgage-backed securities 2,803 90 5 2,888
Collateralized mortgage
obligations 15 - - 15
Corporate bonds 20,857 1,126 - 21,983
State and political
subdivision bonds and
notes 2,432 158 - 2,590
------- ------ ---- -------
$66,641 $1,699 $258 $68,082
======= ====== ==== =======
The contractual maturity distribution of investments in debt obligations at
December 31, 2004 follows:
($000 Omitted)
Within One to Five to Over Total
One Five Ten Ten Amortized
Year Years Years Years Cost
------ ------- ------ ------- -------
US Treasury and other US government agency securities $1,999 $47,915 $5,000 $ -- $54,914
Mortgage-backed securities 2 1,158 120 28,167 29,447
Collateralized mortgage obligations -- -- -- 10 10
Corporate bonds -- 9,983 2,018 -- 12,001
State and political subdivision bonds and notes 1,129 498 819 520 2,966
------ ------- ------ ------- -------
Total amortized cost $3,130 $59,554 $7,957 $28,697 $99,338
====== ======= ====== ======= =======
Fair value $3,130 $59,591 $7,961 $28,520 $99,202
====== ======= ====== ======= =======
Actual maturities of state and political subdivision bonds and notes,
mortgage-backed securities and collateralized mortgage obligations will differ
from the maturities presented because borrowers have the right to prepay
obligations without prepayment penalties.
An analysis of gross realized gains and losses on securities available-for-sale
during the years ended December 31, follows:
($000 Omitted)
2004 2003 2002
------------------------------------------------------------------------------
Realized Realized Realized Realized Realized Realized
Gains Losses Gains Losses Gains Losses
------- --------- ------- ------- ------- -------
Equity securities $ 402 $ 149 $ 97 $ 244 $ 39 $ 449
US government agency securities 5 -- 15 -- 149 --
Mortgage-backed securities -- -- -- -- 159 --
Corporate bonds 539 50 1,682 28 246 --
State and political subdivisions 6 -- -- -- 7 --
------- --------- ------- ------- ------- -------
$ 952 $ 199 $ 1,794 $ 272 $ 600 $ 449
======= ========= ======= ======= ======= =======
The tax provision applicable to these net realized gains amounted to $298,000,
$603,000 and 60,000 for 2004, 2003, and 2002, respectively.
Securities with a carrying amount totaling $72,106,000 and $39,789,000 were
pledged to secure public deposits, securities sold under agreements to
repurchase, FHLB advances and treasury, tax and loan accounts at December 31,
2004 and 2003, respectively.
The aggregate fair value and unrealized losses of securities that have been in
a continuous unrealized loss position for less than twelve months and for
twelve months or more, and are not other than temporarily impaired, are as
follows as of December 31, 2004:
($000 Omitted)
Less than 12 Months 12 Months or Longer Total
---------------------- ------------------------ -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------------------- ------------------------ -----------------------
US government agency securities $41,792 $ 186 $ 9,828 $ 166 $51,620 $ 352
Marketable equity securities 458 32 -- -- 458 32
Mortgage-backed securities 24,428 244 260 4 24,688 248
Corporate bonds 1,998 7 -- -- 1,998 7
---------------------- ------------------------ -----------------------
Total temporarily impaired securities $68,676 $ 469 $10,088 $ 170 $78,764 $ 639
====================== ======================== =======================
At December 31, 2004, securities with a total fair value of $78,764,000 were in
a loss position. These securities included twenty-two US government agency
securities with a fair value of $51,620,000 and an unrealized loss of $352,000.
These securities had an unrealized loss due to the current interest rate
environment. As these securities are guaranteed by US government agencies such
as FHLB, FHLMC or FNMA there is no credit risk associated with them. These
securities are not other-than-temporarily impaired as the Company has the
ability and the intent to hold these securities until recovery.
Mortgage-backed securities with a fair value of $24,688,000 had an unrealized
loss of $248,000 at December 31, 2004. As with the US government agency
securities, these securities have an unrealized loss due to the current
interest rate environment. As all of these mortgage-backed securities are
guaranteed by US government agencies such as FHLMC, GNMA or FNMA there is no
credit risk associated with them. These securities have not been classified as
other-than-temporarily impaired as the Company has the ability and intent to
hold these securities until recovery.
Nine marketable equity securities with a fair value of $458,000 had an
unrealized loss of $32,000 at December 31, 2004. Marketable equity securities
are subject to internal testing on a quarterly basis to determine impairment.
Testing includes review of industry analyst reports, credit ratings, sector
analysis and earnings projections. Based upon the December 31, 2004 review,
these securities were not determined to be other-than-temporarily impaired.
One corporate bond security with a fair value of $1,998,000 had an unrealized
loss of $7,000 at December 31, 2004. Corporate bond securities are subject to
internal testing on a quarterly basis to determine
other-than-temporary-impairment. Based upon the December 31, 2004 review, this
security was not determined to be other-than-temporarily-impaired.
NOTE 4 LOANS
Loan balances were comprised of the following:
($000 Omitted)
December 31, 2004 2003
-------- --------
Real estate:
Residential $147,333 $129,493
Commercial 130,334 120,366
Construction 5,366 3,851
Commercial 27,013 24,528
Installment 29,345 30,291
Indirect installment 116,520 150,807
Other 18,901 14,530
-------- --------
Total loans 474,812 473,866
-------- --------
Less:
Unearned income 106 247
Allowance for loan losses 5,204 5,036
-------- --------
Total unearned income and allowance for
loan losses 5,310 5,283
-------- --------
Net loans $469,502 $468,583
======== ========
Total loans above are net of unearned discount on loans acquired in the amount
of $415,000 and $575,000 at December 31, 2004 and 2003, respectively. In
addition, total loans above are net of unamortized premium on indirect
installment loans originated in the amount of $2,005,000 and $3,392,000 at
December 31, 2004 and 2003, respectively.
Loans are made in the ordinary course of business to directors, executive
officers, and their immediate families and to organizations in which such
persons have more than a 10% ownership interest. These loans are made on
substantially the same terms, including interest rate and collateral, as those
prevailing at the same time for comparable transactions with unrelated persons
and did not involve more than the normal risk of collectibility or present
other unfavorable features. Total loans to such persons and their companies
amounted to $660,000 as of December 31, 2004. During 2004, principal payments
were $148,000 and principal advances amounted to $498,000.
The Company's lending activities are conducted principally in New Hampshire.
Although the loan portfolio is diversified, a portion of its debtors' ability
to repay is dependent upon the economic conditions prevailing in New Hampshire.
The Company maintains significant credit relationships with borrowers in the
hotel and motel industry. The aggregate loan balances to these industries
totaled $59,730,000 at December 31, 2004 and $56,200,000 at December 31, 2003.
Loans serviced for others are not included in the accompanying statements of
financial condition. The unpaid principal balances of these loans total
$43,979,000 and $45,967,000 at December 31, 2004 and 2003, respectively. The
Company sold $15,228,000 of mortgage loans and $5,088,000 of SBA guaranteed
commercial loans in 2004 and $22,483,000 of mortgage loans and $1,482,000 of
indirect installment loans in 2003.
The Company capitalized $80,000 and $187,000 of servicing rights and amortized
$168,000 and $137,000 of those rights in 2004 and 2003, respectively.
Impairment of mortgage servicing rights of $(2,000) and $5,000 was recognized
in 2004 and 2003, respectively. 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 the impairment recognized is the amount by which the capitalized mortgage
servicing rights exceed their fair value. At December 31, 2004 and 2003,
respectively, the carrying amount of servicing rights was $298,000 and
$384,000, and is included in other assets.
Restructured, accruing loans entered into prior to the adoption of SFAS No. 114
and 118 are not required to be reported as impaired loans unless such loans are
not performing in accordance with the restructured terms at adoption of SFAS
No. 114. Restructured, accruing loans entered into subsequent to the adoption
of these statements are reported as impaired loans. In the year subsequent to
restructure these loans may be removed from the impaired loan disclosure
provided that the loan bears a market rate of interest at the time of
restructure and is performing under the restructured terms.
At December 31, 2004 and 2003, loans restructured in a troubled debt
restructuring before January 1, 1995, the effective date of SFAS No. 114, that
are not impaired based on the terms specified by the restructuring agreement
totaled $838,000 and $897,000, respectively. The gross interest income that
would have been recorded in the years ended December 31, 2004 and 2003 if such
restructured loans had been current in accordance with their original terms was
$60,000 and $65,000, respectively. The amount of interest income recognized on
such restructured loans for the years ended December 31, 2004 and 2003 was
$43,000 and $44,000, respectively.
At December 31, 2004 and 2003, nonperforming loans totaled $2,867,000 and
$4,089,000, respectively. No nonperforming loans were past due 90 days or more
and still accruing interest for both December 31, 2004 and 2003.
The recorded investment in loans that are considered to be impaired under SFAS
No. 114 was $1,914,000 and $3,014,000 at December 31, 2004 and 2003,
respectively, for which the related allowance for loan losses is $307,000 and
$485,000 as of December 31, 2004 and 2003, respectively. All of the Company's
impaired loans are collateralized and therefore all impaired loans are measured
by the difference between the fair value of the collateral and the recorded
amount of the loan. All of the Company's impaired loans had a related allowance
for loan losses at December 31, 2004 and 2003. The average recorded investment
in impaired loans during the twelve months ended December 31, 2004 and 2003 was
approximately $2,305,000 and $3,001,000, respectively. For the twelve months
ended December 31, 2004 and 2003 the Company recognized interest income on
impaired loans of $147,000 and $217,000, respectively, which included $128,000
and $168,000 of interest income recognized using the cash-basis method of
income recognition, respectively.
NOTE 5 ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31,
follows:
($000 Omitted)
2004 2003 2002
------ ------ ------
Balance at beginning of year $5,036 $4,920 $4,642
Provision for loan losses 495 805 900
Recoveries on loans previously
charged-off 338 181 202
Loans charged-off (665) (870) (824)
------ ------ ------
Balance at end of year $5,204 $5,036 $4,920
====== ====== ======
NOTE 6 PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
($000 Omitted)
December 31,
----------------------
2004 2003
------- -------
Land $ 2,650 $ 2,445
Buildings 11,509 9,644
Leasehold improvements 365 508
Construction in progress 36 958
Equipment 8,906 7,855
------- -------
23,466 21,410
Less accumulated depreciation and amortization 9,765 8,552
------- -------
$13,701 $12,858
======= =======
Depreciation expense for the years ended December 31, 2004, 2003 and 2002
amounted to $1,415,000, $1,427,000 and $1,315,000, respectively.
The Company leases five of its locations under non-cancelable operating leases
and two locations under tenant at will agreements. In addition, the Company
leases two storage facilities under non-cancelable leases. Minimum lease
payments in future periods under non-cancelable operating leases at December
31, 2004 are as follows:
($000 Omitted)
2005 $ 221
2006 156
2007 123
2008 25
------
$ 525
======
The terms of two of the leases provide that the Company can, at the end of the
current five-year term, renew the lease under one five-year option. All leases
contain a provision that the Company shall pay its pro-rata share of operating
costs. Additionally, two of the leases require that the Company pay all real
estate taxes.
Rent expense for the years ended December 31, 2004, 2003, and 2002 amounted to
$404,000, $421,000 and $369,000, respectively.
NOTE 7 DEPOSITS
The aggregate amount of maturities for time deposits as of December 31, 2004,
for each of the following five years ended December 31 and thereafter, are as
follows:
($000 Omitted)
2005 $ 92,555
2006 34,698
2007 5,134
2008 462
2009 136
Thereafter 20
--------
$133,005
========
Deposits from related parties held by the Banks at December 31, 2004 and 2003
amounted to $2,953,000 and $3,081,000, respectively.
NOTE 8 SHORT-TERM BORROWINGS
Short-term borrowings consist of securities sold under agreements to
repurchase. The securities sold under agreements to repurchase as of December
31, 2004 and 2003 are securities sold on a short term basis by the Company that
have been accounted for not as sales but as borrowings. The underlying
securities associated with securities sold under agreements to repurchase are
under the control of the Company. The purchasers have agreed to sell to the
Company substantially identical securities at the maturity of the agreements.
NOTE 9 LONG-TERM DEBT
Long-term debt at December 31, 2004 and 2003 consisted of FHLB advances of
$78,000,000 and $67,000,000, respectively, as well as $20,620,000 of junior
subordinated debentures, for each year.
As of December 31, 2004, contractual principal payments due under long-term
debt, which consists of FHLB advances and junior subordinated debentures, are
as follows:
($000 Omitted)
2005 $ 2,000
2006 31,000
2007 13,000
2008 4,000
2009 19,000
2010 and years thereafter 29,620
--------
$98,620
=======
The FHLB long-term debt consisted of twenty five separate advances. Seven of
these advances are callable with the following rates terms:
($000 Omitted)
Next
Amount Rate Maturity Date Call Date
------- ----- ------------- ---------
$ 5,000 6.11% 03/28/07 03/28/05
7,000 5.54 11/02/09 02/01/05
7,000 5.57 11/09/09 02/09/05
5,000 5.91 12/17/09 03/17/05
2,000 4.80 12/27/10 03/28/05
3,000 4.50 01/24/11 01/24/05
1,000 4.58 02/07/11 02/07/05
-------
$30,000
=======
The remaining eighteen advances, totaling $48,000,000, are at rates ranging
from 1.96% to 3.85% with a weighted average rate of 2.52%.
The $20,620,000 of junior subordinated debentures consists of the following two
issues:
On April 10, 2002, the Company completed the private placement of $7,217,000
aggregate liquidation amount of floating rate trust preferred securities (the
"Trust I Capital Securities") issued by its Delaware statutory business trust,
Northway Capital Trust I ("Capital Trust I"). The Trust I Capital Securities
were sold to a pooled investment vehicle. The proceeds from the sale of the
Trust I Capital Securities, which included the proceeds from the sale by
Capital Trust I of its common securities to the Company, were invested in
Floating Rate Junior Subordinated Debt Securities of the Company due 2032 (the
"Trust I Junior Subordinated Debt"), which were issued pursuant to an
Indenture, dated April 10, 2002, between the Company and Wilmington Trust
Company, as Trustee. Both the Trust I Capital Securities and the Trust I Junior
Subordinated Debt have a floating rate, which resets semi-annually, equal to
six-month LIBOR plus 3.70%, with a ceiling of 11.00% for the first five years.
Currently, the interest rate on these securities is 6.00%. Payments of
distributions and other amounts due on the Trust I Capital Securities are
irrevocably guaranteed by the Company, to the extent that Capital Trust I has
funds available for the payments of such distributions, pursuant to a Guarantee
Agreement, dated April 10, 2002, between the Company and Wilmington Trust
Company, as Guarantee Trustee. The Trust I Junior Subordinated Debt and the
Trust I Capital Securities may be redeemed at the option of the Company on
fixed semi-annual dates beginning on April 22, 2007.
On July 11, 2002, the Company completed the private placement of $13,403,000
aggregate liquidation amount of floating rate trust preferred securities (the
"Trust II Capital Securities") issued by its Delaware statutory business trust,
Northway Capital Trust II (the "Capital Trust II"). The Trust II Capital
Securities were sold to a pooled investment vehicle. The proceeds from the sale
of the Trust II Capital Securities, which include the proceeds from the sale by
Capital Trust II of its common securities to the Company, were invested in
Floating Rate Junior Subordinated Debt Securities of the Company due 2032 (the
"Trust II Junior Subordinated Debt"), which were issued pursuant to an
Indenture, dated July 11, 2002, between the Company and Wilmington Trust
Company, as Trustee. Both the Trust II Capital Securities and the Trust II
Junior Subordinated Debt have a floating rate, which resets quarterly, equal to
three-month LIBOR plus 3.65%, with a ceiling of 12.50% for the first five
years. Currently, the interest rate on these securities is 5.72%. Payments of
distributions and other amounts due on the Trust II Capital Securities are
irrevocably guaranteed by the Company, to the extent that Capital Trust II has
funds available for the payments of such distributions, pursuant to a Guarantee
Agreement, dated July 11, 2002, between the Company and Wilmington Trust
Company, as Guarantee Trustee. The Trust II Junior Subordinated Debt and the
Trust II Capital Securities may be redeemed at the option of the Company on
fixed quarterly dates beginning on July 7, 2007.
NOTE 10 ACQUISITIONS
On October 18, 2002, the Company acquired certain assets and assumed the
deposits of three branches offices of Fleet National Bank located in Laconia,
Belmont and Pittsfield, New Hampshire. This acquisition has allowed the Company
to expand its market area further into Belknap and Merrimack Counties. Deposits
assumed totaled $54,932,000 for which the Company paid a deposit purchase
premium of 11.25%. In addition, the Company acquired certain loans associated
with the branches totaling $20,192,000. As a result of this purchase the
Company made the following entries to record this transaction:
($000 Omitted)
Cash $26,738
Loans 20,192
Goodwill 4,766
Core deposit intangible 2,639
Land and buildings 430
Furniture and fixtures 13
Leasehold improvements 76
Other assets 83
Building lease and equipment expense 12
Salary expense 7
Deposits $54,932
Other liabilities 17
Other income 7
This transaction was accounted for using the purchase method of accounting. The
results of operations of the acquired branches are included in the 2002
consolidated statements of income of the Company from the date of the
transaction.
The cost of the acquired branch offices exceeded the fair value of the assets
acquired and liabilities assumed by $7,405,000. Of this amount, $2,639,000 was
assigned to core deposit intangible and $4,766,000 was recorded as goodwill.
All of the goodwill was deductible for tax purposes. The core deposit
intangible of $2,639,000 is being amortized to noninterest expense over fifty
months using the straight line method.
Management reviews the carrying amount of intangible assets resulting from
these transactions on an ongoing basis, taking into consideration any events
and circumstances that might have diminished such amount. During 2004 and 2003,
the Company reviewed the carrying amount of intangible assets and determined
that no impairment was required.
NOTE 11 REGULATORY MATTERS
The Company and the Banks are 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 Banks' financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Banks must meet specific capital guidelines that involve quantitative
measures of the Banks' assets, liabilities and certain off-balance sheet items
as calculated under regulatory accounting practices. The Banks' capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Banks to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). As of December 31, 2004, the most
recent notification from the FDIC categorized both banks as "well-capitalized"
under the regulatory framework for prompt corrective action. To be categorized
as "well-capitalized" the Banks must maintain total risk-based, Tier 1
risk-based and Tier 1 leverage ratios above regulatory prescribed minimum
levels. There are no conditions or events since that notification that
management believes have changed the Company's and Banks' categories.
Management believes, as of December 31, 2004 and 2003, that the Company and the
Banks meet all capital adequacy requirements to which they are subject.
These minimum capital amounts and ratios, as well as the Company's and Banks'
actual capital amounts and ratios, are presented in the following table:
($000 Omitted)
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2004
- ------------------------------------------------
Tier 1 capital (to average assets)
Consolidated $52,736 8.43% $25,014 =>4.00% N/A
The Berlin City Bank 30,589 7.71 15,869 =>4.00 $19,836 =>5.00%
The Pemigewasset National Bank of Plymouth, New Hampshire 17,561 7.74 9,071 =>4.00 11,339 =>5.00
Total capital (to risk weighted assets)
Consolidated 62,305 13.94 35,745 =>8.00 N/A
The Berlin City Bank 34,051 11.79 23,097 =>8.00 28,871 =>10.00
The Pemigewasset National Bank of Plymouth, New Hampshire 19,386 12.72 12,197 =>8.00 15,247 =>10.00
Tier 1 capital (to risk weighted assets)
Consolidated 52,736 11.80 17,872 =>4.00 N/A
The Berlin City Bank 30,589 10.59 11,549 =>4.00 17,323 =>6.00
The Pemigewasset National Bank of Plymouth, New Hampshire 17,561 11.52 6,099 =>4.00 9,148 =>6.00
As of December 31, 2003
- ------------------------------------------------
Tier 1 capital (to average assets)
Consolidated $43,769 7.22% $24,256 =>4.00% N/A
The Berlin City Bank 28,732 7.09 16,220 =>4.00 $20,276 =>5.00%
The Pemigewasset National Bank of Plymouth, New Hampshire 16,572 7.55 8,774 =>4.00 10,968 =>5.00
Total capital (to risk weighted assets)
Consolidated 58,020 12.81 36,244 =>8.00 N/A
The Berlin City Bank 32,231 10.51 24,526 =>8.00 30,657 =>10.00
The Pemigewasset National Bank of Plymouth, New Hampshire 18,184 12.50 11,642 =>8.00 14,533 =>10.00
Tier 1 capital (to risk weighted assets)
Consolidated 43,769 9.66 18,122 =>4.00 N/A
The Berlin City Bank 28,732 9.37 12,263 =>4.00 18,394 =>6.00
The Pemigewasset National Bank of Plymouth, New Hampshire 16,572 11.39 5,821 =>4.00 8,732 =>6.00
Federal regulations prohibit banking companies from paying dividends on their
stock if the effect would cause stockholders' equity to be reduced below
applicable regulatory capital requirements or if such declaration and payment
would otherwise violate regulatory requirements.
Under the National Bank Act, the approval of the OCC is required if dividends
declared by PNB to the Company in any year exceed the net profits of that year,
as defined, combined with the retained net profit for the two preceding years.
At December 31, 2004 PNB could, without approval of the OCC, declare dividends
aggregating $1,132,000.
As of December 31, 2004, BCB is restricted from declaring dividends to the
Company in an amount greater than approximately $10,954,000, as such
declaration would decrease capital below BCB's required minimum level of
regulatory capital.
NOTE 12 OTHER NONINTEREST EXPENSE
The major components of other noninterest expense for the years ended December
31, are as follows:
($000 Omitted)
2004 2003 2002
------- ------- -------
Professional fees $1,234 $1,166 $1,096
Stationery and supplies 429 556 596
Telecommunications 595 571 505
Postage and shipping 348 378 378
ATM expense 295 442 366
Other 2,827 2,706 2,652
------ ------ ------
$5,728 $5,819 $5,593
====== ====== ======
NOTE 13 FEDERAL AND STATE TAXES
The components of federal and state tax expense for the years ended December
31, are as follows:
($000 Omitted)
2004 2003 2002
------ ------ ------
Current
Federal $1,289 $1,713 $ 985
State 334 403 327
1,623 2,116 1,312
------ ------ ------
Deferred
Federal 44 (181) 176
State (1) (37) (12)
------ ------ ------
43 (218) 164
Change in valuation allowance -- (31) 31
------ ------ ------
43 (249) 195
------ ------ ------
Total $1,666 $1,867 $1,507
====== ====== ======
The temporary differences (the differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases) that give rise to significant portions of the deferred income tax asset
and deferred income tax liability at December 31, are as follows:
($000 Omitted)
2004 2003
------- ------
Deferred income tax asset
Allowance for loan losses $ 1,988 $1,836
Other 10 10
Interest on nonaccrual loans 19 27
Loan origination costs, net 4 23
Unrealized holding loss on securities
available-for-sale 14 --
Securities writedown -- 9
Capital loss carryforward 70 162
Minimum pension liability adjustment 345 371
Amortization of goodwill and core deposit intangible 130 257
Supplemental pension 250 136
------- ------
2,830 2,831
------- ------
Deferred income liabilities
Depreciation (801) (751)
Unrealized holding gain on securities
available-for-sale -- (571)
Prepaid pension (246) (208)
Mortgage and consumer servicing rights (118) (152)
------- ------
(1,165) (1,682)
------- ------
Deferred income tax asset, net $ 1,665 $1,149
======= ======
The primary sources of recovery of the deferred income tax asset are taxes paid
that are available for carryback and the expectation that the deductible
temporary differences will reverse during periods in which the Company
generates taxable income.
Total income tax expense for the years ended December 31, 2004, 2003 and 2002
differs from the "expected" federal income tax expense at the 34% statutory
rate for the following reasons:
2004 2003 2002
---- ---- ----
Expected federal income taxes 34.0% 34.0% 34.0%
Interest on municipal securities
available-for-sale and municipal loans (4.5) (3.3) (3.8)
State tax expense, net of federal benefit 4.3 4.4 5.1
Valuation allowance for securities - (0.6) -
Other (0.8) (0.4) 1.4
---- ---- ----
Effective tax rates 33.0% 34.1% 36.7%
==== ==== ====
NOTE 14 EMPLOYEE BENEFITS
Pension Plan
The Company maintains a trusteed non-contributory pension plan (the "Plan")
covering substantially all full-time employees. Assuming retirement at age 65
after 30 years or more of service, the benefits are computed as the sum of one
percent of final average earnings up to a covered compensation limit, plus 0.65
percent of final average earnings in excess of covered compensation, times
years of service, up to 30. Final average earnings are defined as the five
consecutive years out of the employee's last ten years of employment during
which compensation is highest. The amounts contributed to the Plan are
determined annually on the basis of (a) the maximum amount that can be deducted
for federal income tax purposes or (b) the amount certified by a consulting
actuary as necessary to avoid an accumulated funding deficiency as defined by
the Employee Retirement Income Security Act of 1974. Contributions are intended
to provide not only benefits attributed to service to date but also for those
expected to be earned in the future.
The following table sets forth information about the Plan as of December 31,
and for the years then ended:
($000 Omitted)
2004 2003 2002
------- ------- -------
Change in benefit obligation
- ----------------------------------------------
Benefit obligation at beginning of year $ 4,901 $ 4,356 $ 3,305
Service cost 481 444 356
Interest cost 303 266 246
Actuarial loss (gain) 233 (46) 747
Benefits paid (113) (119) (298)
------- ------- -------
Benefit obligation at end of year 5,805 4,901 4,356
------- ------- -------
Change in plan assets
- ----------------------------------------------
Fair value of plan assets at beginning of year 3,652 2,685 2,918
Actual return on plan assets 401 540 (248)
Employer contributions 661 546 313
Benefits paid (113) (119) (298)
------- ------- -------
Fair value of plan assets at end of year 4,601 3,652 2,685
------- ------- -------
Funded status at end of year (1,204) (1,249) (1,671)
Unrecognized transition asset -- (1) (5)
Unrecognized net actuarial loss 2,803 2,824 3,371
Unrecognized prior service cost (877) (961) (1,046)
------- ------- -------
Net amount recognized $ 722 $ 613 $ 649
======= ======= =======
Amounts recognized in the consolidated
balance sheets consist of:
- ----------------------------------------------
Accrued benefit liability $(1,018) $(1,092) $(1,707)
Accumulated other comprehensive loss, before
income tax benefit 1,018 1,092 1,707
Prepaid benefit cost 722 613 649
------- ------- -------
Net amount recognized $ 722 $ 613 $ 649
======= ======= =======
The accumulated benefit obligation for the plan was $4,896,000 and $4,131,000
at December 31, 2004 and 2003, respectively.
The expected long-term rate of return for the plan's total assets is based on
the expected return of asset categories identified below, weighted based on the
target allocations for each class. Equity funds are expected to return 8% to
10% over the long-term and bond funds and short-term money markets are expected
to return between 4% and 6%.
($000 omitted)
Components of net periodic benefit cost 2004 2003 2002
- --------------------------------------------------- ----- ----- -----
Service cost $ 481 $ 444 $ 356
Interest cost 303 266 246
Expected return on plan assets (288) (211) (244)
Amortization of prior service cost (84) (84) (84)
Amortization of net actuarial loss 141 172 122
Recognized transition amount (1) (5) (5)
----- ----- -----
Net periodic benefit cost $ 552 $ 582 $ 391
===== ===== =====
Assumptions used to determine benefit
obligations and benefit cost
as of and for the years ending December 31, 2004 2003 2002
- --------------------------------------------------- ----- ----- -----
Discount rate:
Benefit obligation 6.00% 6.25% 6.25%
Benefit cost 6.25 6.25 6.25
Long-term rate of return on plan assets 8.00 8.00 8.50
Rate of compensation increase 3.50 4.00 4.00
At December 31, 2004 and 2003, the comprehensive loss for the unfunded pension
accumulated benefit obligation was $673,000 and $721,000, net of taxes,
respectively. While the Company continues to contribute the maximum amount
permitted by law to its pension plan, the discount rate used to calculate the
future value of such contribution and the poor asset performance of the mutual
funds has resulted in the unfunded pension accumulated benefit obligation.
The Company's pension plan actual asset allocations by asset category are as
follows:
Plan Assets at December 31,
---------------------------------------
2004 2003 2002
---------------------------------------
Asset Category
Mutual funds:
Bond funds 32.6% 32.3% 45.1%
Equity securities 43.6 43.9 50.8
Real estate funds 9.4 8.8 -
Short-term money market 14.4 15.0 4.1
----- ----- -----
Total 100.0% 100.0% 100.0%
===== ===== =====
The investment policy, as established by the Company, is to provide for a
moderate growth of capital with a moderate level of volatility by investing
assets per the target allocations as follows:
2004 2003 2002
- ------------------------------------------------------------------------------
Asset Category
Mutual funds:
Bond funds 40-60% 40.0% 45.0%
Equity securities 30-50 50.0 55.0
Real estate funds 0-15 10.0 --
The assets will be re-allocated quarterly to meet the above target allocations.
The investment policy is reviewed on an annual basis, under the advisement of
our certified investment advisor, to determine if the policy should be changed.
The plan assets do not include any Company common stock at December 31, 2004
and 2003.
The Company expects to contribute $745,000 to its pension plan in 2005.
Estimated future benefit payments, which reflect future service, as
appropriate, are as follows for the years ended December 31:
($000 Omitted)
2005 $ 115
2006 153
2007 165
2008 195
2009 234
2010-2014 1,861
401(k) Plan
The Company offers a contributory 401(k) Plan. Under the Northway Financial,
Inc. 401(k) and Profit Sharing Plan (the "401K Plan") employees must have
attained age 21, completed six months of service and be credited with 1,000
hours of service in order to participate. Employees of the Company are eligible
to participate. Under the 401K Plan, employers match 50 percent of the first 4
percent of employee contributions. Total 401(k) matching expense in 2004, 2003
and 2002 amounted to $143,000, $130,000 and $120,000, respectively, and Profit
Sharing contribution expense for 2004, 2003, and 2002 was $38,000, $0, and $0,
respectively.
Supplemental Executive Retirement Plan (SERP)
Effective May 29, 2003, the existing Executive Life program sponsored by the
Company was terminated and replaced with a SERP. The existing Split Dollar Life
Insurance policy designed to support the Executive Life program is now fully
owned by Northway. This policy will be maintained by Northway and is used as
the benchmark for the SERP.
The total retirement SERP benefit is as follows: Upon Mr. Woodward's
termination of employment for reasons other than death or for cause, the
account balance is paid out to him in ten (10) equal annual installments on the
first day of the month following the month in which employment is terminated.
Upon death after retirement, the unpaid account balance, if any, is paid out in
a lump sum to the named beneficiary. During retirement, an additional
retirement payment, based on the policy gains associated with the prior
calendar year, will also be paid on an annual basis until the executive's
death. In the event of Mr. Woodward's death while employed by the Company, the
SERP permits a death benefit of $2,000,000 be paid to his beneficiary.
Stock-Based Compensation
The Board of Directors (the "Committee") administers the 1999 Stock Option and
Grant Plan (the "1999 Plan") which is described below.
Under the 1999 Plan, the Committee may select the individuals to whom awards
may from time to time be granted; determine the time or times of grant; and
determines the extent, if any, of incentive stock options, non-qualified stock
options, restricted stock awards, unrestricted stock awards, performance share
awards, or any combination of the foregoing.
The 1999 Plan expires in February 2009. The aggregate number of shares of the
Company's common stock which may be issued upon the exercise of options granted
under the 1999 Plan is 175,000. The option price is fixed by the Committee at
the time of the grant and may not be less than 100 percent of the fair market
value of the stock, as determined by the Committee, in good faith as of the
grant date. Each option may be exercised at such times as shall be determined
by the Committee at or after the grant date; provided, however, that no option
may be exercised ten years after the date of grant. The fair value of each
option granted is estimated on grant date using the Black-Scholes option
pricing model.
A summary of the status of the Company's 1999 Plan as of December 31, 2004,
2003 and 2002 and changes during the years then ended is presented below:
2004 2003 2002
----------------------- ----------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ -------
Outstanding, beginning of year 42,000 $ 24.93 42,000 $ 24.93 49,500 $ 24.91
Granted -- -- -- -- -- --
Exercised (4,000) 24.64 -- -- (5,250) 25.70
Forfeited -- -- -- (2,250) 22.63
Outstanding, end of year 38,000 $ 24.96 42,000 $ 24.93 42,000 $ 24.93
====== ====== ======
Options exercisable at year-end 38,000 42,000 36,000
The following table summarizes information about fixed stock options
outstanding as of December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------ -------------------------
Weighted
Weighted Number Average Number Weighted
Average Outstanding Remaining Exercisable Average
Exercise as of Contractual as of Exercise
Price 12/31/04 Life 12/31/04 Price
-------- ----------- ----------- ----------- --------
$28.00 16,500 4.50 years 16,500 $28.00
22.63 21,500 5.63 years 21,500 22.63
------ -----
$24.96 38,000 5.14 years 38,000 $24.96
====== =====
Change in Control
The Company and its subsidiaries have entered into Key Employee agreements with
the specific Executive Officers as well as other Senior Officers of the
Company. These agreements provide for payments, under certain circumstances, to
the officer upon the officer's termination after a change in control. Payments
will be made under these agreements upon the officer's termination or
resignation in connection with certain specified actions adverse to the
officer's employment status after a change in control. The amount of such
payments ranges from 1.0 to 1.5 times such officer's annual compensation.
NOTE 15 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans and standby letters of
credit. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby
letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, are as
follows:
($000 Omitted)
2004 2003
------- --------
Financial instrument whose contract amounts represent
credit risk:
Unadvanced portions of home equity loans $17,748 $13,798
Unadvanced portions of lines of credit 9,216 10,535
Unadvanced portions of commercial real estate loans 1,888 2, 202
Commitments to originate all other loans 15,952 18,391
Commitments to originate municipal notes 2,995 --
Standby letters of credit 400 350
Commitments to originate loans and municipal notes, unadvanced portions of home
equity loans, lines of credit and commercial real estate loans are agreements
to lend to a customer provided 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 are expected to expire without having been drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
borrower.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan commitments to customers. As of December 31, 2004 and 2003,
the maximum potential amount of the Company's obligation was $400,000 and
$350,000, respectively, for financial and standby letters of credit. The
Company's outstanding letters of credit generally have a term of less than one
year. If a letter of credit is drawn upon, the Company may seek recourse
through the customer's underlying line of credit. If the customer's line of
credit is also in default, the Company may take possession of the collateral,
if any, securing the line of credit.
NOTE 16 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statements of
financial condition for cash and cash equivalents approximates the fair value
of those assets.
Securities: Fair values for securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
FHLB and Federal Reserve Bank ("FRB") Stock: The carrying amount reported in
the statements of financial condition for FHLB and FRB Stock approximates their
fair value. If redeemed, the Company will receive an amount equal to the par
value of the stocks.
Loans held-for-sale: Fair values for loans held-for-sale are estimated based on
outstanding investor commitments, or in the absence of such commitments, are
based on current investor yield requirements.
Loans: For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair value
for other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The fair value of nonaccrual loans was
estimated using discounted cash flow analysis or the estimated fair value of
the underlying collateral where applicable.
Accrued interest receivable: The carrying value of accrued interest receivable
approximates its fair value because of the short-term nature of this financial
instrument.
Deposits: The fair value of demand deposits (e.g. NOW and super NOW checking,
noninterest bearing checking, regular savings, money market accounts and
mortgagors' escrow accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e. their carrying amounts). Fair values for
certificates of deposit are estimated using a discounted cash flow technique
that applies interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities of time deposits.
Short-term borrowings: The carrying value of short-term borrowings approximates
its fair value because of the short-term nature of these financial instruments.
Long-term debt: The fair values of long-term debt are determined by discounting
the anticipated future cash payments by using the rates currently available to
the Company for debt with similar terms and remaining maturities.
Junior subordinated debentures: The fair values of junior subordinated
debentures are based on quoted market prices, where available. If quoted market
prices are not available, fair values are based on quoted market prices of
comparable instruments.
Off-balance sheet instruments: The fair value of commitments to originate loans
is estimated using the fees currently charged to enter similar agreements,
taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed-rate loan commitments and the
unadvanced portion of loans, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair value of
letters of credit is based on fees currently charged for similar agreements or
on the estimated cost to terminate them or otherwise settle the obligation with
the counterparties at the reporting date. See Note 15 for further information.
The estimated fair values of the Company's financial instruments are as follows:
($000 Omitted)
December 31,
---------------------------------------------
2004 2003
--------------------- ---------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- -------- --------- --------
Financial assets:
Cash and cash equivalents $ 24,769 $ 24,769 $ 31,085 $ 31,085
Securities available-for-sale 101,133 101,133 68,082 68,082
FHLB stock 5,515 5,515 4,705 4,705
FRB stock 365 365 365 365
Loans held-for-sale 311 314 511 519
Loans, net 469,502 466,679 468,583 472,340
Accrued interest receivable 2,405 2,405 2, 590 2, 590
Financial liabilities:
Deposits $475,359 $475,952 $463,307 $464,605
Short-term borrowings 11,268 11,268 7,401 7,401
Long-term debt 78,000 78,494 67,000 68,961
Junior subordinated debentures 20,620 21,270 20,620 21,083
The carrying amounts of financial instruments shown in the above table are
included in the consolidated balance sheets under the indicated captions except
that accrued interest receivable is included with other assets in the
statements and junior subordinated debentures is included with long-term debt
in the statements.
At December 31, 2004 and 2003, all the Company's financial instruments were
held for purposes other than trading.
LIMITATIONS
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. Because no market exists for some of the Company's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, cash flows, current economic conditions, risk
characteristics, and other factors. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions and changes in the
loan, debt and interest rate markets could significantly affect the estimates.
Further, the income tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on the fair value
estimates and have not been considered. The fair value amounts presented do not
represent the underlying value of the Company because fair values of certain
other financial instruments, assets and liabilities have not been determined.
NOTE 17 CONDENSED PARENT ONLY FINANCIAL STATEMENTS
Condensed financial statements of Northway Financial, Inc. (Parent Company
only) as of December 31, 2004 and 2003 and for the three years ended December
31, 2004 follow:
BALANCE SHEETS
($000 Omitted)
2004 2003
------- -------
Assets
Cash and cash equivalents $ 3,843 $ 3,525
Investment in subsidiary, The Berlin City Bank 37,107 35,991
Investment in subsidiary, The Pemigewasset National
Bank of Plymouth, New Hampshire 24,154 24,277
Investment in unconsolidated subsidiary,
Northway Capital Trust I & II 620 620
Equipment, net 2,058 1,792
Due from subsidiaries 808 978
Other assets 4,117 3,400
------- -------
Total assets $72,707 $70,583
======= =======
Liabilities and stockholders' equity
Accrued expenses $ 571 $ 480
Other liabilities 2,006 1,611
Junior subordinated debentures 20,620 20,620
------- -------
Total liabilities 23,197 22,711
------- -------
Stockholders' equity:
Common stock 1,732 1,732
Additional paid-in-capital 2,075 2,088
Retained earnings 52,484 50,116
Treasury stock (6,090) (6,213)
Accumulated other comprehensive (loss) income (691) 149
------- -------
Total stockholders' equity 49,510 47,872
------- -------
Total liabilities and stockholders' equity $72,707 $70,583
======= =======
STATEMENTS OF INCOME
($000 Omitted)
2004 2003 2002
--------- -------- ----------
Income:
Dividends from subsidiaries $ 2,030 $1,820 $1,520
Interest income 48 54 104
Management fee income from subsidiaries 9,576 9,112 6,710
Other 178 57 20
-------- ------- --------
11,832 11,043 8,354
-------- ------- --------
Expense:
Interest expense 1,079 1,036 665
Salaries and employee benefits 5,639 5,130 3,848
Office occupancy and equipment expense 1,204 1,223 905
Professional fees 925 933 683
Other 1,825 1,830 1,415
-------- ------- --------
10,672 10,152 7,516
-------- ------- --------
Income before income tax benefit and
equity in undistributed net income of
subsidiaries 1,160 891 838
Income tax benefit (345) (316) (232)
-------- ------- --------
Income before equity in undistributed net
income of subsidiaries 1,505 1,207 1,070
Equity in undistributed net income of subsidiaries 1,883 2,410 1,528
-------- ------- --------
Net income $ 3,388 $ 3,617 $ 2,598
======== ======= ========
STATEMENTS OF CASH FLOWS
($000 Omitted)
2004 2003 2002
-------- ------- --------
Cash flows from operating activities:
Net income $ 3,388 $ 3,617 $ 2,598
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Depreciation and amortization 603 467 289
Decrease (increase) in amount due from subsidiaries 170 (463) (73)
Increase in other assets (316) (1,271) (493)
Increase in accrued expenses and other liabilities 535 662 314
Loss on disposal of assets - 27 -
Undistributed net income of subsidiaries (1,883) (2,410) (1,528)
-------- ------- --------
Net cash provided by operating activities 2,497 629 1,107
-------- ------- --------
Cash flows from investing activities:
Capital contributions to subsidiaries:
The Berlin City Bank - (1,000) (3,000)
Pemigewasset National Bank - - (9,500)
Additions to premises and equipment (869) (466) (1,362)
Purchase of company owned life insurance (400) (800) -
-------- ------- --------
Net cash used in investing activities (1,269) (2,266) (13,862)
-------- ------- --------
Cash flows from financing activities:
Proceeds from issuance of junior
subordinated debentures by subsidiaries - - 20,000
Exercise of stock options 110 - 140
Purchases of treasury stock - (502) -
Dividends paid (1,020) (1,024) (1,030)
------- --------- -------
Net cash (used in) provided by financing activities (910) (1,526) 19,110
-------- ------- --------
Net (decrease) increase in cash and cash equivalents 318 (3,163) 6,355
Cash and cash equivalents at beginning of year 3,525 6,688 333
-------- ------- --------
Cash and cash equivalents at end of year $ 3,843 $ 3,525 $ 6,688
======== ======= ========
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Summarized quarterly financial data for 2004 and 2003 follows:
($000 Omitted, except earnings per share)
2004 Quarters Ended
------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Interest and dividend income $7,371 $7,571 $7,595 $7,740
Interest expense 1,827 1,873 1,867 1,864
------ ------ ------- ------
Net interest and dividend income 5,544 5,698 5,728 5,876
Provision for loan losses 150 120 120 105
Noninterest income 1,296 1,264 1,443 1,094
Noninterest expense 5,608 5,702 5,567 5,517
------ ------ ------- ------
Income before taxes 1,082 1,140 1,484 1,348
Income tax expense 353 392 507 414
------ ------ ------- ------
Net income $ 729 $ 748 $ 977 $ 934
====== ====== ====== ======
Basic earnings per common share $ 0.49 $ 0.50 $ 0.65 $ 0.62
====== ====== ====== ======
Earnings per common share assuming dilution $ 0.49 $ 0.49 $ 0.64 $ 0.62
====== ====== ====== ======
2003 Quarters Ended
------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Interest and dividend income $7,999 $8,203 $7,713 $7,592
Interest expense 2,199 2,218 2,084 1,956
------ ------ ------ ------
Net interest and dividend income 5,800 5,985 5,629 5,636
Provision for loan losses 225 220 210 150
Noninterest income 1,050 946 1,765 1,614
Noninterest expense 5,347 5,423 5,648 5,718
------ ------ ------ ------
Income before taxes 1,278 1,288 1,536 1,382
Income tax expense 467 464 558 378
------ ------ ------ ------
Net income $ 811 $ 824 $ 978 $1,004
====== ====== ====== ======
Basic earnings per common share $ 0.54 $ 0.55 $ 0.65 $ 0.66
====== ====== ====== ======
Earnings per common share assuming dilution $ 0.54 $ 0.54 $ 0.65 $ 0.66
====== ====== ====== ======
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shatswell, MacLeod & Company, P.C.
Certified Public Accountants
83 Pine Street
West Peabody, Massachusetts 01960
The Board of Directors and Stockholders
Northway Financial, Inc.
Berlin, New Hampshire
We have audited the accompanying consolidated balance sheets of Northway
Financial, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the
related consolidated statements of income, comprehensive income, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2004. These consolidated financial statements are the
responsibility of the Company'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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated 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 consolidated financial position of
Northway Financial, Inc. and Subsidiaries as of December 31, 2004 and 2003 and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
/s/ SHATSWELL, MacLEOD & COMPANY, P.C.
SHATSWELL, MacLEOD & COMPANY, P.C.
West Peabody, Massachusetts
January 21, 2005
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the company's disclosure controls and procedures as of December 31, 2004.
Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of December 31, 2004. There were no material
changes in the Company's internal control over financial reporting during the
fourth quarter 2004.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is incorporated by reference to the
information set forth under the captions "Information Concerning Directors and
Nominees," "Executive Officers" and "Audit and Compliance Committee" in the
Company's definitive proxy statement to be delivered in connection with its
2005 Annual Meeting of Stockholders.
Furthermore, the Company has adopted a code of ethics that applies to all of
its directors, officers and employees. The Company has filed a copy of this
Code of Ethics as Exhibit 14 to this Form 10-K. The Company has also made the
Code of Ethics available on its website at www.northwayfinancialinc.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information set forth under the caption "Executive Compensation" in the
Company's definitive proxy statement to be delivered in connection with its
2005 Annual Meeting of Stockholders, provided however, that the "Report of the
Human Resources, Compensation and Nominating Committee on Executive
Compensation" and the "Stock Price Performance Graph" contained in such proxy
statement are not incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to the
information set forth under the captions "Security Ownership of Management and
Principal Stockholders," "Information Concerning Directors and Nominees" and
"Equity Compensation Plan Information" in the Company's definitive proxy
statement to be delivered in connection with its 2005 Annual Meeting of
Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information set forth under the caption "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement to be delivered in
connection with its 2005 Annual Meeting of Stockholders.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the
information set forth under the caption "Fees Paid to Independent Auditors" in
the Company's definitive proxy statement to be delivered in connection with its
2005 Annual Meeting of Stockholders.
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are incorporated by reference from
Item 8 hereof:
Auditor's Independent Report
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income for the years ended December 31,
2004 and 2003
Consolidated Statements of Changes in Stockholders Equity for the
years ended December 31, 2004, 2003, 2002 and 2001
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
None
(3) The Exhibits which are filed with this report or which are incorporated
herein by reference are set forth in the Exhibit Index. The Exhibit
Index is incorporated herein by reference.
(b) See Item 15(a)(3) above
(c) See Item 8 of this Annual Report on Form 10-K
SIGNATURES
Pursuant to 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.
NORTHWAY FINANCIAL, INC.
March 23, 2005 BY: /S/ William J. Woodward
-----------------------------------
William J. Woodward
Chairman of the Board, President &
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.
Signature Title Date
--------- ----- ----
Chairman of the Board, March 23, 2005
President and CEO (Principal
/S/ William J. Woodward Executive Officer)
- ---------------------------
William J. Woodward
Senior Vice President and March 23, 2005
Chief Financial Officer
(Principal Financial
/S/ Richard P. Orsillo and Accounting Officer)
- ---------------------------
Richard P. Orsillo
/S/ Fletcher W. Adams Vice Chairman of the Board March 29, 2005
- ---------------------------
Fletcher W. Adams
/S/ John H. Noyes Director March 29, 2005
- ---------------------------
John H. Noyes
/S/ Barry J. Kelley Director March 23, 2005
- ---------------------------
Barry J. Kelley
/S/ Randall G. Labnon Director March 29, 2005
- ---------------------------
Randall G. Labnon
/S/ Stephen G. Boucher Director March 29, 2005
- ---------------------------
Stephen G. Boucher
/S/ Brien L. Ward Director March 23, 2005
- ---------------------------
Brien L. Ward
/S/ Arnold P. Hanson, Jr. Director March 23, 2005
- ---------------------------
Arnold P. Hanson, Jr.
/S/ Frederick C. Anderson Director March 23, 2005
- ---------------------------
Frederick C. Anderson
INDEX OF EXHIBITS
Exhibit Number Description of Exhibit
2.1 Agreement and Plan of Merger, dated as of March 14, 1997, by
and among Northway Financial, Inc., The Berlin City Bank,
Pemi Bancorp, Inc. and Pemigewasset National Bank (the
"Merger Agreement") (incorporated by reference to Exhibit 2.1
to Registration Statement No. 333-33033).
3.1 Amended and Restated Articles of Incorporation of Northway
Financial, Inc. (incorporated by reference to Exhibit 3.1 to
Registration Statement No. 333-33033).
3.2 By-laws of Northway Financial, Inc (incorporated by
reference to Exhibit 3.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
4 Form of Certificate representing the Company Common Stock
(reference is also made to Exhibits 3.1 and 3.2)
(incorporated by reference to Exhibit 4 to Registration
Statement No. 333-33033).
10.1 Employment Agreement for William J. Woodward (incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10.2 Employment Agreement for Fletcher W. Adams (incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10.3 Amendment to the Employment Agreement for William J. Woodward.
(incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998).(2)
10.4 Amendment to the Employment Agreement for Fletcher W. Adams.
(incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998). (2)
10.5 Northway Financial, Inc. 1999 Stock Option and Grant Plan
(incorporated by reference to
Exhibit 4.1 to Registration Statement No. 333-83571 dated July
23,1999). (2)
10.7 Form of Key Employee Agreement (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for
the year ended 1999). (2)
10.8 Supplemental Executive Retirement Plan.
11 Statement re: Computation of Per Share Earnings(1)
14 Code of Ethics(1)
21 List of Subsidiaries(1)
23 Consent of Shatswell, MacLeod & Company, P.C. (1)
31.1 Certification of President of Northway Financial, Inc.,
pursuant to rules 13(a)-15(e) and 15d-15(e), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)
31.2 Certification of Chief Financial Officer of Northway
Financial, Inc., pursuant to rules 13(a)-15(e) and 5d-15(e),
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.(1)
32.1 Certification of President of Northway Financial, Inc.,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.(1)
32.2 Certification of Chief Financial Officer of Northway
Financial, Inc., pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.(1)
(1) Filed herewith.
(2) Management contract or compensatory plan required to be filed as an
exhibit to this form pursuant to Item 14(c) of this report.