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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996 Commission file number 0-16143
FIRST ESSEX BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2943217
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
71 Main Street, Andover, MA 01810
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 475-4313
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
[ X ]
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The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant, based on the closing sale price on the NASDAQ
National Market System on February 28, 1997 was $115,335,257.
As of February 28, 1997, 7,475,830 shares of the registrant's common stock, $.10
par value, were outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Selected information from the Registrant's Proxy Statement for the annual
meeting to be held May 1, 1997 to be filed with the Securities and Exchange
Commission, is incorporated by reference into Part III of this report
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company desires to take advantage of the new "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This Report contains certain
"forward-looking statements" including statements concerning plans, objectives,
future events or performance, assumptions, and other statements which are other
than statements of historical fact. The Company wishes to caution readers that
the following important factors, among others, may have affected, and could in
the future affect, the Company's actual results and could cause the Company's
actual results for subsequent periods to differ materially from those expressed
in any forward-looking statement made by, or on behalf of, the Company herein:
(i) the effect of changes in laws and regulations, including federal and state
banking laws and regulations, with which the Company and the Bank must comply,
the cost of compliance either currently or in the future as applicable; (ii) the
effect of changes in accounting policies and practices, as may be adopted by the
regulatory agencies as well as by the Financial Accounting Standards Board, or
of changes in the organization, compensation and benefit plans; (iii) the effect
on the Company's competitive position within in its market area, increasing
consolidation within the banking industry, and increasing competition from
larger regional and out-of-state banking organizations as well as nonbank
providers of various financial services; (iv) the effect of unforeseen changes
in interest rates; and (v) the effect of changes in the business cycle and
downturns in the New England and national economy.
TABLE OF CONTENTS
Part I
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Part II
Item 5. Market for the Registrant's Common Stock and Related Security
Holder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 8. Financial Statements and Supplementary Data 29
Item 9. Changes in and Disagreements with Accountants and
Financial Disclosure 63
Part III
Item 10. Directors and Executive Officers of the Registrant 63
Item 11. Executive Compensation 63
Item 12. Security Ownership of Certain Beneficial Owners and Management 64
Item 13. Certain Relationships and Related Transactions 64
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 64
PART I
ITEM 1. BUSINESS
GENERAL
First Essex Bancorp, Inc.
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First Essex Bancorp, Inc. ("First Essex" or the "Company") is a Delaware
corporation whose primary activity is to act as the parent holding company for
First Essex Bank, FSB (the "Bank"). Until December 1, 1993, the business of
First Essex Bancorp, Inc. was conducted through two banking subsidiaries, First
Essex Savings Bank, a Massachusetts-chartered savings bank and First Essex
Savings Bank of New Hampshire, a Guaranty Savings Bank. The New Hampshire bank
was owned through a second tier holding company, First Essex Bancorp of New
Hampshire, Inc., which was merged into First Essex Bancorp, Inc. on December 1,
1993.
On December 30, 1996, the Company acquired all of the outstanding shares of the
common stock of Finest Financial Corp. ("Finest"). The purchase price was
composed of 1,353,998 shares of common stock issued at a price of $11.50 per
share and a total cash outlay of $16.3 million. Included in the total
acquisition cost was approximately $1.4 million of capitalized costs incurred in
connection with the acquisition. This transaction was accounted for as a
purchase and, accordingly, the consolidated statement of operations includes the
results of Finest's operations since the acquisition.
On December 30, 1996, Finest Financial Corp. ("Finest"), the parent holding
company of Pelham Bank and Trust Company ("Pelham"), a New Hampshire chartered
bank, was merged into the Company in a transaction that was accounted for as a
purchase. Pelham was simultaneously merged into the Bank.
First Essex Bank, FSB
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The Bank was originally founded under a Massachusetts legislative charter issued
in 1847. On December 1, 1993, First Essex Savings Bank converted to a federal
savings bank with a charter issued by the Office of Thrift Supervision, (the
"OTS") under the name of First Essex Bank, FSB. On the same day First Essex
Savings Bank of New Hampshire was merged into First Essex Bank, FSB. As stated
above, the Bank merged with Pelham on December 30, 1996.
At December 31, 1996, the Bank had total assets of $1.1 billion, of which
approximately $196.6 million was attributable to the acquisition of Pelham. The
Bank is principally engaged in the business of attracting deposits from the
general public and investing in residential mortgage, construction, commercial
real estate, commercial and consumer loans. The Bank also makes investments in
various investment securities to provide a source of interest and dividend
income. The Bank currently maintains fifteen full service banking offices at
various locations throughout its market area. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation (the "FDIC").
MARKET AREA
First Essex's market area is centered in the Merrimack Valley, approximately 25
miles north of Boston and five miles south of New Hampshire, at the intersection
of two major highways: Interstate Route 93, the major north-south roadway
connecting Boston with the northern Boston suburban communities and New
Hampshire, and Interstate Route 495. The Bank's principal executive offices are
located in Andover, Massachusetts, and its main banking office and two of its
branches are located in Lawrence, Massachusetts. Other branches are in the
surrounding communities of Andover, North Andover, Haverhill, Lowell and
Methuen, Massachusetts and Londonderry, Pelham, Salem and Windham, New
Hampshire. First Essex also has loan centers in Lowell and Wellesley,
Massachusetts, and in Nashua and North Hampton, New Hampshire.
CURRENT MARKET CONDITIONS
The New England region, including those portions of northeastern Massachusetts
and southern New Hampshire that constitute First Essex's market area, continues
to experience growth.
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Loan demand to finance new and existing home sales was stronger in 1996 and 1995
than in prior years. The growth in commercial loans to small and mid-size
businesses in the area has also shown strength, although the competition among
lenders for these loans is intense. First Essex was able to grow loans while
adhering to its credit quality guidelines. Automobile sales continued to show
their strength in 1996 and First Essex has been able to participate in that
growth through an indirect automobile lending program that was begun early in
1994. The general improvement in consumer confidence and the consumer's
willingness to take on additional debt has also resulted in growth in direct
lending to consumers.
REGULATION
General
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The Office of Thrift Supervision ("OTS") is the primary regulator of the Company
and the Bank. The Bank's deposits are insured up to applicable limits by the
Bank Insurance Fund ("BIF") of the FDIC. The Company and the Bank must file
reports with the OTS concerning activities and financial condition, in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with or acquisitions of other financial institutions. Periodic
examinations are conducted by the OTS to test the Company's and the Bank's
compliance with various regulatory requirements. The Bank is also a member of
the Federal Home Loan Bank ("FHLB") system, which provides a central credit
facility primarily for member institutions. The Company, as a savings and loan
holding company, is also required to file certain reports, and otherwise comply,
with the rules and regulations of the OTS and of the Securities and Exchange
Commission ("SEC") under the federal securities laws.
Business Activities
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The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit
Insurance Act (the "FDI Act"). The HOLA and the FDI Act were amended by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FDICIA, among other things, requires that federal banking regulators intervene
promptly when a depository institution experiences financial difficulties,
mandates the establishment of a risk-based deposit insurance assessment system
and requires the imposition of numerous additional safety and soundness
operational standards and restrictions. FDICIA contains provisions affecting
numerous aspects of the operations of federal savings institutions and empowers
the OTS and the FDIC, among other agencies, to promulgate regulations
implementing its provision.
Qualified Thrift Lender Test
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The HOLA requires saving institutions to meet a qualified thrift lender ("QTL")
test. Under the QTL test, as modified by FDICIA, a savings association is
required to maintain at least 65% of its "portfolio assets" (total assets less
(i) specified liquid assets up to 20% of total assets, (ii) intangibles,
including goodwill, and (iii) the value of property used to conduct the
association's business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) on a monthly basis in 9 out of every 12 months.
Limitation on Capital Distributions
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OTS regulations impose limitations upon all capital distributions, other than
stock dividends, by savings institutions. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that meets or exceeds all fully phased-in capital requirements
before and after a proposed capital distribution ("Tier 1 Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice but without the approval of the OTS, make capital
distributions during a calendar year equal to the greater of: (i) 100% of its
net income to date during the calendar year plus the amount that would reduce
by one-half its "surplus capital ratio" (the percentage by which its capital to
assets ratio exceeds the ratio of its fully phased-in capital requirements to
its assets) at the beginning of the calendar year; or (ii) 75% of its net income
for the previous four quarters. Any additional capital distributions would
require prior regulatory approval. In the event the Bank's capital fell below
its fully-phased in requirement or the OTS notified the Bank that it was in need
of more than normal supervision, the Bank's ability to make capital
distributions would be restricted. In addition, the OTS could prohibit any
proposed capital distribution by any institution if
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it determines that such distribution would constitute an unsafe or unsound
practice. Furthermore, under the OTS prompt corrective action regulations, which
took effect on December 19, 1992, the Bank generally would be prohibited from
making any capital distribution if, after the distribution, the Bank would have
(i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based
capital ratio of less than 4% or (iii) a Tier 1 core capital ratio of less than
3%. As of December 31, 1996, the Bank exceeds all fully-phased in capital
requirements.
Branching
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The HOLA and OTS regulations permit savings institutions to branch nationwide
provided the institutions meet certain asset composition tests. The OTS
authority preempts any state law purporting to regulate branching by savings
institutions. As of December 31, 1996, the Bank would be permitted to engage in
such nationwide interstate branching.
Capital Requirements
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The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures are established by regulation to ensure the capital
adequacy required of the Bank to maintain minimum amounts and ratios of total
and Tier I capital (as defined in the regulations) to risk- weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as defined).
Management believes, as of December 31, 1996, that the Company meets all capital
adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification received from the OTS
categorized the Company as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Company must
maintain the total risk-based, Tier I risk-based and Tier I average asset
ratios. There are no conditions or events since that notification that
management believes have changed the institution's category.
FDICIA required that the OTS revise risk-based capital standards, with
appropriate transition rules, to ensure that they take account of interest rate
risk, concentration of risk and the risks of nontraditional activities. Under
OTS regulation effective January 1, 1994, a savings institution with interest
rate risk exposure above a specified percentage must deduct a specified interest
rate risk component when calculating total capital for purposes of determining
whether it meets OTS risk-based capital requirements. As of December 31, 1996,
the OTS did not deem it necessary for an interest-rate risk component to be
deducted from capital in determining risk-based capital requirements.
The Company may not declare or pay cash dividends on its shares of common stock
if the effect thereof would cause stockholders' equity to be reduced below
applicable capital maintenance requirements or if such declaration and payment
would otherwise violate regulatory requirements.
The capital ratios discussed above, along with the Company's actual capital
amounts and ratios are presented in a table within footnote 15 to the
consolidated financial statements included in response to Item 8 "Financial
Statements and Supplementary Data" of this report.
INSURANCE OF DEPOSIT ACCOUNTS
As required by FDICIA, in 1993, the FDIC established a risk-based assessment
system for insured depository institutions that takes into account the risks
attributable to different categories and concentrations of assets and
liabilities, the likely amounts of any loss, and the revenue needs of the
insurance fund.
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Insurance of deposits may be terminated by the FDIC after notice and hearing,
upon finding by the FDIC that the savings institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations,
or has violated any applicable law, rule, regulation, order or condition imposed
by, or written agreement with, the FDIC. Additionally, if insurance termination
proceedings are initiated against a savings institution, the FDIC temporarily
may suspend insurance on new deposits received by an institution under certain
circumstances. Management is not aware of any activity or condition which could
result in a termination of its deposit insurance.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain
noninterest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). Because required reserves must be maintained in
the form of either vault cash, a noninterest bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As such, the Company has registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. As a unitary savings and loan holding company, the Company
generally will not be restricted under existing laws as to the types of business
activities in which it may engage, provided that the Bank continues to be a QTL.
The HOLA requires the Company to obtain regulatory approvals prior to entering
into certain transactions such as mergers with or acquisitions of other
institutions or holding companies.
LENDING ACTIVITIES
General
At December 31, 1996, the loan portfolio, before deducting the allowance for
possible loan losses, was $704.7 million, representing 66.0% of total assets and
an increase of $204.6 million over the prior year. The increase in loans
included $97.5 million of loans acquired from Finest Financial Corp ("Finest")
at the time of its acquisition by the Company.
Loan originations increased in 1996 primarily due to the stabilization of
the New England residential real estate market, and in the Massachusetts and New
Hampshire economies generally. The increase also reflects a stronger marketing
effort by the Bank in the commercial and consumer loan areas. First Essex
originates residential first mortgage loans, commercial real estate loans,
construction loans, consumer loans and commercial loans. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition."
The following table sets forth information concerning First Essex's loan
portfolio, including mortgage loans held for sale, at the dates indicated. The
balances shown in the table are net of unadvanced funds and unearned discounts
and fees. Required disclosure regarding maturity distribution is shown on pages
26 and 27.
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Years Ended December 31,
1996 1995 1994 1993 1992
------- -------- -------- -------- ------
(Dollars in Thousands)
Real Estate:
Residential $301,869 42.9% $235,204 47.0% $264,848 61.6% $203,574 70.1% $205,799 69.4%
Commercial 102,718 14.6 53,504 10.7 25,786 6.0 28,755 9.9 38,134 12.9
Construction 24,855 3.5 14,210 2.8 15,527 3.6 14,482 5.0 7,194 2.4
--------- ----- --------- ---- -------- ----- -------- ---- -------- ----
Total real estate loans 429,442 61.0 302,918 60.5 306,161 71.2 246,811 85.0 251,127 84.7
--------- ---- --------- ---- -------- ----- -------- ---- -------- ----
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Owner occupied commercial
real estate(1) 29,465 4.2 --- --- --- --- --- --- --- ---
Commercial loans 63,695 9.0 66,737 13.4 55,377 12.9 15,416 5.3 8,602 2.9
Aircraft loans 33,267 4.7 14,478 2.9 522 0.1 --- 0.0 --- 0.0
Consumer loans:
Home equity 12,088 1.7 12,558 2.5 12,943 3.0 14,745 5.1 19,319 6.5
Automobile 92,175 13.1 76,590 15.3 34,906 8.1 2,435 0.8 5,182 1.7
Other 44,527 6.3 26,770 5.4 19,902 4.7 11,100 3.8 12,404 4.2
---------- ----- --------- ---- ------- ----- --------- ---- -------- ----
Total consumer loans 148,790 21.1 115,918 23.2 67,751 15.8 28,280 9.7 36,905 12.4
--------- ---- -------- ---- ------- ----- --------- ---- -------- ----
Total loans $704,659 100.0% $500,051 100.0% $429,811 100.0% $290,507 100.0% $296,634 100.0%
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(1) During 1996, management began to report this category of loans separate from its other commercial and commercial real estate
loans. Management believes this category of loans is distinguishable from its other commercial lending products. In 1996, the
Company reclassified certain loans to this category from other more
historical classification categories.
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Residential Mortgage Loans
The Bank originates residential first mortgage loans in its market area. At
December 31, 1996, the residential mortgage loan portfolio was $301.9 million,
representing 42.9% of the loan portfolio. The Company's residential first
mortgage loan products consist of six month, one-year, three-year, five year and
seven year adjustable-rate mortgages and fixed-rate mortgages, having terms of
15 to 30 years.
Commercial Real Estate Loans
The Bank also holds loans secured by commercial real estate, such as
manufacturing, retail, apartment and office buildings. At December 31, 1996,
First Essex's commercial real estate loan portfolio had an outstanding balance
of $102.7 million, representing 14.6% of First Essex's loan portfolio.
Generally, commercial real estate loans in the portfolio have been made to
finance the acquisition or retention of income producing properties. The current
policy of First Essex is to limit commercial real estate loans primarily to
properties in eastern Massachusetts and southern New Hampshire.
Commercial real estate loans generally reprice over periods ranging from six
months to five years based on a margin over a published prime rate or other
index.
Construction Loans
Construction loans are primarily made to developers and builders for the
construction of commercial and single family properties. Construction loans have
generally been made with maturities of one year or less at a margin floating
over the published prime, subject to renewal or extension by the Bank.
Additionally, loans are made to qualified individuals for construction of
single-family owner-occupied homes that convert to permanent mortgages upon
completion of construction. At December 31, 1996, the Bank's construction loan
portfolio had an outstanding balance of $24.9 million, representing 3.5% of the
loan portfolio.
Owner-Occupied Commercial Real Estate Loans
Owner-occupied commercial real estate loans are extensions of credit to
commercial borrowers for the construction or purchase of business space,
primarily for the borrower's own use, or loans to commercial borrowers for
operating purposes in which the Bank has taken real estate occupied by the
borrower as collateral. In these instances, the cash flow of the borrower's
business is the primary source of repayment. At December 31, 1996, this
portfolio had total outstandings of $29.5 million, representing 4.2% of the
Bank's loan portfolio.
Commercial Loans
At December 31, 1996, the portfolio of commercial loans totalled $88.5 million,
representing 12.6% of the loan portfolio. Included in that total are $24.8
million of commercial aircraft loans. The Bank offers various types of
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commercial aircraft loans. The Bank offers various types of commercial loans,
which are short term or have adjustable rates at a margin above the prime rate,
including secured and unsecured demand loans, time loans, term loans, lines of
credit and working capital loans. Commercial loans are originated by the Bank's
commercial lending officers and supported by a credit, processing and
documentation staff.
Consumer Loans
The portfolio of consumer loans, consisting of automobile loans, fully or
partially secured personal loans, boat loans, aircraft loans, second mortgage
loans, home equity loans and education loans, as well as unsecured personal
loans, totalled $157.3 million, including $8.5 million of consumer aircraft
loans, at December 31, 1996, representing 22.3% of the loan portfolio.
Automobile loans include dealer indirect loans, as well as loans originated
directly in retail branches. The Bank offers a variable rate home equity line of
credit called "First Line Equity Credit". This product consists of a line of
credit, secured by a second mortgage on residential property, with a monthly
adjustable interest rate at a margin above a published prime rate.
Risks Associated with Commercial Real Estate, Commercial, Owner-Occupied
Commercial Real Estate and Construction Loans
Commercial real estate and commercial lending involve significant additional
risks compared with one-to-four family residential mortgage lending, and,
therefore, typically account for a disproportionate share of delinquent loans
and real estate owned through foreclosure. Such lending generally involves
larger loan balances to single borrowers or groups of related borrowers than
does residential lending, and repayment of the loan depends in part on the
underlying business and financial condition of the borrower and is more
susceptible to adverse future developments. If the cash flow from
income-producing property is reduced (for example, because leases are not
obtained or renewed), the borrower's ability to repay the loan may be materially
impaired. These risks can be significantly affected by considerations of supply
and demand in the market for office, manufacturing and retail space and by
general economic conditions. As a result, commercial real estate and commercial
loans are likely to be subject, to a greater extent than residential property
loans, to adverse conditions in the economy generally.
Construction loans are, in general, subject to the same risks as commercial real
estate loans, but involve additional risks as well. Such additional risks are
due to uncertainties inherent in estimating construction costs, delays arising
from labor problems, shortages of material, uncertain marketability of a
complete project and other unpredictable contingencies that make it relatively
difficult to determine accurately the total loan funds required to complete a
project or the value of the completed project. Construction loan funds are
advanced on the security of the project under construction, which is of
uncertain value prior to the completion of construction. When a construction
project encounters cost overruns, marketing or other problems, it may become
necessary, in order to sustain the project and to preserve collateral values,
for the lender to advance additional funds and to extend the maturity of its
loan. In a declining market, there is no assurance that this strategy will
successfully enable the lender to recover outstanding loan amounts and interest
due. Moreover, foreclosing on such properties results in administrative expense
and substantial delays in recovery of outstanding loan amounts and provides no
assurance that the lender will recover all monies due to it, either by
developing the property, subject to regulatory limitations and to the attendant
risks of development, or by selling the property to another developer.
Residential Loan Servicing and Purchase and Sale of Loans
The Bank has a general policy of writing residential mortgage loans to meet the
requirements for sale in the secondary market. From time to time, the Bank sells
residential mortgage loans and residential loan servicing. Such loan sales
represent a potential source of liquidity to meet lending demand and deposit
flows. See Item 7 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Asset/Liability Management."
At December 31, 1996, the Bank's loan servicing portfolio totalled $95.8
million.
NON-PERFORMING ASSETS
General
Non-performing assets consist of non-accruing loans (including loans impaired
under the Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan,"), other real estate
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owned and other foreclosed property. For further information regarding the
impairment of loans see "Provision for Possible Loan Losses" included in Item 7
- - "Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Non-Accruing Loans
It is the general practice of the Bank to discontinue accrual of interest on
loans for which payment of interest or principal is 90 days or more past due and
such other loans where collection of interest and principal is doubtful. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on non-accrual status. At December 31,
1996, the Bank's non-accruing loans totalled $4.7 million compared to $4.4
million on December 31, 1995. For further information regarding the Bank's
non-accruing loans, see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition -
Non-Performing Assets."
Restructured Loans
These are loans on which concessions have been made in light of the debtor's
financial difficulty with the objective of maximizing recovery and with respect
to which the renegotiated payment terms are being met. At December 31, 1996 and
1995, the Bank had restructured loans with principal balances of $1.0 million
outstanding. For further information regarding restructured loans, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Non-Performing Assets."
Foreclosed Property
Foreclosed property at December 31, 1996 totalled $1.9 million, compared to $1.8
million at December 31, 1995. Such properties were acquired through foreclosure.
Foreclosed property consists of real or tangible property that collateralized a
loan prior to foreclosure or repossession. These properties are carried at the
lower of cost or the estimated net realizable values. Any decreases in value
prior to sale are charged to operations.
For further information regarding the Bank's foreclosed property, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Non-Performing Assets."
INVESTMENT ACTIVITIES
The Bank maintains an investment portfolio to provide a source of interest and
dividend income and a potential source of liquidity to meet lending demand and
deposit flows. At December 31, 1996, the investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities, stock
in the Federal Home Loan Bank of Boston and stock of the Savings Bank Life
Insurance Company of Massachusetts, was $315.7 million, or 29.6% of total
assets. Investment securities totalling $62.1 million are attributable to the
acquisition of Finest.
Interest and dividend income on the investment portfolio generated 26.2% of
total interest and dividend income for the year ended December 31, 1996. See
Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Investments" for further
information regarding the investment portfolio.
The Bank's investment strategy seeks to enhance liquidity and seeks to realize
current income while preserving principal. The Bank will generally invest only
in government or corporate bonds or securities issued in the United States and
will only purchase bonds which are rated A or higher at the time of purchase.
DEPOSITS
The Bank offers a range of deposit accounts including regular passbook savings,
NOW, money market and demand deposit accounts. The Bank offers a number of
relationship products which allow customers to combine balances in checking and
savings accounts in order to avoid service and maintenance fees, and obtain free
banking services. It also includes discounts on installment loans and bonus
rates on certificates of deposit. The
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Bank also offers 60-day to 7 year term deposit certificates. Interest rates on
these certificates vary according to the term selected and are based upon
several indices, including the rates on government securities with similar
maturities. From time to time, the Bank promotes various types of accounts with
the intention of changing the maturity schedule of its liabilities.
The Bank offers its retail banking customers a wide range of deposit services
and the convenience of drive-up ATMs. The Bank is a member of the NYCE(TM),
EXCHANGE(TM), TX(TM) and CIRRUS(TM) networks. These networks allow the Bank's
depositors access to their accounts through ATMs at the Bank, other banks and
locations nationwide and worldwide.
COMPETITION
The Bank faces competition both in originating loans and in attracting deposits.
Competition in originating loans comes from a variety of sources, including, but
not limited to, other thrift institutions, commercial banks, mortgage companies,
insurance companies and consumer and commercial finance companies. The Bank
competes for loans principally on the basis of interest rates and loan fees, the
types of loans originated and the quality of services provided to borrowers. In
attracting deposits, the primary competitors are other thrift institutions,
commercial banks, mutual funds and credit unions. The ability to attract and
retain deposits depends on the ability to provide investment opportunities that
satisfy the requirements of investors with respect to rate of return, liquidity,
risk and other factors. The Bank competes for deposits on the basis of interest
rates and by offering convenient branch locations, extended business hours and
an automated teller network.
EMPLOYEES
At December 31, 1996, the Bank had 294 employees, of whom 50 were part-time.
None of the employees of the Bank are represented by a collective bargaining
group and management considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal banking subsidiary, First Essex Bank, FSB, operates
banking facilities in ten locations in northern Massachusetts, and five
locations in southern New Hampshire. The offices of the Bank are in good
physical condition with modern equipment and facilities considered adequate to
meet the banking needs of customers in the communities serviced.
The offices of the Company are located in the Bank's branch office at 71 Main
Street in Andover, Massachusetts.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its business,
none of which is believed by management to be material to the financial
condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of Stockholders was held on December 19, 1996 for the purpose
of considering and voting upon a proposal to approve and adopt the Agreement and
Plan of Reorganization dated August 5, 1996, as amended as of September 27, 1996
(the "Merger Agreement"), by and among First Essex, Finest and Pelham, and each
of the transactions contemplated thereby, including the merger (the "Merger") of
Finest with and into First Essex, upon the terms and subject to the conditions
set forth in the Merger Agreement.
An affirmative vote of the majority of holders of the outstanding shares of
First Essex Common Stock was required for approval of the Merger Agreement and
the transactions contemplated thereby. Abstentions and broker non-votes had the
same effect as votes against the Merger Agreement. At the close of business on
the record date of October 31, 1996 outstanding shares totalled 6,058,935
requiring a vote in favor of the Merger Agreement of shares totalling 3,029,468.
The number of votes cast in favor of the Merger Agreement totalled 3,207,560.
Shares voted against totalled 79,139 with abstentions of 28,739 and non-votes
totalling 2,743,497.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND
RELATED SECURITY HOLDER MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on the
National Market System of the National Association of Securities Dealers, Inc.
Automated Quotation System (NASDAQ) under the symbol FESX.
At December 31, 1996, there were 7,421,433 shares outstanding and approximately
1,190 shareholders of record. This does not reflect the number of persons or
entities who hold their stock in nominee or street name through various
brokerage firms.
The price information regarding the Company's common stock in the following
table is based on high and low closing sales prices on NASDAQ.
- -------------------------------------------------------------------------------------------
Dividend
Price Per Share Declared
HIGH LOW per Share
1996
First Quarter $11.750 $10.187 $.12
Second Quarter 11.000 10.375 .12
Third Quarter 12.000 10.000 .12
Fourth Quarter 14.500 11.625 .12
1995
First Quarter $8.750 $7.625 $.08
Second Quarter 8.750 8.000 .08
Third Quarter 11.000 8.125 .12
Fourth Quarter 12.000 10.375 .12
- -------------------------------------------------------------------------------------------
The only funds available to the Company for the payment of dividends are cash
and cash equivalents held at the holding company level, dividends from the Bank
and borrowings. In addition, bank regulatory authorities generally restrict the
amounts available for the payment of dividends by the Bank to First Essex to the
net profit of the Bank for that year, see Item 1 - "Business - Regulation -
Limitation on Capital Distributions". The Federal Reserve Act also restricts the
Bank in lending or advancing funds to First Essex unless such loans are
collateralized by specific obligations, and limits collateralized loans to 10%
of the Bank's capital stock and surplus.
The Bank is prohibited from paying cash dividends, to the extent that any such
payment would reduce its capital below required regulatory capital levels or
would impair the liquidation account established in connection with its
conversion from mutual to stock form. See Note 14 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report for further discussion.
The payment of dividends by the Bank could carry significant adverse tax
consequences. To the extent that distributions by the Bank to the holding
company exceeds the Bank's current and accumulated earnings and profits (as
computed for federal income tax purposes for taxable years beginning after
December 31, 1951), those distributions would be treated for tax purposes as
first being made out of the Bank's bad debt reserve. In that case, the Bank
would have federal taxable income equal to approximately one and one-half times
the amount of the actual shareholder distribution that is treated as made out of
the Bank's bad debt reserves.
9
ITEM 6. SELECTED FINANCIAL DATA
At December 31,
1996 1995 1994 1993 1992
------ ------ ------ ------ -----
(Dollars in thousands)
Balance Sheet Data:
Total assets $1,067,175 $808,792 $806,872 $645,873 $506,913
Loans receivable 694,121 493,499 422,574 282,760 284,875
Investment securities (1) 315,664 275,900 346,943 329,823 186,232
Foreclosed property 1,880 1,756 3,038 6,360 12,125
Deposits 690,953 491,469 456,878 398,233 412,218
Borrowed funds 274,958 245,569 279,948 185,001 40,000
Stockholders' equity 83,141 60,172 54,757 50,749 44,619
Years Ended December 31,
1996 1995 1994 1993 1992
-------- -------- -------- --------- --------
(Dollars in thousands, except per share data)
Operating Data:
Interest and
dividend income $63,545 $60,914 $ 45,057 $ 36,183 $ 37,831
Interest Expense 37,317 37,081 22,707 16,654 19,240
------- ------- ------- -------- --------
Net interest income 26,228 23,833 22,350 19,529 18,591
Provision for loan losses 1,415 770 --- --- ---
Net gain (loss) on sales
of securities 497 (13) --- --- 613
Gain on sale of mortgage loans
and mortgage servicing rights 1,352 1,431 260 730 234
Net gain on sales of
foreclosed property 109 53 141 895 943
Other income 2,416 2,290 2,301 2,465 2,252
Noninterest expenses 20,034 19,297 19,331 19,290 21,522
Income tax
expense (benefit) 40 75 (805) (2,621) 13
------- ------- ------- ------- -------
Net income $ 9,113 $ 7,452 $ 6,526 $ 6,950 $ 1,098
======= ======= ======= ======= =======
Per Share Data:
Earnings per share $ 1.47 $ 1.22 $ 1.08 $ 1.15 $ .18
Dividends declared .48 .40 .28 .11 .00
Book value at
end of period 11.20 9.99 9.10 8.44 7.42
Selected Financial Ratios:
Return on average assets 1.08% 0.91% 0.94% 1.24% 0.22%
Return on average equity 14.37 12.79 12.42 14.83 2.50
Average equity as a
percentage of average assets 7.54 7.09 7.56 8.34 8.94
Weighted average interest
rate spread 2.72 2.56 3.02 3.29 3.57
Net yield on average
earning assets 3.22 2.99 3.33 3.60 3.96
(1) Investment securities include short term investments, U.S. government and
agency obligations, mortgage-backed securities, other bonds and obligations,
stock in the Federal Home Loan Bank of Boston and stock in the Savings Bank Life
Insurance Company.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
General
The results of operations of the Company consist primarily of the
results of operations of the Bank which is the Company's sole subsidiary. Pretax
income for 1996 rose $1.6 million or 22% over 1995. The improvement was in part
due to the 2.3% increase in average earning assets combined with decreased
levels of nonperforming assets. See Item 1. "Business - Current Market
Conditions/Recent Operating Results."
Net income for the year ended December 31, 1996 totalled $9.1 million (or $1.47
per share) compared to $7.5 million (or $1.22 per share) for the same period in
1995. The increase in net income is mainly due to an increase of $2.4 million in
net interest income and higher gains in the sale of investment securities of
$510,000, offset by an increase in the provision for possible loan losses of
$645,000 and an increase in salaries and employee benefit expense of $1.1
million.
11
Analysis of Average Yields Earned and Rates Paid
The following table presents an analysis of average yields earned and rates paid
for the years indicated:
- -----------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
1996 1995 1994
--------------------------- --------------------------- ------------------------------
Interest Average Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ------ ------ ------- ------ ------ ------- ------- -----
(Dollars in thousands)
Assets
Earning Assets
Short-term investments $ 8,589 $ 451 5.25% $ 6,735 $ 342 5.08% $ 2,457 $ 107 4.35%
Investment securities 267,493 16,202 6.06 316,501 19,354 6.11 343,303 18,114 5.28
Total loans (1) 538,758 46,892 8.70 473,069 41,218 8.71 325,922 26,836 8.23
------- ------- -------- ----- --------
Total earning assets 814,840 63,545 7.80 796,305 60,914 7.65 671,682 45,057 6.71
------- ------- -------- ----- --------
Allowance for possible loan losses (6,734) (6,447) (7,332)
-------- -------- -------
Total earning assets less allowance
for possible loan losses 808,106 789,858 664,350
Other Assets 32,652 31,889 30,760
-------- -------- --------
Total Assets $840,758 $821,747 $695,110
======== ======== ========
Liabilities and Stockholders' Equity
NOW accounts 32,846 399 1.21% 28,664 325 1.13% $ 30,086 354 1.18%
Money market accounts 72,632 1,606 2.21 79,593 1,586 1.99 105,181 2,210 2.10
Savings accounts 49,822 862 1.73 51,069 816 1.60 58,514 780 1.33
Time deposits 320,649 19,079 5.95 294,473 17,117 5.81 203,500 9,080 4.46
------- ------ -------- ----- ------
Total interest bearing
deposits 475,949 21,946 4.61 453,799 19,844 4.37 397,281 12,424 3.13
Borrowed funds 259,070 15,371 5.93 274,956 17,237 6.27 218,553 10,283 4.71
------- -------- -------- ----- ------
Total interest bearing deposits
and borrowed funds 735,019 37,317 5.08 728,755 37,081 5.09 615,834 22,707 3.69
-------- -------- -------
Demand deposits 30,804 23,550 15,982
Other liabilities 11,530 11,195 10,745
-------- -------- -------
Total liabilities 777,353 763,500 642,561
Stockholders' equity 63,405 58,247 52,549
-------- -------- -------
Total liabilities and
stockholders' equity $840,758 $821,747 $695,110
======== ======== ========
Net interest income $26,228 $23,833 $22,350
======== ======= =======
Weighted average rate spread 2.72% 2.56% 3.02%
==== ===== ====
Net yield on earning assets (2) 3.22% 2.99% 3.33%
======= ======== ====
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for possible loan losses divided by
average interest earning assets.
- -----------------------------------------------------------------------------------------------------------------------------------
12
Rate/Volume Analysis
The following table presents, for the periods indicated, the changes in interest
and dividend income and the changes in interest expense attributable to changes
in interest rates and changes in the volume of interest earning assets and
interest bearing liabilities. The change attributable to both volume and rate
has been allocated proportionally to the two categories.
- --------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
1996 Compared to 1995 1995 Compared to 1994
-------------------------- -----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
Volume Rate Total Volume Rate Total
(Dollars in thousands)
Interest and dividend income:
Loans before the allowance for
possible loan losses $ 6,064 $ (390) $ 5,674 $13,409 $ 973 $14,382
Investment securities (2,970) (182) (3,152) (1,197) 2,437 1,240
Federal funds sold and short-term investments 97 12 109 214 21 235
------ ------- -------- ------- ------ -------
Total interest and dividend income 3,191 (560) 2,631 12,426 3,431 15,857
------ ------- -------- -------- ------ -------
Interest expense:
Savings deposits (48) 188 140 (595) (22) (617)
Time deposits 1,550 412 1,962 4,792 3,245 8,037
Borrowed funds (968) (898) (1,866) 3,039 3,915 6,954
------- ------ -------- ------- ------- -------
Total interest expense 534 (298) 236 7,236 7,138 14,374
------- ------- -------- ------- ------- -------
Net interest and dividend income $ 2,657 $ (262) $ 2,395 $ 5,190 $(3,707) $ 1,483
======== ====== ======== ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Net Interest Income
Net interest income increased by $2.4 million to $26.2 million for the year
ended December 31, 1996, representing a 10.0% increase from $23.8 million in
1995. The increase in net interest income is primarily due to the $18.5 million
increase (2.3%) in average earning assets along with an increase of 23 basis
points in the net yield on average earning assets. The increase in the net yield
is attributable to the declining interest cost of borrowed funds and interest
bearing deposits.
Net interest income increased by $1.5 million to $23.8 million for the year
ended December 31, 1995, representing a 6.6% increase from $22.3 million in
1994. The increase in net interest income is primarily due to the $124.6 million
increase (18.6%) in average earning assets offset by a 34 basis point decrease
in the net yield on average earning assets. The decrease in net yield is
attributable to the rising interest cost of borrowed funds and interest bearing
deposits.
Interest and Dividend Income
Interest and dividend income increased by $2.6 million (4.3%) to $63.5 million
for the year ended December 31, 1996 from $60.9 million in 1995. This increase
was primarily due to the increase in average earning assets. Average earning
assets increased from $796.3 million in 1995 to $814.8 million in 1996, a 2.3%
increase. The net yield on average earning assets rose 23 basis points from the
1995 yield of 2.99% to 3.22% in 1996.
13
Interest and dividend income increased by $15.9 million (35.2%) to $60.9 million
for the year ended December 31, 1995 from $45.1 million in 1994. This increase
was primarily due to the increase in average earning assets. Average earning
assets increased from $671.7 million in 1994 to $796.3 million in 1995, an 18.6%
increase. The average weighted yield on loans rose 48 basis points from the 1994
yield of 8.23% to 8.71% in 1995. The average weighted yield on investment
securities rose from the 1994 yield of 5.28% to 6.11% in 1995.
Interest Expense
Interest expense increased by $236,000 (0.6%) to $37.3 million for the year
ended December 31, 1996 from $37.1 million in 1995. The increase is attributable
in part to an increase of $2.1 million in the amount paid on depositors'
accounts offset by a decrease of $1.9 million paid on borrowed funds. The total
weighted cost of funds decreased slightly from a level of 5.09% in 1995 to 5.08%
in 1996.
Interest expense increased by $14.4 million (63.3%) to $37.1 million for the
year ended December 31, 1995 from $22.7 million in 1994. The main reason for the
increase was an increase of $112.9 million (18.3%) in interest bearing
liabilities utilized to support asset growth. The remainder was primarily due to
the 1.4 percentage point increase in the cost of funds. The total weighted cost
of funds increased from a level of 3.69% in 1994 to 5.09% in 1995.
Provision for Possible Loan Losses
Beginning in 1995, the Company adopted SFAS No. 114, as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114"). Under SFAS
No. 114, the Company considers a loan impaired if it is ninety days or more past
due as to principal and interest, or if management's credit risk assessment
determines that it is probable that principal and interest will not be collected
as contractually scheduled. In addition, loans which are restructured at market
rates and comparable to loans with similar risks are considered impaired only in
the year of the restructuring, so long as they continue to perform according to
the restructured terms. Excluded from the impaired category, but otherwise
considered non-accruing loans, are small balance homogeneous loans which are
ninety days or more past due. Small balance homogeneous loans include
residential mortgage loans, residential construction loans to individuals
(excluding builder construction loans) and consumer loans. The Company evaluates
a loan's level of impairment by measuring the net present value of the expected
future cash flows using the loan's original effective interest rate, or looking
at the fair value of the collateral if the loan is collateral dependent. When
the difference between the net present value of the impaired loan (or fair value
of the collateral if the loan is collateral dependent) is lower than the
recorded investment of the loan, the difference is provided to expense with a
resulting valuation allowance.
Possible losses on loans are provided for under the accrual method of
accounting. Assessing the adequacy of the allowance for possible loan losses
involves substantial uncertainties and is based upon management's evaluation of
the amount required to meet estimated losses inherent in the loan portfolio
after weighing various factors. Among the factors management may consider are
the quality of specific loans, risk characteristics of the loan portfolio
generally, the level of non-accruing loans, current economic conditions, trends
in delinquencies and charge-offs and collateral values of the underlying
security. Ultimate losses may vary significantly from the current estimates.
Losses on loans, including impaired loans, are charged against the allowance
when management believes the collectibility of principal is doubtful.
Provisions for possible loan losses totalled $1.4 million and $770,000 for the
years ended December 31, 1996 and 1995, respectively. Included in those amounts
were $659,000 and $356,000, respectively, of provisions for possible losses
related to loans impaired under SFAS No. 114. There were no provisions for
possible loan losses for the year ended December 31, 1994. Provisions result
from management's continuing internal review of the loan portfolio as well as
its judgment as to the adequacy of the reserves in light of the condition of the
regional real estate market and the economy generally. As a result of increased
loans, there is an expectation that the Bank will continue to find it necessary
to make provisions for possible loan losses in the future. See "Financial
Condition - Non-Performing Assets."
The Bank's total allowance for possible loan losses was $10.5 million (including
$4.1 million acquired from Finest) or 222.4% of non-accruing loans at December
31, 1996 compared to $6.6 million or 148.4% at December 31, 1995 and $7.2
million or 99.0% at December 31, 1994.
14
Noninterest Income
Noninterest income consists of net gains or losses from sales of securities, net
gains from sales of loans and loan servicing rights, fee and other noninterest
income.
Noninterest income increased to $4.3 million for the year ended December 31,
1996 compared to $3.7 million in 1995. The primary reason for the increase from
1995 to 1996 was an increased gain on the sale of investment securities, which
rose by $510,000 from a loss of $13,000 in 1995, to a gain of $497,000 in 1996.
Loan fees also increased by $36,000 from $477,000 in 1995 to $513,000 in 1996.
Noninterest income increased to $3.7 million for the year ended December 31,
1995 compared to $2.6 million in 1994. The primary reason for the increase from
1994 to 1995 was increased gains from sales of loans and loan servicing rights,
which rose by $1.2 million from the gain of $260,000 in 1994 to the gain of $1.4
million in 1995. Loan fees also increased by $84,000 from $393,000 in 1994 to
$477,000 in 1995.
Noninterest Expenses
Noninterest expenses increased by $681,000 (3.5%) to $19.9 million for the year
ended December 31, 1996 compared to $19.2 million in 1995. This increase is
primarily due to a $1.4 million increase in salary and employee benefits and
building and equipment costs, offset by a decrease of $606,000 and $118,000 in
other operating and foreclosed property expenses, respectively.
Noninterest expenses stayed constant at $19.2 million for the year ended
December 31, 1995 compared to 1994. Salary and employee benefits and building
and equipment costs, increased by $1.3 million, which was almost entirely offset
by a decrease of $1.2 million in foreclosed property expenses.
Salaries and employee benefits increased by $1.1 million (11.7%) to $10.1
million for the year ended December 31, 1996 from $9.0 million in 1995 and $8.1
million in 1994. The increases for both years were primarily due to costs
associated with increases in personnel of 12% in 1996 and 6% in 1995 to support
business growth.
Building and equipment costs increased $349,000 to $3.6 million for 1996
compared to $3.3 million in 1995 and $2.8 million in 1994. The increase in 1996
was due in part to costs associated with the opening during 1996 of two new
branches, one located in Salem, New Hampshire, the other at the Crosspoint
Towers in Lowell, Massachusetts.
Expenses associated with foreclosed property totalled $666,000 for the year
ended December 31, 1996 compared to $784,000 in 1995. These expenses include
$82,000 of additional write-downs of the carrying values of properties during
1996 compared to $361,000 in 1995. Other expenses associated with the ownership
of foreclosed property totalled $584,000 in 1996 compared to $423,000 in 1995.
While the regional economy and real estate market continues to recover from the
difficulties of the past several years, there is no assurance that the Bank will
not experience further write-downs in the carrying values of foreclosed
property.
Expenses associated with foreclosed property totalled $784,000 for the year
ended December 31, 1995 compared to $2.0 million in 1994. These expenses include
$361,000 of additional write-downs of the carrying values of properties during
1995 compared to $1.1 million in 1994. Other expenses associated with the
ownership of foreclosed property totalled $423,000 in 1995 compared to $934,000
in 1994.
All other operating expenses decreased in total by $606,000 (9.8%) to $5.6
million for the year ended December 31, 1996 compared to $6.2 million in 1995
and $6.1 million in 1994. The decrease is mainly due to reduction of $498,000 in
insurance expense to $192,000 for 1996 when compared to $690,000 in the prior
year.
Income Taxes
The net provision for income taxes amounted to $40,000 in 1996 compared to a
provision of $75,000 recorded in 1995. The amounts recorded in each year were
based on management's quarterly review of the operations of the Company, the
realizability of the deferred tax asset, and management's analysis of future
taxable income. Management has valued the deferred tax asset in accordance with
regulatory guidelines which resulted in the elimination, during 1996, of the
deferred tax valuation allowance that existed at December 31, 1995.
15
Management expects that during 1997 the Company will return to the position of
having a provision for income taxes that more closely aligns with statutory
rates. For further information on income taxes, see Note 8 of Notes to
Consolidated Financial Statements.
16
FINANCIAL CONDITION
Total assets amounted to $1.1 billion at December 31, 1996, an increase of
$258.4 million or 32.0% from $808.8 million at December 31, 1995. Included in
the increase for 1996 is $191.1 million of assets acquired through the purchase
and acquisition of Finest, which was consummated on December 31, 1996.
Loans
At December 31, 1996, the loan portfolio, excluding the allowance for possible
loan losses, and including mortgage loans held-for-sale, was $704.7 million,
representing 66.0% of total assets, compared to $500.1 million or 61.8% of total
assets at December 31, 1995. The increase in loans is attributable in part to
the acquisition of Finest and its $101.5 million loan portfolio. See Item 1 -
"Business - Lending Activities General" for a table setting forth the
composition of the loan portfolio of the Bank at the end of each of the past
five years.
The Bank's indirect automobile lending program resulted in $92.2 million, $76.6
million and $34.7 million of automobile loans for the years ending December 31,
1996, 1995 and 1994, respectively. Aircraft loans, an increasing lending
activity for the Bank, totalled $33.3 million in 1996 compared to $14.5 million
in 1995, and $22,000 in 1994.
Non-Performing Assets
Non-performing assets consist of non-accruing and restructured loans (including
loans impaired under SFAS No. 114), and foreclosed property. Non-performing
assets totalled $6.6 million at December 31, 1996, compared to $6.2 million at
December 31, 1995 and $10.4 million at December 31, 1994. Included in the 1996
total of $6.6 million, are $1.7 million of non-performing assets acquired from
Finest.
The Bank's general practice is to discontinue the accrual of interest on loans
(including loans impaired under SFAS No. 114) for which payment of interest or
principal is ninety days or more past due or for such other loans as considered
necessary by management if collection of interest and principal is doubtful.
When a loan is placed on non-accrual status, all previously accrued but
uncollected interest is reversed against current period interest income.
The principal balance of restructured loans was $1.0 million for both years
ended December 31, 1996 and 1995. There were no restructured loans outstanding
in 1994.
If the non-accruing loans at December 31, 1996 and 1995 had been current in
accordance with their original terms, the amount of interest income that would
have been recorded is $140,000 and $389,000, respectively. Interest income
recognized on impaired loans, using the cash basis of accounting, amounted to
approximately $244,000 for the year ended December 31, 1996 compared to
approximately $166,000 in 1995. The amount of interest that was collected and
recorded as income on non-performing loans was $350,000 and $511,000 for the
years ended December 31, 1996 and 1995 respectively.
Foreclosed property at December 31, 1996 totalled $1.9 million compared to $1.8
million at December 31, 1995 and consists mainly of real estate collateral from
loans which were foreclosed. Included in the 1996 total is $740,000 of
foreclosed property acquired from Finest at the time of the purchase.
At December 31, 1996, the recorded investment in loans that are considered to be
impaired under SFAS No. 114 totalled $1.4 million of which $1.1 million had a
related allowance for possible loan losses of $491,000. The remaining $286,000
of impaired loans did not require a related allowance for possible loan losses.
The average recorded investment in impaired loans during 1996 was approximately
$1.9 million.
The following table shows the composition of non-performing assets for the
five years ended December 31, 1996.
- -------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accruing loans:
Real estate $ 2,693 $ 2,559 $ 6,548 $ 9,743 $15,816
17
Other 1,004 814 776 1,325 1,974
Restructured loans 1,042 1,043 --- --- 4,447
------- ------- ------- ------- -------
Total non-accruing loans 4,739 4,416 7,324 11,068 22,237
Foreclosed property 1,880 1,756 3,038 6,360 12,125
------- ------- ------- ------- -------
Total non-performing assets $ 6,619 $ 6,172 $10,362 $17,428 $34,362
======= ======= ======= ======= =======
Percentage of non-performing
to total assets 0.62% 0.76% 1.28% 2.70% 6.78%
Percentage of allowance for
possible loan losses
to non-accruing loans 222.4% 148.4% 98.82% 70.00% 52.19%
- -------------------------------------------------------------------------------------------------------------------
The following table summarizes the activity of foreclosed property during the
year ended December 31, 1996:
- -------------------------------------------------------------------------------------------------------------------
Other
Residential Construction Commercial Repossessed
Real Estate Real Estate Real Estate Assets Total
(Dollars in thousands)
Balance at beginning of year $ 406 $ 40 $1,151 $ 159 $1,756
Transfer from loans 309 --- 242 1,409 1,960
Write-downs --- (15) (67) --- (82)
Sales (477) (25) (517) (1,475) (2,494)
Acquired foreclosed property - Finest 740 --- --- --- 740
------ ----- ------ ------ -----
Balance at end of year $ 978 $ 0 $ 809 $ 93 $1,880
====== ===== ====== ===== ======
- -------------------------------------------------------------------------------------------------------------------
18
Allowance for Possible Loan Losses
The allowance for loan losses is maintained at a level determined by management
to be adequate to provide for probable losses inherent in the loan portfolio
including commitments to extend credit. The allowance for loan loss is
maintained through the provision for loan losses, which is a charge to
operations. The potential for loss in the portfolio reflects the risks and
uncertainties inherent in the extension of credit.
The determination of the adequacy of the allowance of possible loan losses is
based upon management's assessment of risk elements in the portfolio, factors
affecting loan quality and assumptions about the economic environment in which
the Company operates. The process includes identification and analysis of loss
potential in various portfolio segments utilizing a credit risk grading process
and specific reviews and evaluations of significant individual problem credits.
In addition, management reviews overall portfolio quality through an analysis of
current levels and trends in charge-off, delinquency and nonaccruing loan data,
review of forecasted economic conditions and the overall banking environment.
These reviews are of necessity dependent upon estimates, appraisals and
judgments, which may change quickly because of changing economic conditions and
the Company's perception as to how these factors may affect the financial
condition of debtors.
The following table summarizes the activity in the allowance for possible loan
losses for the five years ended December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at beginning of year $6,552 $ 7,237 $ 7,747 $11,759 $18,304
Acquired allowance - Finest 4,080 --- ---- ---- ---
Provision for possible loan losses 1,415 770 ---- ---- ---
Charge offs:
Mortgage (1,148) (1,448) (1,703) (4,081) (5,323)
Construction (1) (96) (5) --- (652)
Owner-occupied commercial
real estate (1) --- --- --- --- ---
Commercial (157) (230) (248) (1,023) (788)
Consumer (1,029) (711) (155) (467) (583)
------- --------- -------- -------- -------
Total Charge-offs (2,335) (2,485) (2,111) (5,571) ( 7,346)
------- --------- -------- -------- -------
Recoveries:
Mortgage 277 234 535 649 479
Construction 6 279 240 2 7
Owner-occupied commercial
real estate (1) --- --- --- --- ---
Commercial 461 431 727 815 240
Consumer 82 86 99 93 75
------- --------- ---------- ---------- --------
Total recoveries 826 1,030 1,601 1,559 801
Net Charge-offs (1,509) (1,455) (510) ( 4,012) ( 6,545)
--------- -------- ------- -------- --------
Balance at end of year $10,538 $6,552 $ 7,237 $ 7,747 $11,759
======= ======= ======== ======== =======
Total loans at end of year $704,659 $500,051 $429,811 $290,507 $296,634
Average loans for the year 538,758 473,069 325,922 286,965 330,022
Allowance to loans ratio 1.50% 1.31% 1.68% 2.67% 3.96%
Net Charge-offs to average loans ratio 0.28% 0.30% 0.16% 1.40% 1.98%
(1) During 1996, management began to report this category of loans separate from
its other commercial and commercial real estate loans. Management believes this
category of loans is distinguishable from its other commercial lending products.
In 1996, the Company reclassified certain loans to this category from other more
historical classification categories. In making this reclassification it was
determined that no restatement of charge-offs and/or recoveries, if any, to this
new loan category would be material or meaningful.
- -----------------------------------------------------------------------------------------------------------------------
19
Investments
At December 31, 1996, the Company's investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities,
Federal Home Loan Bank ("FHLB") stock and Savings Bank Life Insurance Company of
Massachusetts stock, totalled $315.7 million or 29.6% of assets, compared to
$275.9 million or 34.1% of assets at December 31, 1995. The portfolio included
U.S. government and agency obligations having a book value of $51.9 million and
a fair value of $52.0 million and mortgage-backed securities with a book value
of $205.6 million and a fair value of $204.6 million. Interest and dividend
income on the Company's investment portfolio generated 26.2% of total interest
and dividend income for the year ended December 31, 1996. During 1996 the
investment portfolio decreased by $22.3 million, net of the effect of $62.1
million of investment securities available-for-sale acquired through the
purchase and acquisition of Finest.
To identify and control risks associated with the investment portfolio, the
Company has established policies and procedures, which include stop loss limits
and stress testing on a periodic basis.
The Company does not have any investments in off balance sheet financial
instruments, except as noted in footnote 9 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report.
The following table sets forth the composition of the investment
portfolio for the years indicated:
- ---------------------------------------------------------------------------------------------------------------
1996 1995 1994
-------- --------- ---------
(Dollars in thousands)
Short-term investments:
Interest bearing deposits $ 3,507 $ 5,086 $ 217
Federal funds sold 16,350 4,500 2,500
-------- -------- --------
Total short-term investments 19,857 9,586 2,717
Investment securities held-to-maturity:
U.S. government & agency obligations 9,978 17,080 54,271
Mortgage backed securities 94,487 118,018 209,747
Other bonds and obligations --- --- 31,039
-------- ------- --------
Total investment securities held-to-maturity 104,465 135,098 295,057
Investment securities available-for-sale:
U.S. government & agency obligations 41,962 --- ---
Mortgage-backed securities 111,062 91,781 35,200
Other bonds and obligations 21,692 23,372 ---
-------- ------- -------
Total investment securities available for sale 174,716 115,153 35,200
Stock in Federal Home Loan Bank of Boston 15,517 14,869 12,775
Stock in Savings Bank Life Insurance Company 1,194 1,194 1,194
-------- -------- --------
Total investments $315,749 $275,900 $346,943
======== ======== ========
Percent of total assets 29.6% 34.1% 43.0%
For further information regarding the Company's investment portfolio,
including information regarding amortized cost and fair value as of December 31,
1996, see notes 1, 3 and 20 to the Company's consolidated financial statements
included in response to Item 8 hereof.
- ---------------------------------------------------------------------------------------------------------------
20
Set forth below is a breakdown of yields and contractual maturities for the
amortized cost of indicated investment securities at December 31, 1996.
- ------------------------------------------------------------------------------------------------------------------------
U.S. Other
government bonds Mortgage-
and agency and backed
obligations obligations securities Total
(Dollars in thousands)
Due in 1 year or less:
Amount $ 9,519 $ 3,641 $ 1,596 $14,756
Yield 5.96% 5.61% 6.16% 5.90%
Due from 1 to 2 years:
Amount 11,985 2,999 16,014 30,998
Yield 5.98% 5.71% 4.87% 5.38%
Due from 2 to 3 years:
Amount 7,000 15,016 --- 22,016
Yield 6.67% 5.84% --- 6.10%
Due from 3 to 5 years:
Amount 19,729 --- 26,725 46,454
Yield 6.49 --- 6.21% 6.33%
Due from 5 to 10 years:
Amount 3,592 106 13,507 17,205
Yield 7.47% 6.79% 6.02% 6.33%
Due after 10 years:
Amount 100 --- 147,745 147,845
Yield 9.25% --- 6.52% 6.52%
------- ------- -------- ---------
Total:
Amount $51,925 $21,762 $205,587 $279,274
Yield 6.37% 5.79% 6.32% 6.29%
- ------------------------------------------------------------------------------------------------------------------------
21
Deposits
Deposits have historically been the Bank's primary source of funds for lending
and investment activities. Deposit flows vary significantly and are influenced
by prevailing interest rates, market conditions, economic conditions and
competition. At December 31, 1996 the Bank had total deposits of $691.0 million,
representing a net increase of $199.5 million compared to $491.5 million at
December 31, 1995. Included in the 1996 total are $162.1 million of deposits
assumed through the purchase and acquisition of Finest. During 1996, the Bank
aggressively marketed deposits resulting in increases of $32.3 million in time
deposits, and $6.2 million in other deposits.
While deposit flows are by nature unpredictable, management attempts to manage
its deposits through selective pricing. Because of the uncertainty of market
conditions, it is not possible for the Bank to predict how aggressively it will
compete for deposits in the future or the likely effect of any such decision on
deposit levels, interest expense and net interest income.
The following table sets forth the composition of average deposits and rates for
the years indicated with respect to categories exceeding 10% of total average
deposits:
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994
------ ------ -----
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Amount Rate Amount Rate Amount Rate
(Dollars in thousands)
NOW $ 32,846 1.21% $ 28,664 1.13% $ 30,086 1.18%
Money market accounts 72,632 2.21 79,593 1.99 105,181 2.10
Savings and notice accounts 49,822 1.73 51,069 1.60 58,514 1.33
Time deposits 320,649 5.95 294,473 5.81 203,500 4.46
------- -------- --------
Total interest bearing deposits 475,949 4.61 453,799 4.37 397,281 3.13
Demand deposits 30,804 23,550 15,982
--------- --------- --------
Total deposits $506,753 $477,349 $413,263
======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
At December 31, 1996, 1995 and 1994, outstanding certificates of deposits in
denominations of $100,000 and over had maturities as follows:
- ---------------------------------------------------------------------------------------------
Remaining Term to Maturity 1996 1995 1994
-------------------------- ------- ------- -------
(Dollars in thousands)
Three months or less $13,993 $ 3,265 $ 2,821
Three to six months 3,998 8,324 2,596
Six to twelve months 11,816 10,549 3,195
Over twelve months 18,530 2,067 11,246
------- ------- -------
Total $48,337 $24,205 $19,858
======= ======= =======
- ---------------------------------------------------------------------------------------------
22
Borrowed Funds
The Bank is a member of the Federal Home Loan Bank ("FHLB") and is entitled to
borrow from the FHLB by pledging certain assets. The Bank also utilizes short
term repurchase agreements, generally with maturities less than three months, as
an additional source of funds. Repurchase agreements are secured by U.S.
government and agency securities. Borrowings are an alternative source of funds
compared to deposits and totalled $275.0 million at December 31, 1996 compared
to $245.6 million and $279.9 million at December 31, 1995 and 1994,
respectively. The increase in borrowings in 1995 to 1996 was used to fund loan
growth during the year. The decrease in borrowings in 1995 was a result of an
increase in deposit accounts.
The following table summarizes the maximum and average amounts of borrowings
outstanding, the majority of which are short-term, during 1996, 1995 and 1994
together with the weighted average interest rates thereon.
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996 At December 31, 1996
--------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $278,318 $249,278 5.89% $267,275 5.74%
Repurchase Agreements 33,473 12,732 5.28 7,683 5.18
For the Year Ended December 31, 1995 At December 31, 1995
-------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $285,372 $263,298 6.22% $219,673 6.10%
Repurchase Agreements 27,019 8,432 5.50 25,896 5.72
For the Year Ended December 31, 1994 At December 31, 1994
-------------------------------------------- ----------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $255,489 $207,067 4.66% $225,017 6.10%
Repurchase Agreements 55,131 11,399 5.47 54,931 5.94
- ----------------------------------------------------------------------------------------------------------------------------
23
ASSET/LIABILITY MANAGEMENT
The Bank's asset/liability management strategy is designed to increase net
interest income and provide adequate earnings in expected future interest rate
environments. As part of this strategy, a balance is sought between the
repricing characteristics of its earning assets and funding sources while
maximizing the spread between interest income and expense. The Bank adjusts the
level of its liquid assets and the mix of its loans and investments based on
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
In order to achieve a better repricing balance between its assets and
liabilities, the Bank continued to originate and hold in portfolio adjustable
rate residential mortgage loans. The Bank has a general policy of writing
substantially all newly originated fixed rate residential loans to meet the
requirements for sale in the secondary market. During 1996 the Bank sold $93.4
million of residential loans. The Bank's commercial real estate, construction,
consumer and commercial business lending programs also provide opportunities to
better match the interest rate sensitivity of its loan portfolio and liabilities
due to the adjustable rate or short term repricing characteristics of these
types of loans. Total loans increased by $204.6 million during the year.
Approximately $101.5 million of that increase was as a result of the Finest
acquisition completed on December 30, 1996.
During 1996 investments increased by $39.8 million. The Finest acquisition
brought an additional $62.1 million into the portfolio. During the year and
prior to the Finest acquisition, investments declined due to maturities,
amortization, prepayments and sales. Most of this cash was redeployed to fund
the growth in the loan portfolio.
Borrowings increased by $29.4 million to fund growth in the commercial and
consumer loan portfolios which, excluding the impact of the Finest acquisition,
outstripped deposit growth during the year.
Deposits increased by $199.5 million in 1996, including $162.2 million assumed
in the Finest acquisition. An aggressive marketing program, along with the
opening of two new branches led to an increase in deposits of $37.3 million over
the course of the year and prior to the Finest acquisition.
It is management's opinion that interest rates will continue to exhibit
volatility. With this in mind, the Bank will continue to follow a strategy which
seeks to achieve a balance in the repricing characteristics of its assets and
liabilities and provide adequate earnings in all plausible interest rate
environments.
24
The following table sets forth the maturity and repricing information relating
to interest sensitive assets and liabilities at December 31, 1996. Fixed-rate
mortgage loans and mortgage-backed investments are shown in the table in the
time period corresponding to computed principal amortization based on their
respective contractual maturity. Short term investments, adjustable-rate loans,
investment securities and adjustable mortgage-backed investments are allocated
to the period in which the rates would be next adjusted. The table reflects an
"expected" prepayment assumption on residential, commercial real estate and
consumer loans and mortgage-backed investments. This prepayment assumption was
derived from both past experience and a market consensus of prepayment speeds
for similar types of loans and mortgage-backed investments. Since regular
savings accounts and NOW accounts are not subject to contractual interest rate
adjustments, such accounts have been included in the other deposits category and
are assumed to reprice within 3-5 years. The Bank believes these deposits are
less interest rate sensitive over long periods of time. Other deposits in the
181 - 365 day time period represent anniversary savings accounts which reprice
in one year.
- ----------------------------------------------------------------------------------------------------------------
December 31, 1996
1-180 181-365 1-3 3-5 5+
Days Days Years Years Years Total
(Dollars in thousands)
Interest-earning assets:
Short-term investments $ 19,772 $ --- $ --- $ --- $ --- $ 19,772
Investment securities 39,107 7,917 20,008 22,345 1,201 90,578
Mortgage-backed securities 90,777 41,676 18,590 51,197 3,074 205,314
Loans held for sale 8,915 --- --- --- --- 8,915
Loans in process 6,536 --- --- --- --- 6,536
Fixed rate loans 47,075 38,552 115,055 95,776 15,003 311,461
Adjustable rate loans 191,919 92,012 49,495 44,321 --- 377,747
--------- ------- -------- --------- ------- -------
Total rate sensitive assets 404,101 180,157 203,148 213,639 19,278 1,020,323
-------- ------- -------- --------- ------- ---------
Interest-bearing liabilities:
Money market deposit accounts 92,173 --- --- --- --- 92,173
Certificates of deposit 183,252 94,630 116,532 21,446 6,123 421,983
Other deposits --- 3,476 --- 114,552 --- 118,028
Borrowed funds 200,683 --- 62,597 8,603 3,075 274,958
-------- ------- ------- ------- -------- -------
Total rate sensitive liabilities 476,108 98,106 179,129 144,601 9,198 907,140
-------- ------- ------- ------- -------- -------
Excess (deficiency) of
interest sensitive assets
over interest sensitive
liabilities $(72,007) $82,051 $ 24,019 $ 69,038 $ 10,080 $113,181
========= ======= ======== ======== ======== ========
Cumulative excess
(deficiency) of interest
sensitive assets over
interest sensitive
liabilities $(72,007) $10,044 $ 34,063 $103,101 $113,181
========= ======= ======== ======== ========
Cumulative excess
(deficiency)
percentage of
total assets (6.75)% 0.94% 3.19% 9.66% 10.61%
- ----------------------------------------------------------------------------------------------------------------
25
The following table reflects the scheduled maturities of selected loans at
December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------
One
One Through Over
Year Five Five
or Less Years Years Total
(Dollars in thousands)
Construction loans $24,647 $ 139 $ 69 $24,855
Owner-occupied commercial real estate 5,374 10,278 13,813 29,465
Commercial loans 9,443 44,387 9,865 63,695
------- -------- ------- --------
Total $39,505 $54,814 $23,747 $118,066
======= ======= ======== ========
A summary of the above categories of loans due after one year as to the rate
variability follows (dollars in thousands):
With predetermined rates $23,369
With floating or adjustable rates 55,192
Total maturing or repricing after one year $78,561
=======
- -----------------------------------------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of liquidity are customer deposits, borrowings from
the FHLB, repurchase agreements, scheduled amortization and prepayments of loan
principal, cash flow from operations, maturities of various investments and loan
sales.
Management believes it is prudent to maintain an investment portfolio that not
only provides a source of income, but also provides a potential source of
liquidity to meet lending demand and deposit flows. The Bank adjusts the level
of its liquid assets and the mix of its loans and investments based upon
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields. At December 31,
1996, short-term investments, bonds and obligations and mortgage-backed
investments totalled $315.7 million, 4.7% of which either matures or is
estimated to be prepaid within one year. At December 31, 1995, short term
investments, bonds and obligations and mortgage backed investments totalled
$275.9 million, 8.6% of which matured within one year.
At December 31, 1996, the Bank had total outstanding borrowings of $275.0
million, 73% of which matures within one year. In 1995 the Bank had outstanding
borrowings of $245.6 million, 61% of which matured in one year.
At December 31, 1996, the Bank had outstanding commitments to loan funds under
mortgage, construction and commercial loans and home equity lines of credit,
amounting to $58.6 million, compared to $56.0 million in 1995. Management
believes the sources of liquidity previously discussed are sufficient to meet
its commitments.
Net cash provided by operating activities totalled $13.8 million in 1996
compared to $5.9 million in 1995. Net income was $9.1 million compared to a net
income of $7.5 million for the respective period. Included in these amounts were
non-cash write-downs of foreclosed properties of $82,000 in 1996 and $361,000 in
1995. The provision for possible loan losses recorded in 1996 was $1.4 million
compared to $770,000 in 1995. Net cash provided by operating activities totalled
$5.9 million in 1995 compared to $13.8 million in 1994. Net income was $7.5
million compared to a net income of $6.5 million for the respective periods.
Included in these amounts were non-cash write-downs of foreclosed properties of
$361,000 in 1995 and $1.0 million in 1994. Provisions for possible loan losses
recorded in 1995 totalled $770,000. No provision for possible loan losses was
recorded in 1994.
Net cash used for investing activities totalled $67.4 million for the year ended
December 31, 1996 compared to net cash provided of $5.8 million in 1995 and net
cash used of $162.7 million in 1994. The 1996 increase in net cash used by
investing activities over 1995 was primarily attributable to increased purchases
of investment securities and increased loan originations. The 1995 increase in
net cash used by investing activities over 1994 was primarily attributable to a
reduction in the purchase of investment securities.
26
Net cash provided by financing activities totalled $64.5 million for the year
ended December 31, 1996 compared to net cash used of $3.0 million for the
comparable period in 1995 and net cash provided of $152.4 million in 1994. Net
cash provided by the increase in borrowed funds (net of repayments) totalled
$29.4 million in 1996, compared to $34.4 million (net of repayments) of cash
used in 1995. Net cash provided by deposits totalled $37.3 million in 1996
compared to of $34.6 million in 1995. Net cash of $2.9 million was used to pay
dividends in 1996.
The Bank is in compliance with and exceeds Federal regulatory capital
requirements. The minimum standards are (i) a total risk-based capital ratio of
8%, (ii) a Tier 1 risk-based capital ratio of 4% or (iii) a Tier 1 core capital
ratio of 3%. As of December 31, 1996, the Bank exceeds all fully-phased in
capital requirements.
IMPACT OF INFLATION
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles which require
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation.
An important concept in understanding the effect of inflation on financial
institutions is the distinction between monetary and non-monetary items. In a
stable environment, monetary items are those assets and liabilities which are or
will be converted into a fixed amount of dollars regardless of changes in
prices. Examples of monetary items include cash, investment securities, loans,
deposits and borrowings. Non-monetary items are those assets and liabilities
which gain or lose general purchasing power as a result of the relationships
between specific prices for the items and price change levels. Examples of
non-monetary items include premises and equipment and real estate in
foreclosure. In the recent environment in the New England region, where real
estate values have dramatically decreased, the deflationary impact of changing
prices of real estate securing loans significantly affects a financial
institution's performance. Additionally, interest rates do not necessarily move
in the same direction, or in the same magnitude, as the prices of goods and
services as measured by the consumer price index. In a volatile interest rate
environment, liquidity and the management of the maturity structure of assets
and liabilities are critical in maintaining acceptable profitability levels.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
FIRST ESSEX BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of First Essex
Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 1996 and 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of First Essex Bancorp, Inc. and
subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 13, 1997
28
FIRST ESSEX BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
1996 1995
---- ----
(Dollars in thousands)
ASSETS
Cash and cash equivalents $ 38,078 $ 27,308
Investment securities available-for-sale (Note 3) 174,716 115,153
Investment securities held-to-maturity
(fair value $103,529,000 and $133,651,000) (Note 3) 104,465 135,098
Stock in Savings Bank Life Insurance Company 1,194 1,194
Stock in Federal Home Loan Bank of Boston (Note 7) 15,517 14,869
Mortgage loans held-for-sale 8,915 5,821
Loans receivable, less allowance for possible loan losses of
$10,538,000 and $6,552,000 (Note 4) 685,206 487,678
Foreclosed property, net of valuation reserve of
$834,000 and $1,316,000 1,880 1,756
Bank premises and equipment (Note 5) 11,609 10,047
Accrued interest receivable 5,970 4,466
Goodwill 11,800 --
Other assets 7,825 5,402
---------- --------
Total assets $1,067,175 $808,792
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Depositors' accounts (Note 6) $ 690,953 $491,469
Borrowed funds (Note 7) 274,958 245,569
Mortgagors' escrow accounts 1,116 718
Other liabilities 17,007 10,864
----------- --------
Total liabilities 984,034 748,620
----------- --------
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY (Note 14)
Serial preferred stock $.10 par value per share;
5,000,000 shares authorized, no shares issued
Common stock $.10 par value per share; 25,000,000 shares
authorized, 9,407,433 and 8,009,267 shares issued 941 801
Additional paid-in-capital 74,408 58,208
Retained earnings 23,727 17,682
Treasury stock, at cost, 1,986,000 shares (15,842) (15,842)
Valuation allowance for unrealized losses on
investment securities available-for-sale (Note 1) (93) (677)
---------- --------
Total stockholders' equity 83,141 60,172
---------- --------
Total liabilities and stockholders' equity $1,067,175 $808,792
========== ========
The accompanying notes are an integral part of these consolidated financial
statements.
29
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
1996 1995 1994
---- ---- ----
(Dollars in thousands, except per share amounts)
Interest and dividend income:
Interest on mortgage loans $25,753 $26,024 $20,399
Interest on other loans 21,139 15,194 6,437
Interest and dividends on investment securities available-for-sale 7,865 2,374 1,799
Interest and dividends on investment securities held-to-maturity 8,337 16,980 16,315
Interest on short term investments 451 342 107
------- -------- -------
Total interest and dividend income 63,545 60,914 45,057
------- -------- -------
Interest expense:
Interest on depositors' accounts 21,946 19,844 12,424
Interest on borrowed funds 15,371 17,237 10,283
------- -------- -------
Total interest expense 37,317 37,081 22,707
------- -------- -------
Net interest income 26,228 23,833 22,350
Provision for possible loan losses (Note 3) 1,415 770 ---
------- -------- -------
Net interest income after provision
for possible loan losses 24,813 23,063 22,350
------- -------- --------
Noninterest income:
Net gain on sales of mortgage loans and mortgage servicing rights 1,352 1,431 260
Net gain (loss) on sales of investment securities 497 (13) ---
Loan fees 513 477 393
Other fee income 1,877 1,759 1,862
Other 26 54 46
------- -------- --------
Total noninterest income 4,265 3,708 2,561
------- -------- --------
Noninterest expense:
Salaries and employee benefits 10,051 8,995 8,140
Buildings and equipment 3,605 3,256 2,800
Professional services 1,093 1,135 1,179
Information processing 1,240 1,233 966
Insurance 192 690 1,146
Expenses, gains and losses on,
and write-downs of, foreclosed property 666 784 2,007
Other 3,078 3,151 2,835
Retail branch write-offs --- --- 117
------- -------- --------
Total noninterest expense 19,925 19,244 19,190
------- -------- --------
Income before provision (benefit) for income taxes 9,153 7,527 5,721
Provision (benefit) for income taxes (Note 8) 40 75 (805)
------- -------- ---------
Net income $ 9,113 $ 7,452 $ 6,526
======== ======== =========
Earnings per share (Note 1) $ 1.47 $ 1.22 $ 1.08
========= ========= =========
Average common and equivalent shares outstanding 6,188,857 6,104,579 6,063,942
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
30
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1996, 1995 and 1994
Valuation Allowance
For Unrealized Losses
Additional On Investment Securities
Common Paid-in Retained Treasury Available-
Stock Capital Earnings Stock For-Sale Total
(Dollars in thousands)
Balance at December 31, 1993 $800 $58,152 $ 7,797 $(15,842) $(158) $ 50,749
Net income -- -- 6,526 -- -- 6,526
Cash dividends declared -- -- (1,685) -- -- (1,685)
Stock options exercised 1 40 -- -- -- 41
Change in valuation allowance
for unrealized losses on
investment securities
available-for-sale -- -- -- -- (874) (874)
----- -------- -------- -------- ----- -------
Balance at December 31, 1994 801 58,192 12,638 (15,842) (1,032) 54,757
Net income -- -- 7,452 -- -- 7,452
Cash dividends declared -- -- (2,408) -- -- (2,408)
Stock options exercised -- 16 -- -- -- 16
Change in valuation allowance
for unrealized losses on
investment securities
available-for-sale -- -- -- -- 355 355
----- -------- -------- -------- -------- --------
Balance at December 31, 1995 801 58,208 17,682 (15,842) (677) 60,172
Net income -- -- 9,113 -- -- 9,113
Cash dividends declared -- -- (3,068) -- -- (3,068)
Issuance of common stock in
conjunction with the
acquisition of
Finest Financial Corp. 136 15,871 -- -- -- 16,007
Stock options exercised 4 329 -- -- -- 333
Change in valuation allowance
for unrealized losses on
investment securities
available-for-sale -- -- -- -- 584 584
-------- -------- -------- -------- -------- --------
Balance at December 31, 1996 $941 $74,408 $23,727 $(15,842) $(93) $ 83,141
==== ======= ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
31
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
1996 1995 1994
--------- --------- ---------
(Dollars in thousands)
Cash flows from operating activities:
Net income $ 9,113 $ 7,452 $ 6,526
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for possible loan losses 1,415 770 --
Provision for depreciation and amortization 1,719 1,603 1,411
Gain on sale of foreclosed property (109) (81) (141)
Write-down of foreclosed property 82 361 1,023
Amortization of investment securities discounts and premiums, net 1,396 1,398 2,257
Provision (benefit) for deferred income taxes (1,908) 55 (825)
Proceeds from sales of mortgage loans and mortgage servicing rights 94,826 80,135 39,883
Mortgage loans originated for sale (96,568) (81,595) (37,275)
Realized (gains) losses on sale of investment securities (497) 13 --
Realized gains on sales of mortgage loans and mortgage servicing rights, net (1,352) (1,431) (260)
Changes in assets and liabilities, net of the effect of the purchase of Finest
Financial, Corp:
Decrease (increase) in accrued interest receivable (112) 71 (803)
Decrease (increase) in other assets 1,704 34 (1,106)
Increase (decrease) in other liabilities 3,830 (2,917) 3,063
--------- --------- ---------
Net cash provided by operating activities 13,539 5,868 13,753
--------- --------- ---------
Cash flows from investing activities:
Acquisition of Finest Financial, Corp., net of cash acquired 3,041 -- --
Proceeds from sales of available-for-sale securities 48,217 28,292 9,237
Proceeds from maturities and principal payments of available-for-sale securities 32,339 2,688 3,320
Proceeds from maturities and principal payments of held-to-maturity securities 55,785 78,687 90,301
Purchases of available-for-sale securities (78,243) (2,412) (12,122)
Purchases of held-to-maturity securities (25,864) (2,094) (111,729)
Loans originated and purchased, net of principal collected (103,446) (99,765) (144,611)
Proceeds from sales of foreclosed property 2,604 3,658 5,155
Receipts for foreclosed property -- -- 245
Purchases of bank premises and equipment (1,697) (3,303) (2,491)
--------- --------- ---------
Net cash provided by (used in) investing activities (67,264) 5,751 (162,695)
--------- --------- ---------
Cash flows from financing activities:
Net increase (decrease) in demand deposits, NOW accounts and savings accounts 6,153 (11,029) (24,689)
Net increase of term deposits 31,122 45,620 83,334
Net increase in borrowed funds with maturities of three months or less 74,806 7,544 13,001
Proceeds from borrowed funds with maturities in excess of three months 92,500 221,297 458,028
Repayments of borrowed funds with maturities in excess of three months (137,917) (263,220) (376,082)
Increase (decrease) in mortgagors' escrow accounts 398 (1,086) 356
Dividends paid (2,900) (2,167) (1,565)
Stock options exercised 333 16 41
--------- --------- ---------
Net cash provided by (used in) financing activities 64,495 (3,025) 152,424
--------- --------- ---------
Net increase in cash and cash equivalents 10,770 8,594 3,482
Cash and cash equivalents at beginning of the year 27,308 18,714 15,232
--------- --------- ---------
Cash and cash equivalents at end of the year $ 38,078 $ 27,308 $ 18,714
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
32
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
Year ended December 31,
1996 1995 1994
---- ---- ----
(Dollars in thousands)
Supplemental disclosures of cash flow information:
Interest paid during the year $37,165 $37,032 $21,974
Income taxes paid during the year 324 --- ---
Supplemental schedule of noncash financing and investing activities:
Real estate acquired through, or deeds in lieu of, foreclosure $ 1,961 $ 2,656 $2,961
Held-to-maturity securities reclassified to available-for-sale --- $82,262 ---
Securitized loans transferred to investments available-for-sale --- $28,305 ---
Acquisition of Finest Financial Corp.:
Fair value of assets acquired $196,645
Liabilities assumed (164,314)
Common stock issued (16,007)
---------
Cash paid $ 16,324
=========
The accompanying notes are an integral part of these consolidated financial
statements.
33
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of First Essex
Bancorp, Inc. ("the Company"), and its principal subsidiary, First Essex Bank,
FSB ("the Bank"). All significant intercompany balances have been eliminated in
consolidation.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of income and expenses during the reporting periods.
Operating results in the future could vary from the amounts derived from
management's estimates and assumptions.
INVESTMENT SECURITIES
The Company accounts for its investment securities under Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". Under this statement, investments in debt
securities may be classified as held-to-maturity and measured at amortized cost
only if the Company has the positive intent and ability to hold such securities
to maturity. Investments in debt securities that are not classified as
held-to-maturity and equity securities that have readily determinable fair
values are classified as trading securities or available-for-sale securities.
Trading securities are investments purchased and held principally for the
purpose of selling in the near term; available-for-sale securities are
investments not classified as trading or held-to-maturity. Unrealized holding
gains and losses for trading securities are included in earnings; unrealized
holding gains and losses for available-for-sale securities are reported in a
separate component of stockholders' equity.
At December 31, 1995, the Bank made a one-time reassessment of its
classification of investment securities held-to-maturity and reclassified $82.3
million to investment securities available-for-sale, with an unrealized loss of
$1.1 million, as allowed by the special report of implementation of SFAS No.
115. This reclassification does not call into question the Company's intent to
hold its remaining investment securities classified as held-to-maturity.
Dividend and interest income, including amortization of premiums and discounts,
is included in earnings for all categories of investment securities. Discounts
and premiums related to debt securities are amortized using a method that
approximates the level-yield method, adjusted for estimated prepayments in the
case of mortgage-backed securities.
34
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
In October 1994, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments". The statement is effective for financial statements
issued for fiscal years ending after December 15, 1994. Derivative Financial
Instruments, as defined by SFAS No. 119, include futures, forwards, swaps or
option contracts, or other financial instruments with similar characteristics.
The Company did not have any such instruments as of December 31, 1996 and 1995,
except as noted in Note 10.
LOANS RECEIVABLE
Loans are stated at the amount of unpaid principal, net of the allowance for
possible loan losses, unearned discounts and unearned net loan origination fees.
Loan origination fees, discounts and certain direct loan origination costs are
deferred and amortized as an adjustment to the related loan yield over the
contractual life of the loan. When loans are sold or fully repaid, the
unamortized fees, discounts and costs are recognized in income.
Interest on loans is included in income as earned based upon interest rates
applied to unpaid principal. Interest is not accrued on loans 90 days or greater
past due or on other loans when management believes collection is doubtful. When
a loan is placed on nonaccrual status, all interest previously accrued is
reversed against current-period interest income.
The allowance for possible loan losses is based on management's estimate of the
amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions known or anticipated at each reporting date. There
are inherent uncertainties with respect to the final outcome of the Bank's loans
and nonperforming loans. Because of these inherent uncertainties, actual losses
may differ from the amounts reflected in these consolidated financial
statements. Factors considered in evaluating the adequacy of the allowance
include previous loss experience, current economic conditions and their effect
on borrowers, the performance of individual loans in relation to contract terms,
and estimated fair values of underlying collateral. Losses are charged against
the allowance when management believes the collectibility of principal is
doubtful.
Key elements of the above estimates, including assumptions used in independent
appraisals, are dependent upon the economic conditions prevailing at the time of
the estimates. Accordingly, uncertainty exists as to the final outcome of
certain of the valuation judgments as a result of economic conditions in the
region. The inherent uncertainties in the assumptions relative to projected
sales prices or rental rates may result in the ultimate realization of amounts
on certain loans that are significantly different from the amounts reflected in
these consolidated financial statements.
Effective January 1, 1995, the Company adopted SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan" as amended by SFAS No. 118 ("SFAS No. 114").
This standard requires that impaired loans be measured based on the present
value of expected future cash flows discounted at each loan's effective interest
rate or, as a practical expedient, at each loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. The statement
also changes the accounting for in-substance foreclosures and troubled debt
restructurings. This statement was applied prospectively with any adjustment
reflected in the provision for possible loan losses. The adoption of this
statement did not have a material effect on the financial position or results of
operations of the Company.
Mortgage loans held-for-sale are carried at the lower of aggregate cost or fair
value. Gains and losses on sales of mortgage loans are recognized at the time
of sale.
In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights", which became effective for fiscal years beginning after December 15,
1995. The Company adopted the provisions of SFAS No.
35
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
122 on January 1, 1996. SFAS No. 122 requires an enterprise involved in mortgage
banking activities to recognize, as separate assets, rights to service mortgage
loans for others regardless of the manner in which the servicing rights are
acquired. In addition, capitalized mortgage servicing rights are required to be
assessed for impairment based on the fair value of those rights. The impact of
this statement depends on the volume of mortgage loans originated and sold, and
servicing rights retained. The current practice of the Company is to sell most
of the mortgage loans it originates with servicing released. Accordingly, the
adoption of this statement did not have a material effect on the financial
position or results of operations of the Company.
FORECLOSED PROPERTY
Collateral acquired through foreclosure is recorded at the lower of cost or fair
value, less estimated costs to sell, at the time of acquisition. A valuation
allowance is established for the estimated costs to sell and is charged to
expense. Subsequent changes in the fair value of other real estate owned are
reflected in the valuation allowance and charged or credited to expense. Net
operating income or expense related to foreclosed property is included in
noninterest expense in the accompanying consolidated statements of operations.
Because of current market conditions, there are inherent uncertainties in the
assumptions with respect to the estimated fair value of other real estate owned.
Because of these inherent uncertainties, the amount ultimately realized on other
real estate owned may differ from the amounts reflected in the consolidated
financial statements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, amounts due from banks,
interest-bearing deposits, federal funds sold and investments with original
maturities of less than three months.
BANK PREMISES AND EQUIPMENT
Real estate held for banking purposes, leasehold improvements and furniture and
fixtures are stated at cost, less accumulated depreciation and amortization.
Depreciation is computed principally on the straight-line method over estimated
service lives. Amortization of leasehold improvements is computed on the
straight-line method over the shorter of the estimated useful lives of the
assets or the related lease term. Expenditures for maintenance, repairs and
renewals of minor items are charged to expense as incurred.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of", which became
effective for fiscal years beginning after December 15, 1995. The Company
adopted the provisions of SFAS No. 121 on January 1, 1996. SFAS No. 121 requires
that long-lived assets and certain identifiable intangibles to be held and used
by an entity be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. The statement also requires that certain long-lived assets and
identifiable intangibles to be disposed of be reported at the lower of the
carrying amount or fair value less cost to sell. The adoption of this statement
did not have a material effect on the results of operations or financial
condition of the Company.
INTANGIBLE ASSETS
Intangible assets are the excess of the purchase price over the fair value of
net assets acquired (goodwill) in the acquisition of Finest Financial Corp.
Goodwill is being amortized on a straight-line basis over 15 years. The Company
will periodically evaluate intangible assets for impairment on the basis of
whether these assets are fully recoverable from projected, undiscounted net cash
flows of the related acquired entity, as required under SFAS
36
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
No. 121 as discussed earlier.
INCOME TAXES
The Company records income taxes under the liability method. Under this method,
deferred tax assets and liabilities are established for the temporary
differences between the accounting bases and the tax bases of the Company's
assets and liabilities. Deferred taxes are measured using enacted tax rates that
are expected to be in effect when the amounts related to such temporary
differences are realized or settled. The Company's deferred tax asset is
reviewed quarterly and adjustments are recognized in the provision or benefit
for income taxes based on management's judgments relating to realizability.
EARNINGS PER SHARE
Earnings per common share are calculated using the weighted average number of
common shares and common stock equivalents outstanding.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1994 consolidated
financial statements to conform to the 1996 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125").
SFAS 125 supersedes SFAS No. 122 and establishes, among other things, new
criteria for determining whether a transfer of financial assets in exchange for
cash or other consideration should be accounted for as a sale or as a pledge of
collateral in a secured borrowing. SFAS 125 also establishes new accounting
requirements for pledged collateral. SFAS 125 is effective for most transactions
occurring after December 31, 1996 with other provisions of the statement
deferred for one year. The Company has determined that the adoption of SFAS 125
will not have a material impact on its consolidated financial statements.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share", which
establishes new standards for computing earnings per share and makes them
comparable to international earnings per share calculations and standards. This
statement is effective for the Company's 1997 financial statements and has no
significant impact on reported financial results.
2. ACQUISITION
On December 30, 1996, the Company acquired all of the outstanding shares of the
common stock of Finest Financial Corp. ("Finest"). The purchase price was
composed of 1,353,998 shares of common stock issued at a price of $11.50 per
share and a total cash outlay of $16.3 million. Included in the total
acquisition cost was approximately $1.4 million of capitalized costs incurred in
connection with the acquisition. This transaction was accounted for as a
purchase and, accordingly, the consolidated statement of operations includes the
results of Finest's operations since the acquisition.
The purchase price was allocated to assets acquired and liabilities assumed
based on estimates of fair value at the
37
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
date of acquisition. The excess of purchase price over the fair value of assets
acquired has been recorded as goodwill. The fair value of these assets and
liabilities is summarized as follows (in thousands):
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ 19,364
Investment securities available-for-sale 62,128
Net loans 97,458
Premises and equipment 1,584
Goodwill 11,800
Foreclosed property 740
Prepaid expenses and other assets 3,571
Deposits (162,209)
Accrued expenses and other liabilities (2,105)
-----------
Total acquisition cost $32,331
=======
- ----------------------------------------------------------------------------------------------------------------
The following is supplemental information reflecting selected unaudited pro
forma results as if this acquisition had been consummated as of January 1, 1995:
December 31,
1996 1995
---- ----
(dollars in thousands)
Total revenue (1) $39,798 $36,444
Income before taxes 12,010 7,966
Net income 11,369 8,061
Earnings per share (EPS) $ 1.50 $ 1.08
(1) Total revenue includes net interest income and noninterest income.
- ----------------------------------------------------------------------------------------------------------------
38
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
3. INVESTMENT SECURITIES
Investment securities at December 31, 1996 and 1995 follow:
- -----------------------------------------------------------------------------------------------------------------------------
1996 1995
---- ----
(Dollars in thousands)
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Gain Loss Value Cost Gain Loss Value
------------------------------------- --------------------------------------
Investment securities held-to-maturity:
U.S. government and
agency obligations $ 9,978 $ 44 $ --- $10,022 $17,080 $ 42 $ --- $17,122
Mortgage-backed securities 94,487 10 (990) 93,507 118,018 95 (1,584) 116,529
------- ----- -------- -------- ------- ------- -------- -------
104,465 54 (990) 103,529 135,098 137 (1,584) 133,651
Investment securities available-for-sale:
U.S. government and
agency obligations 41,947 15 --- 41,962 --- --- --- ---
Mortgage-backed securities 111,100 252 (290) 111,062 92,231 870 (1,320) 91,781
Other bonds and obligations 21,762 4 (74) 21,692 23,599 32 (259) 23,372
-------- ----- -------- -------- -------- ------- -------- --------
174,809 271 (364) 174,716 115,830 902 (1,579) 115,153
Total investment securities $279,274 $ 325 $(1,354) $278,245 $250,928 $ 1,039 $(3,163) $248,804
======== ===== ======== ======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------------
At December 31, 1996 and 1995, U.S. government obligations and mortgage-backed
securities with amortized cost of $144,009,000 and $150,449,000, respectively,
and fair value of $143,212,000 and $150,728,000, respectively, were pledged to
collateralize certain borrowings, deposit accounts and repurchase agreements.
For the year ended December 31, 1996, there were realized gross gains of
$497,000 from the sale of investment securities available-for-sale. For the year
ended December 31, 1995, there were realized gross losses of $13,000 from the
sale of investment securities. There were no gains or losses from the sale of
investment securities in 1994.
39
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The following table shows the maturity distribution of the amortized cost of the
Company's investment securities at December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------
Less than Greater than
1 year 1-5 Years 5-10 Years 10 Years Total
------ --------- ---------- ---------- -----
(Dollars in thousands)
Investment securities
held-to-maturity:
U.S. government and
agency obligations $ --- $9,978 $ --- $ --- $ 9,978
Mortgage-backed securities (1 ) 1,364 --- 1,306 91,817 94,487
Investment securities
available-for-sale:
U.S. government and
agency obligations $ 9,519 $28,736 $3,592 $ 100 $ 41,947
Mortgage-backed securities (1) 232 42,739 12,201 55,928 111,100
Other bonds and obligations 3,641 18,015 106 --- 21,762
---------
$279,274
========
(1) Maturities of mortgage-backed securities are based on contractual maturities
with scheduled amortization. Actual maturities will differ from contractual
maturities due to prepayments.
- -----------------------------------------------------------------------------------------------------------------
The following table shows the maturity distribution of the fair value of the
Company's investment securities at December 31, 1996:
- -----------------------------------------------------------------------------------------------------------------
Less than Greater than
1 year 1-5 Years 5-10 Years 10 Years Total
------ --------- ---------- ---------- -----
(Dollars in thousands)
Investment securities held-to-maturity:
U.S. government and
agency obligations $ --- $10,022 $ --- $ --- $ 10,022
Mortgage-backed securities (1) 1,366 --- 1,294 90,847 93,507
Investment securities available-for-sale:
U.S. government and
agency obligations $ 9,551 $28,738 $ 3,571 $ 102 $ 41,962
Mortgage-backed securities (1) 232 42,690 12,060 56,080 111,062
Other bonds and obligations 3,641 17,945 106 --- 21,692
---------
$278,245
========
(1) Maturities of mortgage-backed securities are based on contractual maturities
with scheduled amortization. Actual maturities will differ from contractual
maturities due to prepayments.
- -----------------------------------------------------------------------------------------------------------------
40
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
4. LOANS RECEIVABLE
Major classifications of loans receivable at December 31, 1996 and 1995 follow:
- --------------------------------------------------------------------------------
1996 1995
-------- --------
(Dollars in thousands)
Mortgage loans:
Residential $292,954 $229,383
Commercial 102,718 53,504
Construction 24,855 14,210
-------- --------
Total mortgage loans 420,527 297,097
-------- --------
Owner-occupied commercial real estate (1) 29,465 --
Commercial 63,695 66,737
Aircraft 33,267 14,478
Consumer loans:
Home equity 12,088 12,558
Automobile 92,175 76,590
Other Consumer 44,527 26,770
-------- --------
Total consumer loans 148,790 115,918
Less:
Allowance for possible loan losses 10,538 6,552
-------- --------
Total loans receivable $685,206 $487,678
======== ========
(1) During 1996, management began to report this category of loans separate from
its other commercial and commercial real estate loans. Management believes this
category of loans is distinguishable from its other commercial lending products.
In 1996, the Company reclassified certain loans to this category from other more
historical classification categories.
- --------------------------------------------------------------------------------
The Company's lending activities are conducted principally in eastern
Massachusetts and southern New Hampshire. The Company originates single family
and multifamily residential loans, commercial real estate loans, commercial
loans, aircraft loans, automobile loans and a variety of consumer loans. In
addition, the Company originates loans for the construction of residential
homes, multifamily properties, commercial real estate properties and land
development. Most loans originated by the Company are collateralized by real
estate. The ability and willingness of the single family residential and
consumer borrowers to honor their repayment commitments is generally dependent
on the level of overall economic activity within the geographic areas and real
estate values. The ability and willingness of commercial real estate, commercial
and construction loan borrowers to honor their repayment commitments is
generally dependent on the health of the real estate economic sector in the
borrowers' geographic areas and the general economy.
41
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
A summary of changes in the allowance for possible loan losses for the years
ended December 31, 1996, 1995 and 1994 follows:
- -------------------------------------------------------------------------------
1996 1995 1994
-------- -------- --------
(Dollars in thousands)
Balance at beginning of year $ 6,552 $ 7,237 $ 7,747
Acquired allowance - Finest (Note 2) 4,080 -- --
Provision for possible loan losses 1,415 770 --
Charge-offs (2,335) (2,485) (2,111)
Recoveries 826 1,030 1,601
-------- -------- --------
Balance at end of year $ 10,538 $ 6,552 $ 7,237
======== ======== ========
- -------------------------------------------------------------------------------
Under SFAS No. 114, the Company considers a loan impaired if it is ninety days
or more past due as to principal and interest, or if management's credit risk
assessment determines that it is probable that principal and interest will not
be collected as contractually scheduled. In addition, loans which are
restructured at market rates and comparable to loans with similar risks are
considered impaired only in the year of the restructuring, so long as they
continue to perform according to the restructured terms. Excluded from the
impaired category, but otherwise considered non-accruing loans, are small
balance homogeneous loans which are ninety days or more past due. Small balance
homogeneous loans include residential mortgage loans, residential construction
loans to individuals (excluding builder construction loans) and consumer loans.
The Company evaluates a loan's level of impairment by measuring the net present
value of the expected future cash flows using the loan's original effective
interest rate, or looking at the fair value of the collateral if the loan is
collateral dependent. When the difference between the net present value of the
impaired loan (or fair value of the collateral if the loan is collateral
dependent) is lower than the recorded investment of the loan, the difference is
provided to expense with a resulting valuation allowance. The average recorded
investment in impaired loans was approximately $1.9 million in 1996 and $1.4
million in 1995.
42
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The following table indicates the recorded investment of non-performing assets
and the related valuation allowance for impaired loans.
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1996 December 31, 1995
------------------ -----------------
Impaired Loan Impaired Loan
Recorded Valuation Recorded Valuation
Investment Allowance (1) Investment Allowance (1)
---------- ------------- ---------- -------------
(Dollars in thousands)
Non-accruing Loans:
Impaired Loans
Requiring a valuation allowance $ 25 $ 25 $ 318 $ 120
Not requiring a valuation allowance 286 --- 541 ---
------ ----- ------ -----
311 25 859 120
Restructured Loans 1,042 466 1,043 152
------ ----- ------ -----
Total impaired 1,353 $ 491 1,902 $ 272
===== =====
Residential Mortgage 2,458 2,039
Other 928 475
------ ------
Total non-accruing loans 4,739 4,416
Foreclosed property, net 1,880 1,756
------ ------
Total non-performing assets $6,619 $ 6,172
====== =======
Percentage of non-performing assets
to total assets 0.62% 0.76%
Percentage of allowance for possible
loan losses to non-accruing loans 222.4% 148.3%
(1) The valuation allowance for impaired loans is included in the allowance for
possible loan losses on the balance sheet.
- ----------------------------------------------------------------------------------------------------------------------------
Interest income recognized on impaired loans, using the cash basis of income
recognition, amounted to approximately $244,000 for the year ended December 31,
1996 compared to $166,000 in 1995.
The amount of interest that would have been earned had the nonaccrual and
restructured loans performed in accordance with original terms and conditions
was $140,000, $389,000 and $754,000 for the years ended December 31, 1996, 1995
and 1994, respectively.
The maximum amount of aggregate loans to directors, executive officers and
principal stockholders for the year ended December 31, 1996 was less than 5% of
stockholders' equity.
At December 31, 1996 and 1995, the Bank was servicing loans sold to the Federal
National Mortgage Association, Federal Home Loan Mortgage Corporation,
Massachusetts Home Finance Agency and various other banks and institutions on a
nonrecourse basis (except as discussed in Note 9), in the amount of $95,848,000
and $74,330,000, respectively. The amount of loans sold and serviced for others
is not included in loans receivable.
43
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
5. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 1996 and 1995 follows:
- ------------------------------------------------------------------------------------------------------------
Estimated Useful
1996 1995 Life
---- ---- ---------
(Dollars in thousands)
Land $ 1,235 $ 674
Buildings 5,566 5,804 20 to 30 years
Leasehold improvements 5,102 5,672 1 to 13 years
Furniture and fixtures 9,173 9,586 3 to 10 years
Construction in process 298 271
------ ------
21,374 22,007
Less accumulated depreciation
and amortization 9,765 11,960
------ ------
$11,609 $10,047
======= =======
Depreciation and amortization expense was $1,719,000, $1,603,000 and $1,411,000
for 1996, 1995 and 1994, respectively.
- ------------------------------------------------------------------------------------------------------------
44
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
6. DEPOSITORS' ACCOUNTS
A summary of depositors' accounts at December 31, 1996 and 1995 follows:
- --------------------------------------------------------------------------------
1996 1995
-------- --------
(Dollars in thousands)
Personal and business checking
accounts (noninterest-bearing) $ 58,769 $ 30,391
NOW accounts 42,246 31,288
Money market accounts 92,173 73,730
Savings accounts 75,782 49,361
Time deposits 421,983 306,699
-------- --------
$690,953 $491,469
======== ========
The following is a summary of original maturities of time deposits as of
December 31, 1996:
(Dollars in thousands)
1997 $277,221
1998 95,941
1999 21,106
2000 10,148
2001 11,382
Thereafter 6,185
--------
$421,983
The following table shows the remaining maturities of certificates of deposits
with balances in excess of $100,000 at December 31, 1996:
(Dollars in thousands)
Three months or less $13,993
Over 3 months and less than 6 months 3,998
Over 6 months and less than 12 months 11,816
12 months and over 18,530
-------
$48,337
- --------------------------------------------------------------------------------
45
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
7. BORROWED FUNDS
Borrowed funds at December 31, 1996 and 1995 are summarized below:
- --------------------------------------------------------------------------------
1996 1995
-------- --------
(Dollars in thousands)
Due during 1996, interest rates from 4.84% to 6.98% $ -- $123,100
Due during 1997, interest rates from 5.35% to 6.24% 193,000 35,000
Due during 1998, interest rates from 5.82% to 6.42% 60,597 58,597
Due during 1999, interest rates from 6.30% to 6.42% 2,000 --
Due during 2000, interest rates from 5.29% to 6.52% 4,660 2,896
Due during 2001, interest rates from 6.54% to 6.58% 3,943 --
Due during 2010, interest rates from 4.51% to 6.08% 78 80
Due during 2016, interest rates at 7.25% 2,997 --
Repurchase agreements 7,683 25,896
-------- --------
$274,958 $245,569
======== ========
- --------------------------------------------------------------------------------
Total lines of credit available under both short-term and long-term borrowings
from the FHLB are dependent upon the amount of FHLB stock owned and other assets
available as collateral with the total credit available being $310,340,000, of
which $43,065,000 was unused at December 31, 1996. The advances from the FHLB
are secured by all FHLB stock (book value of $15,517,000 and $14,869,000 at
December 31, 1996 and 1995) and a pledge of certain assets as collateral.
Repurchase agreements outstanding at December 31, 1996 mature in three months or
less with average interest rates of 5.18% and are secured by certain U.S.
government and agency securities.
The following table summarizes the maximum and average amounts of borrowings
outstanding during 1996 and 1995 together with the weighted average interest
rates thereon.
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996 At December 31, 1996
------------------------------------ --------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $278,318 $249,278 5.89% $267,275 5.74%
Repurchase Agreements 33,473 12,732 5.28 7,683 5.18
For the Year Ended December 31, 1995 At December 31, 1995
------------------------------------ --------------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $285,372 $263,298 6.22% $219,673 6.10%
Repurchase Agreements 27,019 8,432 5.50 25,896 5.72
- ----------------------------------------------------------------------------------------------------------------------------
46
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
8. INCOME TAXES
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 1996 consists of the following:
- --------------------------------------------------------------------------------
1996 1995 1994
------- ------- -------
(Dollars in thousands)
Current $ 1,948 $ 20 $ 20
Deferred (1,908) 55 (825)
------- ------- -------
$ 40 $ 75 $ (805)
======= ======= =======
- --------------------------------------------------------------------------------
The difference between the total expected provision (benefit) for income taxes
computed by applying the statutory federal income tax rate to income before
provision (benefit) for income taxes and the recorded provision (benefit) for
income taxes for the three years in the period ended December 31, 1996 follows:
- --------------------------------------------------------------------------------
1996 1995 1994
------- ------- -------
(Dollars in thousands)
Provision at
statutory rate $ 3,112 $ 2,559 $ 1,945
State taxes, net of
federal benefit 783 903 20
Nondeductible expenses 23 -- --
Dividend received deduction (2) (10) (10)
Change in valuation allowance (4,185) (3,312) (2,770)
Other, net (309) (65) 10
------- ------- -------
Provision (benefit) for
income taxes $ 40 $ 75 $ (805)
======= ======= =======
- --------------------------------------------------------------------------------
At December 31, 1996, tax loss carryforwards, for tax return purposes, of
approximately $4,394,000 are available to be carried forward to future periods
and, if unused, will expire between 2006 and 2010.
In August of 1996, Congress passed the Small Business Job Protection Act of
1996. Included in the bill was the repeal of IRC Section 593, which allowed
thrift institutions special provisions in calculating bad debt deductions for
income tax purposes. Thrift institutions now will be viewed as commercial banks
for income tax purposes. The repeal is effective for tax years beginning after
December 31, 1995.
One effect of this legislative change is to suspend the Bank's bad debt reserve
for income tax purposes as of its base year (October 31, 1988). Any bad debt
reserve in excess of the base year amount is subject to recapture over a
six-year time period. The suspended (i.e. base year) amount is subject to
recapture upon the occurrence of certain events, such as a complete or partial
redemption of the Bank's stock or if the Bank ceases to qualify as a bank for
income tax purposes.
At December 31, 1996, the Bank's surplus includes approximately $7,700,000 of
bad debt reserves, representing the base year amount, for which income taxes
have not been provided. Since the Bank does not intend to use the suspended bad
debt reserve for purposes other than to absorb the losses for which it was
established, deferred taxes in the amount of $3,150,000 have not been recorded
with respect to such reserve.
47
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The components of the net deferred tax asset at December 31, 1996 and 1995
follow:
- --------------------------------------------------------------------------------
1996 1995
------- -------
(dollars in thousands)
Allowance for possible loan losses $ 2,196 $ 2,227
Deferred tax loan loss reserve (1,447) (2,548)
Depreciation 919 789
Deferred loan fees 107 142
Deferred compensation 288 262
Pension accrual 336 238
Net operating loss carryforwards 1,494 4,647
Limited partnership investments (499) (525)
Foreclosed property write-downs 40 851
Contributions -- 133
General business credits 880 490
Purchase business combination 521 --
AMT credits 435 291
Charge-off remaining lease payments 49 77
Unrealized loss on available-for-sale securities -- 230
State income taxes 666 202
Other, net 140 109
------- -------
6,125 7,615
Valuation allowance -- (4,185)
------- -------
Net deferred tax asset included in other assets $ 6,125 $ 3,430
======= =======
- --------------------------------------------------------------------------------
The change in the valuation allowance for the years ended December 31, 1996 and
1995 follows:
- --------------------------------------------------------------------------------
1996 1995
------- -------
(dollars in thousands)
Balance at January 1 $(4,185) $(7,653)
Decrease due to change in estimate of
future taxable earnings 4,185 3,468
------- -------
Balance at December 31 $ -- $(4,185)
======= =======
- --------------------------------------------------------------------------------
48
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
9. PENSION BENEFITS
The Company has a defined benefit pension plan covering most employees.
Employees are eligible to participate upon the attainment of age 21 and the
completion of one year of service. Benefits are based primarily on years of
service and employees' final five year average pay.
Contributions by the Company are consistent with the funding requirements of
federal law and regulations. Pension plan assets consist primarily of mutual
funds, bonds and government securities.
The weighted average discount rate was 7.5% in 1996 and 7.0% in 1995. The rate
of increase in future compensation levels used in determining the actuarial
present value of the projected benefit obligation was 4.0% in 1996 and 1995. The
expected long-term rate of return on assets was 8.0% in 1996 and 1995.
The following table sets forth the plan's funded status and amounts recognized
in the Company's consolidated financial statements at December 31, 1996 and
1995:
- --------------------------------------------------------------------------------------------------
1996 1995
(Dollars in thousands)
Actuarial present value of benefit obligation:
Accumulated benefit obligation, including vested
benefits of $3,012,000 and $3,064,000 $ 3,093 $ 3,168
======= =======
Projected benefit obligation for service rendered to date 4,093 4,236
Plan assets at fair value 5,156 4,705
------- -------
Excess of plan assets over projected benefit obligation 1,063 469
Unrecognized net gain from past experience different
from that assumed and effects of changes in assumptions (2,129) (1,252)
Unrecognized net asset at transition amortized
over approximately 15 years 78 83
------- -------
Accrued pension cost included in other liabilities at December 31 $ (988) $ (700)
======= =======
Net pension cost for the years ended December 31, 1996, 1995 and 1994 included
the following components:
1996 1995 1994
----- ----- -----
(Dollars in thousands)
Service cost - benefits earned during the year $ 409 $ 283 $ 282
Interest cost on projected benefit obligation 297 290 265
Actual return on plan assets (710) (811) (270)
Net amortization and deferral 293 422 (124)
----- ----- -----
Net pension cost $ 289 $ 184 $ 153
===== ===== =====
- --------------------------------------------------------------------------------------------------
The Company has no material postretirement or postemployment benefit
arrangements other than pension benefits with its employees.
49
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
10. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments, held for purposes other than trading, include
commitments to originate loans, standby letters of credit, recourse arrangements
on sold assets, unadvanced portions of construction loans and forward
commitments. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the accompanying
consolidated balance sheets. The contract or notional amounts of these
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, standby letters of
credit and recourse arrangements 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. For forward commitments, the contract or notional amounts do not
represent exposure to credit loss. The Company controls the credit risk of its
forward commitments through credit approvals, limits and monitoring procedures.
Financial instruments with off-balance sheet risk at December 31, 1996 and 1995
follow:
- --------------------------------------------------------------------------------
Contract
Amount
1996 1995
------- -------
(Dollars in thousands)
Commitments to originate loans $20,676 $24,104
Unused lines of credit 40,458 38,428
Commercial and standby letters of credit 3,644 882
Loans sold with recourse 2,073 2,758
Unadvanced portions of
construction loans 14,759 10,495
Forward commitments 8,915 5,821
- --------------------------------------------------------------------------------
Commitments to originate loans are agreements to lend to customers provided
there are no violations of any conditions established in the contracts.
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 being 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 upon
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 facilities to customers.
LEASE COMMITMENTS
The Company has operating leases on eleven of its facilities. Most of the leases
have renewal options. Total rent expense under these leases for 1996, 1995 and
1994 was $712,000, $661,000 and $386,000, respectively.
50
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The following is a schedule of future minimum lease payments for operating
leases (dollars in thousands):
- -------------------------------------------------------------------------------
Year ending December 31,
1997 $ 853
1998 820
1999 689
2000 498
2001 380
Thereafter 1,259
-----
Total future minimum lease payments $4,499
======
- -------------------------------------------------------------------------------
EMPLOYMENT AND TERMINATION AGREEMENTS
The Company and the Bank have entered into employment agreements with three
executive officers. One agreement which commenced January 1, 1994 had an
original term of three years and the other agreements with commencement dates of
January 1, 1994 and December 30, 1996, have an original term of two years. Each
agreement may be extended annually for an additional year by vote of the Boards
of Directors. The employment agreements generally provide for the continued
payment of specified compensation and benefits to the executive officer for
specified periods after termination, unless the termination is for "cause" as
defined in the employment agreement. The current expiration dates of the three
year agreement and two year agreements are December 31, 1999 and December 31,
1998, respectively.
In addition, the Company, the Bank and the officers, referred to above, have
entered into special termination agreements that provide for the payment, under
certain circumstances, of a lump-sum amount upon termination following a "change
of control" which is generally defined to mean a person or group acquiring
ownership of 25% or more of the outstanding common stock of the Company, or
certain other events resulting in a change in control of the Company. The
lump-sum amounts are based on three times two of the executive officer's base
annual compensation and two times the other executive officer's base annual
compensation as defined in the agreements and would be in lieu of any benefits
under the officers' employment agreements, but in addition to amounts payable
pursuant to other benefit plans. Four other senior officers have similar
termination agreements effective following a "change of control." The lump-sum
amount for these officers is equivalent to two times the officer's base annual
compensation.
LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incidental to its business,
none of which is believed by management, based on discussion with legal counsel,
to be material to the financial condition or operations of the Company.
51
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
11. MANAGEMENT INCENTIVE COMPENSATION PLAN
The Company has a Management Incentive Compensation Plan (the "Incentive Plan")
as a means of recognizing achievement on the part of individual officers and
management as a whole. In 1996, 1995 and 1994 the Company awarded $310,000,
$117,000 and $130,000, respectively, for bonuses in connection with the
Incentive Plan.
12. STOCK OPTION PLAN
The Company has two stock options plans. The first was adopted in 1987 as a
performance incentive for its directors, officers, employees and other key
persons (the "1987 Stock Option Plan"). Options granted under the 1987 Stock
Option Plan have an exercise price per share equal to at least the fair market
value of a share of the Company's common stock on the date the option is granted
and expire no later than 10 years after the date of grant. The Company has
reserved 800,000 shares for issuance pursuant to options granted under the 1987
Stock Option Plan. Both "Incentive Stock Options" and "Non-qualified Stock
Options" may be granted pursuant to the 1987 Stock Option Plan.
The second stock option plan (the "1996 Stock Option Plan") was adopted under
the terms of the agreement related to the Company's purchase of Finest (Note 2)
on December 30, 1996. Non-qualified options totaling 114,465 shares have been
granted under this plan at an exercise price of $7.67 per share to two former
officers of Finest. All the options are vested and exercisable as of December
31, 1996. Of the total, 26,415 options expire March 31, 1997. The remainder
expire not later than October 1, 2005. The weighted average life of these
outstanding options is 6.8 years. The estimated fair value of these options was
recorded as part of the acquisition price and, accordingly, the proforma
compensation cost discussed below excludes the effect of these options.
Effective January 1, 1996, the Company adopted the provisions of SFAS No. 123,
"Accounting for Stock- Based Compensation." The Company has elected to continue
to account for stock options at intrinsic value with disclosure of the effects
of fair value accounting on net income and earnings per share on a pro forma
basis. Had compensation costs for the stock option plans been determined using
the fair value method, the Company's 1996 and 1995 net income and earnings per
share from continuing operations would have been reduced to the following pro
forma amounts (dollars in thousands):
- --------------------------------------------------------------------------------
1996 1995
----- -----
Net income:
As reported $9,113 $7,452
Pro forma 8,957 7,451
Primary EPS:
As reported $ 1.47 $ 1.22
Pro forma $ 1.45 $ 1.22
- --------------------------------------------------------------------------------
Pro forma compensation cost may not be representative of that to be expected in
future years.
52
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The following table summarizes various 1987 Stock Option Plan facts and
assumptions for the three years ended December 31, 1996, 1995 and 1994:
- -----------------------------------------------------------------------------------------------
1996 1995 1994
------------ ------------ ------------
Number of Options
Outstanding at beginning of year 421,733 428,000 242,500
Granted 356,000 10,000 195,000
Expired (46,666) (13,500) (3,000)
Exercised (44,168) (2,767) (6,500)
------------ ------------ ------------
Outstanding at end of year 686,899 421,733 428,000
============ ============ ============
Exercisable at end of year 264,363 233,470 139,000
============ ============ ============
Weighted average price per share:
Outstanding at beginning of year $ 7.191 $ 7.169 $ 6.887
Granted 11.375 8.500 7.500
Expired 10.283 7.741 7.896
Exercised 7.501 5.792 6.279
Outstanding at end of year 9.129 7.191 7.169
Exercisable at end of year 7.261 7.397 7.637
Weighted average remaining contractual life of
options outstanding at December 31, 1996 7.5 years
Exercisable option price ranges at
December 31, 1996 $5.25 to $11.375
Expected life of options at grant date 10 years 10 years
Weighted average risk-free interest rates 5.7% 6.4%
Dividend yield 4.2% 5.6%
Expected volatility 27.2% 27.2%
Option model used - Modified Black-Scholes American
- -----------------------------------------------------------------------------------------------
53
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
13. 401(k) PLAN
During 1994, the Company established a 401(k) plan (the "Plan") covering most of
its employees and merged its former Employees' Stock Ownership Plan ("ESOP")
into the Plan. Under the Plan, eligible employees ("participants") may make
contributions up to 15% of their compensation, with certain limitations. The
Company may elect to make basic matching contributions. During 1996 and 1995,
the Company made basic matching contributions equal to 50% of the first 4% of
each participant's compensation, or a maximum of 2%. Basic matching
contributions for 1996, 1995 and 1994 amounted to $116,000, $98,000 and $53,000,
respectively. The Plan also provides for discretionary supplemental matching
contributions. These contributions are allocated to participants in the same
manner as described above. Supplemental matching contributions to the Plan for
1996, 1995 and 1994 amounted to $58,000, $38,000, and $25,000, respectively.
14. STOCKHOLDERS' EQUITY
At the time of conversion to stock form, the Bank established a liquidation
account in the amount of $41,426,000 (unaudited). In accordance with
Massachusetts statutes, the liquidation account is maintained for the benefit of
Eligible Account Holders who continue to maintain their accounts in the Bank
after the conversion. The liquidation account is reduced annually to the extent
that Eligible Account Holders have reduced their qualifying deposits. Subsequent
increases will not restore an Eligible Account Holder's interest in the
liquidation account. In the event of a complete liquidation, each Eligible
Account Holder is entitled to receive a distribution from the liquidation
account in a proportionate amount to the current adjusted qualifying balances
for the account then held. The unaudited balance in the liquidation account was
$4,701,000 at December 31, 1996.
54
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
15. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification 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 Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1996, that the Bank
meets all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from the Office of Thrift
Supervision ("OTS") categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I risk-based,
Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have the institutions's
category.
The Bank's actual capital amounts and ratios are also presented in the table. As
of December 31, 1996, the OTS did not deem it necessary for an interest-rate
risk component to be deducted from capital in determining risk-based capital
requirements.
The Bank may not declare or pay cash dividends on its shares of common stock if
the effect thereof would cause stockholders' equity to be reduced below
applicable capital maintenance requirements or if such declaration and payment
would otherwise violate regulatory requirements.
55
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The following table displays the Bank's capital calculations as defined under
prompt corrective action for the periods indicated:
- -----------------------------------------------------------------------------------------------------------------------------
To Be Well
For Capital Capitalized Under Prompt
Actual Actual Adequacy Purposes Corrective Action Provision:
Amount Ratio Amount Ratio Amount Ratio
December 31, 1996
Tangible Capital (to
Adjusted Assets)
First Essex Bank, FSB $62,216 5.91% $15,790 [greater
than or
=] 1.50 n/a
Tier 1 (Core) Capital
(to Adjusted Assets)
First Essex Bank, FSB 62,216 5.91 31,396 3.00 $52,327 [greater
than or
=] 5.00%
Tier 1 Capital (to Risk
Weighted Assets)
First Essex Bank, FSB 62,216 9.67 25,736 4.00 38,604 6.00
Total Risk Based Capital (to Risk
Weighted Assets)
First Essex Bank, FSB 70,289 10.92 51,471 8.00 64,339 10.00
December 31, 1995 (unaudited)
Tangible Capital (to
Adjusted Assets)
First Essex Bank, FSB $56,227 7.02% $12,014 [greater
than or
=] 1.50% n/a
Tier 1 (Core) Capital (to
Adjusted Assets)
First Essex Bank, FSB 56,227 7.02 24,028 3.00 $40,047 [greater
than or
=] 5.00%
Tier 1 Capital (to Risk
Weighted Assets)
First Essex Bank, FSB 56,227 9.67 18,936 4.00 28,404 6.00
Total Risk Based Capital
(to Risk Weighted Assets)
First Essex Bank, FSB 62,152 13.13 37,872 8.00 47,339 10.00
- -----------------------------------------------------------------------------------------------------------------------------
56
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
16. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS - FIRST ESSEX BANCORP, INC.
Condensed financial statements of First Essex Bancorp, Inc. as of December 31,
1996 and 1995, and for the years ended December 31, 1996, 1995 and 1994 follow:
- --------------------------------------------------------------------------------
1996 1995
------- -------
(Dollars in thousands)
Balance Sheets
Assets
Cash and cash equivalents $ 3,663 $ 5,928
Investment in First Essex Bank, FSB 73,924 55,550
Other assets 7,195 1
------- -------
Total assets $84,782 $61,479
======= =======
Liabilities and stockholders' equity
Other liabilities $ 1,641 $ 1,307
Stockholders' equity 83,141 60,172
------- -------
Total liabilities and stockholders' equity $84,782 $61,479
======= =======
- --------------------------------------------------------------------------------------------------
1996 1995 1994
------ ------ -------
(Dollars in thousands)
Statements of Operations
Income
Interest on investments $ 241 $ 221 $ 87
Distributed income of First Essex Bank, FSB 7,000 3,000 3,000
------ ------ -------
Total income 7,241 3,221 3,087
------ ------ -------
Expenses
Operating expenses 5 7 45
------ ------ -------
Income before provision (benefit) for income taxes and equity in
undistributed net income of First Essex Bank, FSB 7,236 3,214 3,042
Provision (benefit) for income taxes 40 75 (805)
------ ------ -------
7,196 3,139 3,847
Equity in undistributed net income of First Essex Bank, FSB 1,917 4,313 2,679
------ ------ -------
Net income $9,113 $7,452 $ 6,526
====== ====== =======
- --------------------------------------------------------------------------------------------------
57
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
- ------------------------------------------------------------------------------------------------------------
1996 1995 1994
-------- ------- -------
(Dollars in thousands)
Statements of Cash Flows
Cash flows from operating activities
Net income $ 9,113 $ 7,452 $ 6,526
Adjustments to reconcile net income
to net cash provided by (used in) operating activities:
Equity in income of First Essex Bank, FSB (8,917) (7,313) (5,679)
Provision (benefit) for deferred income taxes (1,908) 55 (825)
Accretion of investment
securities discounts -- (165) (71)
(Increase) decrease in other assets 1,908 1 6
(Increase) decrease in other liabilities (50) (28) 19
-------- ------- -------
Net cash provided by (used in) operating activities 146 2 (24)
-------- ------- -------
Cash flows from investing activities
Acquisition cost, net of cash received (14,224) -- --
Purchases of investment securities -- (2,253) (8,810)
Maturities of investment securities -- 6,297 6,984
Dividends and other capital distributions
received from First Essex Bank, FSB 14,380 3,000 3,000
-------- ------- -------
Net cash provided by investing activities 156 7,044 1,174
-------- ------- -------
Cash flows from financing activities
Stock options exercised 333 16 41
Dividends paid (2,900) (2,167) (1,565)
-------- ------- -------
Net cash used in financing activities (2,567) (2,151) (1,524)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents (2,265) 4,895 (374)
Cash and cash equivalents at beginning of year 5,928 1,033 1,407
-------- ------- -------
Cash and cash equivalents at end of year $ 3,663 $ 5,928 $ 1,033
======== ======= =======
- ------------------------------------------------------------------------------------------------------------
17. RESTRICTIONS ON SUBSIDIARY BANK LOANS, ADVANCES AND DIVIDENDS
The Federal Reserve Act restricts the Bank with respect to lending or advancing
funds to the Company unless such loans are collateralized by specific
obligations and limits collateralized loans to 10% of the Bank capital stock and
surplus. At December 31, 1996, no amounts were available to be transferred from
the Bank to the Company in the form of loans or advances. In addition, under the
OTS prompt corrective action regulations, which took effect on December 19,
1992, the Bank generally would be prohibited from making any capital
distribution if, after the distribution, the Bank would have (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio
of less than 4% or (iii) a Tier 1 core capital ratio of less than 3%.
58
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
18. QUARTERLY DATA (UNAUDITED)
A summary of quarterly financial data for the years ended December 31, 1996 and
1995 follows:
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1996
Fourth Third Second First
Quarter Quarter Quarter Quarter
(Dollars in thousands, except per share amounts)
Interest and dividend income $16,893 $16,089 $15,580 $14,983
Interest expense 9,782 9,560 9,103 8,872
------ ------ ------ -----
Net interest income 7,111 6,529 6,477 6,111
Provision for possible loan losses 360 240 326 489
------ ------ ------ -----
Net interest income after
provision for possible loan losses 6,751 6,289 6,151 5,622
Noninterest income 1,308 810 1,048 1,099
Noninterest expense 5,344 4,564 5,060 4,957
----- ------ ------ -----
Income before income taxes 2,715 2,535 2,139 1,764
Provision for income taxes 10 11 9 10
------ ------ ------ ------
Net income $2,705 $2,524 $2,130 $1,754
======= ======= ======= ======
Earnings per share $ .43 $ .41 $ .35 $ .28
======= ======= ====== ======
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1995
Fourth Third Second First
Quarter Quarter Quarter Quarter
(Dollars in thousands, except per share amounts)
Interest and dividend income $15,501 $15,491 $15,342 $14,580
Interest expense 9,411 9,625 9,336 8,709
------ ------ ------ -----
Net interest income 6,090 5,866 6,006 5,871
Provision for possible loan losses 232 209 200 129
------ ------ ------ -----
Net interest income after
provision for possible loan losses 5,858 5,657 5,806 5,742
Noninterest income 1,178 1,082 865 583
Noninterest expense (1) 5,264 4,236 4,880 4,864
----- ------ ------ -----
Income before income taxes 1,772 2,503 1,791 1,461
Provision for income taxes 45 10 19 1
------ ------ ------ ------
Net income $1,727 $2,493 $1,772 $1,460
======= ======= ======= ======
Earnings per share $ .28 $ .41 $ .29 $ .24
======= ======= ====== ======
(1) The third quarter reduction in noninterest expense reflects a
decrease of approximately $250,000 of deposit insurance expense, as
well as a reduction of approximately $360,000 in the net cost of
foreclosed property.
- ------------------------------------------------------------------------------------------------------------------
59
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
19. PREFERRED STOCK
The Company's Board of Directors has authorized a series of 100,000 shares of
preferred stock designated as Series A Junior Participating Cumulative Preferred
Stock, par value $0.10 per share ("Series A Stock") and has declared a dividend
distribution of one Preferred Stock Purchase Right (the "Right") for each
outstanding share of the Company's common stock.
Pursuant to the Company's Shareholder Rights Plan, each Right entitles the
holder to purchase from the Company a unit consisting of one one-hundredth of a
share of Series A Stock, par value $0.10 per share, at an initial cash exercise
price of $28 per unit, subject to adjustment. The Rights are not exercisable and
remain attached to all outstanding shares of the Company's common stock until
the earliest of (i) ten days following a public announcement that a person or
group of affiliated or associated persons (an "Acquiring Person") has acquired
beneficial ownership of 20% or more of the outstanding shares of the Company's
common stock (the date of said announcement being referred to as the "Stock
Acquisition Date"), (ii) ten business days following the commencement of a
tender offer or exchange offer that would result in a person or group becoming
an Acquiring Person or (iii) the declaration by the Company's Board of Directors
that a person is an "Adverse Person," as such term is defined in the Company's
Shareholder Rights Plan.
In the event that a Stock Acquisition Date occurs or the Board determined that a
person is an Adverse Person, each holder of a Right will be entitled to receive,
upon exercise, that number of units of Series A Stock having a fair value of two
times the exercise price of the Right. In the event that, at any time following
the Stock Acquisition Date, (i) the Company is acquired in a merger or other
business combination transaction or (ii) 50% or more of the Company's assets or
earning power is sold, each holder of a Right shall thereafter have the right to
receive, upon exercise, common stock of the acquiring company having a fair
value equal to two times the exercise price of the Right. The holders of Series
A Stock would be entitled to preferred rights with respect to dividends, voting
and liquidation.
20. FAIR VALUE OF FINANCIAL INSTRUMENTS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, amounts due from banks,
interest-bearing deposits, federal funds sold and investments with original
maturities of less than three months. Cash and cash equivalents are recorded at
cost which approximates fair value.
INVESTMENT SECURITIES
Fair values for investment securities, excluding Federal Home Loan Bank (FHLB)
and Savings Bank Life Insurance (SBLI) stock, 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. The carrying values of
FHLB and SBLI stock approximates fair value.
LOANS RECEIVABLE
For variable rate loans that reprice frequently and with no significant change
in credit risk, fair values are based on carrying values. The fair values for
certain mortgage loans (e.g., one-to-four family residential) are based on
quoted market prices of similar loans sold in conjunction with securitization
transactions, adjusted for differences in loan characteristics. The fair values
of other loans (e.g., commercial real estate and rental property mortgage
loans, commercial, industrial loans, and consumer loans) are estimated using a
discounted cash flow analysis, using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality. The carrying
amount of mortgage loans held-for-sale and accrued interest
60
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
approximates its fair value.
DEPOSITORS' ACCOUNTS
The fair values disclosed for certain deposits (e.g., interest and
noninterest-bearing checking, passbook savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on a schedule of aggregated
expected monthly maturities on time deposits. The carrying amount of accrued
interest payable approximates its fair value.
BORROWED FUNDS
The carrying amounts of borrowings within ninety days approximate their fair
values. Fair values of other borrowings are estimated using discounted cash flow
analyses based on the Company's current borrowing rates for similar types of
borrowing arrangements. The carrying value for repurchase agreements
approximates fair value due to the short term nature of these instruments.
OFF-BALANCE-SHEET INSTRUMENTS
The fair values of the Company's off-balance-sheet instruments (lending
commitments and letters of credit) are based on fees currently charged to enter
into similar agreements, taking into account the remaining terms of the
agreement and the counterparties' credit standing.
At December 31, 1996 and 1995, the estimated fair value of off-balance-sheet
financial instruments, consisting primarily of loan commitments, were not
material.
ASSUMPTIONS
Fair value estimates are made at a specific point in time, based on relevant
market information about specific financial instruments. 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 a significant portion of the Company's financial
instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments, 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 could
significantly affect the estimates.
61
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
The estimated fair values of the Company's financial instruments follow:
- -----------------------------------------------------------------------------------------------------------
December 31, 1996 December 31, 1995
----------------- -----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
(Dollars in thousands)
Financial assets:
Cash and cash equivalents $ 38,078 $ 38,078 $ 27,308 $ 27,308
Investment securities available-for-sale 174,716 174,716 115,153 115,153
Investment securities held-to-maturity 104,465 103,529 135,098 133,651
Stock in Federal Home Loan Bank
of Boston and Savings Bank Life
Insurance Company 16,711 16,711 16,063 16,063
Loans receivable, net 685,206 680,622 487,678 491,847
Mortgage loans held-for-sale 8,915 8,915 5,821 5,821
Accrued interest receivable 5,970 5,970 4,466 4,466
Financial liabilities:
Depositors' accounts 690,953 692,266 491,469 486,196
Borrowed funds 274,958 275,450 245,569 244,514
- -----------------------------------------------------------------------------------------------------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in, or disagreements with, accountants on accounting and
financial disclosures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item appears under the headings "Information
Regarding Directors and Nominees" and "Executive Officers" of the Company's
definitive Proxy Statement dated March 31, 1997 for the Annual Meeting of
Stockholders to be held May 1, 1997 filed with the Securities and Exchange
Commission (the "Proxy Statement"), and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item appears in the Proxy Statement under the
headings "Summary Compensation Table," "Stock Options Granted in 1996," "Long
Term Incentive Plan Awards Granted in 1996," " Aggregate Option/SAR Exercises in
Last Fiscal Year, and FY-End Option/SAR Value," "Pension Plan," "Executive
Salary Continuation Agreement," "Employment Contracts, Termination of Employment
and Change in Control Arrangements," "Compensation/Nominating Committee
Interlocks and Insider Participation" and "Compensation/Nominating Committee
Report on Executive Compensation" and is incorporated herein by reference.
62
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item appears in the Proxy Statement under the
headings "Principal and Management Stockholders", "Information Regarding
Directors and Nominees" and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item appears in the Proxy Statement under the
heading "Certain Transactions with Management and Others" and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Index of Financial Statements: The following financial statements
appear in response to Item 8 of this Report.
Reports of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the Years Ended December 31,
1996, 1995 and 1994
Consolidated Statements of Stockholders Equity for the Years Ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended December 31,
1996, 1995 and 1994
Notes to Consolidated Financial Statements
(a) (2) Index of Financial Statement Schedules:
The following financial statement schedules appear in response to
Item 8 of this Report or as part of this Item 14:
Schedule I - Indebtedness to Related Parties.
The information required by this Schedule is not material and is
therefore omitted.
Schedule II - Guarantees of Securities of other Issuers. Not
applicable.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by First Essex during the fiscal
quarter ended December 31, 1996.
(c) Exhibits:
(3) Articles of Incorporation and By-laws:
3.1 The Restated Certificate of Incorporation of the Company is incorporated
herein by reference to Exhibit 3.1 to Amendment No. 1 to the Company's
Registration Statement on Form S-1, Registration No. 33-10966, filed
with the Securities and Exchange Commission on April 17, 1987
("Amendment No. 1 to the Form S-1");
3.2 The Amended and Restated By-laws of the Company are incorporated herein
by reference to Exhibit 4.1 of the Company's current report on Form 8-K
filed on December 28, 1992.
(10) Material Contracts:
*10.1- The First Essex Bancorp, Inc. 1987 Stock Option Plan is incorporated
herein by reference to Appendix B to the prospectus included in the
Company's Registration Statement on Form S-8, registration number
33-21292, filed on April 15, 1988;
10.2- The Shareholder Rights Agreement is incorporated herein by reference
to the exhibit to the Company's Current Report on Form 8-K filed on
October 12, 1989, as amended by the Amendment to the Shareholder
Rights Plan, incorporated herein by reference to Exhibit 28.2 to the
Company's Current Report on Form 8-K filed on February 12, 1990;
*10.3- Amended and Restated Employment Agreement between First Essex
Bancorp, Inc., First Essex Bank, FSB and Leonard A. Wilson is
incorporated herein by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1995;
*10.4- Amended and Restated Employment Agreement between First Essex
Bancorp, Inc., First Essex Bank,
63
FSB and David W. Dailey is incorporated herein by reference to
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
*10.5- Special Termination Agreement between First Essex Bancorp, Inc.,
First Essex Bank, FSB and Leonard A. Wilson is incorporated herein
by reference to Exhibit 10.5 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993;
*10.6- Special Termination Agreement between First Essex Bancorp, Inc.,
First Essex Bank, FSB and David W. Dailey is incorporated herein by
reference to Exhibit 10.6 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993;
*10.7- Executive Salary Continuation Agreement between First Essex Bancorp,
Inc., First Essex Bank, FSB and Leonard A. Wilson is incorporated
herein by reference to Exhibit 10.15 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1988;
*10.8- Form of Special Termination Agreement between First Essex Bancorp,
Inc, First Essex Bank, FSB and each of John M. DiGaetano, David L.
Savoie and William F. Burke (at one year terms) and Wayne C. Golon
(at a 2 year term) is incorporated by reference to Exhibit 10.8 to
the Company's annual report on Form 10-K for the fiscal year ended
December 31, 1993
*10.9- First Essex Bancorp, Inc. Senior Management Incentive Compensation
Plan is incorporated herein by reference to Exhibit 10.9 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.
*10.10- Form of Employment Agreement and Form of Special Termination
Agreement between First Essex Bancorp, Inc., First Essex Bank, FSB
and Brian W. Thompson incorporated herein by reference to Amendment
Number 1 to Form S-4, registration number 333-12793, filed on
November 6, 1996.
*10.11- Common Stock Option Plan for Brian W. Thompson incorporated herein
by reference to Form S-8, registration number 333-22183, filed on
February 21, 1997.
(12) Statements Regarding Computation of Ratios:
Not applicable, as First Essex does not have any debt securities
registered under Section 12 of the Securities Exchange Act of 1934.
(21) Subsidiaries of Registrant:
A list of subsidiaries of the Company is incorporated by reference
to Exhibit 22 to the Company's annual report on Form 10-K for the
fiscal year ended December 31, 1993.
(23) Consent of Experts and Counsel:
Consent of Arthur Andersen LLP is attached hereto as Exhibit 23.
(27) Financial Data Schedule
* Management contract or compensatory plan.
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FIRST ESSEX BANCORP, INC.
Date: March 13, 1997
by /s/Leonard A. Wilson
------------------------------------
Leonard A. Wilson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following people on behalf of the registrant in the
capacities and on the dates indicated.
/s/Leonard A. Wilson President, Chief Executive March 13, 1997
- ----------------------------- Officer and Director
Leonard A. Wilson (Principal Executive Officer)
/s/David W. Dailey Executive Vice President, March 13, 1997
- ----------------------------- (Principal Financial
David W. Dailey and Accounting Officer)
/s/Thomas S. Barenboim Director March 13, 1997
- -----------------------------
Thomas S. Barenboim
/s/Augustine J. Fabiani Director March 13, 1997
- -----------------------------
Augustine J. Fabiani
/s/William L. Lane Director March 13, 1997
- -----------------------------
William L. Lane
/s/Frank J. Leone, Jr. Director March 13, 1997
- -----------------------------
Frank J. Leone, Jr.
Director March 13, 1997
- -----------------------------
Robert H. Pangione
/s/Walter W. Topham Director March 13, 1997
- -----------------------------
Walter W. Topham
/s/Robert H. Watkinson Director March 13, 1997
- -----------------------------
Robert H. Watkinson