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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 Commission file number 0-16143
December 31, 1998
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: (978) 681-7500
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 [ ]
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. [ ]
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
Stock Market on March 12, 1999 was $124,170,363.
As of March 12, 1999, 7,614,634 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 6, 1999, to be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998, is incorporated by reference
into Part III of this report
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
First Essex Bancorp, Inc. ( "First Essex" or 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 Company's 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 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Part II
Item 5. Market for the Registrant's Equity and Related Stockholder Matters 12
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 74
Part III
Item 10. Directors and Executive Officers of the Registrant 74
Item 11. Executive Compensation 74
Item 12. Security Ownership of Certain Beneficial Owners and Management 74
Item 13. Certain Relationships and Related Transactions 74
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 74
Signatures 77
PART I
ITEM 1. BUSINESS
GENERAL
First Essex Bancorp, Inc.
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, 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. 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.
First Essex Bank, FSB
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.
Pursuant to a Purchase and Assumption Agreement, the Bank purchased certain
assets and assumed certain deposit liabilities of another financial institution
in June 1998. Because this branch acquisition was an acquisition of assets and
not the acquisition of a business, separate entity or a subsidiary, no
historical financial statements or pro-forma financial statements are required,
and because the deposit liabilities assumed exceed the assets acquired, there
was a cash payment made to the Bank as a result of this transaction.
At December 31, 1998, the Bank had total assets of $1.2 billion. 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 19 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 approximately 25 miles north of Boston 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 Concord, Hillsboro,
Londonderry, Manchester, Pelham, Salem and Windham, New Hampshire.
1
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.
Loan demand to finance new and existing home sales has remained strong for the
last three years. Commercial loans to small and mid-size businesses in the area
continue to benefit from a growing economy characterized by expansion with
little price inflation, although the competition among lenders for these loans
remains intense. Automobile sales continued to show strength in 1998 and First
Essex participated 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 was reflected in the
growth in direct lending to consumers.
REGULATION
General
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 thrift 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
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
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
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 I 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
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(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 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 I risk-based capital
ratio of less than 4% or (iii) a Tier I core capital ratio of less than 3%. As
of December 31, 1998, the Bank exceeds all fully-phased in capital requirements.
Branching
The Bank currently meets the tests provided in the HOLA and OTS regulations to
permit savings institutions to branch nationwide. Additionally, the OTS
authority preempts any state law purporting to regulate branching by savings
institutions.
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
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
the components of capital, risk weightings of assets, and other factors.
Quantitative measures are established by regulation regarding 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, 1998, that the
Company meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, 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 adjusted 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, 1998,
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 Note 16 to the Consolidated
Financial Statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report.
3
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.
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 financial 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, 1998, the loan portfolio, before deducting the allowance for
loan losses, was $733.9 million, representing 58.8% of total assets and an
increase of $15.2 million over the prior year. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Allowance for Loan Losses."
During 1998, every category of loans evidenced growth with the exception of
residential real estate, which experienced sizable paydowns as a result of the
significant refinancings that took place in the first half of the year. The
overall increase reflects the loans acquired in the branch acquisition (Note 2)
together with the 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."
4
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,
1998 1997 1996 1995 1994
---------------- ----------------- ---------------- ----------------- -----------------
(Dollars in Thousands)
Real Estate:
Residential $189,983 25.9% $274,865 38.2% $301,869 42.9% $235,204 47.0% $264,848 61.6%
Commercial 88,774 12.1 83,077 11.6 102,718 14.6 53,504 10.7 25,786 6.0
Construction 43,220 5.9 31,851 4.4 24,855 3.5 14,210 2.8 15,527 3.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate loans $321,977 43.9 $389,793 54.2 $429,442 61.0 $302,918 60.5 $306,161 71.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Owner occupied commercial
real estate 62,800 8.6 52,335 7.3 29,465 4.2 -- -- -- --
Commercial loans 89,690 12.2 67,018 9.3 63,695 9.0 66,737 13.4 55,377 12.9
Aircraft loans 59,657 8.1 41,220 5.8 33,802 4.8 14,478 2.9 522 0.1
Consumer loans:
Home Equity, Home
Improvement
& Second Mortgage 59,003 8.0 59,897 8.3 52,280 7.4 35,257 7.1 25,263 5.9
Automobile 134,613 18.4 103,551 14.4 92,175 13.1 76,590 15.3 34,906 8.1
Other 6,143 0.8 4,901 0.7 3,800 0.5 4,071 0.8 7,582 1.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer loans 199,759 27.2 168,349 23.4 148,255 21.0 115,918 23.2 67,751 15.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans $733,883 100.0% $718,715 100.0% $704,659 100.0% $500,051 100.0% $429,811 100.0%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
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Residential Mortgage Loans
The Bank originates residential first mortgage loans in its market area. At
December 31, 1998, the residential mortgage loan portfolio was $190.0 million,
representing 25.9% of the loan portfolio. The Bank'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, 1998, the
commercial real estate loan portfolio had an outstanding balance of $88.8
million, representing 12.1% of the Bank'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 the Company 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 published prime rate or other index.
5
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 and a price based on the
published prime rate, 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, 1998, the Bank's construction loan portfolio had
an outstanding balance of $43.2 million, representing 5.9% 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, 1998, this
portfolio had total outstandings of $62.8 million, representing 8.6% of the
Bank's loan portfolio.
Commercial Loans
At December 31, 1998, the portfolio of commercial loans totaled $89.7 million,
representing 12.2% of the loan portfolio. The Bank offers secured and unsecured
demand loans, time loans, term loans, lines of credit and working capital loans
which are short term or have adjustable rates. Commercial loans are originated
by the Bank's commercial lending officers who are supported by a credit,
processing and documentation staff.
Aircraft Loans
The Bank also has a niche market in commercial and consumer aircraft lending,
which represented 8.1% of the loan portfolio, at December 31, 1998. Commercial
aircraft loans totaled $54.8 million and consumer aircraft loans totaled $4.9
million of the $59.7 million aircraft portfolio.
Consumer Loans
The portfolio of consumer loans, representing 27.2% of the loan portfolio,
consists of automobile loans, fully or partially secured personal loans, boat
loans, second mortgage loans, home equity loans and education loans, as well as
unsecured personal loans, which totaled $199.8 million at December 31, 1998.
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
6
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 generally writes 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, 1998, the Bank's residential loan servicing portfolio totaled
$23.2 million.
NONPERFORMING ASSETS
General
Nonperforming assets consist of nonaccruing loans (including impaired and
restructured loans) and foreclosed property. For further information regarding
the impairment of loans see "Provision for Loan Losses" included in Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Nonaccruing 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 nonaccrual status. At December 31,
1998, the Bank's nonaccruing loans totaled $5.5 million which was essentially
the same amount at December 31, 1997. For further information regarding the
Bank's nonaccruing 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, 1998 and
1997, the Bank had restructured loans with outstanding principal balances of
$447,000 and $905,000 respectively. For further information regarding
restructured loans, see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Nonperforming Assets."
Foreclosed Property
Foreclosed property at December 31, 1998 totaled $575,000 compared to $891,000
at December 31, 1997.
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 - Nonperforming Assets."
7
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, 1998, 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 $367.0 million, or 29.4% of total
assets.
Interest and dividend income on the investment portfolio generated 29.4% of
total interest and dividend income for the year ended December 31, 1998. 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 provide liquidity and 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 and 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. These relationship products also include discounts on
installment loans and bonus rates on certificates of deposit. The Bank also
offers 60-day to 7 year term deposit certificates. Interest rates on these
certificates vary according to the term selected. From time to time, the Bank
promotes various types of accounts with the intention of changing the maturity
schedule of its liabilities. See also Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Deposits."
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 and terms 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, service, convenience 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, 1998, the Bank had 340 employees, of whom 81 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.
8
ITEM 2. PROPERTIES
The following table sets forth certain information relating to properties owned
or used in banking activities at December 31, 1998
Owned Lease Renewal Total Office Space
First Essex Bank or Leased Expiration Date Option Through in Square Feet
---------------- --------- --------------- -------------- --------------
Corporate Headquarters (1):
71 Main Street Leased January 31, 2005 January 31, 2015 12,859
Andover, MA
Main Banking Office (2):
296 Essex Street Owned N/A N/A 32,000
Lawrence, MA
Operations Center:
900 Chelmsford Street Leased May 12, 2000 May 12, 2010 31,478
Lowell, MA
Mortage Origination Office:
216 Lafayette Road Leased October 31, 1999 N/A 661
North Hampton, NH
Consumer Lending Office:
211 North Main Street Leased May 30, 1999 May 30, 2001 1,260
Andover, MA May 30, 2000 May 30, 2010 800
Branch Offices:
460 South Union Street Leased February 28, 2009 February 28, 2029 3,500
Lawrence, MA
555 Broadway Owned N/A N/A 2,000
Lawrence, MA
750 Main Street Owned N/A N/A 3,100
Haverhill, MA
555 Chickering Road Leased March 31, 2002 March 31, 2012 4,549
North Andover, MA
211 North Main Street Leased April 30, 2002 April 30, 2007 4,710
Andover, MA
125 Merrimack Street Owned N/A N/A 3,000
Methuen, MA
9
Item 2. Properties
(continued)
Owned Lease Renewal Total Office Space
First Essex Bank or Leased Expiration Date Option Through in Square Feet
---------------- --------- --------------- -------------- --------------
Branch Offices (continued):
15 Burnham Road Leased June 30, 2000 June 30, 2015 3,700
Methuen, MA
539 South Broadway (3) Leased September 30, 2002 September 30, 2012 5,400
Salem, NH
1 Wall Street (4) Owned N/A N/A 7,400
Windham, NH
100 Bridge Street Leased June 30, 2003 June 30, 2008 6,899
Pelham, NH
24 Orchard View Drive Leased November 30, 2003 November 30, 2008 3,130
Londonderry, NH
900 Chelmsford Street Leased September 30, 2001 September 30, 2006 1,400
Lowell, MA
20 North Broadway Owned N/A N/A 3,800
Salem, NH
73 West Street Owned N/A N/A 5,600
Concord, NH
161 North State Street Owned N/A N/A 22,560
Concord, NH
53 West Main Street Owned N/A N/A 4,276
Hillsborough, NH
1 Wall Street (5) Leased June 30, 2001 June 30, 2011 21,787
Manchester, NH
(1) In February 1995, the address of the corporate headquarters and the
principal executive offices of the Company moved to 71 Main Street, Andover,
Massachusetts. This site also serves as a branch location.
(2) Includes two contiguous buildings at 284 Essex Street and 286-288 Essex
Street which were aquired in 1972 and 1980, respectively, as well as an
adjacent parking lot at 7 Lawrence Street which was acquired in 1981.
(3) Second floor of building is subleased for a two year term, commencing on
April 1, 1998 and terminating on March 31, 2000. There is an option to renew
for three additional 3 year terms.
(4) Second floor of building is leased for a two year term, commencing on March
1, 1999 and terminating on February 28, 2001. There is an option to renew
for two additional 1 year terms.
(5) 1,500 s/f of space is subleased on a month to month basis.
Management believes that the Company's existing facilities are adequate for the
conduct of its business.
10
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its business,
none of which are 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
There were no matters submitted to a vote of the shareholders during the fourth
quarter of 1998.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND
RELATED STOCKHOLDER MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on the Nasdaq
National Market System under the symbol FESX.
At December 31, 1998, there were 7,611,635 shares outstanding and 1,266
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.
- --------------------------------------------------------------------------------
Dividend
Price Per Share Declared
1998 HIGH LOW per Share
---- ---- --- ---------
First Quarter $26.125 $20.000 $.14
Second Quarter 25.250 21.250 .14
Third Quarter 23.984 15.000 .14
Fourth Quarter 18.875 13.750 .16
1997
----
First Quarter $16.750 $13.375 $.12
Second Quarter 17.500 14.500 .12
Third Quarter 20.500 16.500 .12
Fourth Quarter 23.250 19.000 .14
- --------------------------------------------------------------------------------
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 Item 1. "Business - Regulation -
Limitation on Capital Distributions" and Note 16 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.
12
ITEM 6. SELECTED FINANCIAL DATA
At December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Balance Sheet Data:
Total assets $1,248,014 $1,197,459 $1,067,175 $808,792 $806,872
Loans receivable, net 722,622 708,145 694,121 493,499 422,574
Investment securities (1) 367,407 416,021 315,749 275,900 346,943
Foreclosed property 575 891 1,880 1,756 3,038
Deposits 934,695 744,322 690,953 491,469 456,878
Borrowed funds 201,499 343,557 274,958 245,569 279,948
Stockholders' equity 97,082 91,065 83,141 60,172 54,757
Years Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Operating Data:
Interest and
dividend income $93,460 $90,078 $63,545 $60,914 $45,057
Interest expense 52,512 52,377 37,317 37,081 22,707
-------- ------- ------- ------- -------
Net interest income 40,948 37,701 26,228 23,833 22,350
Provision for loan losses 1,440 2,040 1,415 770 --
Net gain (loss) on sales
of securities 1,344 439 497 (13) --
Net gain on sales of mortgage loans
and mortgage servicing rights 1,338 1,628 1,352 1,431 260
Net gain on sales of
foreclosed property 373 502 109 53 141
Other income 4,183 3,021 2,416 2,290 2,301
Noninterest expenses 28,551 24,866 20,034 19,297 19,331
Income tax
expense (benefit) 7,130 6,672 40 75 (805)
-------- ------- ------- ------- -------
Net income $11,065 $9,713 $9,113 $7,452 $6,526
-------- ------- ------- ------- -------
Per Share Data:
Earnings per share - basic (2) $1.46 $1.30 $1.51 $1.24 $1.08
Earnings per share - diluted (2) 1.41 1.25 1.47 1.22 1.08
Dividends declared 0.58 0.50 0.48 0.40 0.28
Book value at
end of period 12.75 12.08 11.20 9.99 9.10
Selected Financial Ratios:
Return on average assets 0.90% 0.80% 1.08% 0.91% 0.94%
Return on average equity 11.73 10.54 14.37 12.79 12.42
Average equity as a
percentage of average assets 7.63 7.32 7.54 7.09 7.56
Weighted average interest
rate spread 2.84 2.77 2.72 2.56 3.02
Net yield on average
earning assets 3.44 3.31 3.22 2.99 3.33
(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.
(2) Earnings per share computed in accordance with Statement of Financial
Accounting Standards No. 128.
- --------------------------------------------------------------------------------
13
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. Net income for
the year ended December 31, 1998 totaled $11.1 million (or $1.41 per diluted
share) compared to $9.7 million (or $1.25 per diluted share) for the same period
in 1997, an increase of 14% or $1.4 million. The improvement was in part due to
the increase in net average earnings assets combined with the increase in the
weighted average interest rate spread.
14
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,
------------------------
1998 1997 1996
--------------------------- ---------------------------- ---------------------------
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 $42,580 $2,318 5.45% $9,826 $585 5.95% $8,589 $451 5.25%
Investment securities 390,182 25,054 6.42 405,639 26,418 6.51 267,493 16,202 6.06
Other earning assets 17,336 1,043 6.02 7,333 517 7.05 -- --
Total loans (1) 739,091 65,045 8.80 715,772 62,558 8.74 538,758 46,892 8.70
---------- ------- ---------- ------- -------- -------
Total earning assets 1,189,189 93,460 7.86 1,138,570 90,078 7.91 814,840 63,545 7.80
---------- ------- ---------- ------- -------- -------
Allowance for loan losses (11,037) (10,197) (6,734)
---------- ---------- --------
Total earning assets less
allowance for loan losses 1,178,152 1,128,373 808,106
Other assets 57,071 57,841 32,652
---------- ---------- --------
Total Assets $1,235,223 $1,186,214 $840,758
---------- ---------- --------
Liabilities and Stockholders' Equity
- ------------------------------------
NOW accounts 44,048 518 1.18% 40,806 527 1.29% 32,846 399 1.21%
Money market accounts 66,263 2,200 3.32 73,571 1,698 2.31 72,632 1,606 2.21
Savings accounts 196,343 7,037 3.58 123,204 4,134 3.36 49,822 862 1.73
Time deposits 450,104 25,602 5.69 422,978 24,870 5.88 320,649 19,079 5.95
---------- ------- ---------- ------- -------- -------
Total interest bearing
deposits 756,758 35,357 4.67 660,559 31,229 4.73 475,949 21,946 4.61
Borrowed funds 289,229 17,155 5.93 359,390 21,148 5.88 259,070 15,371 5.93
---------- ------- ---------- ------- -------- -------
Total interest bearing deposits
and borrowed funds 1,045,987 52,512 5.02 1,019,949 52,377 5.14 735,019 37,317 5.08
Demand deposits 77,467 62,220 30,804
Other liabilities 17,473 17,204 11,530
---------- ---------- --------
Total liabilities 1,140,927 1,099,373 777,353
Stockholders' equity 94,296 86,841 63,405
---------- ---------- --------
Total liabilities and
stockholders' equity $1,235,223 $1,186,214 $840,758
---------- ---------- --------
Net interest income $40,948 $37,701 $26,228
------- ------- -------
Weighted average rate spread 2.84% 2.77% 2.72%
---- ---- ----
Net yield on earning assets (2) 3.44% 3.31% 3.22%
-- ---- ---- ----
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for loan losses divided by average
interest earnings assets
- --------------------------------------------------------------------------------
15
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,
------------------------
1998 Compared to 1997 1997 Compared to 1996
--------------------- ---------------------
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
loan losses $2,038 $449 $2,487 $15,392 $274 $15,666
Investment securities (1,007) (357) (1,364) 8,917 1,299 10,216
Interest on other earning assets 705 (179) 526 517 0 517
Federal funds sold and short-term investments 1,788 (55) 1,733 70 64 134
------ ----- ------ ------- ---- -------
Total interest and dividend income 3,524 (142) 3,382 24,896 1,637 26,533
------ ----- ------ ------- ---- -------
Interest expense:
Savings deposits 2,457 449 2,906 2,122 1,370 3,492
Time deposits 1,162 60 1,222 6,089 (298) 5,791
Borrowed funds (4,125) 132 (3,993) 5,952 (175) 5,777
------ ----- ------ ------- ---- -------
Total interest expense (506) 641 135 14,163 897 15,060
------ ----- ------ ------- ---- -------
Net interest and dividend income $4,030 ($783) $3,247 $10,733 $740 $11,473
------ ----- ------ ------- ---- -------
- --------------------------------------------------------------------------------
Net Interest Income
Net interest income increased by $3.2 million to $40.9 million for the year
ended December 31, 1998, representing an 8.6% increase from $37.7 million in
1997. The increase in net interest income was primarily due to the increase of
13 basis points in the net yield on average earning assets combined with the
volume increases in outstanding loans and short term investments partially
offset by the decreased investment securities.
Net interest income increased by $11.5 million to $37.7 million for the year
ended December 31, 1997, representing a 43.7% increase from $26.2 million in
1996. The increase in net interest income was primarily due to the $323.7
million increase (39.7%) in average earning assets (primarily associated with
the Finest acquisition) along with an increase of 9 basis points in the net
yield on average earning assets. As reflected in the above rate/volume table,
the primary contributor to the 1997 increase was the volume increases in
outstanding loans.
Interest and Dividend Income
Interest and dividend income increased by $3.4 million (3.8%) to $93.5 million
for the year ended December 31, 1998 from $90.1 million for the year ended
December 31, 1997. This increase was due to an overall increase in average
earning assets from $1,138.6 million in 1997 to $1,189.2 million in 1998, a 4.4%
increase. The net yield on average earning assets rose 13 basis points from the
1997 yield of 3.31% to 3.44% in 1998 primarily due to a decrease in the cost of
funds and secondarily due to a shift to higher yielding commercial loans.
Interest and dividend income increased by $26.5 million (41.8%) to $90.1 million
for the year ended December 31, 1997 from $63.5 million in 1996. This increase
was due to the increase in average earning assets associated with the Finest
acquisition and the increased leveraging. Average earning assets increased from
$814.8 million in 1996 to $1,138.6 million in 1997, a 39.7% increase. The net
yield on average earning assets rose 9 basis points from the 1996 yield of 3.22%
to 3.31% in 1997 due primarily to the volume increases associated with the
Finest acquisition.
16
Interest Expense
Interest expense increased marginally ($135,000 or 0.3%) to $52.5 million for
the year ended December 31, 1998 from $52.4 million in 1997. The volume
increases in savings and time deposits were more than offset by the volume
decreases in borrowed funds. The total weighted cost of funds decreased 12 basis
points from 5.14% in 1997 to 5.02% in 1998.
Interest expense increased by $15.1 million (40.4%) to $52.4 million for the
year ended December 31, 1997 from $37.3 million in 1996. The increase was also
volume related and attributable to deposits acquired in the Finest acquisition
together with increased borrowings. The total weighted cost of funds increased
slightly from a level of 5.08% in 1996 to 5.14% in 1997.
Provision for Loan Losses
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.
Losses on loans are provided for under the accrual method of accounting.
Assessing the adequacy of the allowance for 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. See "Financial
Condition - Allowance for Loan Losses". Ultimate losses may vary significantly
from the current estimates. Losses on loans, including impaired loans, are
charged against the allowance when management believes the collectability of
principal is doubtful.
Provisions for loan losses totaled $1.4 million, $2.0 million, and $1.4 million
for the years ended December 31, 1998, 1997 and 1996, respectively. The 1998
provision was net of a $463,000 reversal of previous provisions for impaired
loans. Included in the other provision amounts were $635,000 and $659,000,
respectively, of provisions for losses related to impaired loans for fiscal 1997
and 1996. 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 loan losses in the
future. See "Financial Condition - Non-Performing Assets."
The Bank's total allowance for loan losses was $11.3 million or 204.8% of
non-accruing loans at December 31, 1998 compared to $10.6 million or 190.7% at
December 31, 1997 and $10.5 million or 222.4% at December 31, 1996.
Noninterest Income
Noninterest income consists of net gains from sales of securities, net gains
from sales of loans and loan servicing rights, fee
17
and other noninterest income.
Noninterest income increased 34.9% to $6.9 million for the year ended December
31, 1998 compared to $5.1 million in 1997. The primary reasons for this $1.8
million increase were a $905,000 increase in gains on the sales of investment
securities (of which approximately $231,000 were the result of gains realized on
the sale of securities transferred from the held-to-maturity classification),
and a $71,000 increase in total fee income, offset by a $290,000 decrease in
gains on sales of mortgage loans. Other noninterest income was a result of a
special payment received from the Massachusetts Depositors Insurance Fund of
$346,000 and interest on a state tax refund of $145,000.
Noninterest income increased 19.3% to $5.1 million for the year ended December
31, 1998 compared to $4.3 million in 1996. The primary reason for the increase
from 1996 to 1997 was a $631,000 increase in fee income from $2.4 million in
1996 to $3.0 million in 1997. Gains on the sales of mortgage loans and mortgage
servicing rights also rose by $276,000 from $1.4 million in 1996, to $1.6
million in 1997
Noninterest Expenses
Noninterest expenses increased by $3.8 million (15.7%) to $28.2 million for the
year ended December 31, 1998 compared to $24.4 million in 1997. The majority of
this increase relates to the acquisition of four banking offices in June 1998,
and the operation, throughout the reminder of the year, of these additional
banking offices.
Noninterest expenses increased by $4.4 million (22.3%) to $24.4 million for the
year ended December 31, 1997 compared to $19.9 million in 1996. Much of this
increase is attributable to operating five more banking offices in 1997 than in
1996.
Salaries and employee benefits increased by $1.4 million (12.2%) to $13.0
million for the year ended December 31, 1998 from $11.6 million in 1997 and
$10.1 million in 1996. The increases were primarily due to costs associated with
personnel to support the business growth associated with the acquisition of four
additional banking offices for half of 1998, and a full year of operations at
five new banking offices in 1997 when compared to 1996.
Amortization of intangible assets associated with the branch acquisition in 1998
and the purchase of Finest Financial Corp. in 1996 amounted to $1.7 million in
1998 and $780,000 in 1997.
All other operating expenses increased in total by $1.5 million (12.7%) to $13.4
million for the year ended December 31, 1998 compared to $11.9 million in 1997
and $9.8 million in 1996.
Income Taxes
The net provision for income taxes amounted to $7.1 million in 1998 compared to
provisions of $6.7 million and $40,000 recorded in 1997 and 1996, respectively.
The Company returned to the position of providing income taxes at the full
statutory rates in 1997.
FINANCIAL CONDITION
Total assets remained constant at $1.2 billion at December 31, 1998 compared to
the previous period.
18
Loans
At December 31, 1998, the loan portfolio, excluding the allowance for loan
losses, and including mortgage loans held-for-sale, was $733.9 million,
representing 58.8% of total assets, compared to $718.7 million or 60.0% of total
assets at December 31, 1997. 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 had total loans outstanding of
$134.6 million, $103.6 million and $92.2 million for the years ending December
31, 1998, 1997 and 1996, respectively. Aircraft loans, an increasing lending
activity for the Bank, totaled $59.7 million at December 31, 1998 compared to
$41.2 million and $33.8 million at December 31, 1997 and 1996, respectively.
Nonperforming Assets
Nonperforming assets consist of nonaccruing and restructured loans (including
impaired loans), and foreclosed property. Nonperforming assets totaled $6.1
million at December 31, 1998, compared to $6.4 million at December 31, 1997 and
$6.6 million at December 31, 1996.
The Bank's general practice is to discontinue the accrual of interest on loans
(including impaired loans) 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 nonaccrual status, all previously accrued but uncollected interest is
reversed against current period interest income.
The principal balance of restructured loans was $447,000 for the year ended
December 31, 1998, $905,000 for the year ended December 31, 1997 and $1.0
million for the year ended December 31, 1996.
If the nonaccruing loans at December 31, 1998 and 1997 had been current in
accordance with their original terms, the amount of interest income that would
have been recorded is $456,000 and $570,000, respectively. The amount of
interest that was collected and recorded as income on non-performing loans was
$494,000 and $465,000 for the years ended December 31, 1998 and 1997
respectively, of which $265,000 and $293,000, respectively, represented interest
income on impaired loans.
Foreclosed property at December 31, 1998 totaled $575,000 compared to $891,000
at December 31, 1997 and consists mainly of real estate collateral from loans
which were foreclosed together with repossessed automobiles.
At December 31, 1998, the recorded investment in loans that are considered to be
impaired totaled $2.6 million of which $940,000 had a related allowance for loan
losses of $547,000. The remaining $1.6 million of impaired loans did not require
a related allowance for loan losses. The average recorded investment in impaired
loans during 1998 was approximately $3.0 million.
The following table shows the composition of nonperforming assets for the five
years ended December 31, 1998:
19
- --------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Nonaccruing loans:
Real estate $3,260 $3,159 $2,693 $2,559 $6,548
Other 1,792 1,480 1,004 814 776
Restructured loans 447 905 1,042 1,043 --
------ ------ ------ ------ -------
Total nonaccruing loans 5,499 5,544 4,739 4,416 7,324
Foreclosed property 575 891 1,880 1,756 3,038
------ ------ ------ ------ -------
Total nonperforming assets $6,074 $6,435 $6,619 $6,172 $10,362
------ ------ ------ ------ -------
Percentage of nonperforming
to total assets 0.49% 0.54% 0.62% 0.76% 1.28%
Percentage of allowance for
loan losses
to nonaccruing loans 204.8% 190.7% 222.4% 148.4% 98.8%
- --------------------------------------------------------------------------------
The following table summarizes the activity of foreclosed property during the
year ended December 31, 1998:
Other
Residential Construction Commercial Repossessed
Real Estate Real Estate Real Estate Assets Total
----------- ----------- ----------- ------ -----
(Dollars in thousands)
Balance at beginning of year $500 $0 $303 $88 $891
Transfer from loans 341 -- 320 2,436 3,097
Write-downs 0 -- (16) (16)
Sales (841) -- (331) (2,225) (3,397)
---- ---- ---- ------ ------
Balance at end of year $0 $0 $276 $299 $575
---- ---- ---- ------ ------
- --------------------------------------------------------------------------------
20
Allowance for 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 losses 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 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,
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 methodology for assessing the appropriateness of the allowance consists of a
review of the following key elements:
o A formula allowance for the various loan portfolio classifications,
o A valuation allowance for loans identified as impaired, and
o The unallocated allowance.
The formula allowance is a percentage-based reflection of historical loss
experience and assigns required allowance allocations by loan classification
based on a fixed percentage of all outstanding loan balances and commitments to
extend credit. The formula allowance employs a risk-rating model that grades
loans based on general characteristics of credit quality and relative risk. As
credit quality becomes more suspect, so-called "watch list" loans, the risk
rating and allocation percentage increase. The sum of these allocations comprise
the Company's "formula" or "general" allowance.
The Company also has "valuation" allowances for impaired loans. Loans are
evaluated for 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 a 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.
In addition to the formula and valuation components, there is an unallocated
allowance that is composed of two additional elements. The first element, which
is based on the Company's credit policy, consists of an amount that is at least
20% to 25% of the formula and valuation allowances. This element recognizes the
estimation risks associated with the formula model and the valuation allowance.
The second element is based upon management's evaluation of various conditions,
the effects of which are not directly measured in determining the formula and
valuation allowances. The evaluation of the inherent loss resulting from these
conditions involves a higher degree of uncertainty because they are not
identified with specific problem credits or portfolio segments. The conditions
evaluated in connection with the unallocated allowance include the following:
- then-existing general economic and business conditions affecting the
Company's key lending areas,
- credit quality trends, including trends in nonperforming loans
expected to result from existing conditions,
- collateral values,
- loan volumes and concentrations,
- seasoning of the loan portfolio,
- specific industry conditions within portfolio segments,
- recent loss experience in particular segements of the portfolio,
- duration of the current business cycle,
- bank regulatory examination results, and
- findings of our internal credit examiners.
When an evaluation of these conditions signifies a change in the level of risk,
the Company adjusts the formula allowance. Periodic credit reviews enable
further adjustment to the allowance through the risk-rating of loans and
identification of loans requiring a valuation allowance. In addition, the
formula model is designed to be self-correcting by taking into
21
account recent loss experience
The annual provision for loan losses is set based on the factors discussed
above. In addition, it is management's intent to maintain the allowance at a
level consistent with the Company's peers in the banking industry. The allowance
to loans ratio of 1.53% at December 31, 1998 was slightly below the Company's
peer group's average allowance ratio of 1.7%.
The following table summarizes the activity in the allowance for loan losses for
the five years ended December 31, 1998:
- --------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at beginning of year $10,570 $10,538 $6,552 $7,237 $7,747
Acquired allowance - Finest -- -- 4,080 -- --
Acquired allowance - branch acquisition 765 -- -- -- --
Provision for loan losses 1,440 2,040 1,415 770 --
Charge-offs:
Mortgage (709) (1,212) (1,148) (1,448) (1,703)
Construction -- -- (1) (96) (5)
Owner-occupied commercial
real estate -- -- -- -- --
Commercial (726) (2) (157) (230) (248)
Consumer (2,111) (1,612) (1,029) (711) (155)
-------- -------- -------- -------- --------
Total Charge-offs (3,546) (2,826) (2,335) (2,485) (2,111)
Recoveries:
Mortgage 1,288 575 277 234 535
Construction 12 14 6 279 240
Owner-occupied commercial
real estate -- -- -- -- --
Commercial 578 85 461 431 727
Consumer 154 144 82 86 99
-------- -------- -------- -------- --------
Total Recoveries 2,032 818 826 1,030 1,601
Net Charge-offs (1,514) (2,008) (1,509) (1,455) (510)
-------- -------- -------- -------- --------
Balance at end of year $11,261 $10,570 $10,538 $6,552 $7,237
-------- -------- -------- -------- --------
Total loans at end of year $733,883 $718,715 $704,659 $500,051 $429,811
Average loans for the year 739,091 715,772 538,758 473,069 325,922
Allowance to loans ratio 1.53% 1.47% 1.50% 1.31% 1.68%
Net Charge-offs to average loans ratio 0.20% 0.28% 0.28% 0.30% 0.16%
- --------------------------------------------------------------------------------
Investments
At December 31, 1998, 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, totaled $367.4 million or 29.4% of assets, compared to
$416.0 million or 34.7% of assets at December
22
31, 1997. The portfolio included U.S. government and agency obligations having a
book value of $100.1 million and mortgage-backed securities with a value of
$244.1 million. Interest and dividend income on the Company's investment
portfolio which amounted to $27.4 million generated 29.3% of total interest and
dividend income for the year ended December 31, 1998. During 1998, the
investment portfolio decreased by $48.6 million.
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. During the second quarter of 1998, the
Company reclassified to available-for-sale all securities previously classified
as held-to-maturity. This reclassification was the result of an analysis of the
strategic alternatives for the securities portfolio. Under Securities and
Exchange Commission guidelines, this reclassification prohibits the Company from
classifying securities as held-to-maturity for a period of at least two years.
The Company does not have any investments in off-balance-sheet financial
instruments, except as noted in Note 11 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
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Short-term investments:
Interest bearing deposits $107 $122 $3,507
Federal funds sold 281 4,000 16,350
-------- -------- --------
Total short-term investments 388 4,122 19,857
Investment securities held-to-maturity:
U.S. government & agency obligations -- 54,421 9,978
Mortgage backed securities -- 109,661 94,487
Other bonds and obligations -- 14,917 --
-------- -------- --------
Total investment securities held-to-maturity -- 178,999 104,465
Investment securities available-for-sale:
U.S. government & agency obligations 100,122 67,960 41,962
Mortgage-backed securities 244,083 121,977 111,062
Other bonds and obligations 1,635 21,966 21,692
-------- -------- --------
Total investment securities available for sale 345,840 211,903 174,716
Stock in Federal Home Loan Bank of Boston 19,985 19,803 15,517
Stock in Savings Bank Life Insurance Company 1,194 1,194 1,194
-------- -------- --------
Total investments $367,407 $416,021 $315,749
-------- -------- --------
Percent of total assets 29.4% 34.7% 29.6%
For further information regarding the Company's investment portfolio, including
information regarding amortized cost and fair value as of December 31, 1997, see
notes 1, 3, and 20 to the Company's consolidated financial statements included
in response to Item 8 hereof.
- --------------------------------------------------------------------------------
Set forth below is a breakdown of yields and contractual maturities for the
amortized cost of indicated investment securities at December 31, 1998.
- --------------------------------------------------------------------------------
23
- --------------------------------------------------------------------------------
U.S. Other
government bonds Mortgage-
and agency and backed
obligations obligations securities Total
----------- ----------- ---------- -----
(Dollars in thousands)
Due in 1 year or less:
Amount -- $1,511 $59,768 $61,279
Yield -- 5.24% 5.85% 5.47%
Due from 1 to 2 years:
Amount 398 -- 45,596 45,994
Yield 7.24% -- 5.99% 7.25%
Due from 2 to 3 years:
Amount 14,531 -- 22,427 36,958
Yield 6.86% -- 6.00% 6.73%
Due from 3 to 5 years:
Amount 25,947 -- 45,289 71,236
Yield 6.75% -- 6.27% 6.48%
Due from 5 to 10 years:
Amount 55,793 -- 41,109 96,902
Yield 6.55% -- 6.16% 6.88%
Due after 10 years:
Amount 1,476 126 30,749 32,351
Yield 4.20% 4.50% 6.41% 6.07%
------- ------ -------- --------
Total:
Amount $98,145 $1,637 $244,938 $344,720
Yield 6.84% 5.17% 6.08% 6.31%
- --------------------------------------------------------------------------------
24
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, 1998 the Bank had total deposits of $934.7 million,
representing a net increase of $190.4 million compared to $744.3 million at
December 31, 1997. The majority of this increase is represented by the deposit
liabilities assumed in the branch acquisition in June.
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:
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(Dollars in thousands)
NOW $44,048 1.18 % $40,806 1.29 % $32,846 1.21 %
Money market accounts 66,263 3.32 73,571 2.31 72,632 2.21
Savings and notice accounts 196,343 3.58 123,204 3.36 49,822 1.73
Time deposits 450,104 5.69 422,978 5.88 320,649 5.95
Total interest bearing deposits 756,758 4.67 660,559 4.73 475,949 4.61
Demand deposits 77,467 62,220 30,804
-------- -------- --------
Total deposits $834,225 $722,779 $506,753
-------- -------- --------
- --------------------------------------------------------------------------------
At December 31, 1998, 1997 and 1996, outstanding certificates of deposits in
denominations of $100,000 and over had maturities as follows:
- --------------------------------------------------------------------------------
Remaining Term to Maturity 1998 1997 1996
- -------------------------- ---- ---- ----
(Dollars in thousands)
Three months or less $13,220 $10,644 $13,993
Three to six months 8,709 6,673 3,998
Six to twelve months 36,688 27,543 11,816
Over twelve months 12,494 16,926 18,530
------- ------- -------
Total $71,111 $61,786 $48,337
------- ------- -------
- --------------------------------------------------------------------------------
25
Borrowed Funds
The primary source of the Bank's borrowings come from the Federal Home Loan Bank
("FHLB"). 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 totaled
$201.5 million at December 31, 1998 compared to $343.6 million and $275.0
million at December 31, 1997 and 1996, respectively. The decrease in borrowings
in 1998 to 1997 reflects the growth in deposits and the Company's diminished
need to borrow funds to support its assets. The increase in borrowings in 1997
from 1996 was used to fund the investment portfolio and loan growth throughout
the year.
The following table summarizes the maximum and average amounts of borrowings
outstanding, the majority of which are short-term, during 1998, 1997 and 1996
together with the weighted average interest rates thereon.
================================================================================
For the Year Ended December 31, 1998 At December 31, 1998
------------------------------------ --------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Interest Rate
----------- ----------- ------------- ----------- -------------
(Dollars in thousands)
FHLB Borrowings $411,605 $261,662 6.07 % $161,582 5.93 %
Repurchase Agreements 49,495 27,567 4.65 39,917 4.04
For the Year Ended December 31, 1997 At December 31, 1997
------------------------------------ --------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Interest Rate
----------- ----------- ------------- ----------- -------------
(Dollars in thousands)
FHLB Borrowings $394,184 $342,975 5.94 % $319,744 5.98 %
Repurchase Agreements 27,708 16,415 4.75 23,813 4.90
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 Interest 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
- --------------------------------------------------------------------------------
26
YEAR 2000
The Company is addressing the issues inherent in the impending change of
century, otherwise known as "Year 2000", or "Y2K". The following constitutes the
Company's Year 2000 Readiness disclosure under the Year 2000 Information and
Readiness Disclosure Act. The potential problem with Year 2000 concerns the
inability of information systems, primarily software programs, to properly
recognize and process date sensitive information for the year 2000 and beyond. A
bank-wide project team has been organized to address and resolve Y2K issues. In
addition, the Board has established a Year 2000 Compliance Oversight Committee
to oversee activities of management and others in dealing with Y2K issues.
A principal issue the Company faces is the Y2K readiness of its third party
vendor who supplies the Company's primary application systems which are the loan
systems, deposits systems and the general ledger application. This vendor has
developed plans to deal with the Y2K problem and the Company is closely
monitoring the remediation progress of this plan. The Company is also involved
in the testing of all applicable changes that have occurred in the vendor's
software, together with addressing other mission critical systems.
A. The Company's State of Readiness
In preparing for the change of century, the Company has reviewed and assessed
both information technology (IT) and non-IT systems. IT systems include all
significant operating systems (e.g., the deposit system, platform teller system,
financial reporting system, payroll system, loan systems, etc.). The non-IT
systems (otherwise known as "embedded technology") include items such as vault
doors, elevators and security systems. Monitoring the state of readiness is
accomplished by reviewing the various phases of the Company's project plan.
These phases are defined as follows:
1. Awareness - defining the Y2K problem, informing employees and customers,
developing a strategy, project team and plan to resolve issues and risks
attendant to the problem.
2. Assessment - determining the size and complexity of the Y2K problem
together with the magnitude of the effort needed to correct the issues. It
includes establishing an inventory of IT and non-IT systems, identification
of the "mission critical" items, and a determination of the resources
necessary to address the mission critical items.
3. Analysis, renovation (or remediation) and implementation - analyzing and
replacing hardware and software (e.g., personal computers, e-mail, voice
response units, etc.), software reprogramming, third-party vendor
certifications, and other associated changes necessary to correct the items
determined to be mission critical.
4. Validation (or testing) and contingency planning - post-renovation
incremental testing of new, existing and renovated hardware and software,
together with testing the connectivity of new, existing and renovated
systems to each other. The major validation for the Company relates to the
renovation efforts of its third party provider of the Company's major
application systems. Contingency planning accounts for the possibility
that, even with renovation, Y2K issues may still arise
The following table reflects the Company's progress to date, and expected
completion date, with respect to these phases:
- --------------------------------------------------------------------------------
Estimated Estimated
Completion Completion/Completed
% (*) Date
================================================================================
Awareness 100% August 1998
- --------------------------------------------------------------------------------
Assessment 100 August 1998
- --------------------------------------------------------------------------------
Analysis, renovation and
Implementation 90 April 1999
- --------------------------------------------------------------------------------
Validation and contingency
Planning 80 June 1999
- --------------------------------------------------------------------------------
(*) Percentages are rounded to the nearest 10%.
B. Costs To Address the Company's Year 2000 Issues
27
The following table details the expenditures (period and capital) incurred to
date by the Company, together with the estimated expenditures that will be
incurred to bring the Y2K project to closure. Period expenditures have been or
will be expensed in the period incurred. Capital expenditures have been or will
be capitalized and amortized over the estimated useful life of the item. All
capital expenditures reflect hardware and software upgrades that were either
previously planned or would have occurred in the normal course, and not as a
direct result of Y2K remediation efforts.
- --------------------------------------------------------------------------------------------
Additional %
Description 1998 1999 Total Complete
Expenditures Expenditures Expenditures (*)
============================================================================================
Period expenditures: ($000's)
- --------------------------------------------------------------------------------------------
Management and staff salaries
and Board fees $ 130 $ 130 $ 260 50%
- --------------------------------------------------------------------------------------------
Y2K consulting fees 45 80 135 30
- --------------------------------------------------------------------------------------------
Third party vendor expense and
system testing 40 20 60 70
- --------------------------------------------------------------------------------------------
Capital expenditures:
- --------------------------------------------------------------------------------------------
Replacement of noncompliant
IT and non-IT systems 180 370 550 30
- --------------------------------------------------------------------------------------------
(*) Percentages are rounded to the nearest 10%.
C. The Risks of the Company's Year 2000 Issues
The reasonably likely worst case risk related to Y2k for the Company would be
major and prolonged disruptions in electrical power and telephone
communications. Due to the branch network's dependence on computer and telephone
links for data retrieval and security mechanisms, it would be difficult to
operate in either or both of these situations. The Company has been and will
continue to interact with these suppliers, and review the results of their
testing, to confirm their readiness for the Year 2000. Another risk scenario for
the Company would be temporary business disruptions of its large commercial
borrowers due to their failure(s) to be prepared for Y2K. The financial impact
of this contingency on borrowers could cause income and cash flow shortfalls for
the Company. The Company has begun a process of surveying and evaluating its
commercial customers with respect to their readiness for the change of century
by means of a questionnaire. This process allows the Company to be more
proactive in planning for this contingency. If warranted, the Company's
Allowance for Loan Losses would be increased and an appropriate charge-off would
be recorded for the estimated impact of the customer's failure to be compliant.
New loans and loan renewals have clauses inserted in the loan documents to
address the borrowers' Y2K readiness. Because the more probable risk scenarios
of the Company would be intermittent, minor and short-term IT systems failures
that were not previously anticipated, the Company is addressing these risks by
means of formulating contingency plans.
D. The Company's Contingency Plans
The Company has developed contingency plans for its core business operations.
Core business operations are those processes that are required to maintain the
ongoing business of the Company. There have been 10 core operations identified.
Contingency plans for these 10 core business operations have been developed and
are 100% complete. These contingency plans will next be tested to validate the
feasibility of each plan by means of simulations and/or walk through scenarios.
The testing and validation of these plans will be completed by June 30, 1999,
which corresponds with the guideline date imposed by the Federal Financial
Institutions Examination Council (FFIEC) for all financial institutions.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
28
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 generally writes substantially all
newly originated fixed rate residential loans to meet the requirements for sale
in the secondary market. During 1998, the Bank sold $110.3 million of
residential loans. As a result of this strategy and the low interest rate
environment, which resulted in increased refinancing activity, residential loans
decreased by $75.6 million during the year.
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 characteristics of these types of loans. These
types of loans increased by $71.1 million during the year. This growth was due
in part to the addition of approximately $60 million in loans as a result of a
branch acquisition completed June 1998. Total loans increased by $24.4 million
during the year.
During 1998, investments decreased by $45.1 million. This decline was due to
maturities, amortization, prepayments, and the sale of approximately $126.3
million of securities. Most of the proceeds from these sales were utilized to
pay off maturing Federal Home Loan Bank borrowings as well as fund the
prepayment of additional advances. Total Federal Home Loan Bank borrowings
decreased by $158.2 million during the year.
Deposits increased by $190.4 million in 1998. This increase was primarily due to
the addition of approximately $140.3 million of deposits acquired in the branch
acquisition. The Bank also continued to administer an aggressive marketing
campaign for savings and money market products, which resulted in a significant
increase in the balances of these products at December 31, 1998 compared to
December 31, 1997.
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 a variety of interest rate
environments.
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices such as interest rates, foreign currency exchange
rates, commodity prices and equity prices. The Company's primary market risk
exposure is interest rate risk. The ongoing monitoring and management of this
risk is an important component of the Company's asset/liability management
process which is governed by policies established by its Board of Directors that
are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee ("ALCO"). In this capacity ALCO develops guidelines
and strategies impacting the Company's asset/liability management related
activities based upon estimated market risk sensitivity, policy limits and
overall market interest rate levels/trends.
29
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change the interest income and expense streams
associated with the Company's financial instruments also change thereby
impacting net interest income (NII), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling two-year
horizon, it also utilizes additional tools to monitor potential longer-term
interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all assets and liabilities
reflected on the Company's balance sheet. This sensitivity analysis is compared
to ALCO policy limits which specify a maximum tolerance level for NII exposure
over a one year horizon, assuming no balance sheet growth, given both a 200
basis point (bp) upward and downward shift in interest rates. A parallel and pro
rata shift in rates over a 12 month period is assumed. The following reflects
the Company's NII sensitivity analysis as of December 31, 1998.
Estimated
Rate Change NII Sensitivity
----------- ---------------
+ 200 bp (1.56%)
- 200 bp 0.02%
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cashflows,
and others. While assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis,
actual results will also differ due to: prepayment/refinancing levels likely
deviating from those assumed, the varying impact of interest rate change caps or
floors on adjustable rate assets, the potential effect of changing debt service
levels on customers with adjustable rate loans, depositor early withdrawals and
product preference changes, and other internal/external variables. Furthermore,
the sensitivity analysis does not reflect actions that ALCO might take in
responding to or anticipating changes in interest rates.
The following table sets forth the maturity and repricing information relating
to interest sensitive assets and liabilities at December 31, 1998.
30
Fixed-rate investment securities, fixed rate mortgage-backed investments, fixed
rate loans, loans held for sale, short-term investments, and other earning
assets are shown in the table in the time period corresponding to computed
principal amortization based on their respective contractual maturity.
Adjustable rate investment securities, adjustable rate mortgage-backed
investments, and adjustable rate loans are allocated to the period in which the
rates are next adjusted. The table reflects an "expected" prepayment assumption
on residential loans and mortgage-backed investments. Certificates of deposit
and borrowed funds are shown in the table in the time period based on their
respective contractual maturity. Money market deposit accounts and anniversary
savings accounts are not subject to contractual interest rate adjustments,
however, these products are generally more interest rate sensitive and are
assumed to re-price within the 1-180 day time period. Regular savings and NOW
accounts ("other deposits") are assumed to re-price within the 5 years + period.
These deposit products are not subject to contractual interest rate adjustments
either, however, the bank believes that these deposits are less interest rate
sensitive over long periods of time.
- --------------------------------------------------------------------------------
December 31,
1-180 181-365 1-3 3-5 5+
Days Days Years Years Years Total
---- ---- ----- ----- ----- -----
(Dollars in thousands)
Interest-earning assets:
Short-term investments $388 ----- ----- ----- ----- $388
Investment securities 20,085 1,412 15,144 26,443 59,852 122,936
Mortgage-backed securities 68,921 36,953 38,223 43,743 56,243 244,083
Loans held for sale 2,566 ----- ----- ----- ----- 2,566
Loans in process ----- ----- ----- ----- ----- -----
Fixed rate loans 47,755 42,403 144,542 94,312 78,972 407,984
Adjustable rate loans 152,084 67,604 49,030 37,437 17,178 323,333
Other earning assets ----- ----- ----- ----- 17,388 17,388
--------- --------- --------- -------- ------- ---------
Total rate sensitive assets 291,799 148,372 246,939 201,935 229,633 1,118,678
--------- --------- --------- -------- ------- ---------
Interest-bearing liabilities:
Money market deposit accounts 96,773 ----- ----- ----- ----- 96,773
Certificates of deposit 217,214 166,302 70,534 9,898 835 464,783
Other deposits 130,251 ----- ----- ----- 149,923 280,174
Borrowed funds 91,917 25,000 81,603 ----- 2,979 201,499
--------- --------- --------- -------- ------- ---------
Total rate sensitive liabilities 536,155 191,302 152,137 9,898 153,737 1,043,229
--------- --------- --------- -------- ------- ---------
Excess (deficiency) of
interest sensitive assets
over interest sensitive
liabilities ($244,356) ($42,930) $94,802 $192,037 $75,896 $75,449
--------- --------- --------- -------- ------- ---------
Cumulative excess
(deficiency) of interest
sensitive assets over
interest sensitive
liabilities ($244,356) ($287,286) ($192,484) ($447) $75,449
--------- --------- --------- -------- -------
Cumulative excess
(deficiency)
percentage of
total assets (19.58)% (23.02)% (15.42)% (0.04)% 6.05 %
31
The following table reflects the scheduled maturities of selected loans at
December 31, 1998:
- --------------------------------------------------------------------------------
One
One Through Over
Year Five Five
or Less Years Years Total
------- ----- ----- -----
(Dollars in thousands)
Construction loans $23,686 $8,357 $11,177 $43,220
Owner-occupied commercial real estate 7,519 22,388 32,893 62,800
Commercial loans 19,626 57,729 12,335 89,690
------- ------- ------- --------
Total $50,831 $88,474 $56,405 $195,710
------- ------- ------- --------
A summary of the above categories of loans due after one year as to the rate
variability follows (dollars in thousands):
With predetermined rates $45,308
With floating or adjustable rates 99,571
--------
Total maturing or repricing after one year $144,879
--------
- --------------------------------------------------------------------------------
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 and prepayments 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,
1998, short-term investments, bonds and obligations and mortgage-backed
investments totaled $367.4 million, 34.8% of which either matures or is
estimated to be prepaid within one year. At December 31, 1997, short-term
investments, bonds and obligations and mortgage backed investments totaled
$416.0 million, 14.4% of which matured within one year.
At December 31, 1998, the Bank had total outstanding borrowings of $201.5
million, 58% of which matures within one year. At year-end 1997, the Bank had
outstanding borrowings of $343.6 million, 74% of which matured in one year.
At December 31, 1998, the Bank had outstanding commitments to loan funds under
mortgage, construction and commercial loans and home equity lines of credit,
amounting to $97.6 million, compared to $86.2 million in 1997. Management
believes the sources of liquidity previously discussed are sufficient to meet
its commitments.
Net cash provided by operating activities totaled $23.8 million in 1998 compared
to net cash provided of $10.7 million in 1997. Net income was $11.1 million
compared to a net income of $9.7 million for the respective periods. The
provision for loan losses recorded in 1998 was $1.4 million compared to $2.0
million in 1997. Net cash provided by operating activities totaled $10.7 million
in 1997 compared to $13.5 million provided in 1996. Net income was $9.7 million
compared to a net income of $9.1 million for the respective periods. Provisions
for loan losses recorded in 1997 totaled $2.0 million compared to $1.4 million
in 1996.
32
Net cash provided by investing activities totaled $142.9 million for the year
ended December 31, 1998 compared to cash used of $145.0 million in 1997 and
$67.3 million in 1996. The 1998 increase in net cash provided by investing
activities over 1997 was primarily attributable to the cash received in the
branch acquisition, the increased sales of investment securities and the
increased levels of loan repayments. The 1997 increase in net cash used by
investing activities over 1996 was primarily attributable to increased purchases
of investment securities.
Net cash used in financing activities totaled $98.9 million for the year ended
December 31, 1998 compared to net cash provided of $118.7 million and $64.5
million for the comparable periods in 1997 and 1996. Net cash used to repay
borrowed funds (net of new borrowings) totaled $144.5 million in 1998, compared
to cash provided by increased borrowings of $68.6 million in 1997 and $29.4
million in 1996. Net cash provided by increased deposits totaled $50.1 million
in 1998 compared to increases of $53.4 million in 1997 and $37.3 million in
1996. Net cash of $4.2 million, $3.6 million and $2.9 million was used to pay
dividends in 1998, 1997 and 1996, respectively.
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 I risk-based capital ratio of 4% or (iii) a Tier I core capital
ratio of 3%. As of December 31, 1998, 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 nonmonetary 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. Nonmonetary 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
nonmonetary items include premises and equipment and real estate in foreclosure.
If real estate values decreased sharply, the deflationary impact of changing
prices of real estate securing loans foreclosed upon could significantly affect
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
33
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, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1998.
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 as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 26, 1999
34
FIRST ESSEX BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
------------
ASSETS
1998 1997
---- ----
(Dollars in thousands)
Cash and cash equivalents $90,383 $22,542
Investment securities available-for-sale (Note 4) 345,840 211,903
Investment securities held-to-maturity
(fair value of $180,743 at December 31, 1997) (Note 4) ---- 178,999
Stock in Savings Bank Life Insurance Company 1,194 1,194
Stock in Federal Home Loan Bank of Boston (Note 8) 19,985 19,803
Mortgage loans held-for-sale 2,566 11,807
Loans receivable, less allowance for loan losses of
$11,261 and $10,570 (Note 5) 720,056 696,338
Accrued interest receivable 9,170 8,084
Foreclosed property 575 891
Bank premises and equipment, net (Note 6) 11,715 10,545
Intangible assets 24,394 10,991
Other assets 22,136 24,362
---------- ----------
Total assets $1,248,014 $1,197,459
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Depositors' accounts (Note 7) $934,695 $744,322
Borrowed funds (Note 8) 201,499 343,557
Mortgagors' escrow accounts 702 561
Other liabilities 14,036 17,954
---------- ----------
Total liabilities 1,150,932 1,106,394
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY (Note 15)
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, 9,708,135 and 9,522,424 shares issued 971 952
Additional paid-in-capital 77,383 75,303
Retained earnings 36,359 29,685
Treasury stock, at cost, 2,096,500 and 1,986,000 shares (18,335) (15,842)
Unrealized gains on investment
securities available-for-sale, net (Note 1) 704 967
---------- ----------
Total stockholders' equity 97,082 91,065
---------- ----------
Total liabilities and stockholders' equity $1,248,014 $1,197,459
---------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.
35
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
1998 1997 1996
---- ---- ----
(Dollars in thousands, except share and per share amounts)
Interest and dividend income:
Interest on mortgage loans $36,682 $38,820 $25,753
Interest on other loans 28,363 23,738 21,139
Interest and dividends on investment
securities available-for-sale 18,788 14,138 7,865
Interest and dividends on investment
securities held-to-maturity 6,266 12,280 8,337
Interest on other earning assets 1,043 517 --
Interest on short term investments 2,318 585 451
--------- --------- ---------
Total interest and dividend income 93,460 90,078 63,545
--------- --------- ---------
Interest expense:
Interest on depositors' accounts 35,357 31,229 21,946
Interest on borrowed funds 17,155 21,148 15,371
--------- --------- ---------
Total interest expense 52,512 52,377 37,317
--------- --------- ---------
Net interest income 40,948 37,701 26,228
Provision for loan losses (Note 5) 1,440 2,040 1,415
--------- --------- ---------
Net interest income after provision
for loan losses 39,508 35,661 24,813
--------- --------- ---------
Noninterest income:
Net gain on sales of mortgage loans and
mortgage servicing rights 1,338 1,628 1,352
Net gain on sales of investment
securities 1,344 439 497
Loan fees 693 561 513
Other fee income 2,999 2,460 1,877
Other 491 -- 26
--------- --------- ---------
Total noninterest income 6,865 5,088 4,265
--------- --------- ---------
Noninterest expense:
Salaries and employee benefits 13,036 11,618 10,051
Buildings and equipment 4,193 4,124 3,605
Professional services 1,103 1,488 1,093
Information processing 2,296 1,654 1,240
Insurance 264 324 192
Expenses, gains and losses on,
and write-downs of, foreclosed property 350 609 666
Amortization of intangible assets 1,724 780 --
Other 5,212 3,767 3,078
--------- --------- ---------
Total noninterest expense 28,178 24,364 19,925
--------- --------- ---------
Income before provision for income taxes 18,195 16,385 9,153
Provision for income taxes (Note 9) 7,130 6,672 40
--------- --------- ---------
Net income $11,065 $9,713 $9,113
--------- --------- ---------
Earnings per share - basic $1.46 $1.30 $1.51
--------- --------- ---------
- diluted $1.41 $1.25 $1.47
--------- --------- ---------
Weighted average number of shares - basic 7,563,859 7,497,944 6,047,237
--------- --------- ---------
- diluted 7,840,213 7,795,405 6,188,857
--------- --------- ---------
The accompanying notes are an integral part of these consolidated financial
statements.
36
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1998, 1997 and 1996
-----------------------------------------------------------------
Unrealized Gains
(Losses) on
Investment
Additional Securities
Comprehensive Common Paid in Retained Treasury Available-For-Sale,
Income Stock Capital Earnings Stock Net Total
------ ----- ------- -------- ----- --- -----
(Dollars in thousands)
Balance at December 31, 1995 $801 $58,208 $17,682 ($15,842) ($677) $60,172
Comprehensive income:
Net income $9,113 ---- ---- 9,113 ---- ---- 9,113
Other comprehensive income:
- Unrealized securities gains,
net of $0 of tax expense,
arising during the period 1,081
- Less: reclassifcation adjustment
for security gains included in
net income, net of $0 tax expense 497
------
Total other comprehensive income 584 ---- ---- ----- ----- 584 584
------
Total comprehensive income $9,697
------
Cash dividends declared ---- ---- (3,068) ---- ---- (3,068)
Stock options exercised 4 329 ----- ----- ----- 333
Issuance of common stock in conjunction
with the acquisition of Finest Financial Corp. 136 15,871 ----- ----- ----- 16,007
---- ------- ------- -------- ----- -------
Balance at December 31,1996 941 74,408 23,727 (15,842) (93) 83,141
Compehensive income:
Net income $9,713 ---- ---- 9,713 ---- ---- 9,713
Other comprehensive income:
- Unrealized securities gains,
net of $907 tax expense,
arising during the period 1,320
- Less: reclassifcation adjustment
for security gains included in
net income, net of $179 tax expense 260
--------
Total other comprehensive income 1,060 ---- ---- ----- ----- 1,060 1,060
--------
Total comprehensive income $10,773
--------
Cash dividends declared ---- ---- (3,755) ---- ---- (3,755)
Stock options exercised 11 895 ----- ----- ----- 906
---- ------- ------- -------- ----- -------
Balance at December 31, 1997 $952 $75,303 $29,685 ($15,842) $967 $91,065
---- ------- ------- -------- ----- -------
The accompanying notes are an integral part of these consolidated financial
statements.
37
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(continued)
Years ended December 31, 1998, 1997 and 1996
---------------------------------------------------------------
Unrealized Gains
(Losses) on
Investment
Additional Securities
Comprehensive Common Paid in Retained Treasury Available-For-Sale,
Income Stock Capital Earnings Stock Net Total
------ ----- ------- -------- ----- --- -----
(Dollars in thousands)
Balance at December 31, 1997 $952 $75,303 $29,685 ($15,842) $967 $91,065
Compehensive income:
Net income $11,065 ---- ---- 11,065 ---- ---- 11,065
Other comprehensive income:
- Unrealized securities gains,
net of $357 tax expense,
arising during the period 554
- Less: reclassifcation adjustment
for security gains included in
net income, net of $527 tax expense 817
------- ---- ----
Total other comprehensive income (expense) (263) ---- ---- ---- ---- (263) (263)
------- ---- ----
Total comprehensive income $10,802
-------
Cash dividends declared ---- ---- (4,391) ---- ---- (4,391)
Common stock repurchases ---- ---- ----- (2,493) ---- (2,493)
Stock options exercised 19 2,080 ----- ----- ---- 2,099
---- ------- ------- -------- ---- -------
Balance at December 31, 1998 $971 $77,383 $36,359 ($18,335) $704 $97,082
---- ------- ------- -------- ---- -------
The accompanying notes are an integral part of these consolidated financial
statements.
38
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Cash flows from operating activities:
Net income $11,065 $9,713 $9,113
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 1,440 2,040 1,415
Provision for depreciation and amortization 1,963 1,900 1,719
Gain on sale of foreclosed property (373) (502) (109)
Write-down of foreclosed property 16 35 82
Amortization of investment securities discounts
and premiums, net 1,192 511 1,396
Amortization of intangible assets 1,724 780 --
Provision for deferred (prepaid) income taxes (88) 2,294 (1,908)
Proceeds from sales of mortgage loans and
mortgage servicing rights 111,618 96,821 94,826
Mortgage loans originated for sale (101,039) (98,085) (96,568)
Realized gains on sales of investment securities (1,344) (439) (497)
Realized gains on sales of mortgage loans and
mortgage servicing rights, net (1,338) (1,628) (1,352)
Changes in assets and liabilities, net of the
effect of the purchase of Finest Financial Corp.
Increase in accrued interest receivable (1,086) (2,114) (112)
Decrease (increase) in other assets 4,545 (1,559) 1,704
Increase (decrease) in other liabilities (4,453) 947 3,830
-------- ------- -------
Net cash provided by operating activities 23,842 10,714 13,539
-------- ------- -------
Cash flows from investing activities:
Acquisition of branch assets and assumed
deposit liabilities, net of cash acquired 65,033 -- --
Acquisition of Finest Financial, Corp., net of
cash acquired -- -- 3,041
Proceeds from sales of available-for-sale securities 209,926 71,043 48,217
Proceeds from maturities and principal payments
of available-for-sale securities 70,002 38,547 32,339
Proceeds from maturities and principal payments
of held-to-maturity securities 36,771 21,071 55,785
Purchases of available-for-sale securities (251,087) (145,407) (78,243)
Purchases of held-to-maturity securities (21,892) (96,125) (25,864)
Purchases of Federal Home Loan Bank stock (182) (4,286) --
Purchase of a Federal Home Loan Bank certificate
of deposit -- (17,244) --
Loans originated and purchased, net of principal
collected 31,411 (16,651) (103,446)
Proceeds from sales of foreclosed property 3,795 4,910 2,604
Purchases of bank premises and equipment (911) (836) (1,697)
-------- ------- -------
Net cash provided by (used in) investing activities 142,866 (144,978) (67,264)
-------- ------- -------
Cash flows from financing activities:
Net increase in demand deposits, NOW accts and
savings accounts 70,097 56,579 6,153
Net increase (decrease) in term deposits (20,023) (3,210) 31,122
Net increase (decrease) in borrowed funds with
maturities of three months or less (73,298) (49,869) 74,806
Proceeds from borrowed funds with maturities
in excess of three months 158,000 159,000 92,500
Repayments of borrowed funds with maturities
in excess of three months (229,162) (40,532) (137,917)
Increase (decrease) in mortgagors' escrow accounts 141 (555) 398
Dividends paid (4,228) (3,591) (2,900)
Stock options exercised 2,099 906 333
Common stock repurchases (2,493) -- --
-------- ------- -------
Net cash provided by (used in) financing
activities (98,867) 118,728 64,495
-------- ------- -------
Net increase (decrease) in cash and cash
equivalents 67,841 (15,536) 10,770
Cash and cash equivalents at beginning of the year 22,542 38,078 27,308
-------- ------- -------
Cash and cash equivalents at end of the year $90,383 $22,542 $38,078
-------- ------- -------
The accompanying notes are an integral part of these consolidated financial
statements.
39
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
Year ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Supplemental disclosures of cash flow information:
Interest paid during the year $52,320 $51,666 $37,165
Income taxes paid during the year 7,240 7,247 324
Supplemental schedule of noncash financing and investing activities:
Real estate acquired through, or deeds in lieu of, foreclosure 961 1,445 1,961
Held-to-maturity securities reclassified to available-for-sale (Note 1) 162,861 --- ---
The accompanying notes are an integral part of these consolidated financial
statements.
40
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
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
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 comprehensive income and as a separate component of
stockholders' equity.
During the second quarter of 1998, the Company reclassified to
available-for-sale all securities previously classified as held-to-maturity.
This reclassification was the result of an analysis of the strategic
alternatives for the securities portfolio. Under Securities and Exchange
Commission guidelines, this reclassification prohibits the Company from
classifying securities as held-to-maturity for a period of at least two years.
The amortized cost basis of the held-to-maturity securities transferred to the
available-for-sale classification was $162.3 million. Subsequent to this
reclassification, and as part of a balance sheet realignment, approximately $231
thousand of gains of the sale of some of these transferred investment securities
were realized. Also as a result of this reclassification, approximately $612
thousand of unrealized gains, net of $408 thousand of tax expense, were
reflected in other comprehensive income and on the Statement of Stockholders'
Equity.
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. Realized gains and losses on security
transactions are computed using the specific identification method.
41
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
LOANS RECEIVABLE
Loans are stated at the amount of unpaid principal, net of the allowance for
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.
Loans considered impaired, as defined below, are nonaccruing. When a loan is
placed on nonaccrual status, all interest previously accrued is reversed against
current-period interest income.
A loan is impaired when, based on current information and events, it is probable
that the Bank will be unable to collect all amounts due in accordance with the
contractual terms of the loan agreement. All loans are individually evaluated
for impairment, except for smaller balance homogeneous residential and consumer
loans which are evaluated in aggregate, according to the Bank's normal loan
review process, including overall credit evaluation, nonaccrual status and
payment experience. Loans identified as impaired are further evaluated to
determine the estimated extent of impairment.
Impaired loans are 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. For collateral-based loans, the
extent of impairment is the shortfall, if any, between the collateral value,
less costs to dispose of such collateral, and the carrying value of the loan.
Loans on nonaccrual status and restructured troubled debt are considered to be
impaired.
The allowance for 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. The methodology for
assessing the appropriateness of the allowance consists of a review of the
following three key elements:
o A formula allowance for the various loan portfolio classifications,
o A valuation allowance for loans identified as impaired, and
o The unallocated allowance.
The formula allowance is a percentage-based reflection of historical loss
experience and assigns required allowance allocations by loan classification
based on a fixed percentage of all outstanding loan balances and commitments to
extend credit. The formula allowance employs a risk-rating model that grades
loans based on general characteristics of credit quality and relative risk. As
credit quality becomes more suspect, so-called "watch list" loans, the risk
rating and allocation percentage increase. The sum of these allocations comprise
the Company's "formula" or "general" allowance.
The Company also has "valuation" allowances for impaired loans. When impaired
loans are evaluated, if 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 shortfall is
provided to expense with a resulting "valuation" allowance.
In addition to the formula and valuation components, there is an unallocated
allowance that is based on the Company's credit policy and consists of an amount
that is at least 20% to 25% of the formula and valuation allowances. This
element recognizes the estimation risks associated with the formula model and
the valuation allowance. It is further adjusted for
42
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
qualitative factors including, among others, general economic and business
conditions, credit quality trends, loan volumes and concentrations and specific
industry conditions within portfolio segments.
There are inherent uncertainties with respect to the final outcome of 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 the 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.
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.
MORTGAGE SERVICING RIGHTS
On January 1, 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") SFAS No. 125, "Accounting Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"). SFAS No.
125 requires the transfer of financial assets in which the Company surrenders
control over those financial assets to be accounted for as a sale to the extent
that consideration other than beneficial interests in the transferred assets is
received in exchange. Each time the Company undertakes an obligation to service
financial assets it recognizes either a servicing asset or a servicing liability
for that contract, unless it securitizes the asset, retains all of the
securities, and classifies them as debt securities held-to-maturity. Because the
current practice of the Company is to sell most of the mortgage loans it
originates, the adoption of this statement did not have a material effect on the
financial position or results of operations of the Company. The carrying amount
of capitalized mortgage servicing rights at December 31, 1998 and 1997 was
$104,000 and $130,000, respectively.
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. The excess, if
any, of the loan balance over the fair value of the property at the time of
transfer from loans to foreclosed property is charged to the allowance for loan
losses. Subsequent impairments in the fair value of foreclosed property are
charged to expense in the period incurred. 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 foreclosed property. Because of these inherent
uncertainties, the amount ultimately realized on foreclosed property may differ
from the amounts reflected in the consolidated financial statements.
43
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
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.
Bank premises and equipment are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Based on its review, the Company does not believe that any
material impairment of its long-lived assets has occurred. Long-lived assets to
be disposed of are reported at the lower of the carrying amount or fair value
less cost to sell.
INTANGIBLE ASSETS
Intangible assets, comprised of goodwill and a core deposit premium, represent
the excess of the purchase price over the fair value of net assets acquired in
the acquisition of Finest Financial Corp. in 1996 (Note 3) and the 1998 branch
acquisition (Note 2). Goodwill is being amortized on a straight-line basis over
15 and 20 years, respectively. The core deposit premium, is being amortized over
an eight year period on an accelerated basis. At each balance sheet date, the
Company evaluates the realizability of intangible assets based on expectations
of nondiscounted future cash flows of the related acquired entity and branches.
If the sum of the nondiscounted future cash flows is less than the carrying
amount of the intangible asset, the Company would recognize an impairment loss.
Based on its review, the Company does not believe that any material impairment
of its intangible assets has occurred at December 31, 1998.
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 for income
taxes based on management's judgments relating to realizability.
OTHER ASSETS
Other assets include a $17.4 million long-term fixed rate certificate of deposit
with the Federal Home Loan Bank of Boston at December 31, 1998 and $17.3 million
as of December 31, 1997.
44
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
EARNINGS PER SHARE
The Company adopted the provisions of SFAS No. 128, "Earnings per Share", in
1997. This statement requires the dual presentation of basic and dilutive
earnings per share (EPS) on the face of the statement of operations and a
reconciliation of the numerators and denominators of the basic and dilutive EPS
calculations. Basic EPS amounts have been computed by dividing reported earnings
available to common shareholders by the weighted average number of common and
common equivalent shares outstanding during the year. Dilutive EPS amounts have
been computed using the weighted average number of common and common equivalent
shares and the dilutive potential common shares (stock options outstanding and
exercisable) outstanding during the year. Included in diluted EPS are 276,354,
297,461 and 141,620 dilutive potential common shares for 1998, 1997 and 1996,
respectively.
COMPREHENSIVE INCOME
The Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive
Income", which requires the display of comprehensive income and its components.
The Company has chosen, as permitted by SFAS No. 130, to disclose comprehensive
income, which is comprised of net income and unrealized gains or losses on
securities classified as available-for-sale, in the Consolidated Statements of
Stockholders' Equity. All prior year data has been restated to conform to the
SFAS No. 130 requirements.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1996 consolidated
financial statements to conform to the 1998 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". The
statement establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded on the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998)
The Company has not yet quantified the impact of adopting SFAS No. 133 on the
financial statements, and has not determined the timing of or method of the
adoption of the statement. The adoption of SFAS No. 133 could have the effect of
increasing the volatility in reported earnings and accumulated other
comprehensive income.
45
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." The statement requires that after the
securitization of mortgage loans held for sale, a company engaged in mortgage
banking activities classify the resulting mortgage-backed securtities or other
retained interests based on its ability and intent to sell or hold those
investments. The statement is not expected to have a material impact on the
Company's financial condition or results of operations.
In March 1998, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed of Obtained for Internal use." SOP 98-1 requires computer
software costs associated with internal software to be expensed as incurred
until certain capitalization criteria are met. The Company does not believe that
adoption of SOP 98-1 will have a material impact on the Company's financial
statements.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities." This position statement requires all costs associated with
pre-opening, pre-operating and organization activities to be expensed as
incurred. The Company will adopt SOP 98-5 beginning January 1, 1999, and does
not believe the adoption will have a material impact on the Company's financial
condition or results of operations.
2. BRANCH ACQUISITION
Pursuant to a Purchase and Assumption Agreement, the Company purchased certain
assets from and assumed certain deposit liabilities relating to five branch
offices of another financial institution on June 19 and June 26, 1998. The
purchase price was allocated to assets acquired and liabilities assumed based on
estimates of fair value at the date of acquisition. The assets acquired
consisted of approximately $63.9 million of loans, fixed and other assets, real
property related to the owned branches and cash at the branches. The premium, or
the excess of the purchase price over the fair value of assets acquired, was
approximately $15.1 million. Of this premium, approximately $10.5 million was
allocated to a core deposit intangible (CDI) and the resulting residual amount,
approximately $4.6 million, was recorded as goodwill. CDI will be amortized over
eight years on a 125% declining balance method while the goodwill will be
amortized over a twenty year life on a straight line basis.
Because the acquisition of the branches represents the acquisition of assets and
does not represent the acquisition of a business, separate entity or subsidiary,
no pro forma financial information is presented. Because the deposit liabilities
assumed exceed the assets acquired, there was a cash payment made to the Company
as a result of this transaction. The following is a summarization of the
components of the transaction based on estimates of fair value at the date of
acquisition (in thousands):
Loans, net $60,425
Bank premises and equipment 2,222
Core deposit intangible 10,544
Goodwill 4,580
Prepaid expenses and other assets 434
Deposit and repurchase agreement liabilities assumed (142,701)
Accrued expenses and other liabilities (537)
-------
Net cash received $65,033
-------
46
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
3. ACQUISITION OF FINEST FINANCIAL CORP.
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 statements of operations include 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 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, 1996:
- --------------------------------------------------------------------------------
December 31,
1996
----
(Dollars in thousands)
Total revenue (1) $39,798
Income before taxes 12,010
Net income 11,369
Earnings per share - basic $1.54
Earnings per share - diluted $1.50
(1) Total revenue includes net interest income and noninterest income.
- --------------------------------------------------------------------------------
47
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
4. INVESTMENT SECURITIES
Investment securities at December 31,1998 and 1997 are as follows:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(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 $ -- $ -- $ -- $ -- $54,421 $961 $ -- $55,382
Mortgage-backed securities -- -- -- -- 109,661 393 -- $110,054
Other bonds and obligations -- -- -- -- 14,917 390 -- 15,307
-------- ------ ----- -------- -------- ------ ----- --------
-- -- -- -- 178,999 1,744 -- 180,743
Investment securities available-for-sale:
U.S. government and
agency obligations 98,145 1,977 -- 100,122 67,177 827 (44) 67,960
Mortgage-backed securities 244,938 -- (855) 244,083 121,008 969 -- 121,977
Other bonds and obligations 1,637 -- (2) 1,635 22,079 -- (113) 21,966
-------- ------ ----- -------- -------- ------ ----- --------
344,720 1,977 (857) 345,840 210,264 1,796 (157) 211,903
Total investment securities $344,720 $1,977 ($857) $345,840 $389,263 $3,540 ($157) $392,646
-------- ------ ----- -------- -------- ------ ----- --------
At December 31, 1998 and 1997, U.S. government obligations and mortgage-backed
securities with amortized cost of $82,995,000 and $134,513,000, respectively,
and fair value of $83,307,000 and $135,289,000, respectively, were pledged to
collateralize certain borrowings, deposit accounts and repurchase agreements.
For the year ended December 31, 1998, there were realized gross gains of $1.3
million from the sale of investment securities available-for-sale. For the years
ended December 31, 1997 and 1996, there were realized gains before taxes from
the sale of investment securities of $439,000 and $497,000, respectively.
48
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following table shows the maturity distribution of the amortized cost of the
Company's investment securities at December 31, 1998.
- --------------------------------------------------------------------------------
Less than Greater than
1 year 1-5 years 5-10 years 10 years Total
------ --------- ---------- -------- -----
(Dollars in thousands)
Investment securities available-for-sale:
U.S. government and
agency obligations $ ---- $40,876 $55,793 $1,476 $98,145
Mortgage-backed securities (1) 59,768 113,312 41,109 30,749 244,938
Other bonds and obligations 1,511 ---- ---- 126 1,637
------- -------- ------- ------- --------
$61,279 $154,188 $96,902 $32,351 $344,720
------- -------- ------- ------- --------
(1) Maturities of mortgage-backed securities are based on contractual
maturities with scheduled amortization based on expected prepayments.
Actual maturities will differ from the scheduled maturities due to the
timing of actual prepayments.
- --------------------------------------------------------------------------------
The following table shows the maturity distribution of the fair value of the
Company's investment securities at December 31, 1998.
- --------------------------------------------------------------------------------
Less than Greater than
1 year 1-5 years 5-10 years 10 years Total
------ --------- ---------- -------- -----
(Dollars in thousands)
Investment securities available-for-sale:
U.S. government and
agency obligations $ -- $41,595 $57,053 $1,474 $100,122
Mortgage-backed securities (1) 59,482 112,846 40,999 30,756 244,083
Other bonds and obligations 1,510 -- -- 125 1,635
------- -------- ------- ------- --------
$60,992 $154,441 $98,052 $32,355 $345,840
------- -------- ------- ------- --------
(1) Maturities of mortgage-backed securities are based on contractual
maturities with scheduled amortization. Actual maturities will differ from
contractual maturities due to prepayments.
- --------------------------------------------------------------------------------
49
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
5. LOANS RECEIVABLE
Major classifications of loans receivable at December 31, 1998 and 1997 follow:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(Dollars in thousands)
Mortgage loans:
Residential $187,417 $263,058
Commercial 88,774 83,077
Construction 43,220 31,851
-------- --------
Total mortgage loans $319,411 $377,986
-------- --------
Owner-occupied commercial real estate (1) 62,800 52,335
Commercial 89,690 67,018
Aircraft 59,657 41,220
Consumer loans:
Second Mortgage,Home Equity
& Home Improvement 59,003 59,897
Automobile 134,613 103,551
Other Consumer 6,143 4,901
-------- --------
Total consumer loans 199,759 168,349
Less:
Allowance for loan losses (11,261) (10,570)
-------- --------
Total loans receivable $720,056 $696,338
-------- --------
- --------------------------------------------------------------------------------
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 are 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,
50
commercial and construction loan borrowers to honor their repayment commitments
are generally dependent on the health of the real estate economic sector in the
borrowers' geographic areas, the borrowers' financial conditions and the economy
in general.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
A summary of changes in the allowance for loan losses for the years ended
December 31, 1998, 1997 and 1996 follows:
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Balance at beginning of year $10,570 $10,538 $6,552
Acquired allowance - Finest (Note 3) --- --- 4,080
Acquired allowance - Branch (Note 2) 765 --- ---
Provision for loan losses 1,440 2,040 1,415
Charge-offs (3,546) (2,826) (2,335)
Recoveries 2,032 818 826
------- ------- -------
Balance at end of year $11,261 $10,570 $10,538
------- ------- -------
- --------------------------------------------------------------------------------
The Company considers a loan impaired if it is 90 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 nonaccruing 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
considering 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 $3.0 million in 1998 and $2.6 million in 1997.
51
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following table indicates the recorded investment in nonperforming assets
and the related valuation allowance for impaired loans.
- --------------------------------------------------------------------------------
December 31, 1998 December 31, 1997
Impaired Loan Impaired Loan
Recorded Valuation Recorded Valuation
Investment Allowance (1) Investment Allowance (1)
---------- ------------- ---------- -------------
(Dollars in thousands)
Nonaccruing Loans:
Impaired Loans
Requiring a valuation allowance $493 $393 $1,577 $590
Not requiring a valuation allowance 1,619 -- 309 --
------ ---- ------ ------
2,112 $393 1,886 $590
Restructured Loans 447 154 905 420
------ ---- ------ ------
Total impaired 2,559 $547 2,791 $1,010
------ ---- ------
Residential Mortgage 1,526 1,525
Other 1,414 1,228
------ ------
Total nonaccruing loans 5,499 5,544
Foreclosed property, net 575 891
------ ------
Total nonperforming assets $6,074 $6,435
------ ------
Percentage of nonperforming assets
to total assets 0.49% 0.54%
Percentage of allowance for loan losses
to nonaccruing loans 204.8% 190.7%
(1) The valuation allowance for impaired loans is included in the allowance for
loan losses on the balance sheet.
- --------------------------------------------------------------------------------
Interest income recognized on impaired loans, using the cash basis of income
recognition, amounted to approximately $265,000 for the year ended December 31,
1998 compared to $293,000 in 1997 and $244,000 in 1996.
The amount of interest that would have been earned had the nonaccrual and
restructured loans performed in accordance with original terms and conditions
was $456,000, $570,000 and $140,000 for the years ended December 31, 1998, 1997
and 1996 respectively.
The maximum amount of aggregate loans to directors, executive officers and
principal stockholders for the year ended December 31, 1998 was less than 5% of
stockholders' equity.
At December 31, 1998 and 1997, 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 11), in the amount of $23,249,000
and $32,114,000, respectively. The amount of loans sold and serviced for others
is not included in loans receivable.
52
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
6. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 1998 and 1997 follows:
- --------------------------------------------------------------------------------
Estimated Useful
1998 1997 Life
---- ---- ----
(Dollars in thousands)
Land $1,595 $1,235
Buildings 8,965 7,706 20 to 30 years
Leasehold improvements 5,402 4,930 1 to 13 years
Furniture and fixtures 10,587 9,487 3 to 10 years
Construction in process --- 11
------- -------
26,549 23,369
Less accumulated depreciation
and amortization 14,834 12,824
------- -------
$11,715 $10,545
------- -------
Depreciation and amortization expense was $1,963,000, $1,900,000, and $1,719,000
for 1998, 1997 and 1996, respectively.
- --------------------------------------------------------------------------------
53
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
7. DEPOSITORS' ACCOUNTS
A summary of depositors' accounts at December 31, 1998 and 1997 follows:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(Dollars in thousands)
Personal and business checking
accounts (noninterest-bearing) $92,965 $61,099
NOW accounts 53,735 44,178
Money market accounts 96,773 63,929
Savings accounts 226,439 156,343
Time deposits 464,783 418,773
-------- --------
$934,695 $744,322
-------- --------
The following is a summary of original maturities of time deposits as of
December 31, 1998:
(Dollars in thousands)
1999 $149,816
2000 241,647
2001 22,530
2002 10,758
2003 18,690
Thereafter 21,342
--------
$464,783
--------
The following table shows the remaining maturities of certificates of deposits
with balances in excess of $100,000 at December 31, 1998.
(Dollars in thousands)
Three months or less $13,220
Over 3 months and less than 6 months 8,709
Over 6 months and less than 12 months 36,688
12 months and over 12,494
-------
$71,111
-------
54
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
8. BORROWED FUNDS
Borrowed funds at December 31, 1998 and 1997 are summarized below:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(Dollars in thousands)
Due during 1998, interest rates from 5.65% to 6.42% $ ---- $229,597
Due during 1999, interest rates from 4.99% to 6.43% 77,000 47,000
Due during 2000, interest rates from 5.29% to 6.52% 78,149 36,412
Due during 2001, interest rates from 6.54% to 6.58% 3,454 3,707
Due during 2005, interest rates at 6.08% 73 76
Due during 2016, interest rates at 7.25% 2,906 2,952
Repurchase agreements 39,917 23,813
-------- --------
$201,499 $343,557
-------- --------
- --------------------------------------------------------------------------------
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 $407,105,000, of
which $245,523,000 was unused at December 31, 1998. The advances from the FHLB
are secured by all FHLB stock (book value of $19,985,000 and $19,803,000 at
December 31, 1998 and 1997, respectively) and a pledge of certain assets as
collateral. Repurchase agreements outstanding at December 31, 1998 mature in
three months or less with average interest rates of 4.04% and are secured by
certain U.S. government and agency securities.
The following table summaries the maximum and average amounts of borrowings
outstanding during 1998 and 1997 together with the weighted average interest
rates thereon.
- --------------------------------------------------------------------------------
For the Year Ended December 31, 1998 At December 31, 1998
------------------------------------ --------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
----------- ----------- ------------- ----------- ---------
(Dollars in thousands)
FHLB Borrowings $411,605 $261,662 6.07% $161,582 5.93%
Repurchase Agreements 49,495 27,567 4.65% 39,917 4.04%
For the Year Ended December 31, 1997 At December 31, 1997
------------------------------------ --------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
FHLB Borrowings $394,184 $342,975 5.94% $319,744 5.98%
Repurchase Agreements 27,708 16,415 4.75% 23,813 4.90%
55
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
9. INCOME TAXES
The provision for income taxes for each of the three years in the period ended
December 31, 1998 consists of the following:
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Current $7,218 $4,378 1,948
Deferred (prepaid) (88) 2,294 (1,908)
------ ------ ------
$7,130 $6,672 $40
------ ------ ------
The difference between the total expected provision for income taxes computed by
applying the statutory federal income tax rate to income before provision for
income taxes and the recorded provision for income taxes for the three years in
the period ended December 31, 1998 follows:
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Provision at statutory rate $6,369 $5,571 $3,112
State taxes, net of federal benefit 511 1,181 783
Goodwill amortization 273 265 ---
Nondeductible expenses 5 10 23
Tax exempt interest (10) (14) ---
Dividend received deduction (25) (39) (2)
Tax Credits (107) (101) ---
Change in valuation allowance --- --- (4,185)
Other, net 114 (201) 309
------ ------ ------
Provision for income taxes $7,130 $6,672 $40
------ ------ ------
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 are now viewed as commercial banks for
income tax purposes. The repeal is effective for tax years after December 31,
1995.
One effect of this legislative change was 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
56
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.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The components of the net deferred tax asset at December 31, 1998 and 1997
follow:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(dollars in thousands)
Allowance for loan losses $2,664 $2,196
Deferred tax loan loss reserve (1,220) (1,447)
Depreciation 687 768
Deferred loan fees --- 36
Deferred compensation 384 335
Pension accrual 377 424
Limited partnership investments (409) (371)
Accretion on bonds (126) ---
Purchase business combination 336 880
Charge-off remaining lease payments --- 17
Unrealized gain on available-for-sale securities (376) (329)
State income taxes 1,090 777
Other, net 43 93
------ ------
Net deferred tax asset included in other assets $3,450 $3,379
------ ------
- --------------------------------------------------------------------------------
10. 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 data in the table below is presented in accordance with SFAS No. 132,
"Employer's Disclosures About Pensions and Other Postretirement Benefits," which
is effective for fiscal years beginning after December 15, 1997. This statement
revises the Company's disclosures but does not change the measurement or
recognition of pension benefits. The assumptions utilized include a weighted
average discount rate of 7.25% and 7.50%, respectively, for the plan years ended
in 1998 and 1997. The discount rates at October 31, 1998 and 1997, were 6.75%
and 7.25%, respectively. The rate of increase in future compensation levels used
in determining the actuarial present value of the projected benefit obligation
was 4.0% in 1998, 1997 and 1996. The expected long-term rate of return on assets
was 8.0% in 1998, 1997 and 1996.
57
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following table sets forth the changes in the plan's benefit obligations and
assets together with the plan's funded status and the amounts recognized in the
Company's consolidated financial statements at December 31, 1998 and 1997 for
the plan's October 31 fiscal year end.
- --------------------------------------------------------------------------------
1998 1997
---- ----
(Dollars in thousands)
Change in Benefit Obligation:
Projected benefit obligation at the beginning of the plan year $4,721 $4,093
Service cost 479 436
Interest cost 343 307
Actuarial loss 321 222
Benefits paid (439) (337)
------ ------
Projected benefit obligation at the end of the plan year $5,425 $4,721
------ ------
Actuarial present value of vested benefits $3,713 $3,295
------ ------
Actuarial present value of accumulated benefit obligation $3,841 $3,364
------ ------
Change in Plan Assets:
Fair value of plan assets at the beginning of the year $5,738 $5,156
Return on assets 458 919
Contributions 337 ---
Benefits paid (439) (337)
------ ------
Fair value of plan assets at the end of the year $6,094 $5,738
------ ------
Reconciliation of the Funding Status of the Plan:
Transition liability $68 $73
Deferred gain (1,926) (2,338)
Accrued expense 1,189 1,248
------ ------
Funded status ($669) ($1,017)
------ ------
Net periodic pension benefit cost for the years ended December 31, 1998, 1997
and 1996 included the following components:
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Service cost - benefits earned during the year $479 $436 $409
Interest cost on projected benefit obligation 343 307 297
Expected return on plan assets (459) (778) (710)
Net amortization and deferral (85) 295 293
---- ---- ----
Net pension cost $278 $260 $289
---- ---- ----
- --------------------------------------------------------------------------------
58
The Company has no material postretirement or postemployment benefit
arrangements other than pension benefits with its employees, except as stated in
Note 11.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
11. 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, 1998 and 1997
follow:
- --------------------------------------------------------------------------------
Contract
Amount
---------
1998 1997
---- ----
(Dollars in thousands)
Commitments to originate loans $27,389 $34,132
Unused lines of credit 70,177 52,053
Commercial and standby letters of credit 11,807 4,430
Loans sold with recourse 1,356 1,840
Unadvanced portions of
construction loans 28,400 21,074
Forward commitments 2,566 11,808
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.
59
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 twelve of its facilities. Most of the leases
have renewal options. Total rent expense under these leases for 1998, 1997 and
1996 was $918,000, $853,000, $712,000, respectively.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following is a schedule of future minimum lease payments for operating
leases (dollars in thousands):
Year ending December 31,
1999 $1,088
2000 913
2001 631
2002 463
2003 372
Thereafter 567
------
Total future minimum lease payments $4,034
------
EMPLOYMENT AND TERMINATION AGREEMENTS
The Company and the Bank have entered into employment agreements with two
executive officers. One agreement, which commenced January 1, 1997, had an
original term of three years and the other agreement had a commencement date of
January 1, 1997 have an original term of two years. Each agreement is extended
on a daily basis until terminated by the officer, the Company or the Board of
Directors. The employment agreements generally provide for the continued payment
of specified compensation and benefits to the executive officer for the
remaining term of the contract after termination of employment, unless the
termination is for "cause" as defined in the employment agreement.
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 for these executive officers are based on three times their
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. Three 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.
The Company's former Chief Financial Officer, David W. Dailey, retired from the
Company on December 31, 1998. In connection with his retirement, the Company
entered into an agreement with Mr. Dailey which provides for certain retirement
benefits, including a lump sum special payment of $237,500, accelerated vesting
and extension of the exercise date of certain stock options held by him; and
continuation of health insurance benefits for a period of six months following
the date of retirement. Mr. Dailey's Employment Agreement and Special
Termination Agreement terminated upon his retirement.
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.
60
12. 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 1998, 1997 and 1996 the Company awarded $457,000,
$168,000, and $310,000, respectively, for bonuses in connection with the
Incentive Plan.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
13. STOCK PLANS
The Company has three stock 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"). The 1987 Stock Option Plan provided for
the granting of "Incentive Stock Options" and "Non-qualified Stock Options".
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. As of December 31, 1998, 450,902 shares are reserved for
issuance under this plan with respect to the current outstanding options; no
more options may be granted under this plan.
The second stock plan (the "1996 Stock Option Plan") was assumed under the terms
of the agreement related to the Company's purchase of Finest (Note 3) 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. During 1997, 26,415 options were exercised. The remaining
88,050 options were vested and exercisable at December 31, 1998 and 1997, and
expire October 1, 2005. None of these options were exercised during 1998. 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 pro forma compensation cost discussed below excludes the effect
of these options. No more options may be granted under this plan.
The third stock plan (the "1997 Stock Incentive Plan") was adopted in 1997 as a
performance incentive for the Company's directors, officers, and employees.
Incentive stock options, non-qualified stock options, unrestricted stock awards,
conditioned stock awards, performance share awards, and stock appreciation
rights may be granted pursuant to the 1997 Stock Incentive Plan. Incentive stock
options granted under the 1997 Stock Incentive 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 awards granted under the 1997 Stock Incentive Plan.
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 based upon the Modified Black-Scholes American option
model, the Company's 1998, 1997 and 1996 net income and earnings per share from
operations would have been reduced to the following pro forma amounts (dollars
in thousands except per share amounts).
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Net income:
As reported $11,065 $9,713 $9,113
Pro forma 10,525 9,361 8,957
Basic EPS:
As reported $1.46 $1.30 $1.51
Pro forma $1.39 $1.25 $1.48
Diluted EPS:
As reported $1.41 $1.25 $1.47
Pro forma $1.35 $1.21 $1.45
- --------------------------------------------------------------------------------
Pro forma compensation cost may not be representative of that in future years.
61
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following table summarizes various facts and assumptions pertaining to the
1987 Stock Option Plan and the 1997 Stock Incentive Plan for the three years
ended December 31, 1998, 1997 and 1996.
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Number of Options
Outstanding at beginning of year 804,019 686,899 421,733
Granted 169,200 230,366 356,000
Expired (34,706) (21,970) (46,666)
Exercised (185,711) (91,276) (44,168)
Outstanding at end of year 752,802 804,019 686,899
Exercisable at end of year 361,407 341,065 264,363
For options exercisable from
$5.25 to $11.375 per share:
Weighted average price per share:
Outstanding at beginning of year $9.223 $9.129 $7.191
Granted --- --- 11.375
Expired 11.375 11.039 10.283
Exercised 8.518 8.099 7.501
Outstanding at end of year 9.497 9.223 9.129
Exercisable at end of year 8.808 8.232 7.261
Weighted average remaining contractual life of
options outstanding at December 31, 1998 6.33 years 6.9 years Not applicable
Weighted average expected life of options at grant Not applicable Not applicable 10 years
Weighted average risk-free interest rates at grant Not applicable Not applicable 5.70%
Weighted average dividend yield at grant Not applicable Not applicable 4.20%
Weighted average expected volatility at grant Not applicable Not applicable 27.20%
For options exercisable from
$16.375 to $23.9837 per share:
Weighted average price per share:
Outstanding at beginning of year $18.749 $ --- Not applicable
Granted 23.883 18.752 Not applicable
Expired 20.589 19.750 Not applicable
Exercised 16.375 --- Not applicable
Outstanding at end of year 20.968 18.749 Not applicable
Exercisable at end of year 18.838 --- Not applicable
Weighted average remaining contractual life of
options outstanding at December 31, 1998 9.02 years 9.6 years Not applicable
Weighted average expected life of options at grant 10 years 10 years Not applicable
Weighted average risk-free interest rates at grant 5.38% 6.20% Not applicable
Weighted average dividend yield at grant 2.34% 2.60% Not applicable
Weighted average expected volatility at grant 27.20% 27.20% Not applicable
- --------------------------------------------------------------------------------
62
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
14. 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 1998, 1997 and
1996, 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 1998, 1997 and 1996 amounted to $147,000, $136,000 and
$116,000, 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 1997 and 1996 amounted to $66,000 and $58,000, respectively. There was no
supplemental matching contribution in 1998.
15. 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
$3,160,000 at December 31, 1998.
63
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
16. 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, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, 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 is aware of that would have
changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table. As
of December 31, 1998, 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.
64
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following table displays the Bank's capital calculations as defined under
prompt corrective action for the periods indicated:
- --------------------------------------------------------------------------------
(Dollars in Thousands) To Be Well
For Capital Capitalized Under Prompt
Actual Actual Adequacy Purposes Corrective Action Provision
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1998
Tangible Capital (to Adjusted Assets) $71,154 5.79% $18,429 > or = 1.50% n/a n/a %
Tier I (Core) Capital (to Adjusted Assets) 71,154 5.79 36,859 3.00 61,428 > or = 5.00
Tier I Capital (to Risk Weighted Assets) 71,154 9.45 30,114 4.00 45,172 6.00
Total Risk Based Capital (to Risk Weighted Assets) 80,459 10.69 60,229 8.00 75,286 10.00
To Be Well
For Capital Capitalized Under Prompt
Actual Actual Adequacy Purposes Corrective Action Provision
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1997
Tangible Capital (to Adjusted Assets) $72,319 6.09% $17,822 > or = 1.50% n/a n/a %
Tier I (Core) Capital (to Adjusted Assets) 72,319 6.09 35,644 3.00 59,408 > or = 5.00
Tier I Capital (to Risk Weighted Assets) 72,319 10.20 28,372 4.00 42,559 6.00
Total Risk Based Capital (to Risk Weighted Assets) 81,194 11.45 56,744 8.00 70,931 10.00
- --------------------------------------------------------------------------------
65
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
17. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS - FIRST ESSEX BANCORP, INC.
Condensed financial statements of First Essex Bancorp, Inc. as of December 31,
1998 and 1997, and for the years ended December 31, 1998, 1997 and 1996 follow:
- --------------------------------------------------------------------------------
1998 1997
---- ----
(Dollars in thousands)
Balance Sheets
- --------------
Assets:
Cash and cash equivalents $890 $7,928
Investment in First Essex Bank, FSB 96,262 84,412
Other assets 1,640 195
------- -------
Total assets $98,792 $92,535
------- -------
Liabilities and stockholders' equity:
Other liabilities $1,710 $1,470
Stockholders' equity 97,082 91,065
------- -------
Total liabilities and stockholders' equity $98,792 $92,535
------- -------
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Statements of Operations
- ------------------------
Income:
Interest on investments $112 $473 $241
Distributed income of First Essex Bank,FSB ---- ---- 7,000
Other Income 145 ---- ----
------- ------ ------
Total income 257 473 7,241
------- ------ ------
Expenses:
Operating expenses (income) ---- (17) 5
------- ------ ------
Income before provision for income taxes and equity in
undistributed net income of First Essex Bank, FSB 257 490 7,236
Provision for income taxes 105 204 40
------- ------ ------
Income before equity in subsidiary 152 286 7,196
Equity in undistributed net income of First Essex Bank, FSB 10,913 9,427 1,917
------- ------ ------
Net income $11,065 $9,713 $9,113
------- ------ ------
- --------------------------------------------------------------------------------
66
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Statements of Cash Flows
- ------------------------
Cash flows from operating activities:
Net income $11,065 $9,713 $9,113
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in income of First Essex Bank, FSB (10,913) (9,427) (8,917)
Provision for deferred (prepaid) income taxes (88) 2,294 (1,908)
Increase (Decrease) in other assets (57) 4,706 1,908
Increase (Decrease) in other liabilities 80 (336) (50)
------- ------ -------
Net cash provided by operating activities 87 6,950 146
------- ------ -------
Cash flows from investing activities:
Acquisition cost, net of cash received (Note 3) --- --- (14,224)
Dividends and other capital distributions
received from (paid to) First Essex Bank, FSB (2,000) --- 14,380
------- ------ -------
Net cash provided by (used in) investing activities (2,000) --- 156
------- ------ -------
Cash flows from financing activities:
Common Stock Repurchase (2,493) --- ---
Stock options exercised 1,596 906 333
Dividends paid (4,228) (3,591) (2,900)
------- ------ -------
Net cash used in financing activities (5,125) (2,685) (2,567)
------- ------ -------
Net increase (decrease) in cash and cash equivalents (7,038) 4,265 (2,265)
Cash and cash equivalents at beginning of year 7,928 3,663 5,928
------- ------ -------
Cash and cash equivalents at end of year $890 $7,928 $3,663
------- ------ -------
18. 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, 1998, 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 I risk-based capital ratio
of less than 4% or (iii) a Tier I core capital ratio of less than 3%.
67
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
19. QUARTERLY DATA (UNAUDITED)
A summary of quarterly financial data for the years ended December 31, 1998 and
1997 follows:
- --------------------------------------------------------------------------------
Year Ended December 31, 1998
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands, except per share amounts)
Interest and dividend income $23,361 $23,405 $23,344 $23,350
Interest expense 12,048 12,942 13,943 13,579
------- ------- ------- -------
Net interest income 11,313 10,463 9,401 9,771
Provision for loan losses 280 290 435 435
------- ------- ------- -------
Net interest income after
provision for loan losses 11,033 10,173 8,966 9,336
Noninterest income 1,871 1,732 2,272 990
Noninterest expense 8,286 (1) 7,409 6,675 5,808
------- ------- ------- -------
Income before income taxes 4,618 4,496 4,563 4,518
Provision for income taxes 1,798 1,698 1,814 1,820
------- ------- ------- -------
Net income $2,820 $2,798 $2,749 $2,698
------- ------- ------- -------
Earnings per share - basic $.37 $.37 $.36 $.36
------- ------- ------- -------
Earnings per share - diluted $.36 $.36 $.35 $.34
------- ------- ------- -------
- --------------------------------------------------------------------------------
Year Ended December 31, 1997
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands, except per share amounts)
Interest and dividend income $22,978 $23,265 $22,765 $21,070
Interest expense 13,389 13,905 13,170 11,913
------- ------- ------- -------
Net interest income 9,589 9,360 9,595 9,157
Provision for loan losses 510 510 510 510
------- ------- ------- -------
Net interest income after
provision for loan losses 9,079 8,850 9,085 8,647
Noninterest income 1,379 1,250 1,256 1,203
Noninterest expense 6,668 5,529 6,003 6,164
------- ------- ------- -------
Income before income taxes 3,790 4,571 4,338 3,686
Provision for income taxes 1,400 1,921 1,812 1,539
------- ------- ------- -------
Net income $2,390 $2,650 $2,526 $2,147
------- ------- ------- -------
Earnings per share - basic $.32 $.35 $.34 $.29
------- ------- ------- -------
Earnings per share - diluted $.30 $.34 $.33 $.28
------- ------- ------- -------
- --------------------------------------------------------------------------------
(1) Approximately $525,000 of the increase in the quarter was due to one-time
write-downs in the carrying values of certain assets.
68
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
20. 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) 10 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) 10 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.
21. 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 approximate 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
69
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
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 approximates fair value.
OTHER EARNING ASSETS
Other earning assets consist of a long term fixed rate certificate of deposit
with the Federal Home Loan Bank of Boston. The fair value for this certificate
of deposit is estimated using a discounted cash flow calculation that applies an
interest rate currently being offered on a time deposit of similar maturity.
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 fair value.
BORROWED FUNDS
The carrying amount of borrowings payable within 90 days approximates fair
value. 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, 1998 and 1997, 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.
70
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The estimated fair values of the Company's financial instruments follow:
- --------------------------------------------------------------------------------
December 31, 1998 December 31, 1997
----------------- -----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
(Dollars in thousands)
Financial assets:
Cash and cash equivalents $90,383 $90,383 $22,543 $22,543
Investment securities available-for-sale 345,840 345,840 211,903 211,903
Investment securities held-to-maturity ----- ----- 178,999 180,743
Stock in Federal Home Loan Bank
of Boston and Savings Bank Life
Insurance Company 21,179 21,179 20,997 20,997
Loans receivable, net 720,056 730,219 696,338 700,967
Mortgage loans held-for-sale 2,566 2,566 11,807 11,807
Other earning assets 17,388 17,388 17,291 17,291
Accrued interest receivable 9,170 9,170 8,084 8,084
Financial liabilities:
Depositors' accounts 934,695 939,152 744,322 746,127
Borrowed funds 201,499 200,859 343,557 343,445
- --------------------------------------------------------------------------------
22. BUSINESS SEGMENTS
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
operating segments of a business enterprise and descriptive information about
the operating segments in financial statements. Operating segments are
components of an enterprise which are evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. The Company's chief operating decision-maker is the Chief Executive
Officer and Chairman of the Board of the Company. The adoption of SFAS No. 131
did not have a material effect on the Company's primary financial statements,
but did result in the disclosure of segment information contained herein. The
Company has identified its reportable operating business segment as Community
Banking, based on the products and services provided to its customers.
The Company's community banking business segment consists of commercial banking
and retail banking. The community banking segment is managed as a single
strategic unit and derives its revenues from a wide range of banking services,
including lending activities, and the acceptance of demand, savings and time
deposits.
Nonreportable operating segments of the Company's operations which do not have
similar characteristics to the community banking operations and do not meet the
quantitative thresholds requiring disclosure, are included in the other category
in the disclosure of business segments below. The nonreportable segment
represents the holding company financial information (Note 17).
The accounting policies used in the disclosure of business segments are the same
as those described in the summary of significant accounting policies (Note 1).
The consolidation adjustments reflect certain eliminations of intersegment
revenue, cash and investments in subsidiaries.
71
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
The following tables reflect reportable community banking segment specific
information and a reconciliation of the community banking segment information to
the consolidated financials.
(Dollars in Thousands)
1998 1997 1996
Additions to bank premises and equipment $ 3,134 $ 836 $ 3,277
Depreciation and amortization $ 1,963 $ 1,900 $ 1,719
1
Interest and dividend income:
Interest on loans $65,045 $62,558 $46,892
Interest and dividend on investment securities 25,054 26,418 16,127
Interest on other earning assets 1,039 517 -
Interest on short term investments 2,318 452 285
------- ------- -------
Total interest income 93,456 89,945 63,304
Interest expense:
Interest on depositor's accounts 35,465 31,569 21,946
Interest on borrowed funds 17,155 21,148 15,371
------- ------- -------
Total interest expense 52,620 52,717 37,317
Provision for possible loan losses 1,440 2,040 1,415
Noninterest income:
Net gain on sales of mortgage loans and
mortgage servicing rights 1,338 1,628 1,352
Net gain on sales of investment securities 1,344 439 497
Loan fees 693 561 513
Other fee income 2,999 2,460 1,877
Other 346 ----- 26
------- ------- -------
Total noninterest income 6,720 5,088 4,265
Noninterest expenses:
Salaries and employee benefits 13,036 11,618 10,051
Building and equipment 4,193 4,124 3,605
Professional 1,103 1,488 1,093
Other noninterest expenses 9,846 7,149 5,171
------- ------- -------
Total noninterest expense 28,178 24,379 19,920
Income before provision for income taxes 17,938 15,897 8,917
Provision for income taxes 7,022 6,473 4
------- ------- -------
Net income $10,916 $9,424 $8,913
------- ------- -------
72
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
Consolidation
Community Adjustments
Banking Other and Eliminations Consolidated
------- ----- ---------------- ------------
December 31, 1998
Investment securities $367,019 $ ---- $ ----- $367,019
Net loans 722,622 ---- ----- 722,622
Total assets 1,246,213 49,856 (48,055) 1,248,014
Total deposits 935,424 ---- (729) 934,695
Borrowed funds 201,499 ---- ----- 201,499
Total liabilities 1,149,950 1,711 (729) 1,150,932
Total interest income 93,456 112 (108) 93,460
Total interest expense 52,620 ---- (108) 52,512
Net interest income 40,836 112 ----- 40,948
Provision for loan losses 1,440 ---- ----- 1,440
Total noninterest income 6,720 145 ----- 6,865
Total noninterest expense 28,178 ---- ----- 28,178
Provision for income taxes 7,022 105 3 7,130
Net income 10,916 152 (3) 11,065
December 31, 1997
Investment securities 411,899 ---- ----- 411,899
Net loans 708,145 ---- ----- 708,145
Total assets 1,197,128 54,400 (54,069) 1,197,459
Total deposits 752,114 ---- (7,792) 744,322
Borrowed funds 343,557 ---- ----- 343,557
Total liabilities 1,112,722 1,465 (7,793) 1,106,394
Total interest income 89,945 473 (340) 90,078
Total interest expense 52,717 ---- (340) 52,377
Net interest income 37,228 ---- ----- 37,701
Provision for loan losses 2,040 ---- ----- 2,040
Total noninterest income 5,088 ---- ----- 5,088
Total noninterest expense 24,379 (15) ----- 24,364
Provision for income taxes 6,473 199 ----- 6,672
Net income 9,424 289 ----- 9,713
December 31, 1996
Investment securities 295,892 ---- ----- 295,892
Net loans 694,121 ---- ----- 694,121
Total assets 1,063,473 40,910 (37,208) 1,067,175
Total deposits 691,109 ---- (156) 690,953
Borrowed funds 274,958 ---- ----- 274,958
Total liabilities 989,550 1,424 (6,784) 984,190
Total interest income 63,304 241 ----- 63,545
Total interest expense 37,317 ---- ----- 37,317
Net interest income 25,987 241 ----- 26,228
Provision for loan losses 1,415 ---- ----- 1,415
Total noninterest income 4,265 ---- ----- 4,265
Total noninterest expense 19,920 5 ----- 19,925
Provision for income taxes 4 36 ----- 40
Net income 8,913 200 ----- 9,113
73
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 will appear under the headings
"Information Regarding Directors and Nominees", "Executive Officers" and
"Compliance with Section 16(a) of the Exchange Act" of the Company's definitive
Proxy Statement for the Annual Meeting of Stockholders to be held May 6, 1999 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1998 (the "Proxy Statement"), and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will appear in the Proxy Statement under
the headings "Summary Compensation Table," "Stock Options Granted in Fiscal
1998," " Aggregated Option/SAR Exercises in Last Fiscal Year and FY-end
Option/SAR Values," "Pension Plan," "Executive Salary Continuation Agreement,"
"Employment Contracts, Termination of Employment and Change in Control
Arrangements," and "Compensation/Nominating Committee Interlocks and Insider
Participation" and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will appear in the Proxy Statement under
the headings "Security Ownership of Certain Beneficial Owners and Management"
and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will appear 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, 1998 and 1997
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996
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.
74
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by First Essex during the fiscal
quarter ended December 31, 1998.
(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- Executive Salary Continuation Agreement between First Essex Bancorp,
Inc., First Essex Bank, FSB and Leonard A. Wilson 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;
*10.4- Amended and Restated Employment Agreement dated as of October 9, 1997
between Leonard A. Wilson and First Essex Bancorp, Inc., incorporated
herein by reference to Exhibit 10.4 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
*10.5- Amended and Restated Employment Agreement dated as of October 9, 1997
between Leonard A. Wilson and First Essex Bank, FSB, incorporated herein
by reference to Exhibit 10.5 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997.
*10.6- Amended and Restated Employment Agreement dated as of October 9, 1997
between Brian W. Thompson and First Essex Bancorp, Inc., incorporated
herein by reference to Exhibit 10.8 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
*10.7- Amended and Restated Employment Agreement dated as of October 9, 1997
between Brian W. Thompson and First Essex Bank, FSB, incorporated herein
by reference to Exhibit 10.9 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997.
*10.8- Special Termination Agreement dated January 1, 1994 and restated as of
October 9, 1997 between Leonard A. Wilson and First Essex Bancorp, Inc.
incorporated by reference to Exhibit 10.10 to the Company's Quarterly
report on Form 10-Q for the quarter ended September 30, 1997.
*10.9- Special Termination Agreement dated January 1, 1994 and restated as of
October 9, 1997 between Brian W.Thompson and First Essex Bancorp, Inc.
incorporated by reference to Exhibit 10.12 to the Company's Quarterly
report on Form 10-Q for the quarter ended September 30, 1997.
*10.10- Form of Special Termination Agreement between First Essex Bancorp, Inc.,
First Essex Bank, FSB, and each of William F. Burke, John M. DiGaetano,
and Wayne C. Golon, incorporated herein by reference to Exhibit 10.13 to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997.
*10.11- Common Stock Option Agreement with Brian W. Thompson incorporated herein
by reference to Form S-8, Registration No.333-22183, filed on February
21, 1997.
*10.12- First Essex Bancorp, Inc. 1997 Stock Incentive Plan incorporated herein
by reference to Form S-8, Registration No. 333-35057, filed on September
5, 1997.
*10.13- Deferred Compensation Plan for Directors of First Essex Bancorp, Inc.
and Its Subsidiaries.
*10.14- First Essex Bancorp, Inc. Senior Management Incentive Compensation Plan.
75
*10.15- Agreement between First Essex Bancorp, Inc., First Essex Bank, FSB and
David W. Dailey.
*10.16- Agreement between First Essex Bank, FSB and David L. Savoie.
(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 the subsidiaries of the Company is attached hereto as Exhibit
21.
(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.
76
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 11, 1999
by /s/Leonard A. Wilson
-----------------------
Leonard A. Wilson
Chairman and Chief Executive Officer
77
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 Chairman and Chief Executive Officer
- ------------------------ (Principal Executive Officer) March 11, 1999
Leonard A. Wilson
/s/William F. Burke Chief Financial Officer
- ------------------------ (Principal Financial and
William F. Burke Accounting Officer) March 11, 1999
/s/Thomas S. Barenboim Director March 11, 1999
- ------------------------
Thomas S. Barenboim
/s/Augustine J. Fabiani Director March 11, 1999
- ------------------------
Augustine J. Fabiani
/s/William L. Lane Director March 11, 1999
- ------------------------
William L. Lane
/s/Frank J. Leone, Jr. Director March 11, 1999
- ------------------------
Frank J. Leone, Jr.
- ------------------------
Robert H. Pangione Director March 11, 1999
- ------------------------ President, Chief Operating Officer March 11, 1999
Brian W. Thompson and Director
/s/Walter W. Topham Director March 11, 1999
- ------------------------
Walter W. Topham
/s/Robert H. Watkinson Director March 11, 1999
- ------------------------
Robert H. Watkinson
78