U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1997
Commission File No.: 01-13465
FALMOUTH BANCORP, INC.
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(Name of small business issuer in its charter)
04-3337685
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 Davis Straits, Falmouth, Massachusetts 02540
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(Address of principal executive offices)
(508) 548-3500
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(Issuer's Telephone Number)
Securities registered pursuant to section 12(b) of the Exchange Act:
Title of each class Name of Exchange on which registered:
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Common Stock, par value $0.01 per share American Stock Exchange
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. [X]
The revenues for the issuer's fiscal year ended September 30, 1997 are
$6,503,977.
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, as of a specified date within the last 60 days. On
November 13, 1997: $23,841,895.
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. The Company had 1,454,750
shares outstanding as of December 19, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement pursuant to Regulation 14A,
which was delivered to the Commission for filing on December 23, 1997, and the
1997 Annual Report to Stockholders for the fiscal year ended September 30,
1997, which has not previously been mailed to the Commission, are incorporated
by reference into Part II and III of this report.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
TABLE OF CONTENTS
<TABLE>
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Page
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PART I
Item 1. Description of Business............................................. 3
Item 2. Description of Property............................................. 30
Item 3. Legal Proceedings................................................... 30
Item 4. Submission of Matters to a Vote of Security Holders................. 30
PART II
Item 5. Market for Common Equity and Related Stockholder Matters............ 31
Item 6. Management's Discussion and Analysis................................ 31
Item 7. Financial Statements................................................ 36
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................... 37
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.................. 37
Item 10. Executive Compensation.............................................. 37
Item 11. Security Ownership of Certain Beneficial Owners and Management...... 37
Item 12. Certain Relationships and Related Transactions...................... 37
Item 13. Exhibits............................................................ 38
SIGNATURES........................................................................
</TABLE>
PART I
ITEM 1. BUSINESS
General
Falmouth Bancorp, Inc. (the "Company" or "Bancorp"), a Delaware
corporation, is the holding company for Falmouth Co-operative Bank (the
"Bank"), a Massachusetts-chartered stock co-operative bank. The Bank converted
to stock form on March 28, 1996, and issued 1,454,750 shares of common stock at
$10.00 per share (the "Conversion"). On October 14, 1997, the Company acquired
all of the capital stock of the Bank and stockholders of the Bank became
stockholders of the Company in a share for share exchange pursuant to a plan of
reorganization approved by the Bank's stockholders on January 21, 1997 (the
"Reorganization") whereby the Bank became the wholly-owned subsidiary of the
Company. At September 30, 1997, there were 1,454,750 shares outstanding. The
Company's sole business activity is ownership of the Bank. The Company also
makes investments in long and short-term marketable securities and other liquid
investments. The Company's Common Stock trades on the American Stock Exchange
under the symbol "FCB." Unless otherwise disclosed, the information presented
in this Report on Form 10-KSB represents the activities of the Bank for the
fiscal year 1997, which ended September 30, 1997.
The Bank had total assets of $96.4 million as of September 30, 1997. The
Bank conducts its business through an office located in Falmouth,
Massachusetts, where it was originally founded in 1925 as a Massachusetts
chartered mutual co-operative Bank, and two branches located in East Falmouth
and North Falmouth, Massachusetts. The Bank's deposits are currently insured up
to applicable limits by the Bank Insurance Fund of the Federal Deposit
Insurance Corporation ("FDIC") and the Share Insurance Fund of the Co-operative
Central Bank of Massachusetts.
The Bank's principal business consists of attracting deposits from the
general public and using these funds to originate mortgage loans secured by
one- to four-family residences located primarily in Falmouth, Massachusetts and
surrounding areas and to invest in United States Government and Agency
securities.
Business Strategy
The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank dedicated to financing home ownership
and consumer needs in its market area and to provide quality service to its
customers. The Bank has implemented this strategy by: (i) closely monitoring
the needs of customers and providing quality service; (ii) emphasizing
consumer-oriented banking by originating residential mortgage loans and
consumer loans, and by offering checking accounts and other financial services
and products; (iii) focusing on expanding lending activities to produce
moderate increases in loan originations; (iv) maintaining asset quality; (v)
maintaining capital in excess of regulatory requirements; and (vi) producing
stable earnings.
The Bank serves its primary market area, the Massachusetts communities of
Falmouth and Mashpee located in the Cape Cod region of Massachusetts, through
its office in Falmouth, Massachusetts. In February, 1997, the Bank opened a new
branch located in East Falmouth and in August, 1997, the Bank opened a branch
in North Falmouth. The Bank competes with fifteen branches of financial
institutions (including national banks, savings banks, savings and loans and
credit unions) which are headquartered outside its market area. The Bank is the
only independent financial institution headquartered in Falmouth.
To a lesser extent, Falmouth also makes commercial real estate loans and
consumer loans, including passbook loans, automobile, home equity and other
consumer loans. Falmouth originates both fixed-rate and adjustable-rate loans
and emphasizes the origination of residential real estate mortgage loans with
adjustable interest rates, and makes other investments which allow Falmouth to
more closely match the interest rate and maturities of its assets and
liabilities.
Market Area
The Bank considers its primary market area to be the communities of
Falmouth and Mashpee in Barnstable County, which is located in the Cape Cod
region of Massachusetts, approximately 72 miles south of Boston. The year-round
population of Barnstable County is 186,605 (based on 1990 Census data). The
majority of the Bank's lending has been in Falmouth and Mashpee. The Cape Cod
region is a major recreational resort/retirement community, with seasonal
tourism being the most significant economic activity. Falmouth's year-round
population of approximately 27,000 increases to a summer population of
approximately 68,000. Visitors find accommodations in the many motels, hotels
and inns in the area. Falmouth has approximately 44 miles of ocean and lake
shoreline. There are nine harbors and inlets, some with docking and most with
mooring facilities. Two major harbors offer access, via ferry, to the island of
Martha's Vineyard with service to the island of Nantucket during the summer
months from Woods Hole. In addition to swimming, boating, fishing and other
forms of water recreation, Falmouth also has four public and two private golf
courses.
The major employers in the Falmouth area are the Woods Hole Oceanographic
Institute, with approximately 800 employees, Falmouth Hospital, with 750
employees and Woods Hole, Martha's Vineyard and Nantucket Steamship Authority,
with 500 employees. Other major employers include Marine Biological
Laboratories and ORE International, Inc. The housing vacancy rate in Falmouth,
which is where a majority of the Bank's loans are located, was approximately
3.8% at December 31, 1994.
Employees
At September 30, 1997, the Bank employed 26 full-time and 6 part-time
employees.
Lending Activities
General. The principal lending activity of the Bank is the origination of
conventional mortgage loans for the purpose of purchasing or refinancing
owner-occupied, one- to four-family residential properties in its designated
community reinvestment area of the Massachusetts towns of Falmouth and Mashpee.
To a lesser extent, the Bank also originates consumer loans including home
equity and passbook loans and commercial loans. The Bank also originates and
retains in its loan portfolio adjustable-rate loans and fixed-rate loans with
maturities of up to 15 years. Historically, fixed-rate loans with terms in
excess of 15 years were sold in the secondary market. Beginning in March 1995,
the Bank began to retain its fixed-rate loans with terms in excess of 15 years
in the portfolio. The Bank is a qualified seller/servicer for Federal National
Mortgage Corporation ("FNMA") and was servicing $432,000 in loans for FNMA at
September 30, 1997. The Bank's five largest loans to one borrower, outstanding
as of September 30, 1997, ranged from $384,000 to $1.17 million.
Loan Portfolio. The following table presents selected data relating to
the composition of Falmouth's loan portfolio by type of loan on the dates
indicated.
<TABLE>
<CAPTION>
At September 30,
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1997 1996 1995 1994 1993
----------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
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(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential mortgage loans....... $48,367 87.14% $33,993 82.57% $26,094 78.67% $22,029 78.33% $22,923 78.05%
Commercial real estate loans..... 2,425 4.37% 4,347 10.67% 3,538 10.67% 3,111 11.06% 2,886 9.83%
Consumer loans................... 877 1.58% 771 1.87% 819 2.47% 832 2.96% 1,104 3.76%
Home equity loans................ 2,756 4.96% 1,683 4.09% 1,890 5.70% 2,150 7.65% 2,456 8.36%
Commercial loans................. 1,079 1.95% 373 1.91% 830 2.49% -- --% -- --%
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Total loans................ 55,504 100.00% 41,167 100.00% 33,171 100.00% 28,122 100.00% 29,369 100.00%
------- ======= ------- ======= ------- ======= ------- ======= ------- =======
Less:
Unearned income................ 97 143 121 101 96
Unadvanced principal........... 1,025 289 102 127 40
Allowance for possible loan
losses........................ 501 498 445 310 277
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Loans, net..................... $53,881 $40,237 $32,503 $27,584 $28,956
======= ======= ======= ======= =======
</TABLE>
One- to Four-Family Residential Real Estate Lending. The primary emphasis
of the Bank's lending activity is the origination of conventional mortgage
loans secured by one- to four-family residential dwellings located in the
Bank's primary market area. As of September 30, 1997, loans on one- to
four-family residential properties accounted for 87.14% of the loan portfolio.
The Bank's mortgage loan originations are for terms of up to 30 years,
amortized on a monthly basis with interest and principal due each month.
Residential real estate loans often remain outstanding for significantly
shorter periods than their contractual terms as borrowers may refinance or
prepay loans at their option, without penalty. Conventional residential
mortgage loans granted by the Bank customarily contain "due-on-sale" clauses
which permit Falmouth to accelerate the indebtedness of the loan upon transfer
of ownership of the mortgaged property.
The Bank makes conventional mortgage loans and Falmouth uses standard
FNMA documents to allow for the sale of loans in the secondary mortgage market.
The Bank's lending policies generally limit the maximum loan-to-value ratio on
mortgage loans secured by owner-occupied properties to 95% of the lesser of the
appraised value or purchase price of the property, with the condition that
private mortgage insurance is required on loans with a loan-to-value ratio in
excess of 80%.
The Bank, since the early 1980s, has offered adjustable-rate mortgage
loans with terms of up to 30 years. Adjustable-rate loans offered by the Bank
include loans which reprice every one, three and five years and provide for an
interest rate which is based on the interest rate paid on United States
Treasury securities of a corresponding term, plus a margin of 2.75%. The Bank
currently offers adjustable-rate loans with initial rates below those which
would prevail under the foregoing computations, based upon the Bank's
determination of market factors and competitive rates for adjustable-rate loans
in its market area. For adjustable-rate loans, borrowers are qualified at the
initial rate plus an anticipated upward adjustment of 200 basis points.
The Bank retains all adjustable-rate mortgages it originates. The Bank's
adjustable-rate mortgages include caps on increases or decreases of 2% per
year, and 6% over the life of the loan (3% per adjustment, and 5% over the life
of the loan for three-year adjustable-rate loans). The retention of
adjustable-rate mortgage loans in the Bank's loan portfolio helps reduce the
Bank's exposure to increases in interest rates. However, there are
unquantifiable credit risks resulting from potential increased costs to the
borrower as a result of repricing of adjustable-rate mortgage loans. It is
possible that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest cost to the borrower.
During the year ended September 30, 1997, the Bank originated $9.1
million in adjustable-rate mortgage loans and $9.6 million in fixed-rate
mortgage loans. Approximately 6.07% of all loan originations during fiscal 1997
were refinancings of loans already in the Bank's loan portfolio. At September
30, 1997, the Bank's loan portfolio included $26.5 million in adjustable-rate
one- to four-family residential mortgage loans or 47.75% of the Bank's total
loan portfolio, and $ 21.9 million in fixed-rate one- to four-family
residential mortgage loans, or 39.46% of the Bank's total loan portfolio.
The Bank engages in a limited amount of construction lending usually for
the construction of single family residences. Most are construction/permanent
loans structured to become permanent loans upon the completion of construction.
All construction loans are secured by first liens on the property. Loan
proceeds are disbursed as construction progresses and inspections warrant.
Loans involving construction financing present a greater risk than loans for
the purchase of existing homes, since collateral values and construction costs
can only be estimated at the time the loan is approved. Due to the small amount
of construction loans in the Bank's portfolio, the risk in this area is
limited.
Commercial Real Estate Loans. At September 30, 1997, the Bank's
commercial real estate loan portfolio totaled $2.4 million, or 4.37% of total
loans. The Bank's largest loan is a commercial loan with an outstanding balance
of $762,000 at September 30, 1997 secured by an office complex located in
Falmouth, Massachusetts.
Commercial real estate lending entails additional risks compared with
one- to four-family residential lending. For example, commercial real estate
loans typically involve large loan balances to single borrowers or groups of
related borrowers and the payment experience on such loans is typically
dependent on the successful operation of a real estate project and/or the
collateral value of the commercial real estate securing the loan. At September
30, 1997, all of the Bank's commercial real estate loans were performing.
Home Equity Loans. Falmouth also originates home equity loans which are
loans secured by available equity based on the appraised value of one- to
four-family residential property. If the Bank currently holds the first
mortgage on the property securing the loan, home equity loans will be made for
up to 80% of the tax assessed or appraised value of the property (less the
amount of the first mortgage). If the Bank does not hold the first mortgage,
home equity loans are limited to 70% of the appraised value of the property
(less the amount of the first mortgage). Home equity loans have an adjustable
interest rate which ranges from 0% to 1% above the prime rate as reported in
The Wall Street Journal and have terms of ten years or less. At September 30,
1997, the Bank had $2.6 million in home equity loans with unused credit
available to existing borrowers of $ 3.8 million.
Consumer Loans. The Bank's consumer loans consist of passbook loans, and
other consumer loans, including automobile loans. At September 30, 1997, the
consumer loan portfolio totaled $877,000 or 1.58% of total loans. Consumer
loans generally are offered for terms of up to five years at fixed interest
rates. Consumer loans do not exceed $15,000 individually. Management expects to
continue to promote consumer loans as part of its strategy to provide a wide
range of personal financial services to its customers and as a means to
increase the yield on the Bank's diversified loan portfolio.
The Bank makes loans up to 90% of the amount of the depositor's savings
account balance. The interest rate on the loan is 4.0% higher than the rate
being paid on regular savings accounts and 3% higher than the rate being paid
on certificates of deposit. The Bank also makes other consumer loans, which may
or may not be secured. The terms of such loans usually depend on the
collateral. At September 30, 1997, the total amount of passbook and other
consumer loans was $557,000.
The Bank makes loans for automobiles, both new and used, directly to the
borrowers. The loans are generally limited to 80% of the purchase price or the
retail value listed by the National Automobile Dealers Book. The terms of the
loans are determined by the age and condition of the collateral. Collision
insurance policies are required on all these loans. At September 30, 1997, the
total amount of automobile loans was $85,000.
Consumer loans generally are originated at higher interest rates than
residential mortgage loans but also tend to have a higher credit risk than
residential loans due to the loan being unsecured or secured by rapidly
depreciable assets. Despite these risks, the Bank's level of consumer loan
delinquencies generally has been low. No assurance can be given, however, that
the Bank's delinquency rate on consumer loans will continue to remain low in
the future, or that the Bank will not incur future losses on these activities.
Commercial Loans. In August 1994, the Bank hired a commercial loan
officer with over 18 years of experience in commercial lending in the Falmouth
market for the purpose of establishing a commercial lending program for the
Bank. The Bank is pursuing on a selective basis the origination of commercial
loans to meet the working capital and short-term financing needs of established
local businesses. Unless otherwise structured as a mortgage on commercial real
estate, such loans are generally be limited to terms of five years or less.
Substantially all such commercial loans have variable interest rates tied to
the prime rate as reported in The Wall Street Journal. Whenever possible, the
Bank collateralizes these loans with a lien on commercial real estate, or
alternatively, with a lien on business assets and equipment and the personal
guarantees from principals of the borrower. Commercial loans do not presently
comprise a significant portion of the Bank's loan portfolio. At September 30,
1997 the Bank's commercial loan portfolio totaled $1.1 million.
Commercial business loans generally are considered to involve a higher
degree of risk than residential mortgage loans because the collateral may be in
the form of intangible assets and/or inventory subject to market obsolescence.
Commercial loans also may involve relatively large loan balances to single
borrowers or groups of related borrowers, with the repayment of such loans
typically dependent on the successful operation and income stream of the
borrower. Such risks can be affected significantly by economic conditions. In
addition, commercial business lending generally requires substantially greater
oversight efforts compared to residential real estate lending.
Loan Commitments. The Bank makes a 60-day loan commitment to borrowers.
At September 30,1997, the Bank had $1.4 million in loan commitments
outstanding, all for the origination of one- to four-family residential real
estate loans.
Loan Solicitation Origination and Loan Fees. Falmouth originates loans
through its main office located in Falmouth, Massachusetts and two branch
offices located in East and North Falmouth. Loan originations are derived from
a number of sources, including the Bank's existing customers, referrals,
realtors, advertising and "walk-in" customers at the Bank's offices.
The Bank has two full-time residential loan originators who are
compensated by salary and commission. The originators meet with applicants at
their convenience and location and are in regular contact with real estate
brokers, attorneys, accountants, building contractors, developers and others in
the Bank's local market area. The Bank increased its advertising in locally
distributed newspapers and has utilized local radio advertising to increase
market share of residential loan originations.
Upon receipt of a loan application from a prospective borrower, a credit
report and verifications are ordered to verify specific information relating to
the loan applicant's employment, income and credit standing. For all mortgage
loans, an appraisal of real estate intended to secure the proposed loan is
obtained from an independent fee appraiser who has been approved by the Bank's
Board of Directors. Fire and casualty insurance are required on all loans
secured by improved real estate.
Insurance on other collateral is required unless waived by the loan
committee. The Board of Directors of the Bank has the responsibility and
authority for the general supervision over the loan policies of the Bank. The
Board has established written lending policies for the Bank. All applications
for residential and commercial real estate mortgages and commercial business
loans must be ratified by the Bank's Board of Directors. In addition, certain
designated officers of the Bank have limited authority to approve consumer
loans.
Interest rates charged by the Bank on all loans are primarily determined
by competitive loan rates offered in its market area and the Bank generally
charges an origination fee on new mortgage loans. The origination fees, net of
direct origination costs, are deferred and amortized into income over the life
of the loan. At September 30, 1997, the amount of deferred loan origination
fees was $97,000.
Loan Maturities. The following table sets forth certain information at
September 30, 1997 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less.
<TABLE>
<CAPTION>
At September 30, 1997(1)
-------------------------------
Real Consumer Total
Estate and Other Loans
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(In thousands)
<S> <C> <C> <C>
Total loans scheduled to mature:
In one year or less.................................... $ 3,339 $ 2,889 $ 6,288
After one year through five years...................... 799 380 1,179
Beyond five years...................................... 46,756 159 46,915
-------------------------------
Total.............................................. $ 50,954 $ 3,428 $ 54,382
===============================
Loan balance by type scheduled to mature after one year:
Fixed.................................................. $ 21,827 $ 405 $ 22,232
Adjustable............................................. 25,728 134 25,862
<FN>
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<F1> Net of deferred loan origination fees and unadvanced principal.
</FN>
</TABLE>
Originations and Sales of Loans. The following table sets forth
information with respect to originations and sales of loans during the periods
indicated.
Originations for the year ended September 30, 1997 have increased due to
the addition of a mortgage loan originator and a senior commercial lending
officer in recent years. Loan sales were reduced during the same period as the
Bank has begun to retain certain fixed-rate loans with terms of greater than 15
years in its portfolio.
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Beginning balance(1)................. $ 40,735 $ 32,948 $ 27,894 $ 29,233 $ 31,310
----------------------------------------------------
Mortgage loan originations(2)...... 18,712 13,090 8,722 6,214 7,586
Consumer loan originations......... 3,145 1,844 964 613 559
Commercial loan originations....... 1,710 1,321 1,127 -- --
Less:
Amortization and payoffs(3)........ (9,920) (8,468) (5,310) (5,496) (4,990)
Transfers to OREO.................. -- -- -- -- --
Net loans originated............... 13,647 7,787 5,503 1,331 3,155
----------------------------------------------------
Total loans sold................... -- -- (449) (2,670) (5,232)
----------------------------------------------------
Ending balance(1).................... $ 54,382 $ 40,735 $ 32,948 $ 27,894 $ 29,233
====================================================
<FN>
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<F1> Net of deferred loan origination fees and unadvanced principal.
<F2> Includes residential and commercial real estate loans.
<F3> Includes unadvanced principal.
</FN>
</TABLE>
Non-Performing Assets, Asset Classification and Allowances for Losses.
Loans are reviewed on a regular basis and are placed on a non-accrual status
when, in the opinion of management, the collection of principal and interest
are doubtful.
Real estate acquired by the Bank as a result of foreclosure is classified
as real estate owned until such time as it is sold. When such property is
acquired, it is recorded at the lower of the unpaid principal balance or its
fair value. Any required write-down of the loan to its fair value is charged to
the allowance for loan losses.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans 30-89 days past due (not included in
non-performing loans)....................... $ 290 $ 81 $ -- $ 62 $ --
Loans 30-89 days past due as a percent of
total loans................................. .53% .20% --% .22% --%
Non-performing loans: (90 days past due)..... $ 30 $ 14 $ -- $ 322 $ 342
OREO......................................... $ -- -- -- -- 85
-----------------------------------------
Total non-performing assets............ $ 30 $ 14 $ -- $ 322 $ 427
=========================================
Non-performing loans as a percent of total
loans....................................... .06% .03% --% 1.15% 1.17%
Non-performing assets as a percent of total
assets...................................... .03% .02% --% .43% .57%
</TABLE>
During the year ended September 30, 1997, gross interest income of $3,426
would have been recorded on loans accounted for on a non-accrual basis if the
loans had been current throughout the period. No interest on such loans was
included in income during the respective periods. At September 30, 1997,
management was not aware of any loans not currently classified as non-accrual,
90 days past due or restructured but which may be so classified in the near
future because of concerns over the borrower's ability to comply with repayment
terms.
Federal and state regulations require each banking institution to
classify its asset quality on a regular basis. In addition, in connection with
examinations of such banking institutions, federal and state examiners have
authority to identify problem assets and, if appropriate, classify them. An
asset is classified substandard if it is determined to be inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. As a general rule, the Bank will classify a loan as
substandard if the Bank can no longer rely on the borrower's income as the
primary source for repayment of the indebtedness and must look to secondary
sources such as guarantors or collateral. An asset is classified as doubtful if
full collection is highly questionable or improbable. An asset is classified as
loss if it is considered uncollectible, even if a partial recovery could be
expected in the future. The regulations also provide for a special mention
designation, described as assets which do not currently expose a banking
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's
close attention. Assets classified as substandard or doubtful require a banking
institution to establish general allowances for loan losses. If an asset or
portion thereof is classified loss, a banking institution must either establish
specific allowances for loan losses in the amount of the portion of the asset
classified loss, or charge off such amount. Examiners may disagree with a
banking institution's classifications and amounts reserved. If a banking
institution does not agree with an examiner's classification of an asset, it
may appeal this determination to the FDIC Regional Director. At September 30,
1997, the Bank had no assets classified as special mention or doubtful, and $
101,000 in assets designated as substandard and $6,000 classified as loss.
In originating loans, the Bank recognizes that credit losses will occur
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. It is management's policy to maintain an adequate
general allowance for loan losses based on, among other things, the Bank's and
the industry's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality.
Further, after properties are acquired following loan defaults, additional
losses may occur with respect to such properties while the Bank is holding them
for sale. The Bank increases its allowances for loan losses and losses on real
estate owned by charging provisions for possible losses against the Bank's
income. Specific reserves also are recognized against specific assets when
warranted.
Results of recent examinations by bank regulators indicate that these
regulators may be applying more conservative criteria in evaluating real estate
market values, requiring significantly increased provisions for potential loan
losses. While Falmouth believes it has established its existing allowances for
loan losses in accordance with generally accepted accounting principles, there
can be no assurance that regulators, in reviewing the Bank's loan portfolio,
will not request the Bank to increase its allowance for loan losses, thereby
negatively affecting the Bank's financial condition and earnings.
In December 1993, the banking regulatory agencies, including the FDIC,
adopted a policy statement regarding maintenance of an adequate allowance for
loan and lease losses and an effective loan review system. This policy includes
an arithmetic formula for checking the reasonableness of an institution's
allowance for loan loss estimate compared to the average loss experience of the
industry as a whole. Examiners will review an institution's allowance for loan
losses and compare it against the sum of (i) 50% of the portfolio that is
classified doubtful; (ii) 15% of the portfolio that is classified as
substandard; and (iii) for the portions of the portfolio that have not been
classified (including those loans designated as special mention), estimated
credit losses over the upcoming twelve months given the facts and circumstances
as of the evaluation date. This amount is considered neither a "floor" nor a
"safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.
The following table analyzes activity the Bank's allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Average loans, net................................ $ 47,288 $ 36,387 $ 30,244 $ 28,283 $ 29,563
Period-end total loans............................ 54,382 40,735 32,948 27,894 29,233
Allowance for possible loan losses at beginning
of period........................................ 498 445 310 277 313
Loans charged-off................................. -- -- -- (2) (37)
Plus recoveries................................... 3 2 135 26 1
Provision charged to operations................... -- 51 -- 9 --
--------------------------------------------------------
Allowance for possible loan losses at end of
period........................................... $ 501 $ 498 $ 445 $ 310 $ 277
========================================================
Ratios:
Allowance for possible loan losses as a
percentage of period end total loans........... .92% 1.22% 1.35% 1.11% .95%
Allowance for possible loan losses as a
percentage of non-performing loans............. 1,670.00% 3,557.14% --% 96.27% 80.99%
Net charge-offs to average loans, net........... -- -- -- -- .12
Net charge-offs to allowance for possible loan
losses......................................... -- -- -- -- 13.36
</TABLE>
The following table sets forth a breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. These
allocations are not necessarily indicative of future losses and do not restrict
the use of the allowance to absorb losses in any loan category.
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage:
Residential $ 363 86.88% $ 428 82.57% $ 295 78.67% $ 188 78.33% $ 199 78.05%
Commercial 64 4.46% 32 10.56 96 10.67 103 11.06 63 9.83%
Commercial loans, other 38 1.98% 8 .91 32 2.49 -- -- -- --
Consumer, including home
equity loans 36 6.68% 30 5.96 22 8.17 19 10.61 15 12.12%
-------------------------------------------------------------------------------------------
Total allowance for
loan losses $ 501 100.00% $ 498 100.00% $ 445 100.00% $ 310 100.00% $ 277 100.00%
===========================================================================================
</TABLE>
Investment Activities
General. The Bank is required to maintain an amount of liquid assets
appropriate for its level of net withdrawals from savings accounts and current
borrowings. It has been generally the Bank's policy to maintain a liquidity
portfolio in excess of regulatory requirements. At September 30, 1997, the
Bank's liquidity ratio was 56.05%. Liquidity levels may be increased or
decreased depending upon the yields on investment alternatives, management's
judgment as to the attractiveness of the yields then available in relation to
other opportunities, management's expectations of the level of yield that will
be available in the future and management's projections as to the short-term
demand for funds to be used in Falmouth's loan origination and other
activities.
Interest income from investments in various types of liquid assets
provides a significant source of revenue for the Bank. In the late 1980s, the
Bank maintained its conservative underwriting standards in an effort to avoid
asset quality problems and chose instead to invest excess liquidity in its
investment portfolio. The Bank's short-term investments include United States
Treasury securities and United States Agency securities, commercial paper, bank
certificates of deposits, equity securities, short-term corporate debt
securities and overnight federal funds. The balance of the securities
investments maintained by the Bank in excess of regulatory requirements
reflects management's historical objective of maintaining liquidity at a level
that assures the availability of adequate funds, taking into account
anticipated cash flows and available sources of credit, for meeting withdrawal
requests and loan commitments and making other investments.
The Bank purchases securities through a primary dealer of United States
Government obligations or such other securities dealers authorized by the Board
of Directors and requires that the securities be delivered to the safekeeping
agent (First National Bank of Boston) before the funds are transferred to the
broker or dealer. The Bank purchases investment securities pursuant to an
investment policy established by the Board of Directors.
All securities and investments are recorded on the books of the Bank in
accordance with generally accepted accounting principles. The Bank does not
purchase securities and investments for trading. Effective October 1, 1994, the
Bank implemented SFAS 115. Available-for-sale securities are reported at fair
value with unrealized gains or losses reported as a separate component of net
worth. All purchases of securities and investments conform to the Bank's
interest rate risk policy.
The following tables sets forth the scheduled maturities, carrying
amounts, average yields, amortized cost and market value for the Bank's
investment securities at September 30, 1997.
<TABLE>
<CAPTION>
September 30, 1997
------------------------------------------------------------------------------------------------------
One Year or Less More than Ten
Years One to Five Years Five to Ten Years Years Total Investment Portfolio
----------------- ----------------- ----------------- ----------------- --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount
-------- ------- -------- ------- -------- ------- -------- ------- -------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
Obligations............. $ 6,809 5.85% $ 6,814 6.31% $ 1,000 6.13% $ -- --% $ 14,623 6.09% $14,634
Mortgage-backed
Securities.............. -- -- -- -- 583 5.05 2,828 7.51 3,411 7.09 3,434
Corporate Notes and
Bonds................... 5,407 6.46 3,794 7.91 1,092 8.35 -- -- 10,293 7.20 10,302
------- ------- ------- -------- -------- -------
Total.............. $12,216 6.12 10,608 6.89 $ 2,675 6.80 $ 2,828 7.51 28,327 6.62 28,370
======= ======= ======= ======== ======== =======
Marketable Equity
Securities.............. 7,670 4.87 7,670
FHLB Stock............... 405 5.67 405
-------- -------
Total Investment
Portfolio......... $ 36,402 6.24 $36,445
======== =======
</TABLE>
<TABLE>
<CAPTION>
September 30, 1997
-------------------------------------------------------------------
Available-for-Sale Held-to-Maturity
-------------------------------- --------------------------------
Amortized Market Amortized Market
Cost Value Percent(1) Cost Value Percent(2)
--------- ------- ---------- --------- ------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities(3):
U.S. government obligations............ $11,486 $11,529 45.3% $ 3,095 $ 3,104 29.4%
Other bonds and obligations............ 3,448 3,468 13.6 6,824 6,834 64.9
Marketable equity securities........... 7,087 7,670 30.1 -- -- --
Mortgage-backed securities(4).......... 2,755 2,814 11.0 597 621 5.7
----------------------------------------------------------------
Total Investment Portfolio......... $24,776 $25,481 100.0% $10,516 $10,559 100.0%
================================================================
</TABLE>
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities(3):
U.S. government obligations............ $14,624 40.6% $25,486 55.9% $19,301 54.3%
Other bonds and obligations............ 10,292 28.6 10,440 22.9 7,732 21.7
Marketable equity securities........... 7,670 21.3 6,764 14.9 6,583 18.5
Mortgage-backed securities(4).......... 3,411 9.5 2,863 6.3 1,960 5.5
-----------------------------------------------------------
Total Investment Portfolio......... $35,997 100.0% $45,553 100.0% $35,576 100.0%
===========================================================
<FN>
- -------------------
<F1> As a percentage of market value.
<F2> As a percentage of amortized cost.
<F3> Includes $4.2 million invested in Bank Investment Fund One, a mutual bond
fund offered by the Co-operative Central Bank, a quasi-governmental
agency, and does not include interest-earning overnight deposits of
$1,352,403 or Federal Home Loan Bank Stock of $405,200.
<F4> Consists of collateralized mortgage obligations, GNMA and FHLMC
certificates.
</FN>
</TABLE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from principal repayments and interest payments on loans and investments as
well as other sources arising from operations in the production of net
earnings. Loan repayments and interest payments are a relatively stable source
of funds, while deposit inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds from
other sources, or on a longer term basis for general business purposes.
Deposits. Deposits are attracted principally from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including passbook savings, NOW accounts, demand deposits, money
market accounts and certificates of deposit. Deposit account terms vary, with
the principal differences being the minimum balance required, the time periods
the funds must remain on deposit and the interest rate.
The Bank's policies are designed primarily to attract deposits from local
residents and businesses rather than to solicit deposits from areas outside its
primary market. The Bank does not accept deposits from brokers due to the
volatility and rate sensitivity of such deposits. Interest rates paid, maturity
terms, service fees and withdrawal penalties are established by the Bank on a
periodic basis. Determination of rates and terms are predicated upon funds
acquisition and liquidity requirements, rates paid by competitors, growth goals
and federal regulations.
Management attributes the net decrease in deposits before interest
credited in recent years primarily to the interest rates offered by the Bank as
compared to alternative investments and increased competition from other
financial institutions.
The following table sets forth the various types of deposit accounts at
Falmouth and the balances in these accounts at September 30, 1997.
<TABLE>
<CAPTION>
At September 30,
-----------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Savings deposits $15,828 21.9% $13,986 21.1% $13,921 21.5% $16,092 24.2% $16,596 24.6%
NOW accounts 6,983 9.7 5,674 8.5% 5,562 8.6% 5,261 7.9% 5,161 7.6
Money market deposits 9,111 12.6 7,770 11.7% 8,441 13.0% 10,268 15.5% 10,825 16.0
-----------------------------------------------------------------------------------------------------
Total 31,922 44.2 27,430 41.3% 27,924 43.1% 31,621 47.6% 32,582 48.2
=====================================================================================================
Demand deposits 3,136 4.4 947 1.4% 701 1.1% 141 0.2% -- --
Certificates of deposit 37,133 51.4 38,066 57.3% 36,157 55.8% 34,666 52.2% 34,989 51.8
-----------------------------------------------------------------------------------------------------
Total deposits $72,191 100.00% $66,443 100.0% $64,782 100.0% $66,428 100.0% $67,571 100.0%
=====================================================================================================
</TABLE>
For more information on the Bank's deposit accounts, see Note 6 of Notes
to Financial Statements.
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity at September 30,
1997.
<TABLE>
<CAPTION>
Maturity Period Certificates of Deposit
--------------- -----------------------
(In thousands)
<S> <C>
0-12 months................... $ 3,587
1-2 years..................... 770
2-3 years..................... --
-------
Total......................... $ 4,357
</TABLE>
The following table sets forth the deposit activity, exclusive of
mortgage escrow accounts, of the Bank for the periods indicated.
<TABLE>
<CAPTION>
Years Ended September 30,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Deposits...................................... $179,911 $153,704 $ 84,785 $ 70,679 $ 73,404
Withdrawals................................... 176,904 155,067 88,973 73,950 76,675
--------------------------------------------------------
Net increase (decrease) before interest
credited............................... 3,007 (1,363) (4,188) (3,271) (3,271)
Interest credited............................. 2,740 2,786 2,542 2,128 2,461
--------------------------------------------------------
Net increase (decrease) in deposits..... $ 5,747 $ 1,423 $ (1,646) $ (1,143) $ (810)
========================================================
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Boston to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. Advances from the FHLB would be secured by the Bank's
stock in the FHLB and a portion of the Bank's mortgage loans. The Bank had no
FHLB advances outstanding at September 30, 1997.
The FHLB of Boston functions as a central reserve bank providing credit
for savings institutions and certain other financial institutions. As a member,
the bank is required to own capital stock in the FHLB and is authorized to
apply for advances on the security of such stock and certain of its home
mortgages and other assets (principally, securities which are obligations of,
or guaranteed by the United States) provided certain standards related to
creditworthiness have been met.
Competition
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits primarily comes from larger commercial
banks and other savings institutions located in or near the Bank's primary
market area which generally have significantly greater financial and
technological resources than the Bank. Additional significant competition for
savings deposits comes from credit unions, money market funds and brokerage
firms. The primary factors in competing for loans are interest rates and loan
origination fees and the range of services offered by the various financial
institutions. Competition for origination of real estate loans normally comes
from commercial banks, other thrift institutions, mortgage bankers, mortgage
brokers and insurance companies. Management considers the Bank's competitors in
its market area to consist of 15 branches of financial institutions
headquartered outside of its market area. The Bank is the only independent
financial institution headquartered in Falmouth.
Employees
At September 30, 1997, the Bank had 26 full-time and 6 part-time
employees. The Bank's employees are not represented by a collective bargaining
agreement, and the Bank considers its relationship with its employees to be
good.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The following is a discussion of material federal income tax
matters and does not purport to be a comprehensive description of the federal
income tax rules applicable to the Bank or the Company. The Bank has not been
audited by the Internal Revenue Service since 1975. For federal income tax
purposes, after the Reorganization, Bancorp and the Bank may file consolidated
income tax returns and report their income on a fiscal year basis using the
accrual method of accounting and will be subject to federal income taxation in
the same manner as other corporations with some exceptions, including
particularly the Bank's tax reserve for bad debts, discussed below.
Tax Bad Debt Reserves. The Small Business Job Protection Act of 1996 (the
"1996 Tax Act"), which was enacted on August 20, 1996, made significant changes
to provisions of the Internal Revenue Code of 1986 (the "Code") relating to a
savings institution's use of bad debt reserves for federal income tax purposes
and requires such institutions to recapture (i.e., take into income) certain
portions of their accumulated bad debt reserves. The effect of the 1996 Tax Act
on the Bank is discussed below. Prior to the enactment of the 1996 Tax Act, the
Bank was permitted to establish tax reserves for bad debts and to make annual
additions thereto, which additions, within specified formula limits, were
deducted in arriving at the Bank's taxable income. The Bank's deduction with
respect to "qualifying loans," which are generally loans secured by certain
interests in real property, was permitted to be computed using an amount based
on a six-year moving average of the Bank's charge-offs for actual losses (the
"Experience Method"), or a percentage equal to 8% of the Bank's taxable income
(the "PTI Method"), computed without regard to this deduction and with
additional modifications and reduced by the amount of any permitted addition to
the non-qualifying reserve. The Bank's deduction with respect to non-qualifying
loans was required to be computed under the Experience Method. Each year the
Bank reviewed the most favorable way to calculate the deduction attributable to
an addition to the tax bad debt reserves, which historically has been the PTI
Method.
The 1996 Tax Act. Under the 1996 Tax Act, the PTI Method was repealed for
savings institutions and the Bank will be required to use only the Experience
Method of computing additions to its bad debt reserves for taxable years
beginning with the taxable year beginning October 1, 1996. In addition, the
Bank will be required to recapture (i.e., take into income) over a six year
period the excess of the balance of its bad debt reserves for losses on
nonqualifying and qualifying loans as of September 30, 1996 over the greater of
(a) the balance of such reserves as of September 30, 1988 or (b) an amount that
would have been the balance of such reserves as of September 30, 1996 had the
Bank always computed the additions to its reserves using the Experience Method.
However, under the 1996 Act, such recapture requirements will be suspended for
each of the Bank's two successive taxable years beginning October 1, 1996 in
which the Bank originates a minimum amount of certain residential loans during
such years that is not less than the average of the principal amounts of such
loans made by the Bank during its six taxable years preceding October 1, 1996.
The Bank's post-September 30, 1988 nonqualifying and qualifying bad debt
reserves at September 30, 1997 was approximately $239,000 which will require
the Bank to report an additional tax liability of approximately $98,000. Since
the Bank has already provided a deferred income tax liability of this amount
for financial reporting purposes, there will be no adverse impact to the Bank's
financial condition or results of operations from the enactment of this
legislation.
Distributions. Under the 1996 Tax Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of September 30, 1988) and then from the Bank's
supplemental reserve for losses on loans, to the extent thereof, and an amount
based on the amount distributed (but not in excess of the amount of such
reserves) will be included in the Bank's income. Non- dividend distributions
include distributions in excess of the Bank's current and accumulated earnings
and profits, as calculated for federal income tax purposes, distributions in
redemption of stock, and distributions in partial or complete liquidation.
Dividends paid out of the Bank's current or accumulated earnings and profits
will not be so included in the Bank's income.
The amount of additional taxable income created from a non-dividend
distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, approximately one and
one-half times the nondividend distribution would be includable in income for
federal income tax purposes, assuming a 34% federal corporate income tax rate.
The Bank does not intend to pay dividends that would result in a recapture of
any portion of its tax bad debt reserves.
Corporate Alternative Minimum Tax. The Code imposes a tax ("AMT") on
alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI
can be offset by net operating loss carryovers. AMTI is also adjusted by
determining the tax treatment of certain items in a manner that negates the
deferral of income resulting from the regular tax treatment of those items.
Thus, the Bank's AMTI is increased by an amount equal to 75% of the amount by
which the Bank's adjusted current earnings exceeds its AMTI (determined without
regard to this adjustment and prior to reduction for net operating losses). In
addition, for taxable years beginning after December 31, 1986 and before
January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with
certain modifications) over $2 million is imposed on corporations, including
the Bank, whether or not an AMT is paid. The Bank does not expect to be subject
to the AMT, but may be subject to the environmental tax liability.
Elimination of Dividends; Dividends Received Deduction. The Company may
exclude from its income 100% of dividends received from the Bank as a member of
the same affiliated group of corporations. A 70% dividends received deduction
generally applies with respect to dividends received from domestic corporations
that are not members of such affiliated group, except that an 80% dividends
received deduction applies if Bancorp and the Bank own more than 20% of the
stock of a corporation paying a dividend.
State Taxation
Massachusetts Taxation. The Bank currently files a separate Massachusetts
excise tax return, based on net income. Prior to July, 1995, the Bank was
subject to an annual Massachusetts excise (income) tax equal to 12.54% of its
pre-tax income. In 1995, legislation was enacted to reduce the Massachusetts
bank excise (income) tax rate and to allow Massachusetts-based financial
institutions to apportion income earned in other states. Further, this
legislation expands the applicability of the tax to non-bank entities and
out-of-state financial institutions. The Massachusetts excise tax rate for
co-operative banks is currently 11.32% of federal taxable income, adjusted for
certain items. It is anticipated that this rate will be gradually reduced over
the next few years so that the Bank's tax rate will become 10.5% by March 31,
2000. Taxable income includes gross income as defined under the Code, plus
interest from bonds, notes and evidences of indebtedness of any state,
including Massachusetts, less deductions, but not the credits, allowable under
the provisions of the Code. No deductions, however, are allowed for dividends
received until July 1, 1999. In addition, carryforwards and carrybacks of net
operating losses are not allowed.
The Bank's active subsidiary, Falmouth Securities Corporation, was
established solely for the purpose of acquiring and holding investments which
are permissible for banks to hold under Massachusetts law. Falmouth Securities
Corporation has applied to the Massachusetts Department of Revenue to qualify
as a "security corporation" under Massachusetts law, qualifying it to take
advantage of the 1.32% income tax rate on gross income applicable to companies
that are so classified.
The Bank and the Company are not permitted to file a combined
Massachusetts excise tax return. The Company will be subject to Massachusetts
corporate excise tax, which is determined by two measures: (1) the income
measure, a tax of 9.5% on net income attributable to Massachusetts; and (2) the
non-income measure, a tax of $2.60 per $1,000 imposed on either (a) tangible
property, if the corporation is a tangible property corporation, or (b) net
worth, if the corporation is an intangible property corporation. Unlike the
definition of net income for purposes of the Bank's taxation, net operating
loss carryovers and a 95% dividends received deduction for intercompany
dividends is permissible for corporations.
For additional information regarding taxation, see Note 7 of the Notes to
Financial Statements.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
REGULATION AND SUPERVISION
General
As a co-operative bank chartered by the Commonwealth of Massachusetts
whose deposits are insured by the BIF of the FDIC, the Bank is subject to
extensive regulation under state law with respect to many aspects of its
banking activities; this state regulation is administered by the Division of
Banks. In addition, the FDIC levies assessments or deposit insurance premiums
and is vested with authority to supervise the Bank and to exercise a broad
range of enforcement powers. Finally, the Bank is required to maintain reserves
against deposits according to a schedule established by the Federal Reserve
System. These laws and regulations have been established primarily for the
protection of depositors and the deposit insurance fund, not the Company's
stockholders.
The following references to the laws and regulations under which the Bank
is regulated are brief summaries thereof, do not purport to be complete and are
qualified in their entirety by reference to such laws and regulations.
Federal Banking Regulations
Capital Requirements. Under FDIC regulations, insured state-chartered
banks that are not members of the Federal Reserve System ("state non-member
banks") are required to maintain minimum levels of capital. State non-member
banks must satisfy a leverage capital ratio of Tier 1 capital to total assets
of at least 3% if the FDIC determines that the institution is not anticipating
or experiencing significant growth and has well diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity,
good earnings and is in general a strong banking organization, rated composite
1 under the Uniform Financial Institutions Ranking System (the CAMEL rating
system) established by the Federal Financial Institutions Examination Council.
For all but the most highly rated institutions meeting the conditions set forth
above, the minimum leverage capital ratio is 3% plus an additional "cushion"
amount of at least 100 to 200 basis points. Tier 1 capital is the sum of common
stockholders' equity, noncumulative perpetual preferred stock (including any
related surplus) and minority investments in certain subsidiaries, less most
intangible assets.
The FDIC has also adopted risk-based capital guidelines to which the Bank
is subject. The guidelines establish a systematic analytical framework designed
to make regulatory capital requirements sensitive to differences in risk
profiles among banking organizations. The FDIC guidelines require state
non-member banks to maintain certain levels of regulatory capital in relation
to regulatory risk-weighted assets. The ratio of such regulatory capital to
regulatory risk-weighted assets is referred to as the Bank's "risk-based
capital ratio." Risk-based capital ratios are determined by allocating assets
and specified off- balance sheet items to four risk-weighted categories ranging
from 0% to 100%, with higher levels of capital being required for the
categories perceived as representing greater risk. Under the FDIC's
risk-weighting system, cash and securities backed by the full faith and credit
of the U.S. government are given a 0% risk weight. Mortgage-backed securities
that qualify under the Secondary Mortgage Enhancement Act, including those
issued, or fully guaranteed as to principal and interest, by the FNMA or the
Federal Home Loan Mortgage Corporation ("FHLMC"), are assigned a 20% risk
weight. Single-family first mortgages not more than 90 days past due with
loan-to-value ratios under 80%, multi-family mortgages (maximum 36 dwelling
units) with loan-to-value ratios under 80% and average annual occupancy rates
over 80%, and certain qualifying loans for the construction of one- to
four-family residences pre-sold to home purchasers, are assigned a risk weight
of 50%. Consumer loans and commercial real estate loans, repossessed assets and
assets more than 90 days past due, as well as all other assets not specifically
categorized, are assigned a risk weight of 100%.
State non-member banks must maintain a minimum ratio of qualifying total
capital to risk-weighted assets of at least 8%, of which at least one-half must
be Tier 1 capital. Qualifying total capital consists of Tier 1 capital plus
Tier 2 or supplementary capital items, which include allowances for loan losses
in an amount of up to 1.25% of risk-weighted assets, cumulative preferred
stock, preferred stock with a maturity of over 20 years, and certain other
capital instruments. The includable amount of Tier 2 capital cannot exceed the
amount of the institution's Tier 1 capital. Qualifying total capital is further
reduced by the amount of the bank's investments in banking and finance
subsidiaries that are not consolidated for regulatory capital purposes,
reciprocal cross-holdings of capital securities issued by other banks and
certain other deductions.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
required each federal banking agency to revise its risk-based capital standards
for insured institutions to ensure that those standards take adequate account
of interest-rate risk ("IRR"), concentration of credit risk, and the risk of
nontraditional activities, as well as to reflect the actual performance and
expected risk of loss on multi-family residential loans. In August 1995, the
FDIC, along with the other federal banking agencies, adopted a regulation
providing that the agencies will take account of the exposure of a bank's
capital and economic value to the risks of changes in interest rates in
assessing a bank's capital adequacy. According to the agencies, applicable
considerations include the quality of the bank's interest rate risk management
process, the overall financial condition of the bank, and the level of other
risks at the bank for which capital is needed. Institutions with significant
interest rate risk may be required to hold additional capital. The agencies
also issued a joint policy statement providing guidance on interest rate risk
management, including a discussion of the critical factors affecting the
agencies' evaluation of interest rate risk in connection with capital adequacy.
The agencies have determined not to proceed with a previously issued proposal
to develop a supervisory framework for measuring interest rate risk and to
require an explicit capital component for interest rate risk.
The following table shows the Bank's leverage capital ratio, its Tier 1
risk-based capital ratio, and its total risk-based capital ratio, at September
30, 1997. The Bank exceeded the minimum capital adequacy requirements at
September 30, 1997.
<TABLE>
<CAPTION>
At September 30, 1997
-------------------------------------------------
Percent
Capital Percent of Capital of
Amount Assets(1) Requirement Assets(1)
------- ---------- ----------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Tier 1 leverage capital $22,390 23.64% $3,789 4.00%
Tier 1 risk-based capital 22,390 41.36 2,166 4.00
Total risk-based capital 22,891 42.28 4,331 8.00
<FN>
- -------------------
<F1> For purposes of calculating the Tier 1 leverage capital ratio, assets
include adjusted total average assets. In calculating Tier 1 risk-based
capital and total risk-based capital ratio, assets include total
risk-weighted assets.
</FN>
</TABLE>
Enforcement
The FDIC has extensive enforcement authority over insured co-operative
banks, including the Bank. This enforcement authority includes, among other
things, the ability to assess civil money penalties, to issue cease and desist
orders and to remove directors and officers. In general, these enforcement
actions may be initiated in response to violations of laws and regulations and
to unsafe or unsound practices.
The FDIC has authority under federal law to appoint a conservator or
receiver for an insured bank under certain circumstances. The FDIC is required,
with certain exceptions, to appoint a receiver or conservator for an insured
state bank if that bank was "critically undercapitalized" on average during the
calendar quarter beginning 270 days after the date on which the bank became
"critically undercapitalized." For this purpose, "critically undercapitalized"
means having a ratio of tangible capital to total assets of less than 2%. The
FDIC may also appoint a conservator or receiver for a state bank on the basis
of the institution's financial condition or upon the occurrence of certain
events, including: (i) insolvency (whereby the assets of the bank are less than
its liabilities to depositors and others); (ii) substantial dissipation of
assets or earnings through violations of law or unsafe or unsound practices;
(iii) existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the bank will be unable to meet the demands of its depositors
or to pay its obligations in the normal course of business; and (v)
insufficient capital, or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
Deposit Insurance
The FDIC has adopted a risk-based deposit insurance assessment system.
The FDIC assigns an institution to one of three capital categories based on the
institution's financial information, as of the reporting period ending seven
months before the assessment period, consisting of (1) well capitalized, (2)
adequately capitalized or (3) undercapitalized, and one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information that the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is
assigned. Assessment rates for BIF deposits currently range from 0 basis points
to 27 basis points. The Bank's assessment rate is currently 0 basis points. The
FDIC is authorized to raise the assessment rates in certain circumstances,
including to maintain or achieve the designated reserve ratio of 1.25%, which
requirement the BIF currently meets. The FDIC has exercised its authority to
raise rates in the past and may raise insurance premiums in the future. If such
action is taken by the FDIC, it could have an adverse effect on the earnings of
the Bank. In addition, recent legislation requires BIF-insured institutions
like the Bank to assist in the payment of FICO bonds.
Under the Deposit Insurance Funds Act of 1996 (the "Funds Act"), the
assessment base for the payments on the FICO bonds was expanded to add,
beginning January 1, 1997, the deposits of BIF-insured institutions, such as
the Bank. Until December 31, 1999, or such earlier date on which the last
savings association ceases to exist, the rate of assessment for BIF-assessable
deposits shall be one-fifth of the rate imposed on SAIF-assessable deposits.
The annual rate of assessments for the payments on the FICO bonds for the
semi-annual period beginning on January 1, 1997 was 0.0130% for BIF-assessable
deposits and 0.0648% for SAIF-assessable deposits and for the semi-annual
period beginning on July 1, 1997 was 0.0126% for BIF-assessable deposits and
0.0630% for SAIF-assessable deposits.
Under the Federal Deposit Insurance Act (the "FDI Act"), insurance of
deposits may be terminated by the FDIC upon a finding that the institution has
engaged in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, rule, order
or condition imposed by the FDIC or the Division. The management of the Bank
does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
Transactions with Affiliates and Insiders
Transactions between state non-member banks and any affiliate are
governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a
bank is any company or entity which controls, is controlled by or is under
common control with the bank but does not include a subsidiary of the bank.
Generally, Section 23A (i) limits the extent to which the bank or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such bank's capital and surplus, and contains an
aggregate limit on all such transactions with all affiliates to an amount equal
to 20% of such capital and surplus and (ii) requires that all such transactions
be on terms that are consistent with safe and sound banking practices. The term
"covered transaction" includes the making of loans, purchase of assets,
issuance of guarantees and similar other types of transactions. In addition,
most extensions of credit by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100% to 130% of the loan amounts, depending
on the type of collateral. Section 23B requires that any covered transaction,
and certain other transactions, including the bank's sale of assets and
purchase of services from an affiliate must be on terms that are substantially
the same, or at least as favorable, to the institution as those that would
prevail in a comparable transaction with a non-affiliate.
Banks are also subject to the restrictions contained in Section 22(h) of
the Federal Reserve Act and the FRB's Regulation O thereunder on loans to
executive officers, directors and principal stockholders. Under Section 22(h),
loans to a director, an executive officer or a holder of more than 10% of the
shares of a bank, as well as certain affiliated interests of such persons, may
not exceed, together with all other outstanding loans to such person and
affiliated interests, the loans-to-one-borrower limit applicable to national
banks (generally 15% of an institution's unimpaired capital and surplus) and
all loans to all such persons in the aggregate may not exceed an institution's
unimpaired capital and unimpaired surplus. Regulation O also prohibits the
making of loans in an amount greater than the lesser of $25,000 or 5% of
capital and surplus but in any event over $500,000, to a director, executive
officer and greater than 10% stockholder of a bank, and the respective
affiliates of such a person, unless such loans are approved in advance by a
majority of the board of directors of the bank, with any "interested" director
not participating in the voting. Further, the FRB pursuant to Regulation O
requires that loans to directors, executive officers and principal stockholders
(a) be made on terms substantially the same as those that are offered in
comparable transactions to persons not affiliated with the bank and (b) follow
credit underwriting procedures not less stringent than those prevailing for
comparable transactions with persons not affiliated with the bank. Regulation O
also prohibits a depository institution from paying, with certain exceptions,
an overdraft of any of the executive officers or directors of the institution
or any of its affiliates unless the overdraft is paid pursuant to written
pre-authorized extension of interest-bearing extension of credit or transfer of
funds from another account at the bank.
State chartered non-member banks are further subject to the requirements
and restrictions against certain tying arrangements and on extensions of credit
involving correspondent banks. Specifically, a depository institution is
prohibited from extending credit to or offering any other service, or fixing or
varying the consideration for such extension of credit or service, on the
condition that the customer obtain some additional service from the institution
or certain of its affiliates or not obtain services of a competitor of the
institution, subject to certain exceptions. In addition, a depository
institution with a correspondent banking relationship with another depository
institution is prohibited from extending credit to the executive officers,
directors, and holders of more than 10% of the stock of the other depository
institution, unless such extension of credit is on substantially the same terms
as those prevailing at the time for comparable transactions with other persons
and does not involve more than the normal risk of repayment or present other
unfavorable features.
Real Estate Lending Policies
Under FDIC regulations which became effective March 19, 1993,
state-chartered nonmember banks must adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit that are
secured by liens or interest in real estate or are made for the purpose of
financing permanent improvements to real estate. These policies must establish
loan portfolio diversification standards, prudent underwriting standards,
including loan-to-value limits, that are clear and measurable, loan
administration procedures and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of
the Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") that have been adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon a depository
institution to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multi-family or other nonresidential property, the supervisory limit is 80%;
(iv) for loans for the construction of one- to four-family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including non-owner-occupied, one- to four-family property), the limit
is 85%. Although no supervisory loan-to-value limit has been established for
owner-occupied, one- to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
Standards for Safety and Soundness
Under FDICIA, each federal banking agency is required to prescribe, by
regulation, safety and soundness standards for institutions under its
authority. The federal banking agencies, including the FDIC, have adopted
standards covering internal controls, information systems and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, employee compensation, fees, and benefits, asset quality and earnings
sufficiency. These standards are in the form of broad guidelines for
performance that generally leave to each institution the methods for achieving
the objectives. The Bank believes it meets the FDIC's safety and soundness
standards.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
Federal Home Loan Banks subject to supervision and regulation by the Federal
Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a central
credit facility primarily for member institution. As a member of the FHLB, the
Bank is required to acquire and hold shares of capital stock in the FHLB in an
amount at least equal to 1% of the aggregate unpaid principal of its home
mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB,
whichever is greater. Falmouth was in compliance with this requirement with an
investment in FHLB of Boston stock at September 30, 1997, of $405,200.
The FHLB of Boston serves as a reserve or central bank for its member
institutions within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It offers
policies and procedures established by the FHFB and the Board of Directors of
the FHLB of Boston. Long-term advances may only be made for the purpose of
providing funds for residential housing finance.
Federal Reserve System
Pursuant to regulations of the FRB, a bank must maintain average daily
reserves equal to 3.0% on the first $52 million of net transaction accounts,
above an exempt amount of $4.3 million, plus 10% on the remainder. This
percentage is subject to adjustment by the FRB. Because required reserves must
be maintained in the form of vault cash or in a non-interest bearing account at
a Federal Reserve Bank, the effect of the reserve requirement is to reduce the
amount of the institution's interest-earning assets. As of September 30, 1997,
the Bank met its reserve requirements.
Massachusetts Banking Laws and Supervision
Massachusetts co-operative banks such as the Bank are also regulated and
supervised by the Division of Banks. The Division of Banks is required to
regularly examine each state-chartered bank. The approval of the Division of
Banks is required to establish or close branches, to merge with another bank,
to form a bank holding company, to issue stock or to undertake many other
activities. Any Massachusetts bank that does not operate in accordance with the
regulations, policies and directives of the Division of Banks is subject to
sanctions. The Division of Banks may under certain circumstances suspend or
remove directors or officers of a bank who have violated the law, conducted a
bank's business in a manner which is unsafe, unsound or contrary to the
depositors' interests, or been negligent in the performance of their duties.
All Massachusetts-chartered co-operative banks are required to be members
of the Co-operative Central Bank and are subject to its assessments. The
Co-operative Central Bank maintains the Share Insurance Fund, a private deposit
insurer, which insures all deposits in member banks in excess of FDIC deposit
insurance limits. In addition, the Co-operative Central Bank acts as a source
of liquidity to its members in supplying them with low-cost funds, and
purchasing certain qualifying obligations from them.
Major changes in Massachusetts law in 1982 and 1983 substantially
expanded the powers of co-operative banks. Their powers were made virtually
identical to those of state-chartered commercial banks. The powers which
Massachusetts-chartered co-operative banks can exercise under these laws are
summarized below.
Lending Activities. A wide variety of mortgage loans may be made.
Fixed-rate loans, adjustable-rate loans, variable-rate loans, participation
loans, graduated payment loans, construction loans, condominium and
co-operative loans, second mortgage loans and other types of loans may be made
in accordance with applicable regulations. Mortgage loans may be made on real
estate in Massachusetts or in another New England state if the bank making the
loan has an office there or under certain other circumstances. In addition,
certain mortgage loans may be made on improved real estate located anywhere in
the United States. Commercial loans may be made to corporations and other
commercial enterprises with or without security. With certain exceptions, such
loans may be made without geographic limitations. Consumer and personal loans
may be made with or without security and without geographic limitations. Loans
to individual borrowers generally will be limited to 20% of the total of the
Bank's capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered co-operative banks have
broad investment powers under Massachusetts law, including so-called "leeway"
authority for investments that are not otherwise specifically authorized. The
investment powers authorized under Massachusetts law are restricted by federal
law to permit only investments of the kinds that would be permitted for
national banks. The Bank has authority to invest in all of the classes of loans
and investments that are permitted by its existing loan and investment
policies.
Payment of Dividends. A co-operative bank only may pay dividends on its
capital stock if such payment would not impair the bank's capital stock and
surplus account. No dividends may be paid to stockholders of a bank if such
dividends would reduce stockholders' equity of the bank below the amount of the
liquidation account required by Massachusetts conversion regulations.
Branches. With the approval of the Division of Banks, bank branches may
be established in any city or town in Massachusetts. In addition, co-operative
banks may operate automated teller machines at any of their offices or, with
the approval of the Division of Banks, anywhere in Massachusetts. Sharing of
ATMs or "networking" is also permitted with the approval of the Division of
Banks. Massachusetts chartered co-operative banks may also operate ATMs outside
of Massachusetts if permitted to do so by the law of the jurisdiction in which
the ATM is located.
Interstate Acquisitions. In 1996, the Massachusetts legislature passed a
new interstate banking statute in anticipation of the June 1, 1997 effective
date of the federal interstate banking law. Pursuant to this statute, an
out-of-state bank may (subject to various regulatory approvals and to
reciprocity in its home state) establish and maintain bank branches in
Massachusetts by (i) merging with a Massachusetts bank that has been in
existence for at least three years, (ii) acquiring a branch or branches of a
Massachusetts bank without acquiring the entire bank, or (iii) opening such
branches de novo. Massachusetts banks' ability to exercise similar interstate
banking powers in other states depends upon the laws of the other states. For
example, according to the law of the bordering state of New Hampshire,
out-of-state banks may acquire New Hampshire banks by merger, but may not
establish de novo branches in New Hampshire.
Other Powers. Massachusetts-chartered co-operative banks may also lease
machinery and equipment, act as trustee or custodian for tax qualified
retirement plans, establish trust departments and act as professional trustee
or fiduciary, provide payroll services for their customers, issue or
participate with others in the issuance of mortgage-backed securities and
establish mortgage banking companies and discount securities brokerage
operations. Some of these activities require the prior approval of the Division
of Banks.
Regulation of Holding Company
Federal Regulation. The Company is subject to examination, regulation and
periodic reporting under the BHCA, as administered by the FRB. The FRB has
adopted capital adequacy guidelines for bank holding companies on a
consolidated basis substantially similar to those of the FDIC for the Bank.
The Company is required to obtain the prior approval of the FRB and the
Massachusetts Board of Bank Incorporation ("BBI") to acquire all, or
substantially all, of the assets or any bank of bank holding company. Prior FRB
and BBI approval would be required for the Company to acquire direct or
indirect ownership or control of any voting securities of any bank or bank
holding company if, after giving effect to such acquisition, it would, directly
or indirectly, own or control more than 5% of any class of voting shares of
such bank or bank holding company.
Bancorp will be required to give the FRB prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding
12 months, is equal to 10% or more of Bancorp's consolidated net worth. The FRB
may disapprove such a purchase or redemption if it determines that the proposal
would constitute an unsafe and unsound practice, or would violate any law,
regulation, FRB order or directive, or any condition imposed by, or written
agreement with, the FRB. Such notice and approval is not required for a bank
holding company that would be treated as "well capitalized" under applicable
regulations of the FRB, that has received a composite "1" or "2" rating at its
most recent bank holding company inspection by the FRB, and that is not the
subject of any unresolved supervisory issues.
The status of Bancorp as a registered bank holding company under the BHCA
will not exempt it from certain federal and state laws and regulations
applicable to corporations generally, including, without limitation, certain
provisions of the federal securities laws.
In addition, a bank holding company is prohibited generally from engaging
in, or acquiring 5% or more of any class of voting securities of any company
engaged in, non-banking activities. One of the principal exceptions to this
prohibition is for activities found by the FRB to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
Some of the principal activities that the FRB has determined by regulation to
be so closely related to banking as to be a proper incident thereto are: (i)
making or servicing loans; (ii) performing certain data processing services;
(iii) providing discount brokerage services; (iv) acting as fiduciary,
investment or financial advisor; (v) leasing personal or real property; (vi)
making investments in corporations or projects designed primarily to promote
community welfare; and (vii) acquiring a savings and loan association.
Under FIRREA, depository institutions are liable to the FDIC for losses
suffered or anticipated by the FDIC in connection with the default of a
commonly controlled depository institution or any assistance provided by the
FDIC to such an institution in danger of default. This law would have potential
applicability if Bancorp ever acquired as a separate subsidiary a depository
institution in addition to the Bank. There are no current plans for such an
acquisition.
Subsidiary banks of a bank holding company are subject to certain
quantitative and qualitative restrictions imposed by the Federal Reserve Act on
any extension of credit to, or purchase of assets from, or letter of credit on
behalf of, the bank holding company or its subsidiaries, and on the investment
in or acceptance of stocks or securities of such holding company or its
subsidiaries as collateral for loans. In addition, provisions of the Federal
Reserve Act and FRB regulations limit the amounts of, and establish required
procedures and credit standards with respect to, loans and other extensions of
credit to officers, directors and principal stockholders of the Bank, Bancorp,
any subsidiary of Bancorp and related interests of such persons. Moreover,
subsidiaries of bank holding companies are prohibited from engaging in certain
tie-in arrangements (with the holding company or any of its subsidiaries) in
connection with any extension of credit, lease or sale of property or
furnishing of services.
Federal Securities Laws
The Company's Common Stock is registered with the SEC under Section 12(b)
of the Securities Exchange Act of 1934 (the "Exchange Act") . The Company is
subject to the information, proxy solicitation, insider trading restrictions
and other requirements under the Exchange Act.
ITEM 2. DESCRIPTION OF PROPERTY.
The following table sets forth certain information at September 30, 1997
regarding Falmouth's office facilities, and certain other information relating
to the properties at that date.
<TABLE>
<CAPTION>
Net Book Value
Year Completed at September 30,
or Acquired Square Footage 1997
-------------- -------------- ----------------
<S> <C> <C> <C>
Main Office: 1978 10,696 $282,106
20 Davis Straits
Falmouth, MA 02540
Branch Offices:
North Falmouth, MA 1997 400 23,321
91 County Rd.
N. Falmouth, MA 02556
East Falmouth, MA 1997 2,200 354,308
775 E. Falmouth Hwy
E. Falmouth, MA 02536
</TABLE>
At September 30, 1997, the net book value of Falmouth's computer
equipment and other furniture, fixtures and equipment at its office totaled
$1.0 million. For more information, see Note 5 of Notes to Financial
Statements.
ITEM 3. LEGAL PROCEEDINGS.
Although the Bank and the Company, from time to time, are involved in
various legal proceedings in the normal course of business, there are no
material legal proceedings to which the Bank or the Company, its directors or
its officers is a party or to which any of its property is subject as of the
date of this Form 10-KSB.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE BANK'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The following information included in the Falmouth Bancorp, Inc. 1997
Annual Report to Stockholders (the "Annual Report") is incorporated herein by
reference: "Market for the Bank's Common Stock."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information included in the Falmouth Bancorp, Inc.1997
Annual Report to Stockholders (the "Annual Report") is incorporated herein by
reference: "Management's Discussion and Analysis of Financial Condition and
Results of Operations"
Asset/Liability Management
A principal operating objective of the Bank is to produce stable earnings
by achieving a favorable interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Since the Bank's principal
interest-earning assets have longer terms to maturity than its primary source
of funds, i.e., deposit liabilities, increases in general interest rates will
generally result in an increase in the Bank's cost of funds before the yield on
its asset portfolio adjusts upwards. Banking institutions generally have sought
to reduce their exposure to adverse changes in interest rates by attempting to
achieve a closer match between the periods in which their interest-bearing
liabilities and interest-earning assets can be expected to reprice through the
origination of adjustable-rate mortgages and loans with shorter terms and the
purchase of other shorter term interest-earning assets.
The term "interest rate sensitivity" refers to those assets and
liabilities which mature and reprice periodically in response to fluctuations
in market rates and yields. Thrift institutions historically have operated in a
mismatched position with interest-sensitive liabilities exceeding
interest-sensitive assets in the short-term time periods. As noted above, one
of the principal goals of the Bank's asset/liability program is to more closely
match the interest rate sensitivity characteristics of the asset and liability
portfolios.
In order to properly manage interest rate risk, the Bank's Board of
Directors has an Executive Committee to monitor the difference between the
Bank's maturing and repricing assets and liabilities and to develop and
implement strategies to decrease the "negative gap" between the two. The
primary responsibilities of the committee are to assess the Bank's
asset/liability mix, recommend strategies to the Board of Directors that will
enhance income while managing the Bank's vulnerability to changes in interest
rates and report to the Board of Directors the results of the strategies used.
Since the mid 1980s, the Bank has stressed the origination of
adjustable-rate residential mortgage loans and adjustable-rate home equity
loans. Historically, the Bank did not retain fixed rate loans with terms in
excess of 15 years in its portfolio. Beginning in March, 1995, the Bank
retained a portion of its fixed rate loans with terms in excess of 15 years in
the portfolio. At September 30, 1997, the Bank's loan portfolio included $26.0
million of adjustable-rate mortgages and $2.8 million of adjustable-rate home
equity loans which together represent 53.0% of the Bank's total loans.
In order to increase the interest rate sensitivity of its assets, the
Bank has also maintained a consistent level of investment securities and other
assets of maturities of three years or less. At September 30, 1997, the Bank
had $15.7 million of investment securities maturing within one year or less and
$12.7 million of investment securities maturing over one through five years.
In the future, in managing its interest rate sensitivity, the Bank
intends to continue to stress the origination of adjustable-rate mortgages and
loans with shorter maturities and the maintenance of a consistent level of
short-term securities.
Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and
by monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities, and is considered
negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. Generally, during a period of rising
interest rates, a negative gap would adversely affect net interest income while
a positive gap would result in an increase in net interest income, while
conversely during a period of falling interest rates, a negative gap would
result in an increase in net interest income and a positive gap would
negatively affect net interest income.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1997 which are
expected to mature or reprice in each of the time periods shown. The investment
securities and mortgage backed securities in the following table are presented
at amortized cost.
<TABLE>
<CAPTION>
At September 30, 1997
-------------------------------------------------------
Over One Over Five
One Year Through Through Over Ten
or Less Five Years Ten Years Years Total
-------- ---------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities..................... $ 15,744 $ 10,581 $ 2,073 $ -- $ 28,398
Mortgage-backed securities................ -- -- 583 2,769 3,352
Other interest-earning assets............. 1,395 4,233 -- -- 5,628
Adjustable rate 1-4 family loans.......... 12,466 12,374 1,178 -- 26,018
Fixed rate 1-4 family loans............... 258 690 2,023 18,886 21,857
Commercial real estate loans.............. 4,418 631 -- 113 5,162
Consumer and commercial loans............. 1,223 122 -- -- 1,345
-------------------------------------------------------
Total................................. $ 35,504 $ 28,631 $ 5,857 $ 21,768 $ 91,760
=======================================================
Interest-bearing liabilities:
Certificates of deposit................... $ 29,826 $ 7,292 $ -- $ 15 $ 37,133
Money market accounts..................... 9,111 -- -- -- 9,111
NOW accounts.............................. 6,983 -- -- -- 6,983
Passbook accounts......................... 15,828 -- -- -- 15,828
ESOP loan................................. -- 742 -- -- 742
-------------------------------------------------------
Total................................. $ 61,748 $ 8,034 $ -- $ 15 $ 69,797
=======================================================
Interest sensitivity gap.................. (26,244) 20,597 5,857 21,753 21,963
Cumulative interest sensitivity gap....... (26,244) (5,647) 210 21,963
Ratio of cumulative gap to total assets... (27.23%) (5.86%) .22% 22.80%
</TABLE>
Management believes the current one-year gap of negative 27.23% presents
a risk to net interest income should a sustained increase occur in the current
level of interest rates. If interest rates increase, the Bank's negative
one-year gap should cause the net interest margin to decrease. A conservative
rate-gap policy provides a stable net interest income margin. Accordingly,
management emphasizes a structured schedule of investments spread by term to
maturity with greater emphasis on maturities of one year or less. The preceding
table utilized no assumptions or adjustments regarding prepayment of loans and
decay rates based upon Falmouth's actual experience. Accordingly, it is
possible that the actual interest rate sensitivity of the Bank's assets and
liabilities could vary significantly from the information set forth in the
table due to market and other factors.
Certain shortcomings are inherent in the method of analysis presented.
Although certain assets and liabilities may have similar maturity or periods of
repricing, they may react in different degrees to changes in the market
interest rates. The interest rates on certain types of assets and liabilities
may fluctuate in advance of changes in market interest rates, while rates on
other types of assets and liabilities may lag behind changes in market interest
rates. Certain assets, such as adjustable-rate mortgages, generally have
features which restrict changes in interest rates on a short-term basis and
over the life of the asset. In the event of a change in interest rates,
prepayments and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Additionally, an increased credit risk
may result as the ability of many borrowers to service their debt may decrease
in the event of an interest rate increase. Virtually all of the adjustable-rate
loans in the Bank's portfolio contain conditions which restrict the periodic
change in interest rate.
Average Balances, Interest and Average Yields
The following tables set forth certain information relating to the Bank's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and
rates paid for the periods indicated. Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from monthly balances. Management does not believe that the use of
monthly balances instead of daily balances has caused any material difference
in the information presented. Interest earned on loan portfolios is net of
reserves for uncollected interest.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans, net:
Mortgages $43,301 $3,416 7.89% $32,693 $2,573 7.87% $26,867 $2,113 7.86%
Consumer and other 3,987 360 9.03 3,694 393 10.64 3,377 313 9.27
------- ------ ------- ------ ------- ------
Total loans, net 47,288 3,776 7.99 36,387 2,966 8.15 30,244 2,426 8.02
Investments 34,120 2,085 6.11 37,086 2,154 5.81 34,096 2,031 5.96
Other earning assets 7,372 398 5.40 7,203 456 6.33 5,633 358 6.36
------- ------ ------- ------ ------- ------
Total interest-earning assets 88,780 6,259 7.05 80,676 5,576 6.91 69,973 4,815 6.88%
------ ------ ------
Cash and due from banks 1,161 1,080 910
Other assets 1,417 1,387 1,461
------- ------- -------
Total assets $91,358 $83,143 $72,344
======= ======= =======
Liabilities:
Interest-bearing liabilities:
Deposits:
Savings deposits $14,118 $ 360 2.55% $13,829 $ 366 2.65% $14,143 $ 357 2.53%
NOW 5,690 54 .95 5,972 73 1.22 4,930 74 1.50
Money market deposits 8,303 254 3.06 8,081 259 3.21 8,879 288 3.24
Certificates of deposit 37,603 2,060 5.48 37,198 2,100 5.65 35,386 1,768 5.00
Borrowed money 785 66 8.41 429 35 8.16 -- -- --
------- ------ ------- ------ ------- ------
Total interest-bearing
liabilities 66,499 2,794 4.20 65,509 2,833 4.32% 63,338 2,487 3.93%
------ ------ ------
Non-interest bearing liabilities 2,617 1,375 1,008
------- ------- -------
Total liabilities 69,116 66,884 64,346
Stockholders' equity 22,242 16,259 7,998
------- ------- -------
Total liabilities and
stockholders' equity $91,358 $83,143 $72,344
======= ======= =======
Net interest and dividend income $3,465 $2,743 $2,328
====== ====== ======
Interest rate spread 2.85% 2.59% 2.95%
Net interest margin 3.90% 3.40% 3.33%
Ratio of average interest-earning
assets to average interest-
bearing liabilities 133.51% 123.15% 110.48%
</TABLE>
Rate/Volume Analysis
The following table sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change
in rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) are allocated between changes in rate and
changes in volume.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
Increase (Decrease) Increase (Decrease)
Due To Due To
------------------------- -------------------------
Volume Rate Total Volume Rate Total
------ ------- ------ ------ ------- ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $ 869 $ (59) $ 810 $ 494 $ 46 $ 540
Investments (167) 40 (127) 277 (56) 221
------------------------------------------------------
Total interest-earning assets 702 (19) 683 771 (10) 761
------------------------------------------------------
Interest-bearing liabilities:
Savings deposits 8 (14) (6) (8) 16 8
NOW (3) (16) (19) 14 (15) (1)
Money Market deposits 7 (12) (5) (27) (2) (29)
Certificates of Deposit 23 (63) (40) 98 234 332
ESOP loan 29 2 31 35 -- 35
------------------------------------------------------
Total interest-bearing liabilities 64 (103) (39) 112 233 345
------------------------------------------------------
Net change in net interest income $ 638 $ 84 $ 722 $ 659 $ (243) $ 416
======================================================
</TABLE>
Impact of New Accounting Standards
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. SFAS No. 125 provides
consistent standards for distinguishing transfers of financial assets that are
sales from transactions that are secured borrowings. SFAS No. 125 is effective
for transfers occurring after December 31, 1996. In December 1996, the FASB
issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of
FASB State No. 125, an Amendment of FASB Statement No. 125." In February 1997,
the FASB issued SFAS No. 128, "Earnings per Share," which provides for the
computation, presentation and disclosure requirements for earnings per share.
SFAS No. 128 simplifies the computation of earnings per share for common stock
and potential common stock. The adoption of SFAS Nos. 125, 127 and 128 is not
expected to have a material effect on the Bank's or the Company's future
financial condition, results of operations or reported results of operations.
In June of 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). Accounting principles generally require all recognized
revenue, expenses, gains and losses to be included in net income. Various FASB
statements, however, require companies to report certain changes in assets and
liabilities as a separate component of the equity section of the balance sheet
such as unrealized gains and losses on available for sale securities. This such
item, along with net income, is a component of comprehensive income. SFAS 130
is effective for fiscal years beginning after December 15, 1997, and is not
expected to have a material impact on the Company.
Also, in June of 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information," ("SFAS 131"). SFAS 131 is effective for financial statements for
periods beginning after December 15, 1997 and is not expected to have a
material effect on the Company. SFAS 131 establishes standards for the way that
public companies report information about operating segments in annual
financial statements and selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Generally, financial information is required to be reported on the
basis that it is used internally for evaluating segment performance and
deciding how to allocate resources to segments.
SFAS 131 also requires companies to report information about the way that
the operating segments were determined, the product and services provided by
the operating segments, differences between the measurements used in reporting
segment information and those used by the company in its general purpose
financial statements, and changes in the measurement of segment amounts from
period to period.
Year 2000
All of the material data processing of the Bank that could be affected by
this potential Year 2000 problem is provided by a third party service bureau.
The service bureau of the Bank has advised the Bank that it expects to resolve
any Year 2000 issues by December 31, 1998. However, if the service bureau is
unable to solve this potential problem in time, the Bank would likely
experience significant data processing delays, mistakes or failures. These
delays, mistakes or failures could have a significant adverse impact on the
financial condition and results of operation of the Bank.
Internally, the Bank has determined that continued monitoring of the
progress made by outside vendors will be key to a successful move into the next
millennium. The Bank does not believe that the costs associated with its
actions and those of its vendors will be material.
An FDIC off-site examinations was conducted on September 9, 1997 and
based upon the examination results, the Bank was considered to be (1) aware of
the Year 2000 issues; (2) advanced in reviewing the issues with outside
vendors; (3) advanced in evaluating internal software and hardware; (4) in
compliance with Year 2000 Director awareness; and (5) making progress with its
Year 2000 action plan.
ITEM 7. FINANCIAL STATEMENTS
The following information included in the Annual Report is incorporated
herein by reference: "Financial Statements and Notes to Financial Statements."
ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND PRINCIPAL OFFICERS OF THE BANK
(a) Directors of the Bank
---------------------
The following information included in the Proxy Statement is incorporated
herein by reference: "Proposal 1 -- Election of Directors."
(b) Principal Officers of the Company and the Bank
----------------------------------------------
The following information included in the Proxy Statement is incorporated
herein by reference: "Management of the Company."
(c) Compliance with Section 16 (a) of the Exchange Act
--------------------------------------------------
The following information included in the Proxy Statement is incorporated
herein by reference: "Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 10. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is incorporated
herein by reference: "Proposal 1 -- Election of Directors -- Directors'
Compensation," "-- Summary Compensation Table," "-- Certain Employee Benefit
Plans and Employment Agreement" and "-- Transactions with Certain Related
Persons."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included in the Proxy Statement is incorporated
herein by reference: "Stock Ownership of Management" and "Security Ownership of
Certain Beneficial Owners."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included in the Proxy Statement is incorporated
herein by reference: "Transactions with Certain Related Persons."
ITEM 13. EXHIBIT AND REPORTS ON FORM 8-K
(a) (1) The following financial statements included in the 1997
Annual Report are incorporated herein by reference:
Balance Sheets -- At September 30, 1997 and 1996;
Statements of Income -- Years Ended September 30, 1997, 1996 and
1995;
Statements of Changes in Stockholders' Equity -- Years Ended
September 30, 1997, 1996 and 1995;
Statements of Cash Flows -- Years Ended September 30, 1997, 1996
and 1995; and
Notes to Financial Statements -- Years Ended September 30, 1997,
1996 and 1995
(b) Exhibits. The following exhibits are either filed as part of this
report or are incorporated herein by reference:
3.1 Certificate of Incorporation of Falmouth Bancorp, Inc.(1)
3.2 By-laws of Falmouth Bancorp, Inc.(1)
4.3 Specimen Stock Certificate of Falmouth Bancorp, Inc.(1) .
10.1 1997 Stock Option Plan for Outside Directors, Officers
and Employees of Falmouth Bancorp, Inc.(1)
10.2 1997 Recognition and Retention Plan for Outside Directors,
Officers and Employees of Falmouth Bancorp, Inc.(1)
10.3 Agreement and Plan of Reorganization by and among Falmouth
Co-operative Bank and Falmouth Bancorp, Inc., dated November
25, 1997 (1)
10.4 Employment Agreement by and between Falmouth Co-operative
Bank and Santo Pasqualucci.(1)
10.5 Employment Agreement by and between Falmouth Co-operative
Bank and George Young.(1)
10.6 Falmouth Co-operative Bank Employee Stock Ownership Plan.(1)
10.7 Falmouth Bancorp, Inc. Employee Stock Ownership Trust.(1)
13 Annual Report to Stockholders for the Year Ended September
30, 1997.
14 1997 Proxy Statement to Stockholders, dated December 23,
1997.(2)
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.*
- -------------------
(1) Incorporated herein by reference Registration Statement on Form S-4
(Registration No. 333- 16931), as filed with the Securities and Exchange
Commission on November 27, 1996.
(2) Incorporated by reference, to Schedule 14A filed with the Securities and
Exchange Commission on December 23, 1997.
* Filed in electronic format only.
b. Reports on Form 8-K.
None.
This Form 10-KSB contains certain forward looking statements consisting
of estimates with respect to the financial condition, results of operations and
business of the Bank and the Company that are subject to various factors which
could cause actual results to differ materially from these estimates. These
factors include: changes in general, economic and market conditions, or the
development of an adverse interest rate environment that adversely affects the
interest rate spread or other income anticipated from the Bank's or the
Company's operations and investments.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FALMOUTH BANCORP, INC.
By: /s/ Santo P. Pasqualucci
-------------------------------------------
Santo P. Pasqualuuci
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ---------------------------------- --------------------------------------- ------------------
<S> <C> <C>
/s/ Santo P. Pasqualucci Director, President and Chief Executive December 16, 1997
- ---------------------------------- Officer (Principal executive officer)
Santo P. Pasqualucci
/s/ George E. Young, III Vice President and Chief Financial December 16, 1997
- ---------------------------------- Officer (Principal financial officer)
George E. Young, III
/s/ John W. Holland, Jr. Director December 16, 1997
- ----------------------------------
John W. Holland, Jr.
/s/ James A. Keefe Director December 16, 1997
- ----------------------------------
James A. Keefe
/s/ Gardner L. Lewis Director December 16, 1997
- ----------------------------------
Gardner L. Lewis
/s/ John J. Lynch, Jr. Director December 16, 1997
- ----------------------------------
John J. Lynch, Jr.
/s/ Ronald L. McLane Director December 16, 1997
- ----------------------------------
Ronald L. McLane
/s/ Eileen C. Miskell Director December 16, 1997
- ----------------------------------
Eileen C. Miskell
/s/ Robert H. Moore Director December 16, 1997
- ----------------------------------
Robert H. Moore
/s/ Walter A. Murphy Director December 16, 1997
- ----------------------------------
Walter A. Murphy
/s/ William E. Newton Director December 16, 1997
- ----------------------------------
William E. Newton
/s/ Armand Ortins Director December 16, 1997
- ----------------------------------
Armand Ortins
</TABLE>
FALMOUTH BANCORP, INC.
Annual Report
1997
TABLE OF CONTENTS
<TABLE>
<S> <C>
Company Profile................................................................. 1
President's Message............................................................. 2
Financial Highlights............................................................ 3
Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 5
Market for the Company's Common Stock .......................................... 10
Independent Auditors' Reports................................................... 11
Balance Sheets.................................................................. 12
Statements of Income............................................................ 13
Statements of Changes in Stockholders' Equity................................... 14
Statements of Cash Flows........................................................ 15
Notes to Financial Statements................................................... 17
Directors and Corporate Information............................................. Inside Back Cover
</TABLE>
This Annual Report to Stockholders contains certain forward looking
statements consisting of estimates with respect to the financial condition,
results of operations and business of the Company and the Bank that are subject
to various factors which could cause actual results to differ materially from
these estimates. These factors include: changes in general, economic and market
conditions, or the development of an adverse interest rate environment that
adversely affects the interest rate spread or other income anticipated from the
Bank's operations and investments.
COMPANY PROFILE
Falmouth Bancorp, Inc. (the "Company" or "Bancorp") was incorporated for
the purpose of becoming the holding company for Falmouth Cooperative Bank (the
"Bank"), a Massachusetts- chartered stock co-operative bank. The Bank converted
to stock form on March 28, 1996, and issued 1,454,750 shares of common stock at
$10.00 per share. In October 1997, the Bank became the wholly-owned subsidiary
of the Company.
The Bank had total assets of $96.4 million as of September 30, 1997. The
Bank conducts its business through an office located in Falmouth,
Massachusetts, where it was originally founded in 1925 as a Massachusetts
chartered mutual co-operative Bank, and two branches located in East Falmouth
and North Falmouth, Massachusetts. The Bank's deposits are currently insured up
to applicable limits by the Bank Insurance Fund of the Federal Deposit
Insurance Corporation and the Share Insurance Fund of the Co-operative Central
Bank of Massachusetts.
The Bank considers its primary market area to be the communities of
Falmouth and Mashpee in Barnstable County, Massachusetts.
The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank dedicated to financing home ownership
and consumer and small business needs in its market area and to provide quality
service to its customers. The Bank has implemented this strategy by: (i)
closely monitoring the needs of customers and providing quality service; (ii)
emphasizing consumer-oriented banking by originating residential mortgage loans
and consumer loans, and by offering checking accounts and other financial
services and products; (iii) focusing on expanding the volume of the Bank's
existing lending activities to produce moderate increases in loan originations;
(iv) maintaining high asset quality through conservative underwriting
standards; (v) maintaining capital in excess of regulatory requirements; and
(vi) producing stable earnings.
Falmouth Bancorp, Inc. is headquartered in Falmouth, Massachusetts. The
Company's stock trades on the American Stock Exchange under the symbol "FCB."
PRESIDENT'S MESSAGE
We believe that the strategic initiatives implemented during fiscal 1997
will prove to be one of the most pivotal years in the 72 year history of the
Bank. Key strategic initiatives were initiated to improve our prospects for
future growth opportunities and to enhance our financial performance. We feel a
sense of pride in our accomplishments and urgency to bring the Bank to the next
level.
Net income for the fiscal year ended September 30, 1997 was $752,000 or
$.55 per share as compared to $570,000 or $.32 per share for the prior year.
The increase of $182,000 or 33% in net income was primarily the result of a
$722,000 increase in net interest income and $120,000 increase in other income.
Net interest income continues to be a source of strength for the Bank powered
by an increase of $683,000 in interest and dividend income primarily due to the
continued growth in our loan portfolio. On September 30, 1997 92% of the loan
portfolio mix was in predominantly single family residential real estate as
compared to 91% at September 30, 1996. Total loans were 56% of total assets or
$53.9 million at September 30, 1997 as compared to 45% of total assets or $40.2
million at September 30, 1996. Loan production for fiscal 1997 was at an
unprecedented level which positioned the Bank as the leading force in the
Falmouth market for residential loan originations. Quality loan production
continues to override quantity of loans considerations.
Consistent with our stated goals of seeking out and identifying
opportunities for growth and expansion, we established our first branch office
in February 1997 and our second in August 1997. These branch facilities not
only help fulfill our long-term strategy to expand our delivery system, but
also bring greater diversity to our deposit base for growth and entry into the
East Falmouth and North Falmouth/Pocasset markets. We believe that the addition
of these branches has produced immediate value to your banking franchise.
The on-going expansion of our national and local economies coupled with
the continued favorable business outlook have not lulled us into a sense of
complacency, but one of vigilance and planning. To this end, your Company has
embraced a strategic planning process focused on the standard fundamentals of
understanding who we are, where we intend to go, and how we intend to get there
in the next few years. Internal debate which has been wide and far reaching,
has created greater clarity of our vision of where we want to be in the next
few years. In summary, your Company sees itself as the leading provider of
traditional banking products and services in the Falmouth and surrounding
markets. This will be accomplished by delivering our personal brand of
individualized service to an expanding customer base.
While we envision the component of our personal brand of individualized
service to be the cornerstone of our community bank tradition, we recognize and
embrace the need to incorporate proven technological advances into our array of
diversified products and services in order to expand our customer base.
Under the direction and support of our Board of Directors, we will
systematically execute our strategic plans which are inherently designed to
incorporate a balance of safety and soundness issues with those of increasing
profitability, asset quality and growth with increasing shareholder value.
It is interesting to note that since our conversion to stock form in
March 1996 at $10.00 per share, the original investors over an 18 month period
experienced a total value appreciation of 110.8%, including dividends, at
September 30, 1997 when the market price was $20.88
As we look ahead, we should recognize the dedication and energy of all
our employees and Board of Directors. We have made tremendous strides from a
mutual thrift to a progressive publically held company in a period of 18
months. We express our sincere appreciation to you, our shareholder, for your
continued confidence and support.
/s/ SANTO P. PASQUALUCCI
Santo P. Pasqualucci
President & Chief Executive Officer
FINANCIAL HIGHLIGHTS
The selected consolidated financial and other data of the Company and the
Bank set forth below is derived in part from and should be read in conjunction
with the Financial Statements of the Bank and Notes thereto.
<TABLE>
<CAPTION>
At September 30,
-------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total amount of:
Assets...................................... $96,391 $90,516 $73,679 $74,666 $75,144
Loans, net.................................. 53,881 40,237 32,503 27,584 28,956
Investment Securities(1).................... 36,402 45,553 35,576 38,992 35,326
Deposits.................................... 72,191 66,439 65,061 66,696 67,571
Stockholders' equity/Net worth(2)........... 22,806 21,914 8,435 7,847 7,196
</TABLE>
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------
1997 1996 1995 1994 1993
--------- ------------- ------- ------- -------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Selected Operating Data:
Interest and dividend income................................... $ 6,259 $ 5,576 $ 4,815 $ 4,629 $ 5,207
Interest expense on deposits and borrowings.................... 2,794 2,833 2,487 2,137 2,455
-----------------------------------------------------------
Net interest income............................................ 3,465 2,743 2,328 2,492 2,752
Provision for possible loan losses............................. 3 51 -- 9 --
-----------------------------------------------------------
Net interest income after provision for possible loan losses... 3,462 2,692 2,328 2,483 2,752
-----------------------------------------------------------
Other income:
Gain on sales of investment securities, net.................. 112 2 16 16 48
Other........................................................ 133 123 99 214 140
-----------------------------------------------------------
Total other income....................................... 245 125 115 230 188
-----------------------------------------------------------
Operating expenses............................................. 2,524 1,888 1,793 1,615 1,652
-----------------------------------------------------------
Income before income taxes..................................... 1,183 929 650 1,098 1,288
Income taxes................................................... 431 359 211 447 470
-----------------------------------------------------------
Income before cumulative effect of change in accounting
principle..................................................... 752 570 439 651 818
Cumulative effect of change in accounting principles........... -- -- -- -- 106
-----------------------------------------------------------
Net income..................................................... $ 752 $ 570 $ 439 $ 651 $ 924
===========================================================
Net income per common share.................................... $ .55 $ .32(3) -- -- --
Weighted average number of common shares outstanding........... 1,376,193 1,454,750(4) -- -- --
<FN>
- -------------------
<F1> Effective October 1, 1994, the Bank adopted Statement of Financial
Accounting Standards No. 115 ("SFAS No. 115") which requires the
classification of the Bank's investment securities as "trading
securities," "held-to-maturity" or "available-for-sale." See Note 3 to
the Financial Statements for a breakdown of the investment securities
under SFAS No. 115 at September 30, 1997, 1996, and 1995, respectively.
<F2> Includes unrealized gain on available-for-sale securities of $416,000,
$144,000 and $149,000, net of tax, at September 30, 1997, 1996 and 1995,
respectively.
<F3> Amount calculated from March 28, 1996, the date of the Bank's conversion
from mutual to stock form (the "Conversion"), to September 30, 1996. For
the twelve months ended September 30, 1996, net income per share of
common stock was $0.39.
<F4> Calculated from March 28, 1996, the date of the Conversion, to September
30, 1996.
</FN>
</TABLE>
<TABLE>
<CAPTION>
At or for the Year Ended September 30,
1997 1996 1995 1994 1993
------- ------- ------ ------ ------
<S> <C> <C> <C> <C> <C>
Interest rate spread information:(1)
Average during period................................. 3.03% 2.59% 2.95% .21% 3.56%
End of period......................................... 3.40 2.73 2.97 3.12 3.52
Net interest margin(2).................................. 3.92 3.40 3.33 3.49 3.80
Return on average assets................................ .83 .69 .61 .88 1.23
Return on average equity................................ 3.37 3.51 5.48 8.52 13.55
Non-performing loans as a percent of total loans........ .06 .03 -- 1.15 1.17
Non-performing assets as a percent of total assets...... .03 .02 -- .43 .57
Allowance for possible loan losses as a percent of
non-performing loans................................... 1,670.0 3,557.14 -- 96.27 80.99
Capital Ratios:
Average equity to average assets...................... 24.45 19.56 11.06 10.36 9.10
Regulatory Tier 1 leverage capital ratio.............. 3.64 24.27 1.52 0.55 .54
<FN>
- -------------------
<F1> Interest rate spread represents the difference between weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
<F2> Net interest margin represents net interest income divided by average
interest-earning assets.
</FN>
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
- -------
Falmouth Bancorp, Inc. (the "Company" or "Bancorp"), a Delaware
corporation, is the holding company for Falmouth Co-operative Bank (the "Bank"
or "Falmouth"), a Massachusetts-chartered stock co-operative bank. The Bank
converted to stock form on March 28, 1996, and issued 1,454,750 shares of
common stock at $10.00 per share (the "Conversion"). On October 14, 1997, the
Company acquired all of the capital stock of Bank and stockholders of the Bank
became stockholders of the Company in a share for share exchange pursuant to a
plan of reorganization approved by the Bank's stockholders on January 21, 1997
(the "Reorganization"). At September 30, 1997 there were 1,474,750 shares
outstanding. The Company's sole business activity is ownership of the Bank. The
Company also makes investments in long and short-term marketable securities and
other liquid investments. The financial data presented in this 1997 Annual
Report consists of the activity of the Bank prior to the Reorganization for the
fiscal year 1997.
The business of the Bank consists of attracting deposits from the general
public and using these funds to originate mortgage loans secured by one- to
four-family residences located primarily in Falmouth, Massachusetts and
surrounding areas and to invest in United States Government and Agency
securities. To a lesser extent, the Bank engages in various forms of consumer
and home equity lending. The Bank's profitability depends primarily on its net
interest income, which is the difference between the interest income it earns
on its loans and investment portfolio and its cost of funds, which consists
mainly of interest paid on deposits. Net interest income is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities
and the interest rates earned or paid on these balances. When interest-earning
assets approximate or exceed interest-bearing liabilities, any positive
interest rate spread will generate net interest income.
The Bank's profitability is also affected by the level of noninterest
income and expense. Noninterest income or other income consists primarily of
service fees, late charges and other loan fees, and gain on sale of investment
securities. Noninterest expense or operating expenses consist of salaries and
benefits, deposit insurance premiums paid to the Federal Deposit Insurance
Corporation ("FDIC"), occupancy related expenses and other operating expenses.
The operations of the Bank, and banking institutions in general, are
influenced significantly by general economic conditions and related monetary
and fiscal policies of financial institutions' regulatory agencies. Deposit
flows and the cost of funds are influenced by interest rates on competing
investments and general market rates of interest. Lending activities are
affected by the demand for financing real estate and other types of loans,
which in turn are affected by the interest rates at which such financing may be
offered and other factors affecting loan demand and the availability of funds.
Business Strategy
- -----------------
The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank dedicated to financing home ownership
and consumer needs in its market area and to provide quality service to its
customers. The Bank has implemented this strategy by: (i) closely monitoring
the needs of customers and providing quality service; (ii) emphasizing
consumer-oriented banking by originating residential mortgage loans and
consumer loans, and by offering checking accounts and other financial services
and products; (iii) focusing on expanding lending activities to produce
moderate increases in loan originations; (iv) maintaining asset quality; (v)
maintaining capital in excess of regulatory requirements; and (vi) producing
stable earnings.
Comparison of Financial Condition at September 30, 1997 and 1996
- ----------------------------------------------------------------
The Bank's total assets increased by $5.9 million or 6.5% for the year
ended September 30, 1997 from $90.5 million in September 30, 1996 to $96.4
million at September 30, 1997. Total assets increased primarily due to
increases in the loan portfolio. Total net loans were $53.9 million or 74.6% of
total deposits at September 30, 1997 as compared to $40.2 million or 60.6% of
total deposits at September 30, 1996, representing an increase of $13.7
million. Investment securities were $36.4 million or 37.8% of total assets at
September 30, 1997 as compared to $45.9 million or 50.7% of total assets at
September 30, 1996. The proceeds from maturing securities were in part
allocated to fund an increased volume of loan production, with the balance
redeployed into short-term securities investments. Total deposits were $72.2
million at September 30, 1997 as compared to $66.4 million at September 30,
1996, an 8.7% increase. Total deposits increased by $5.7 million for the year
ended September 30, 1997. Stockholders' equity was $22.8 million at September
30, 1997 as compared to $21.9 million at September 30, 1996, an increase of
$891,000. Stockholders' equity reported at September 30, 1997 included an
unrealized gain in available-for-sale securities of $416,000 and retained
earnings of $9.3 million. The ratio of stockholders' equity to total assets was
23.6% at September 30, 1997 and the book value per share of common stock was
$15.68. Net income per share of common stock for the fiscal year ended
September 30, 1997 was $.55.
Comparison of Financial Condition at September 30, 1996 and 1995
- ----------------------------------------------------------------
The Bank's total assets increased by $16.8 million or 22.9% for the year
ended September 30, 1996 from $73.7 million in September 30, 1995 to $90.5
million at September 30, 1996. Total assets increased primarily from the
proceeds of the Bank's mutual to stock conversion on March 28, 1996 and to a
lesser extent from the growth in deposits. Total net loans were $40.2 million
or 60.6% of total deposits at September 30, 1996 as compared to $32.5 million
or 50.0% of total deposits at September 30, 1995, representing an increase of
$7.7 million. Investment securities were $45.9 million or 50.7% of total assets
at September 30, 1996 as compared to $35.9 million or 48.7% of total assets at
September 30, 1995. The proceeds from maturing securities were in part
allocated to fund an increased volume of loan production, with the balance
redeployed into short-term securities investments. Total deposits were $66.4
million at September 30, 1996 as compared to $65.1 million at September 30,
1995. Total deposits increased by $1.3 million for the year ended September 30,
1996 despite the $2.5 million transferred from deposits to purchase the Bank's
initial public offering of stock on March 28, 1996. Stockholders' equity was
$21.9 million at September 30, 1996 as compared to net worth of $8.4 million at
September 30, 1995, an increase of $13.5 million which was primarily the result
of the conversion of the Bank from mutual to stock form. The issuance of
1,454,750 common shares at a par value of $0.10 per share provided capital of
$145,475 with additional paid-in capital of $13.6 million and unearned ESOP
shares costing $872,850. Stockholders' equity reported at September 30, 1996
included an unrealized gain in available-for-sale securities of $144,000 and
retained earnings of $8.9 million. The ratio of stockholders' equity to total
assets was 24.2% at September 30, 1996 and the book value per share of common
stock was $15.06. Historical net income per share of common stock from March
28, 1996 (date of Conversion) to September 30, 1996 was $0.32.
Comparison of Operating Results at September 30, 1997 and 1996
- --------------------------------------------------------------
Net Income. The Bank's net income for the twelve months ended September
30, 1997 was $752,000 as compared to $570,000 for the twelve months ended
September 30, 1996. The $182,000 increase in net income was primarily the
result of a $683,000 increase in interest and dividend income a $39,000
decrease in interest expense on deposits and borrowed funds. There was a
$635,000 increase in other expenses and a $72,000 increase in income taxes.
Net Interest Income. Net interest income for the twelve months ended
September 30, 1997 was $3.5 million as compared to $2.7 million for the twelve
months ended September 30, 1996. The $722,000 increase in net interest income
was the result of the increase in interest income on loans. The net interest
margin for the twelve months ended September 30, 1997 was 3.92%, an increase
of .52% as compared to 3.40% for the twelve months ended September 30, 1996.
The return on average assets for the twelve months ended September 30, 1997
was .83%, an increase of .14% as compared to .69% for the same period of the
prior year. The primary reason for the increase in the return on average assets
was the deployment of proceeds from maturing securities into an increased
volume of residential and commercial loan originations during the year ended
September 30, 1997.
Interest Income. Total interest and dividend income for the twelve months
ended September 30, 1997 was $6.3 million, an increase of $683,000 as compared
to $5.6 million for the twelve months ended September 30, 1996. The increase in
interest and dividend income was due primarily to an $810,000 increase in
interest income on loans and a $127,000 decrease in interest and dividends on
securities and short-term investments. The increases in interest income on
loans was, for the most part, the result of an increase in the volume of loans
originated and held.
Interest Expense. Interest expense for the twelve months ended September
30, 1997 was $2.8 million, a decrease of $39,000 as compared to $2.8 million
for the twelve months ended September 30, 1996. The decrease in interest
expense was due primarily to lower deposit rates paid on certificates of
deposit accounts during the period.
Provision for Loan Losses. The provision for possible loan losses for the
twelve months ended September 30, 1997 was $3,000 compared to $51,000 for the
twelve months ended September 30, 1996. The decrease in the amount of the
provision for possible loan losses was in response to the Bank's current high
level of reserves and its historical record of few charge-offs.
Non-Interest Income. Non-interest income or other income for the twelve
months ended September 30, 1997 was $245,000 as compared to $125,000 for the
twelve months ended September 30, 1996. The $120,000 increase was due to modest
increases in income from service charges and other fee income, as well as an
increase of $110,000 on sales of investment securities.
Operating Expense. Operating expenses for the twelve months ended
September 30, 1997 were $2.5 million as compared to $1.9 million for the twelve
months ended September 30, 1996. The $636,000 increase was primarily due to an
increase in salaries and employee benefits of $178,000, an increase in legal
and professional fees of $141,000 and an increase in other operating expenses
of $203,000. It is expected that the leasehold improvements and non-interest
expenses will continue to increase during fiscal 1998 as the Bank continues to
expand.
Comparison of Operating Results for the Years Ended September 30, 1996 and 1995
- -------------------------------------------------------------------------------
Net Income. The Bank's net income for the twelve months ended September
30, 1996 was $570,000 as compared to $439,000 for the twelve months ended
September 30, 1995. The $131,000 increase in net income was primarily the
result of a $760,000 increase in interest and dividend income which was partly
offset by a $346,000 increase in interest expense on deposits and borrowed
funds, a $95,000 increase in other expenses and a $148,000 increase in income
taxes.
Net Interest Income. Net interest income for the twelve months ended
September 30, 1996 was $2.8 million as compared to $2.3 million for the twelve
months ended September 30, 1995. The $415,000 increase in net interest income
was the result of the increase in interest income on loans and securities that
more than offset the increase in interest expense on deposits. The net interest
margin for the twelve months ended September 30, 1996 was 3.40%, an increase of
.07% as compared to 3.33% for the twelve months ended September 30, 1995. The
return on average assets for the twelve months ended September 30, 1996 was
.69%, an increase of .08% as compared to .61% for the same period of the prior
year. The primary reason for the increase in the return on average assets was
the deployment of proceeds from maturing securities into an increased volume of
residential loan originations during the year ended September 30, 1996.
Interest Income. Total interest and dividend income for the twelve months
ended September 30, 1996 was $5.6 million, an increase of $761,000 as compared
to $4.8 million for the twelve months ended September 30, 1995. The increase in
interest and dividend income was due primarily to a $518,000 increase in
interest income on loans and a $242,000 increase in interest and dividends on
securities and short-term investments. The increases in interest income on
loans and securities was, for the most part, the result of an increase in the
volume of loans and securities held.
Interest Expense. Interest expense for the twelve months ended September
30, 1996 was $2.8 million, an increase of $346,000 as compared to $2.5 million
for the twelve months ended September 30, 1995. The increase in interest
expense was due to higher deposit rates paid on primarily certificates of
deposit accounts during the period.
Provision for Loan Losses. The provision for possible loan losses for the
twelve months ended September 30, 1996 was $51,000 was compared to zero for the
twelve months ended September 30, 1995. The increase in the amount of the
provision for possible loan losses was in response to the increase in the
balance of loans held by the Bank and the Bank's commitment to maintain general
loan loss reserves at adequate levels.
Non-Interest Income. Non-interest income or other income for the twelve
months ended September 30, 1996 was $125,000 as compared to $115,000 for the
twelve months ended September 30, 1995. The $10,000 increase was due to modest
increases in income from service charges coupled with a moderate increase in
other fee income that offset a decrease in gain on sales of investment
securities.
Operating Expense. Operating expenses for the twelve months ended
September 30, 1996 were $1,888,000 as compared to $1,793,000 for the twelve
months ended September 30, 1995. The $95,000 increase was primarily due to an
increase in salaries and employee benefits of $104,000, an increase in legal
and professional fees of $48,000 and an increase in other operating expenses of
$63,000 offset by a decrease in deposit insurance expense of $100,000 and a
decrease in director's fees of $10,000. It is expected that the leasehold
improvements and non-interest expenses will increase during fiscal 1997 as work
progresses on the new branch located in East Falmouth scheduled to be in
operation in February, 1997.
Liquidity and Capital Resources
- -------------------------------
The Bank's primary sources of funds consist of deposits, repayment and
prepayment of loans and mortgaged-backed securities, maturities of investments
and interest-bearing deposits, and funds provided from operations. While
scheduled repayments of loans and mortgage-backed securities and maturities of
investment securities are predictable sources of funds, deposit flows and loan
prepayments are greatly influenced by the general level of interest rates,
economic conditions and competition. The Bank uses its liquidity resources
principally to fund existing and future loan commitments, to fund net deposit
outflows, to invest in other interest-earning assets, to maintain liquidity,
and to meet operating expenses. Management believes that loan repayments and
other sources of funds will be adequate to meet the Bank's liquidity needs for
fiscal year 1998.
The Bank is required to maintain adequate levels of liquid assets. This
guideline, which may be varied depending upon economic conditions and deposit
flows, is based upon a percentage of deposits and short-term borrowings. The
Bank has historically maintained a level of liquid assets in excess of
regulatory requirements. The Bank's liquidity ratio at September 30, 1997 was
72.4%.
A major portion of the Bank's liquidity consists of short-term U.S.
Government obligations. The level of these assets is dependent on the Bank's
operating, investing, lending and financing activities during any given period.
At September 30, 1997, regulatory liquidity totaled $48.2 million.
The primary investing activities of the Bank include origination of loans
and purchase of investment securities. During the year ended September 30,
1997, purchases of investment securities and mortgage-backed securities totaled
$43.2 million, while loan originations totaled $16.3 million. These investments
were funded primarily from loan repayments of $8.5 million and investment
security maturities of $33.3 million.
Liquidity management is both a daily and long-term function of
management. If the Bank requires funds beyond its ability to generate them
internally, the Bank believes that it could borrow additional funds from the
FHLB of Boston. At September 30, 1996, the Bank had no outstanding advances
from the FHLB of Boston.
At September 30, 1997, the Bank had $1.8 million in outstanding
commitments to originate loans. The Bank anticipates that it will have
sufficient funds available to meet its current loan origination commitments.
Certificates of deposit which are scheduled to mature in one year or less
totaled $29.7 million at September 30, 1996. Based on historical experience,
management believes that a significant portion of such deposits will remain
with the Bank.
At September 30, 1996, the Bank exceeded all of its regulatory capital
requirements.
Impact of Inflation and Changing Prices
- ---------------------------------------
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and results of operations in
terms of historical dollars without considering changes in the relative
purchasing power of money over time because of inflation. Unlike most
industrial companies, virtually all of the assets and liabilities of the Bank
are monetary in nature. As a result, interest rates have a more significant
impact on the Bank's performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services.
MARKET FOR THE COMPANY'S COMMON STOCK
Falmouth Bancorp, Inc.'s common stock is traded on the American Stock
Exchange and quoted under the symbol "FCB." The table below shows the high and
low sales price during the periods indicated. The Bank's common stock began
trading on March 28, 1996, the date of the Conversion and initial public
offering. The Bank's common stock traded as Company common stock when
Reorganization became effective in October 1997, subsequent to the end of the
Bank's 1997 fiscal year.
At September 30, 1997, the last trading date in the Bank's fiscal year,
the Bank's common stock closed at $207/8. At December 8, 1997, there were
1,454,750 shares of the Company's common stock outstanding, which were held of
record by approximately 900 stockholders, not including persons or entities who
hold the stock in nominee or "street" name through various brokerage firms.
On November 18, 1997, the Board of Directors of the Company declared a
quarterly cash dividend of $0.05 per share of common stock, which was paid on
December 22, 1997 to stockholders of record on December 8, 1997.
The Board of Directors considers paying dividends, dependant on the
results of operations and financial condition of the Company, tax
considerations, industry standards, economic conditions, regulatory
restrictions and other factors. There are significant regulatory limitations on
the Company's ability to pay dividends depending on the dividends it receives
from its subsidiary, Falmouth Co-operative Bank, which are subject to
regulations and the Bank's continued compliance with all regulatory capital
requirements and the overall health of the institution.
<TABLE>
<CAPTION>
Price Range
---------------------
Quarter Ended High Low Dividends
- --------------------------------------------------- -------- -------- ---------
<S> <C> <C> <C>
Fiscal year ended September 30, 1996:
Second Quarter ended March 31, 1996.............. $ 11 1/8 $ 10 5/8 N/A
Third Quarter ended June 30, 1996................ 11 5/8 10 1/8 N/A
Fourth Quarter ended September 30, 1996.......... 12 7/8 10 1/4 $ .05
Fiscal year ended September 30, 1997:
First Quarter ended December 31, 1996............ 14 1/8 12 .05
Second Quarter ended March 31, 1997.............. 15 5/8 13 1/8 .05
Third Quarter ended June 30, 1997................ 16 1/2 13 1/8 .05
Fourth Quarter ended September 30, 1997.......... 21 1/2 16 1/4 .05
Fiscal year ending September 30, 1998:
First Quarter (through December 11, 1997)........ 22 5/8 19 1/4 N/A
</TABLE>
SHATSWELL, MacLEOD & COMPANY, P.C.
CERTIFIED PUBLIC ACCOUNTANTS
83 PINE STREET
WEST PEABODY, MASSACHUSETTS 01960-3635
TELEPHONE (508) 535-0206
FACSIMILE (508) 535-9908
The Board of Directors
Falmouth Co-Operative Bank
Falmouth, Massachusetts
INDEPENDENT AUDITORS' REPORT
----------------------------
We have audited the accompanying balance sheets of Falmouth Co-Operative
Bank as of September 30, 1997 and 1996 and the related statements of income,
changes in stockholders' equity and cash flows for the years then ended.
These financial statements are the responsibility of the Bank's management.
Our responsibility is to express an opinion on these financial statements
based on our audits. The financial statements of Falmouth Co-Operative Bank
as of September 30, 1995, were audited by other auditors whose report dated
November 20, 1995, expressed an unqualified opinion on those statements.
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 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 1997 and 1996 financial statements referred to above
present fairly, in all material respects, the financial position of Falmouth
Co-Operative Bank as of September 30, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/s/ SHATSWELL, MacLEOD & COMPANY, P.C.
SHATSWELL, MacLEOD & COMPANY, P.C.
October 16, 1997
FALMOUTH CO-OPERATIVE BANK
--------------------------
BALANCE SHEETS
--------------
September 30, 1997 and 1996
---------------------------
<TABLE>
<CAPTION>
ASSETS 1997 1996
- ------ ----------- -----------
<S> <C> <C>
Cash and due from banks $ 2,563,517 $ 1,171,761
Federal funds sold 1,352,403 1,583,437
--------------------------
Total cash and cash equivalents 3,915,920 2,755,198
Investments in available-for-sale securities
(at fair value) 25,481,370 22,713,053
Investments in held-to-maturity securities
(fair values of $10,558,749 as of September 30,
1997 and $22,845,398 as of September 30, 1996) 10,515,369 22,839,596
Federal Home Loan Bank stock, at cost 405,200 300,900
Loans, net 53,881,171 40,236,846
Premises and equipment 999,707 526,061
Accrued interest receivable 614,289 746,601
Cooperative Central Bank Reserve Fund Deposit 285,680 285,680
Other assets 292,478 112,173
--------------------------
$96,391,184 $90,516,108
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Demand deposits $ 3,136,116 $ 947,248
Savings and NOW deposits 31,922,355 27,430,549
Time deposits 37,132,618 38,065,803
--------------------------
Total deposits 72,191,089 66,443,600
Other liabilities 652,656 328,883
Due to broker 1,000,000
Employee Stock Ownership Plan loan 741,923 829,208
--------------------------
Total liabilities 73,585,668 68,601,691
--------------------------
Stockholders' equity:
Preferred stock, par value $.10 per share,
authorized 500,000 shares; none issued
Common stock, par value $.10 per share,
authorized 2,500,000 shares; issued and
outstanding 1,454,750 shares 145,475 145,475
Paid-in capital 13,651,570 13,598,174
Retained earnings 9,334,011 8,856,291
Employee Stock Ownership Plan loan (741,923) (829,208)
Net unrealized holding gain on
available-for-sale securities 416,383 143,685
--------------------------
Total stockholders' equity 22,805,516 21,914,417
--------------------------
$96,391,184 $90,516,108
==========================
</TABLE>
The accompanying notes are an integral part of these financial statements.
FALMOUTH CO-OPERATIVE BANK
--------------------------
STATEMENTS OF INCOME
--------------------
Years Ended September 30, 1997, 1996 and 1995
---------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Interest and dividend income:
Interest and fees on loans $3,775,916 $2,966,330 $2,448,193
Interest and dividends on securities:
Taxable 1,901,373 1,984,622 1,831,655
Dividends on marketable equity securities 183,353 169,728 174,865
Dividends on Cooperative Bank Investment
and Liquidity Fund 241,095 282,891 262,445
Other interest 157,115 172,261 98,223
--------------------------------------
Total interest and dividend income 6,258,852 5,575,832 4,815,381
--------------------------------------
Interest expense:
Interest on deposits 2,728,402 2,797,827 2,486,994
Interest on borrowings 65,576 35,060
--------------------------------------
Total interest expense 2,793,978 2,832,887 2,486,994
--------------------------------------
Net interest and dividend income 3,464,874 2,742,945 2,328,387
Provision for loan losses 3,208 51,000
--------------------------------------
Net interest income after provision
for loan losses 3,461,666 2,691,945 2,328,387
--------------------------------------
Other income:
Service charges on deposit accounts 54,412 53,094 49,789
Gain on sales of investment securities, net 112,035 2,338 16,079
Other income 78,678 69,908 49,180
--------------------------------------
Total other income 245,125 125,340 115,048
--------------------------------------
Other expense:
Salaries and employee benefits 1,343,385 1,165,167 1,061,389
Occupancy expense 109,101 61,253 57,415
Equipment expense 98,327 71,054 62,826
Deposit insurance expense 6,307 7,666 107,554
Other real estate owned expense 2,447
Data processing expense 150,838 111,410 119,129
Director's fees 57,000 57,100 66,900
Legal and professional fees 199,344 58,485 9,884
Other expenses 559,504 356,329 305,755
--------------------------------------
Total other expense 2,523,806 1,888,464 1,793,299
--------------------------------------
Income before income taxes 1,182,985 928,821 650,136
Income taxes 430,900 358,600 210,900
--------------------------------------
Net income $ 752,085 $ 570,221 $ 439,236
======================================
Net income per share of common stock $ .55
==========
Average shares outstanding 1,376,193
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
FALMOUTH CO-OPERATIVE BANK
--------------------------
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
---------------------------------------------
Years Ended September 30, 1997, 1996 and 1995
---------------------------------------------
<TABLE>
<CAPTION>
Net
Unrealized Employee
Holding Stock
Gain on Ownership
Common Paid-in Retained Available-for- Plan
Stock Capital Earnings Surplus Sale Securities Loan Total
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1994 $ $ $ $7,846,834 $ $ $ 7,846,834
Net income 439,236 439,236
Net unrealized gain on
available-for-sale securities 149,216 149,216
-------------------------------------------------------------------------------------------
Balance, September 30, 1995 8,286,070 149,216 8,435,286
Transfer of surplus to
retained earnings 8,286,070 (8,286,070)
Issuance of common stock 145,475 13,598,174 13,743,649
Employee Stock Ownership
Plan loan (872,850) (872,850)
Principal payments on Employee
Stock Ownership Plan loan 43,642 43,642
Net income 570,221 570,221
Net change in unrealized
holding gain on available-
for-sale securities (5,531) (5,531)
-------------------------------------------------------------------------------------------
Balance, September 30, 1996 145,475 13,598,174 8,856,291 143,685 (829,208) 21,914,417
Employee Stock Ownership Plan 41,103 41,103
Adjustment of costs incurred
on issuance of common stock 12,293 12,293
Principal payments on Employee
Stock Ownership Plan loan 87,285 87,285
Net income 752,085 752,085
Dividends declared ($.20 per share) (274,365) (274,365)
Net change in unrealized
holding gain on available-
for-sale securities 272,698 272,698
-------------------------------------------------------------------------------------------
Balance, September 30, 1997 $145,475 $13,651,570 $9,334,011 $ $416,383 $(741,923) $22,805,516
===========================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
FALMOUTH CO-OPERATIVE BANK
--------------------------
STATEMENTS OF CASH FLOWS
------------------------
Years Ended September 30, 1997, 1996 and 1995
---------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 752,085 $ 570,221 $ 439,236
Adjustments to reconcile net income to net cash
provided by operating activities:
Disposal of fixed assets 21,840
Provision for loan losses 51,000
Accretion of investment securities, net of amortization (129,033) (51,206) (51,139)
Change in unearned income (46,627) 22,246 20,264
Gain on sales of investment securities, net (112,035) (2,338) (16,079)
Deferred tax benefit 49,904 (6,432) (3,000)
Depreciation and amortization 93,381 55,908 33,912
(Increase) decrease in accrued interest receivable 132,312 (226,808) 24,297
(Increase) decrease in other assets (180,305) 273,079 (122,216)
Increase (decrease) in other liabilities 89,937 164,489 (1,634)
-----------------------------------------
Net cash provided by operating activities 671,459 850,159 323,641
-----------------------------------------
Cash flows from investing activities:
Purchases of available-for-sale securities (15,406,219) (24,655,599)
Proceeds from sales of available-for-sale securities 2,810,711 237,841
Proceeds from maturities of available-for-sale securities 9,425,805 22,300,000
Purchases of held-to-maturity securities (6,330,000) (17,564,866)
Proceeds from maturities of held-to-maturity securities 18,753,311 10,750,416
Purchase of Federal Home Loan Bank stock (104,300) (20,800)
Proceeds from the sale of and maturity of investment
securities 22,973,324
Purchases of investment securities (15,095,206)
Proceeds from principal repayment on mortgage-
backed investments 115,264
Net increase in loans (13,597,698) (7,807,190) (4,939,160)
Capital expenditures (588,867) (50,722) (196,066)
-----------------------------------------
Net cash provided by (used in) investing activities (5,037,257) (16,810,920) 2,858,156
-----------------------------------------
Cash flows from financing activities:
Dividends paid (274,365)
Employee Stock Ownership Plan 41,103
Adjustment of costs incurred on issuance of common stock 12,293
Proceeds from issuance of common stock 14,547,500
Costs related to issuance of common stock (803,851)
Net increase (decrease) in demand deposits, NOW and
savings accounts 6,680,674 (534,255) (3,190,835)
Net increase in time deposits (933,185) 1,908,951 1,563,406
-----------------------------------------
Net cash provided by (used in) financing activities 5,526,520 15,118,345 (1,627,429)
-----------------------------------------
Increase (decrease) in cash and cash equivalents 1,160,722 (842,416) 1,554,368
Cash and cash equivalents at beginning of period 2,755,198 3,597,614 2,043,246
-----------------------------------------
Cash and cash equivalents at end of period $ 3,915,920 $ 2,755,198 $ 3,597,614
=========================================
Supplemental disclosures:
Interest paid $ 2,859,554 $ 2,832,887 $ 2,486,994
Income taxes paid 472,023 229,000 213,762
</TABLE>
The accompanying notes are an integral part of these financial statements.
FALMOUTH CO-OPERATIVE BANK
--------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------
Years Ended September 30, 1997, 1996 and 1995
---------------------------------------------
NOTE 1 - NATURE OF OPERATIONS
- -----------------------------
As of March 28, 1996 Falmouth Co-Operative Bank (Bank) converted from a
Massachusetts chartered mutual co-operative bank to a Massachusetts
chartered stock co-operative bank. The Bank was organized in 1925 and is
headquartered in Falmouth, Massachusetts. The Bank is engaged principally
in the business of attracting deposits from the general public and investing
those deposits in residential, real estate, consumer and small business
loans.
The Bank has a wholly-owned subsidiary, Falmouth Bancorp, Inc., newly formed
for the purpose of effecting an Agreement and Plan of Reorganization. As of
September 30, 1997 this subsidiary had no assets or liabilities. See Note
16.
NOTE 2 - ACCOUNTING POLICIES
- ----------------------------
The accounting and reporting policies of the Bank conform to generally
accepted accounting principles and predominant practices within the savings
institution industry. The financial statements were prepared using the
accrual method of accounting. The significant accounting policies are
summarized below to assist the reader in better understanding the
consolidated financial statements and other data contained herein.
PERVASIVENESS OF ESTIMATES:
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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from the estimates.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, cash items, due from banks and federal funds sold.
INVESTMENT SECURITIES:
As of October 1, 1994, the Bank adopted the provisions of Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The Statement establishes
standards for all debt securities and for equity securities that have
readily determinable fair values. As required under SFAS No. 115, prior
year financial statements were not restated.
SFAS No. 115 requires that investments in debt securities that management
has the positive intent and ability to hold-to-maturity be classified as
"held-to-maturity" and reflected at amortized cost. Investments that are
purchased and held principally for the purpose of selling them in the near
term are classified as "trading securities" and reflected on the balance
sheet at fair value, with unrealized gains and losses included in earnings.
Investments not classified as either of the above are classified as
"available-for-sale" and reflected on the balance sheet at fair value, with
unrealized gains and losses excluded from earnings and reported as a
separate component of net worth. The cumulative effect of the change in
accounting principle as of September 30, 1995, was to increase net worth,
net of income tax effects, by $149,216. There was no effect on 1995 net
income relating to the adoption of SFAS No. 115.
Prior to September 30, 1995, debt securities that management had the intent
and ability to hold until maturity were reflected at amortized cost.
Marketable equity securities were stated at the lower of aggregate cost or
fair value. Net unrealized losses applicable to marketable equity
securities were reflected as a charge to net worth. For all years
presented, restricted equity securities are reflected at cost. Purchase
premiums and discounts are amortized to earnings by a method that
approximates the interest method over the terms of the investments.
Declines in the value of investments that are deemed to be other than
temporary are reflected in earnings when identified. Gains and losses on
disposition of investments are computed by the specific identification
method.
For regulatory capital purposes, unrealized gains or losses, after tax
effects, on securities available-for-sale are not recognized.
LOANS:
Loans receivable that management has the intent and ability to hold for the
foreseeable future, or until maturity or payoff, are reported at their
outstanding principal balances reduced by amounts due to borrowers on
unadvanced loans, any charge-offs, the allowance for loan losses and any
deferred fees, costs on originated loans or unamortized premiums or
discounts on purchased loans.
Interest on loans is generally recognized on a simple interest basis.
Loan origination, commitment fees and certain direct origination costs are
deferred and the net amount amortized as an adjustment of the related loan's
yield. The Bank is generally amortizing these amounts over the contractual
life of the related loans.
Cash receipts of interest income on impaired loans is credited to principal
to the extent necessary to eliminate doubt as to the collectibility of the
net carrying amount of the loan. Some or all of the cash receipts of
interest income on impaired loans is recognized as interest income if the
remaining net carrying amount of the loan is deemed to be fully collectible.
When recognition of interest income on an impaired loan on a cash basis is
appropriate, the amount of income that is recognized is limited to that
which would have been accrued on the net carrying amount of the loan at the
contractual interest rate. Any cash interest payments received in excess of
the limit and not applied to reduce the net carrying amount of the loan are
recorded as recoveries of charge-offs until the charge-offs are fully
recovered.
ALLOWANCE FOR POSSIBLE LOAN LOSSES:
An allowance is available for losses which may be incurred in the future on
loans in the current portfolio. The allowance is increased by provisions
charged to current operations and is decreased by loan losses, net of
recoveries. The provision for loan losses is based on management's
evaluation of current and anticipated economic conditions, changes in the
character and size of the loan portfolio and other indicators. The balance
in the allowance for possible loan losses is considered adequate by
management to absorb any reasonably foreseeable loan losses.
As of October 1, 1995, the Bank adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended by SFAS No. 118. According to
SFAS No. 114 a loan is impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. The Statement
requires that impaired loans be measured on a loan by loan basis by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's observable market price, or the fair
value of the collateral if the loan is collateral dependent.
The Statement is applicable to all loans, except large groups of smaller
balance homogeneous loans that are collectively evaluated for impairment,
loans that are measured at fair value or at the lower of cost or fair value,
leases, and convertible or nonconvertible debentures and bonds and other
debt securities. The Bank considers its residential real estate loans and
consumer loans that are not individually significant to be large groups of
smaller balance homogeneous loans.
Factors considered by management in determining impairment include payment
status, net worth and collateral value. An insignificant payment delay or
an insignificant shortfall in payment does not in itself result in the
review of a loan for impairment. The Bank applies SFAS No. 114 on a loan-
by-loan basis. The Bank does not apply SFAS No. 114 to aggregations of
loans that have risk characteristics in common with other impaired loans.
Interest on a loan is not generally accrued when the loan becomes ninety or
more days overdue. The Bank may place a loan on nonaccrual status but not
classify it as impaired, if (i) it is probable that the Bank will collect
all amounts due in accordance with the contractual terms of the loan or (ii)
the loan is an individually insignificant residential mortgage loan or
consumer loan. Impaired loans are charged-off when management believes that
the collectibility of the loan's principal is remote.
The financial statement impact of adopting the provisions of this Statement
was not material.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Cost and related allowances for depreciation and amortization
of premises and equipment retired or otherwise disposed of are removed from
the respective accounts with any gain or loss included in income or expense.
Depreciation and amortization are calculated principally on the straight-
line method over the estimated useful lives of the assets.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
Other real estate owned includes properties acquired through foreclosure and
properties classified as in-substance foreclosures in accordance with
Financial Accounting Standards Board Statement No. 15, "Accounting by
Debtors and Creditors for Troubled Debt Restructuring." These properties
are carried at the lower of cost or estimated fair value less estimated
costs to sell. Any write-down from cost to estimated fair value, required
at the time of foreclosure or classification as in-substance foreclosure, is
charged to the allowance for possible loan losses. Expenses incurred in
connection with maintaining these assets, subsequent write-downs and gains
or losses recognized upon sale are included in other expense.
Beginning in 1995, in accordance with Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," the
Bank classifies loans as in-substance repossessed or foreclosed if the Bank
receives physical possession of the debtor's assets regardless of whether
formal foreclosure proceedings take place.
COOPERATIVE CENTRAL BANK RESERVE FUND DEPOSIT:
The Reserve Fund was established for liquidity purposes and consists of
deposits required of all insured cooperative banks in Massachusetts. The
Fund is used by the Central Bank to advance funds to member banks, but such
advances generally are not made until Federal Home Loan Bank and commercial
bank sources of borrowings have been exhausted. The Bank has not borrowed
funds from the Central Bank since rejoining the Federal Home Loan Bank on
January 2, 1975.
INCOME TAXES:
The Bank recognizes income taxes under the asset and liability method.
Under this method, deferred tax assets and liabilities are established for
the temporary differences between the accounting basis and the tax basis of
the Bank's assets and liabilities at enacted tax rates expected to be in
effect when the amounts related to such temporary differences are realized
or settled.
RETIREMENT PLAN:
The compensation cost of an employee's pension benefit is recognized on the
net periodic pension cost method over the employee's approximate service
period. The aggregate cost method is used for funding purposes.
FAIR VALUES OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments," requires that the Bank disclose estimated
fair value for its financial instruments. Fair value methods and
assumptions used by the Bank in estimating its fair value disclosures are as
follows:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and federal funds sold approximate those assets' fair values.
Securities (including mortgage-backed securities): Fair values for
securities are based on quoted market prices, where available. If quoted
market prices are not available, fair values are based on quoted market
prices of comparable instruments.
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 other loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. The carrying amount
of accrued interest approximates its fair value.
Deposit liabilities: The fair values disclosed for demand deposits (e.g.,
interest and non-interest checking, passbook savings and 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
certificates to a schedule of aggregated expected monthly maturities on time
deposits.
Off-balance sheet instruments: The fair value of commitments to originate
loans is estimated using the fees currently charged to enter similar
agreements, taking into account the remaining terms of the agreements and
the present creditworthiness of the counterparties. For fixed-rate loan
commitments and the unadvanced portion of loans, fair value also considers
the difference between current levels of interest rates and the committed
rates. The fair value of letters of credit is based on fees currently
charged for similar agreements or on the estimated cost to terminate them or
otherwise settle the obligation with the counterparties at the reporting
date.
EARNINGS PER SHARE:
Earnings per share for fiscal 1997 has been computed on the basis of the
weighted-average number of shares of common stock outstanding. Shares
issuable upon the exercise of stock option grants have not been included in
the per share computation because they did not have a significant dilutive
effect. Because of the Bank's conversion in mid 1996 from mutual form to
stock ownership, a presentation of earnings per share for fiscal 1996 would
not be meaningful.
STOCK BASED COMPENSATION
In accordance with SFAS No. 123, entities can recognize stock-based
compensation expense in the basic financial statements using either (i) the
intrinsic value approach set forth in APB Opinion No. 25 or (ii) the fair
value method in SFAS No. 123. Entries electing to follow the provisions of
APB Opinion No. 25 must make pro forma disclosure of net income and earnings
per share, as if the fair value method of accounting defined in SFAS No. 123
had been applied. Management measures stock-based compensation costs in
accordance with APB Opinion No. 25 and has made the pro forma disclosure
requirements of SFAS No. 123 for the year ended September 30, 1997.
NOTE 3 - INVESTMENTS IN SECURITIES
- ----------------------------------
Debt and equity securities have been classified in the balance sheets
according to management's intent. The carrying amount of securities and
their approximate fair values are as follows as of September 30:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost Holding Holding Fair
Basis Gains Losses Value
--------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
September 30, 1997:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $11,485,860 $ 44,890 $ 1,290 $11,529,460
Other debt securities 3,447,578 20,920 3,468,498
Mortgage-backed securities 2,755,018 58,551 2,813,569
Marketable equity securities 7,087,351 825,351 242,859 7,669,843
---------------------------------------------------
$24,775,807 $949,712 $244,149 $25,481,370
===================================================
September 30, 1996:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $10,345,434 $ 21,408 $ 9,823 $10,357,019
Other debt securities 4,082,553 19,826 1,421 4,100,958
Mortgage-backed securities 1,485,000 5,643 1,490,643
Marketable equity securities 6,551,133 546,755 333,455 6,764,433
---------------------------------------------------
$22,464,120 $593,632 $344,699 $22,713,053
===================================================
Gross Gross
Amortized Unrealized Unrealized
Cost Holding Holding Fair
Basis Gains Losses Value
---------------------------------------------------
Held-to-maturity:
September 30, 1997:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $ 3,094,510 $ 9,526 $ $ 3,104,036
Other debt securities 6,823,853 10,089 107 6,833,835
Mortgage-backed securities 597,006 23,872 620,878
---------------------------------------------------
$10,515,369 $ 43,487 $ 107 $10,558,749
September 30, 1996:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $15,128,466 $ 8,534 $ 25,437 $15,111,563
Other debt securities 6,338,239 8,026 7,460 6,338,805
Mortgage-backed securities 1,372,891 26,206 4,067 1,395,030
---------------------------------------------------
$22,839,596 $ 42,766 $ 36,964 $22,845,398
===================================================
</TABLE>
The scheduled maturities of held-to-maturity securities and available-for-
sale securities (other than equity securities) were as follows as of
September 30, 1997:
<TABLE>
<CAPTION>
Available-for-sale Held-to-maturity
securities: securities:
-------------------------- -------------------------
Amortized Amortized
Cost Fair Cost Fair
Basis Value Basis Value
------------------------------------------------------
<S> <C> <C> <C> <C>
Debt securities other than mortgage-backed securities:
Due within one year $ 7,793,728 $ 7,812,250 $ 4,404,136 $ 4,411,900
Due after one year through five years 5,066,913 5,093,548 5,514,227 5,525,971
Due after five years through ten years 2,072,797 2,092,160
Mortgage-backed securities 2,755,018 2,813,569 597,006 620,878
------------------------------------------------------
$17,688,456 $17,811,527 $10,515,369 $10,558,749
======================================================
</TABLE>
For the year ended September 30, 1997, proceeds from sales of securities
available-for-sale amounted to $2,810,711. Gross realized gains and gross
realized losses on those sales amounted to $155,042 and $43,007,
respectively. For the year ended September 30, 1996, proceeds from sales of
securities available-for-sale amounted to $237,841. Gross realized gains
and gross realized losses on those sales amounted to $24,775 and $22,437,
respectively. For the year ended September 30, 1995, proceeds from the
sales of securities were $458,738. Gross realized gains and gross realized
losses on those sales amounted to $62,402 and $26,910, respectively.
The aggregate carrying amount and fair value of securities of issuers which
exceeded 10% of stockholders' equity were as follows as of September 30,
1997:
<TABLE>
<CAPTION>
Amortized
Cost Fair
Issuer Basis Value
- --------------------------------- ------------------------
<S> <C> <C>
Co-operative Bank Investment Fund $4,232,557 $4,002,892
</TABLE>
NOTE 4 - LOANS
- --------------
Loans consisted of the following as of September 30:
<TABLE>
<CAPTION>
1997 1996
--------------------------
<S> <C> <C>
Commercial, financial and agricultural $ 1,079,024 $ 419,668
Real estate - construction and land development 451,410 295,152
Real estate - residential 48,016,182 35,092,069
Real estate - commercial 4,291,104 4,300,059
Consumer 641,387 771,247
--------------------------
54,479,107 40,878,195
Unearned income (96,499) (143,126)
Allowance for possible loan losses (501,437) (498,223)
--------------------------
Loans, net $53,881,171 $40,236,846
==========================
</TABLE>
Certain directors and executive officers of the Bank were customers of the
Bank during 1997. Total loans to such persons and their companies amounted
to $226,146 as of September 30, 1997. During the year ended September 30,
1997, total payments amounted to $521,931 and principal advances were
$195,633.
Changes in the allowance for possible loan losses were as follows for the
years ended September 30:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------------------
<S> <C> <C> <C>
Balance at beginning of period $498,223 $445,216 $309,931
Provision for loan losses 51,000
Recoveries of loans previously charged off 3,259 2,007 135,285
Loans charged off (45)
--------------------------------
Balance at end of period $501,437 $498,223 $445,216
================================
</TABLE>
As of September 30, 1997 and 1996 there were no loans that met the
definition of an impaired loan in Statement of Financial Accounting
Standards No. 114. There was no investment in impaired loans or related
interest-income recognized on impaired loans during the years ended
September 30, 1997 and 1996.
NOTE 5 - PREMISES AND EQUIPMENT
- -------------------------------
The following is a summary of premises and equipment as of September 30:
<TABLE>
<CAPTION>
1997 1996
--------------------------
<S> <C> <C>
Bank building $ 986,215 $ 615,219
Furniture and equipment 627,214 459,492
Vehicle 25,071 25,071
--------------------------
1,638,500 1,099,782
Accumulated depreciation and amortization (638,793) (573,721)
--------------------------
$ 999,707 $ 526,061
==========================
</TABLE>
NOTE 6 - DEPOSITS
- -----------------
The aggregate amount of time deposit accounts (including CDs), each with a
minimum denomination of $100,000, was approximately $4,356,835 and
$5,153,781 as of September 30, 1997 and 1996, respectively.
For time deposits as of September 30, 1997, the aggregate amount of
maturities for each of the following five years ended September 30 and
thereafter are as follows:
<TABLE>
<CAPTION>
(in thousands)
<C> <C>
1998 $29,826
1999 5,927
2000 1,220
2001 78
2002 67
2003 and thereafter 15
-------
$37,133
=======
</TABLE>
NOTE 7 - INCOME TAXES
- ---------------------
The components of income tax expense are as follows for the years ended
September 30:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------------------
<S> <C> <C> <C>
Current:
Federal $334,704 $241,168 $140,650
State 146,100 111,000 73,250
--------------------------------
480,804 352,168 213,900
--------------------------------
Deferred:
Federal (5,717) 9,154 10,185
State (1,973) 3,710 4,297
--------------------------------
(7,690) 12,864 14,482
--------------------------------
473,114 365,032 228,382
Changes in valuation allowance (42,214) (6,432) (17,482)
--------------------------------
Total income tax expense $430,900 $358,600 $210,900
================================
</TABLE>
The deferred income tax provision is a result of certain income and expense
items being accounted for in different time periods for financial reporting
purposes than for income tax purposes.
The components of net deferred tax liability are as follows as of September
30:
<TABLE>
<CAPTION>
1997 1996
---------------------
<S> <C> <C>
Deferred tax asset:
Federal $ 213,172 $179,442
State 87,692 76,053
---------------------
300,864 255,495
Valuation allowance on asset (45,500)
---------------------
300,864 209,995
---------------------
Deferred tax liability:
Federal (353,266) (182,131)
State (130,873) (77,112)
---------------------
(484,139) (259,243)
---------------------
Net deferred tax liability $(183,275) $(49,248)
=====================
</TABLE>
The tax effects of each type of item that gives rise to deferred taxes are
as follows as of September 30:
<TABLE>
<CAPTION>
1997 1996
---------------------
<S> <C> <C>
Allowance for loan losses $ 112,640 $111,327
Deferred income 71,960 60,006
Unrealized gain on securities (289,179) (105,248)
Reserve for contingencies 46,692 16,143
Excess depreciation (95,903) (89,262)
Deferred loan costs (31,038)
Other 1,553
---------------------
(183,275) (7,034)
Valuation allowance 0 (42,214)
---------------------
Net deferred tax liability $(183,275) $(49,248)
=====================
</TABLE>
Deferred tax assets as of September 30, 1997 have not been reduced by a
valuation allowance because management believes that it is more likely than
not that the full amount of deferred tax assets will be realized.
A summary of the change in the net deferred tax liability is as follows for
the years ended September 30:
<TABLE>
<CAPTION>
1997 1996
---------------------
<S> <C> <C>
Balance at beginning of year $ (49,248) $(53,300)
Deferred tax provision 7,690 (6,432)
Deferred tax liability on SFAS 115 unrealized
gain on available-for-sale securities (183,931) 4,052
Utilization of valuation allowance 42,214 6,432
---------------------
Balance at end of year $(183,275) $(49,248)
=====================
</TABLE>
The reasons for the differences between the tax at the statutory federal
income rate and the effective tax rate are summarized as follows for the
years ended September 30:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Tax at statutory rate of 34% $402,215 $315,799 $221,046
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 95,124 66,858 53,832
Utilization (provision) of deferred tax asset valuation reserve (42,214) (6,432) (17,482)
Dividend received deduction (38,173) (33,051) (33,504)
Other, net 13,948 15,426 (12,992)
-------- -------- --------
Income tax provision $430,900 $358,600 $210,900
======== ======== ========
</TABLE>
As part of the Adoption Tax Credit within the Minimum Wage Bill that was
enacted into law on August 20, 1996 the Section 593 tax additions to the
reserve for bad debts was repealed, effective for taxable years beginning
after December 31, 1995. Thus, the Bank will be allowed a tax deduction for
bad debts under the experience method only starting with the year beginning
October 1, 1996.
As part of this legislation the Bank will have to recapture in taxable
income the excess of the tax reserve for bad debts at September 30, 1996
over the tax reserve at April 30, 1988. The recapture amount is $238,709
resulting in Federal and Massachusetts income taxes of approximately $98,000
which will be paid over a six year period starting with the tax year
beginning October 1, 1998. This tax has been provided for in past years and
will not result in any charge to earnings.
In prior years, the Bank was allowed a special tax-basis bad debt deduction
under certain provisions of the Internal Revenue Code. As a result,
retained earnings of the Bank as of September 30, 1997 includes
approximately $1,639,418 for which federal and state income taxes have not
been provided. Under the provisions of recent federal income tax
legislation, if the Bank no longer qualifies as a bank as defined in certain
provisions of the Internal Revenue Code, this amount will be subject to
recapture in taxable income ratably over six (6) years, subject to a
combined federal and state tax rate of approximately 41% based on the
effective tax rates of the Bank in prior years.
NOTE 8 - EMPLOYEE RETIREMENT, PENSION PLANS AND BENEFITS
- --------------------------------------------------------
Retirement Plan
- ---------------
The Bank is a participant in the Cooperative Banks Employee Retirement
Association Defined Contribution and Defined Benefit Plans (a multi-employer
plan). The plans provide benefits to substantially all of the Bank's
employees. Benefits under the defined contribution plan are based on a
percentage of employee contributions while benefits under the defined
benefit plan are based primarily on years of service and employees'
compensation. The Bank's funding policy for the defined benefit plan is to
fund amounts required by applicable regulations and which are tax
deductible. Amounts charged to retirement fund expense for the years ending
September 30, 1997, 1996 and 1995 totaled $103,310, $93,870 and $84,144,
respectively.
Employee Stock Ownership Plan
- -----------------------------
Effective March 1996 the Bank adopted the Falmouth Co-Operative Bank
Employee Stock Ownership Plan (ESOP).
On March 26, 1996 the ESOP borrowed $872,850 from Bridgewater Savings Bank
to purchase 87,285 shares of the stock of Falmouth Co-Operative Bank. The
loan is secured by a pledge of the stock purchased. The Bank will make
annual contributions to the ESOP in amounts determined by the Board of
Directors. Dividends received by the ESOP may be credited to participants'
accounts or may be used to repay the ESOP's debt.
Any shares of the Bank purchased by the ESOP are subject to the accounting
specified by the American Institute of CPA's Statement of Position 93-6.
Under the statement, as any shares are released from collateral, the Bank
will report compensation expense equal to the current market price of the
shares and the shares will be outstanding for earnings-per-share
computations. Also, as the shares are released, the related dividends will
be recorded as a reduction of retained earnings and dividends on the
allocated shares will be recorded as a reduction of debt and accrued
interest.
The shares purchased by the ESOP were pledged as collateral for its debt.
As the debt is repaid, shares are released from collateral and allocated to
active employees, based on the proportion of debt service paid in the year.
The debt of the ESOP is recorded as debt of the Bank and the shares pledged
as collateral are reported as unearned ESOP shares in the balance sheet.
The ESOP shares were as follows as of September 30:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Allocated shares 4,364
Committed to be released shares 8,728 4,364
Unreleased shares 74,193 82,921
---------- ----------
87,285 87,285
========== ==========
Fair value of unreleased shares $1,548,779 $1,036,513
</TABLE>
For the first five years of the ESOP debt, the interest rate per annum is
8.15%. At the end of said five year period, the interest rate per annum
shall be adjusted to equal 2.65 percentage points above the weekly average
yield on U.S. Treasury Securities adjusted to a constant maturity of five
years. Interest expense on the note was $65,576 and $35,060 for the years
ended September 30, 1997 and 1996, respectively.
Although the Bank has guaranteed payment of the loan, and annual
contributions to the plan are discretionary, an implied guarantee exists as
the only source of income available to the Employee Stock Ownership Plan for
payments on the loan is from the normal retirement contributions made by the
Bank to the plan. Contributions to the ESOP Plan by the Bank were $87,285
and $78,702 for the years ended September 30, 1997 and 1996, respectively
and ESOP compensation expense was $128,389 and $43,642, respectively. The
minimum principal payments due on the loan are as follows as of September
30, 1997 for the years ended September 30:
<TABLE>
<CAPTION>
Principal
---------
<C> <C>
1998 $ 25,917
1999 72,216
2000 78,327
2001 84,954
2002 92,143
Years thereafter 388,366
--------
Total due $741,923
========
</TABLE>
Stock Option Plan
- -----------------
On November 19, 1996, the Bank adopted the 1997 Stock Option Plan for
Outside Directors, Officers, and Employees of the Bank. The plan was
approved by shareholders effective as of January 21, 1997. The Board of
Directors formed an Option Committee to administer the plan. The plan is
subject to the approval of the Division of Banks of the Commonwealth of
Massachusetts.
Stock Options Granted to Eligible Directors
- -------------------------------------------
The price, at which an option granted to an eligible director may be
exercised, is the fair market value of a share on the date on which the
option is granted. Such options expire ten years after the grant date. The
options are not exercisable in the first year after grant. In the second
through fifth year after the grant, the options are exercisable on a pro
rata basis up to 80% of the grant by the fifth year. After the fifth year,
100% of the grant not previously exercised may be exercised.
Stock Options Granted to Eligible Employees
- -------------------------------------------
An option granted to an eligible employee must be designated as either an
Incentive Stock Option or a Non-Qualifying Stock Option. The price at which
an option may be exercised is determined by the Committee, it its
discretion; provided, however, that the exercise price shall not be less
than the fair market value of a share on the grant date. These options may
be exercised in periods specified by the Committee in the option agreement.
The Bank applies APB Opinion 25 and related Interpretations in accounting
for its plan. Accordingly, no compensation cost has been recognized for its
stock option plan. Had compensation cost for the Bank's stock-based
compensation plan been determined based on the fair value at the grant dates
for awards under those plans consistent with the method of FASB Statement
123, the Bank's net income and earnings per share for the year ended
September 30, 1997 would have been reduced to the pro forma amounts
indicated below:
Net income As reported $752,085
Pro forma $733,053
Earnings per share As reported $.55
Pro forma $.53
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the year ended September 30, 1997: dividend
yield of 2 percent; expected volatility of 19 percent, risk-free interest
rate of 7 percent; and expected lives of 8 years.
A summary of the status of the Bank's stock option plan as of September 30,
1997 and changes during the year ending on that date is presented below:
<TABLE>
<CAPTION>
Weighted-Average
Options Shares Exercise Price
------- ------ ----------------
<S> <C> <C>
Outstanding at beginning of year 0
Granted 109,125 $13.375
Exercised 0
Forfeited 0
-------
Outstanding at end of year 109,125 $13.375
=======
Options exercisable at year-end 0
Weighted-average fair value of
options granted during the year $4.36
</TABLE>
The options outstanding at September 30, 1997 had a weighted-average
remaining contractual life of 9.5 years.
The pro forma disclosure amounts and the 109,125 shares granted include
41,965 shares granted but not yet approved by the Division of Banks.
Management of the Bank is expecting that this approval will be granted.
Recognition and Retention Plan
- ------------------------------
On November 19, 1996, the Bank adopted the 1997 Recognition and Retention
Plan for Outside Directors, Officers and Employees of Falmouth Co-operative
Bank (the RRP). The Board of Directors formed an RRP Committee to
administer the RRP. The Bank will establish a trust, (Trust) and will
contribute, or cause to be contributed, to the Trust, from time to time,
such amounts of money or property as shall be determined by the RRP
Committee. In no event shall the assets of the Trust be used to purchase
more than 58,190 shares of Bank common stock. In its discretion, the RRP
Committee may grant awards of restricted stock to officers and employees.
Each award will become vested and distributable at a rate of 20% on each
anniversary date of the grant and fully vested on the date of the award
holder's death or disability. Stock subject to awards is held in the Trust
until the award is vested. An individual to whom an award is granted is
entitled to exercise voting rights and receive cash dividends with respect
to stock subject to awards granted to him/her whether or not vested. The
RRP Committee will exercise voting rights with respect to the shares in the
RRP Trust that have not been allocated as directed by the individuals
eligible to participate. On April 15, 1997, 39,000 shares of the Bank's
common stock were awarded under this plan and related compensation cost is
being accrued.
NOTE 9 - REGULATORY MATTERS
- ---------------------------
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
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of September 30, 1997,
that the Bank meets all capital adequacy requirements to which it is
subject.
As of September 30, 1997 the most recent notification from the Federal
Deposit Insurance Corporation 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 1
risk-based and Tier 1 leverage ratios as set forth in the table. There are
no conditions or events since that notification that management believes
have changed the institution's category.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
----------------- ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1997:
Total Capital (to Risk Weighted Assets) $22,891 42.28% $4,331 >=8.0% $5,414 >=10.0%
Tier 1 Capital (to Risk Weighted Assets) 22,390 41.36 2,166 >=4.0 3,248 >=6.0
Tier 1 Capital (to Average Assets) 22,390 23.64 3,789 >=4.0 4,736 >=5.0
As of September 30, 1996:
Total Capital (to Risk Weighted Assets) 22,268 55.81 3,192 >=8.0 3,990 >=10.0
Tier 1 Capital (to Risk Weighted Assets) 21,770 54.56 1,596 >=4.0 2,394 >=6.0
Tier 1 Capital (to Average Assets) 21,770 24.27 3,588 >=4.0 4,485 >=5.0
</TABLE>
The ability of the Bank to pay dividends on its common stock is restricted
by Massachusetts banking law. No dividends may be paid if such dividends
would reduce stockholders' equity of the Bank below the amount of the
liquidation account required by Massachusetts conversion regulations and
described in Note 10. In addition, the Bank may not pay dividends in excess
of current earnings for three years following the conversion of the Bank
from mutual to stock form.
NOTE 10 - FINANCIAL INSTRUMENTS
- -------------------------------
The Bank is 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 include commitments to originate loans. The
instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheets. The contract amounts of
those instruments reflect the extent of involvement the Bank has in
particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments is represented
by the contractual amounts of those instruments. The Bank uses the same
credit policies in making commitments and conditional obligations as it does
for on-balance sheet instruments.
Commitments to originate loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the borrower.
Collateral held varies, but may include secured interests in mortgages,
accounts receivable, inventory, property, plant and equipment and income-
producing properties.
The estimated fair values of the Bank's financial instruments, all of which
are held or issued for purposes other than trading, are as follows as of
September 30:
<TABLE>
<CAPTION>
1997 1996
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 3,915,920 $ 3,915,920 $ 2,755,198 $ 2,755,198
Available-for-sale securities 25,481,370 25,481,370 22,713,053 22,713,053
Held-to-maturity securities 10,515,369 10,558,749 22,839,596 22,845,398
Federal Home Loan Bank stock 405,200 405,200 300,900 300,900
Loans 53,881,171 54,260,000 40,236,846 39,971,000
Accrued interest receivable 614,289 614,289 746,601 746,601
Cooperative Central Bank Reserve Fund
Deposit 285,680 285,680 285,680 285,680
Financial liabilities:
Deposits 72,191,089 72,226,000 66,443,600 66,536,000
Employee Stock Ownership Plan loan 741,923 738,519 829,208 813,025
</TABLE>
The carrying amounts of financial instruments shown in the above table are
included in the balance sheet under the indicated captions. Accounting
policies related to financial instruments are described in Note 2.
Notional amounts of financial instrument liabilities with off-balance sheet
credit risk are as follows as of
September 30:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Commitments to grant mortgage loans $1,788,200 $1,781,455
Unadvanced funds on construction loans 1,024,942 289,442
Unadvanced funds on home equity lines of credit 3,832,129 2,361,777
Unadvanced funds on commercial lines of credit 688,116 292,500
Unadvanced funds on overdraft lines of credit 56,632 18,861
---------- ----------
$7,390,019 $4,744,035
========== ==========
</TABLE>
There is no material difference between the notional amount and the
estimated fair value of the off-balance sheet liabilities.
The Bank has no derivative financial instruments subject to the provisions
of SFAS No. 119 "Disclosure About Derivative Financial Instruments and Fair
Value of Financial Instruments."
NOTE 11 - CONVERSION
- --------------------
On March 28, 1996, The Falmouth Co-Operative Bank converted from a mutual
cooperative bank to a Massachusetts-chartered capital stock cooperative
bank. The Bank issued 1,454,750 shares of common stock through a public
offering which provided net proceeds of $13,743,649 after conversion costs
of $803,851.
At the time of conversion to stock form, the Bank established a liquidation
account in an amount equal to the Bank's net worth as of the date of the
latest financial statements included in the final Offering Circular used in
connection with the Conversion. 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 balance in the liquidation account
was $1,900,800 as of September 30, 1997.
NOTE 12 - EMPLOYMENT AGREEMENTS
- -------------------------------
The Bank has employment agreements with its President and Chief Executive
Officer and its Vice President and Treasurer. The employment agreements
generally provide for the continued payment of specified compensation and
benefits for specified periods after termination, unless the termination is
for "cause" as defined in the employment agreements. The employment
agreements provide for the payment, under certain circumstances, of lump-sum
amounts upon termination following a "change in control" as defined in the
Agreements. The employment agreements also provide for lump-sum payments in
the event of the officers' voluntary termination of employment on the
occurrence of certain specified events.
NOTE 13 - COMMITMENTS AND CONTINGENT LIABILITIES
- ------------------------------------------------
The Bank is obligated under certain agreements issued during the normal
course of business which are not reflected in the accompanying financial
statements.
The Bank is obligated under lease agreements covering office space for its
two branches. These agreements are considered to be operating leases. The
total minimum rental payments due in future periods under these agreements
are as follows as of September 30, 1997:
<TABLE>
<C> <C>
1998 $23,600
1999 20,000
2000 20,000
2001 1,667
-------
Total minimum lease payments $65,267
=======
</TABLE>
One lease contains provisions for escalation of minimum lease payments
contingent upon percentage increases in the consumer price index.
NOTE 14 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
- ---------------------------------------------------------
Most of the Bank's business activity is with customers located within the
state. There are no concentrations of credit to borrowers that have similar
economic characteristics. The majority of the Bank's loan portfolio is
comprised of loans collateralized by real estate located in the state of
Massachusetts.
NOTE 15 - RECLASSIFICATION
- --------------------------
Certain amounts in the prior years have been reclassified to be consistent
with the current year's statement presentation.
NOTE 16 - SUBSEQUENT EVENT, FORMATION OF BANK HOLDING COMPANY
- -------------------------------------------------------------
As of November 19, 1996 the Bank entered into an Agreement and Plan of
Reorganization (the "Plan") by and between the Bank and Falmouth Bancorp,
Inc. (the "Bancorp"). Under the Plan, the Bank would become a wholly-owned
subsidiary of Bancorp, a bank holding company which was newly formed for the
purpose of effecting the Plan. The Plan became effective on October 14,
1997 at which date all outstanding shares of the Bank's common stock, par
value $0.10 per share were converted into and exchanged for an equal number
of shares of Bancorp common stock, on a one-for-one basis. Bancorp is
incorporated under the General Corporation Law of the State of Delaware.
Directors and Officers of Falmouth Bancorp, Inc. and Falmouth Co-operative Bank
Directors
- ---------
Walter A. Murphy
Chairman of the Board
Retired President, Falmouth Co-operative Bank
Santo P. Pasqualucci
President and Chief Executive Officer
John W. Holland, Jr.
Attorney at Law
James A. Keefe
Principal, Falmouth Ford
Gardner L. Lewis
Retired, Former Owner, The Pancake Man
Family Restaurant
John J. Lynch, Jr.
President, Paul Peters Insurance Agency
Ronald L. McLane
Retired building contractor
Eileen C. Miskell, CPA
CPA, Principal and Treasurer, Wood Lumber
Company
Robert H. Moore
Agent, Paul Peters Insurance Agency
William E. Newton
Principal, C. H. Newton Builders, Inc.
Armand Ortins
Retired, Former Owner, Ortins Photo Supply
Executive Officers
- ------------------
Santo P. Pasqualucci
President and Chief Executive Officer
George E. Young, III
Vice President, Chief Financial Officer and
Treasurer
Jeanne E. Alves
Secretary
Ronald Garcia
Vice President/Senior Loan Officer
Sharon L. Shoner
Vice President/Residential Loans
Corporate Information
Transfer Agent and Registrar
- ----------------------------
Inquiries regarding stockholder administration and services should be directed
to:
ChaseMellon Shareholder Services, L.L.C.
Overpeck Centre
85 Challenger Road
Ridgefield Park, NJ 07660
(800) 851-9677
Independent Auditors
- --------------------
Shatswell MacLeod & Co., P.C.
83 Pine Street
West Peabody, MA 01960-3635
(508) 535-0206
Legal Counsel
- -------------
Thacher Proffitt & Wood
1500 K Street, N.W., Suite 200
Washington, D.C. 20005
(202) 347-8400
Stock Information
- -----------------
The Company's Common Stock trades on the American Stock Exchange under the
symbol "FCB." Prices for the stock are reported in the American Stock Exchange
Composite Transactions section of The Wall Street Journal and other major
newspapers as "FalmthBcp."
Investor Relations
- ------------------
Inquiries regarding Falmouth Co-operative Bank and Falmouth Bancorp, Inc.
should be directed to:
Santo P. Pasqualucci
Falmouth Co-operative Bank
20 Davis Straits
Falmouth, MA 02540
(508) 548-3500
Annual Meeting of Stockholders The Company's Annual Meeting of Stockholders
will be held at 3:00 p.m. Eastern Standard time on Tuesday, January 20, 1998,
at the Quality Inn, 921 Jones Road, Falmouth, Massachusetts. Holders of common
stock as of December 8, 1997 will be eligible to vote.
FALMOUTH BANCORP, INC.
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
The Company has one wholly-owned subsidiary, Falmouth Co-operative Bank,
a stock co-operative bank chartered under the laws of the Commonwealth of
Massachusetts.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated Balance Sheet as of September 30, 1997 and the consolidated
statement of income for the year ended September 30, 1997 for the Bank and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 2,563,517
<INT-BEARING-DEPOSITS> 72,191,089
<FED-FUNDS-SOLD> 1,352,403
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 25,481,370
<INVESTMENTS-CARRYING> 10,515,369
<INVESTMENTS-MARKET> 10,558,749
<LOANS> 53,881,171
<ALLOWANCE> 501,437
<TOTAL-ASSETS> 96,391,184
<DEPOSITS> 72,191,089
<SHORT-TERM> 0
<LIABILITIES-OTHER> 652,656
<LONG-TERM> 741,923
0
0
<COMMON> 145,475
<OTHER-SE> 22,660,041
<TOTAL-LIABILITIES-AND-EQUITY> 22,805,516
<INTEREST-LOAN> 3,775,916
<INTEREST-INVEST> 2,325,821
<INTEREST-OTHER> 157,115
<INTEREST-TOTAL> 6,258,852
<INTEREST-DEPOSIT> 2,728,402
<INTEREST-EXPENSE> 2,793,978
<INTEREST-INCOME-NET> 3,464,874
<LOAN-LOSSES> 3,208
<SECURITIES-GAINS> 112,035
<EXPENSE-OTHER> 2,523,806
<INCOME-PRETAX> 0
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 752,085
<EPS-PRIMARY> .52
<EPS-DILUTED> .55
<YIELD-ACTUAL> 3.78
<LOANS-NON> 29,780
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 106,885
<ALLOWANCE-OPEN> 498,223
<CHARGE-OFFS> 0
<RECOVERIES> 3,214
<ALLOWANCE-CLOSE> 501,437
<ALLOWANCE-DOMESTIC> 283,253
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 218,184
</TABLE>
