<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934, for the quarter ended September 30, 1998 or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, for the transition period from ________ to _______.
COMMISSION FILE NUMBER 000-23557
MECH FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-1500984
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
100 PEARL STREET
HARTFORD, CONNECTICUT 06103
(Address of principal executive offices) (Zip code)
(860) 293-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(b) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes [X] No [_]
Common Stock Par Value $.01 Per Share
5,223,266 Outstanding (as of September 30, 1998)
<PAGE>
Table of Contents
-----------------
<TABLE>
<CAPTION>
Part I. Item 1. Financial Information Page
<S> <C>
A. Consolidated Statements of Condition as of September 30, 1998 and 1
December 31, 1997
B. Consolidated Statements of Operations for the Three and Nine Month Periods 2
Ended September 30, 1998 and September 30, 1997
C. Consolidated Statements of Changes in Stockholders' Equity for the Nine 3
Month Periods Ended September 30, 1998 and September 30, 1997
D. Consolidated Statements of Cash Flows for the Nine Month Periods Ended 4
September 30, 1998 and September 30, 1997
E. Notes to Consolidated Financial Statements 6
Part I. Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Part I. Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Part II. Other Information 27
Signatures 28
Exhibit 29
</TABLE>
<PAGE>
MECH Financial, Inc. and Subsidiaries
Consolidated Statements of Condition (unaudited)
<TABLE>
<CAPTION>
(dollars in thousands) September 30, 1998 December 31, 1997
------------------------ -------------------
<S> <C> <C>
ASSETS
Cash and due from banks:
Non-interest-bearing deposits and cash $ 17,194 $ 22,884
Short-term investments 1,770 10,140
------------------------ -------------------
Cash and cash equivalents 18,964 33,024
Investments:
Available-for-sale, at market value 174,106 152,200
Held-to-maturity (market value at September 30, 1998 - $104,803; 103,707 75,199
at December 31, 1997 - $76,186)
Federal Home Loan Bank stock, at cost 9,037 6,450
Loans, net 604,095 571,112
Loans held-for-sale - 1,922
Bank premises and equipment 4,737 4,823
Investment in Real Estate Partnership 13,751 14,485
Accrued interest receivable 4,951 4,347
Foreclosed real estate owned 479 1,204
Cash surrender value life insurance 16,667 16,053
Goodwill 781 -
Other assets 8,742 11,552
======================== ==================
$ 960,017 $ 892,371
======================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 690,655 $ 667,564
Borrowings 167,527 129,720
Mortgage escrow 2,832 1,388
Other liabilities 4,581 5,150
------------------------ ------------------
Total liabilities 865,595 803,822
------------------------ ------------------
Stockholders' Equity:
Preferred stock - par value $.01; 1,000,000 shares - -
authorized, none issued
Common stock - par value $.01; 15,000,000 shares 53 53
authorized; 5,295,266 issued at September 30, 1998 and
5,293,266 issued at December 31, 1997
Additional paid in capital 50,961 50,927
Retained earnings 43,648 37,891
Net unrealized gains on securities 480 398
Less: Unallocated ESOP shares (72,000 shares) (720) (720)
------------------------ ------------------
Total stockholders' equity 94,422 88,549
======================== ==================
$ 960,017 $ 892,371
======================== ==================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
1
<PAGE>
MECH Financial, Inc. and Subsidiaries
Consolidated Statements of Operations (unaudited)
<TABLE>
<CAPTION>
(in thousands except for earnings per share) For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $11,870 $11,211 $35,490 $32,301
Interest and dividends on investment securities:
Interest on debt securities 3,961 3,117 11,189 9,498
Dividends on equity securities 200 80 546 227
------- ------- ------- -------
4,161 3,197 11,735 9,725
Other interest income 625 99 1,610 225
------- ------- ------- -------
Total interest income 16,656 14,507 48,835 42,251
------- ------- ------- -------
Interest expense:
Interest on deposits:
Savings deposits 786 896 2,195 2,723
Time deposits 5,374 5,115 15,990 14,999
------- ------- ------- -------
Total interest on deposits 6,160 6,011 18,185 17,722
Interest on securities sold under agreements
to repurchase - - - 243
Interest on other borrowings 2,429 1,183 7,110 2,291
------- ------- ------- -------
Total interest expense 8,589 7,194 25,295 20,256
------- ------- ------- -------
Net interest income 8,067 7,313 23,540 21,995
Provision for loan losses - 600 600 8,800
------- ------- ------- -------
Net interest income after provision for loan losses 8,067 6,713 22,940 13,195
------- ------- ------- -------
Other income:
Service charges on deposit accounts 673 569 1,902 1,701
Investment brokerage services commissions 576 648 1,871 2,542
Loan servicing and other fees 238 192 728 594
Appreciation of cash surrender value life insurance 235 189 694 196
Income from investment in Real Estate Partnership 150 136 518 442
Net gain on sales of loans 1 19 46 26
Net gain on sales of investment securities - - 4 2
Other 203 200 821 865
------- ------- ------- -------
Total other income 2,076 1,953 6,584 6,368
------- ------- ------- -------
Other expenses:
Salaries, commissions and employee benefits 2,987 2,994 9,216 9,254
Occupancy 856 801 2,426 2,398
Data processing 303 259 873 789
Furniture and equipment 245 238 719 715
Advertising 240 157 696 623
Legal and accounting 170 212 498 696
Communications 127 125 384 377
Operation of foreclosed real estate owned 100 60 282 317
Write-downs and net losses on sale
of foreclosed real estate owned - - 85 120
Amortization of goodwill 29 - 29 -
Other 799 719 2,447 2,215
------- ------- ------- -------
Total other expenses 5,856 5,565 17,655 17,504
------- ------- ------- -------
Income before income taxes 4,287 3,101 11,869 2,059
------- ------- ------- -------
Income tax expense (benefit) 1,632 1,191 4,524 (9,014)
------- ------- ------- -------
Net income $ 2,655 $ 1,910 $ 7,345 $11,073
======= ======= ======= =======
Earnings per share:
Basic $ 0.51 $ 0.37 $ 1.41 $ 2.13
Diluted $ 0.50 $ 0.36 $ 1.38 $ 2.12
Weighted average shares outstanding:
Basic 5,223 5,195 5,223 5,194
Diluted 5,303 5,268 5,335 5,220
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
2
<PAGE>
MECH Financial, Inc.and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
<TABLE>
<CAPTION>
Additional Net Unrealized Unallocated
Common Paid in Retained Gains (Losses) ESOP
(in thousands) Stock Capital Earnings on Securities Shares
------------ -------------- ------------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 53 $ 50,611 $ 24,815 $ 321 $ (960)
Net income - - 11,073 - -
Change in net unrealized gains
(losses) on securities - - - 475 -
Exercised stock options - 57 - - -
============ ============== ============= ============ ===========
Balance at September 30, 1997 $ 53 $ 50,668 $ 35,888 $ 796 $ (960)
============ ============== ============= ============ ===========
Balance at December 31, 1997 $ 53 $ 50,927 $ 37,891 $ 398 $ (720)
Net income - - 7,345 - -
Change in net unrealized gains
(losses) on securities - - - 82 -
Exercised stock options - 34 - - -
Dividends on common stock
($0.30 per share declared) - - (1,588) - -
============ ============== ============= ============ ===========
Balance at September 30, 1998 $ 53 $ 50,961 $ 43,648 $ 480 $ (720)
============ ============== ============= ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
MECH FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
(in thousands) SEPTEMBER 30, 1998 SEPTEMBER 30,1997
------------------ -------------------
Cash flows from operating activities:
Net income $ 7,345 $ 11,073
------------------ -------------------
<S> <C> <C>
Adjustments to reconcile net income to cash provided by operating
activities:
Provision for loan losses 600 8,800
Depreciation and amortization 726 709
Amortization of investment security premiums/discounts, net 77 119
Deferred loan costs, net of amortization (728) (479)
Net gain on sale of loans (46) (26)
Proceeds from loan sales 14,388 2,791
Originations of loans held for sale (14,008) (4,237)
Loss on retirement of bank premises and equipment 5 -
Decrease (increase) in deferred tax assets 2,830 (10,666)
Realized losses on available-for-sale securities - 92
Realized gains on available-for-sale securities (4) (94)
(Increase) decrease in interest and dividend receivables (604) 67
Income from investment in Real Estate Partnership (518) (442)
Write-downs and net losses on sale of foreclosed real estate owned 85 120
Increase in cash surrender value life insurance (614) (14,719)
Increase in other assets (833) (509)
(Decrease) increase in other liabilities (569) 2,330
------------------- -------------
Total adjustments 787 (16,144)
------------------- -------------
Net cash provided (used) by operating activities 8,132 (5,071)
------------------- -------------
Cash flows from investing activities:
Proceeds from sale of available-for-sale securities 41,171 22,823
Proceeds from principal payments on available-for-sale securities 59,496 26,572
Proceeds from principal payments on held-to-maturity securities 19,085 2,132
Proceeds from maturities and calls of available-for-sale securities 18,847 11,500
Proceeds from maturities and calls of held-to-maturity securities 11,005 -
Purchases of available-for-sale securities (141,502) (70,051)
Purchases of held-to-maturity securities (58,475) -
Purchases of Federal Home Loan Bank stock (2,587) (575)
Net originations and purchases of loans (31,907) (62,616)
Decrease in investment in Real Estate Partnership 1,252 940
Proceeds from sale of foreclosed real estate owned 1,280 1,201
Purchases of bank premises and equipment (645) (197)
------------------- -------------
Net cash used in investing activities (82,980) (68,271)
------------------- -------------
Cash flows from financing activities:
Net increase (decrease) in demand deposits, money market and savings accounts 14,625 (15,264)
Net increase in certificates of deposit 8,466 11,214
Net increase in mortgage escrow 1,444 171
Advances from FHLB 124,495 250,828
Repayments of FHLB borrowings (86,688) (176,828)
Issuance of common stock 34 57
Dividends paid (1,588) -
------------------- -------------
Net cash provided by financing activities 60,788 70,178
------------------- -------------
Net decrease in cash and cash equivalents (14,060) (3,164)
------------------- -------------
Cash and cash equivalents at beginning of period 33,024 30,006
------------------- -------------
Cash and cash equivalents at end of period $ 18,964 $ 26,842
=================== =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
4
<PAGE>
MECH FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
For the nine months ended
September 30, 1998 September 30, 1997
----------------------- ----------------------
(in thousands)
<S> <C> <C>
Non-cash investing and financing activities
Change in net unrealized gain (loss) on securities available-for-sale $ (33) $ 679
Change in net unrealized gain (loss) on securities held-to-maturity 146 44
Transfer of loans to foreclosed real estate owned 690 2,311
Supplemental disclosures of cash flow information
Income taxes paid 2,609 641
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
5
<PAGE>
MECH FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION
On November 25, 1997, the shareholders of Mechanics Savings Bank (the "Bank")
approved the formation of a holding company, MECH Financial, Inc. (the
"Company"). MECH Financial, Inc. provides additional corporate structuring
opportunities and powers to respond to the changing and expanding needs of the
Bank's customers and to the competitive conditions in the financial services
industry. The holding company structure became effective January 1, 1998, as
approved by the appropriate regulatory agencies. Shares of common stock of
Mechanics Savings Bank were automatically converted into shares of MECH
Financial, Inc. on a one-for-one tax-free exchange basis on that date.
The accompanying unaudited consolidated financial statements include the
accounts of MECH Financial, Inc. and its wholly-owned subsidiary, Mechanics
Savings Bank. Mechanics Savings Bank and its wholly-owned subsidiaries include
Mech Corporation, Mech Two Corporation, Mech Three Corporation, Eighty Pearl
Street Corporation and Mechanics Investment Services, Inc. Mechanics Investment
Services, Inc. ("MIS") was formed during 1996 to enable the Bank to serve its
customers with a wholly-owned fully disclosed broker / dealer. On July 2, 1997,
MIS became a licensed broker / dealer and registered investment advisor.
Intercompany accounts and transactions have been eliminated in consolidation.
The condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles and with the instructions to Form
10-Q. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Bank's 1997 Annual Report on
Form 10-K.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Dollars are presented in thousands, except for per share data, in the following
footnotes.
NOTE 2 - INVESTMENTS
The amortized cost and market values as of September 30, 1998 of available-for-
sale securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
U. S. Government and agency securities $ 4,994 $ 85 $ 14 $ 5,065
Mortgage-backed securities 139,601 1,313 25 140,889
Debt securities issued by foreign governments 1,350 - - 1,350
Corporate debt securities 5,996 - 135 5,861
Marketable equity securities 5,181 48 289 4,940
Mutual funds 15,973 105 77 16,001
============== ============== ============== =============
$ 173,095 $ 1,551 $ 540 $ 174,106
============== ============== ============== =============
</TABLE>
6
<PAGE>
The amortized cost and market values as of December 31, 1997 of available-for-
sale securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
U. S. Government and agency securities $ 2,996 $ 1 $ - $ 2,997
Mortgage-backed securities 126,147 1,045 7 127,185
Debt securities issued by foreign governments 350 - - 350
Corporate debt securities 999 3 - 1,002
Marketable equity securities 3 20 - 23
Mutual funds 20,662 20 39 20,643
------------- ------------- ------------- ------------
$ 151,157 $ 1,089 $ 46 $ 152,200
============== ============== ============== =============
</TABLE>
The amortized cost and market values as of September 30, 1998 of held-to-
maturity securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
U. S. Government and agency securities $ 22,995 $ 273 $ - $ 23,268
Mortgage-backed securities 79,712 872 9 80,575
Corporate debt securities 1,000 - 40 960
--------------- ------------ ------------ -------------
$ 103,707 $ 1,145 $ 49 $ 104,803
=============== ============= ============= =============
</TABLE>
The amortized cost and market values as of December 31, 1997 of held-to-maturity
securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
U. S. Government and agency securities $ 5,000 $ 7 $ - $ 5,007
Mortgage-backed securities 70,199 989 9 71,179
-------------- ------------ ------------ ------------
$ 75,199 $ 996 $ 9 $ 76,186
=============== ============= ============= =============
</TABLE>
7
<PAGE>
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDING
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
----------------- ------------------
<S> <C> <C>
Balance at beginning of year $ 14,031 $ 7,983
Provision for loan losses 600 8,800
Loan charge-offs (2,389) (3,272)
Loan recoveries 430 692
================= ==================
Balance $ 12,672 $ 14,203
================= ==================
</TABLE>
NOTE 4 - NON-PERFORMING ASSETS
The components of non-performing assets were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
----------------------- ---------------------
<S> <C> <C>
Non-accrual loans $ 3,716 $ 2,830
Accruing loans past due > 90 days - -
----------------------- ---------------------
Total non-performing loans 3,716 2,830
Foreclosed real estate owned 479 1,204
----------------------- ---------------------
Total non-performing assets $ 4,195 $ 4,034
======================= =====================
Non-performing assets as a
percentage of total assets 0.44% 0.45%
======================= =====================
Non-performing assets as a
percentage of gross loans and
foreclosed real estate owned 0.68% 0.69%
======================= =====================
Allowance for loan losses
as a percentage of
non-performing loans 341.01% 495.80%
======================= =====================
</TABLE>
8
<PAGE>
NOTE 5 - BORROWINGS
Advances from the Federal Home Loan Bank of Boston ("FHLB") and the repayment
schedule were as follows:
Borrowing
<TABLE>
<CAPTION>
MATURITY DATE INTEREST RATE SEPTEMBER 30, 1998 DECEMBER 31, 1997
- ---------------------- ---------------- -------------------- ----------------------
<S> <C> <C> <C>
January 6, 1998 5.59 % $ - $ 16,000
October 1, 1998 6.09 6,062 -
March 1, 1999 6.35 - 5,000
July 1, 1999 6.15 13,000 13,000
August 25, 1999 6.00 7,000 7,000
October 20, 2000 6.21 10,000 10,000
October 20, 2000 6.24 20,000 20,000
November 30, 2000 6.61 - 8,000
February 27, 2001 5.71 7,000 -
December 15, 2001 5.95 10,000 10,000
November 7, 2002 * 5.71 30,000 30,000
March 12, 2003 5.78 8,745 -
November 3, 2004 * 5.80 10,000 10,000
January 10, 2008 * 4.99 15,000 -
May 8, 2008 * 5.52 10,000 -
June 4, 2008 * 5.52 10,000 -
April 8, 2013 * 5.49 % 10,000 -
------------- ----------------
$ 166,807 $ 129,000
============= ================
</TABLE>
* initial call dates ranging from January 1999 to April 2003
During the first quarter of 1998, the Bank prepaid the $8,000 FHLB advance
scheduled to mature November 30, 2000 that carried an interest rate of 6.61%
thereby incurring a $192 prepayment penalty. The Bank prepaid this advance in
anticipation of being able to extend its overall maturities of borrowings while
reducing its weighted average interest cost of borrowings. On April 8, 1998, the
Bank accomplished the objectives by taking out a $10,000 advance maturing in
April 2013 carrying an interest rate of 5.49%. This advance is callable in April
2003 and on a quarterly basis thereafter. In addition, during the third quarter
of 1998, the Bank prepaid the $5,000 FHLB advance scheduled to mature March 1,
1999 that carried an interest rate of 6.35% thereby incurring a $25 prepayment
penalty. The Bank analyzes its borrowing portfolio on a regular basis through
its asset/liability and investment committees.
The Bank has access to a pre-approved line of credit up to approximately $15,000
and the capacity to borrow in excess of 40% of the Bank's total assets. In
accordance with an agreement with the FHLB, the Bank is required to maintain
qualified collateral, as defined in the FHLB Statement of Credit Policy, free
and clear of liens, pledges and encumbrances as collateral for the advances.
In addition, the Employee Stock Ownership Plan ("ESOP") borrowed $1,200 to
purchase 120,000 shares of the Bank's stock for the ESOP in conjunction with the
Bank's conversion from a Connecticut-chartered mutual savings bank to a
Connecticut-chartered capital stock savings bank, completed on June 25, 1996.
The shares in the ESOP were converted into shares of MECH Financial, Inc. on
January 1, 1998. At September 30, 1998 and December 31, 1997, this borrowing
had an outstanding balance of $720. The loan's final principal payment is due
on December 31, 2000. The loan carries an interest rate equal to the prime
rate. The Bank has fully guaranteed this borrowing.
9
<PAGE>
NOTE 6 - EARNINGS PER SHARE
Earnings per share is computed based upon the weighted average number of shares
of common stock and common stock equivalents (if dilutive) outstanding during
the periods presented. Common stock equivalents consist of stock options granted
under the 1996 Director and Officer Stock Option Plans. The option exercise
price for the options granted is the market price at the time of the grant.
The weighted average shares outstanding totaled 5,223,266 and 5,195,327 for the
quarters ended September 30, 1998 and 1997, respectively. The weighted average
shares outstanding totaled 5,222,536 and 5,194,447 for the nine months ended
September 30, 1998 and 1997, respectively. The effect of dilutive stock options
was 116,170 and 72,576 shares for the quarters ended September 30, 1998 and
1997, respectively. The effect of dilutive stock options was 112,947 and 26,014
shares for the nine months ended September 30, 1998 and 1997, respectively.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131 "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131
requires public companies to report financial and descriptive information about
operating segments in annual financial statements and requires selected
information about operating segments to be reported in interim financial reports
issued to shareholders. Operating segment financial information is required to
be reported on the basis that it is used internally for evaluating segment
performance and allocation of resources. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997 and requires
presentation of comparative information for prior periods presented. This
statement does not apply to interim financial statements in the initial year of
application. The Company does not have operating segments, as defined by SFAS
No. 131, and therefore, does not expect the adoption of SFAS No. 131 to impact
the Company's reporting.
In February 1998, FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Post Retirement Benefits" ("SFAS No. 132") This statement
revised employers' disclosure about pension and other post retirement benefits,
however, it does not change the measurement or recognition of those plans. This
statement standardized disclosure requirements to the extent practicable,
requires additional information on changes in the benefits obligations and fair
value of plans assets, and eliminates certain disclosure requirements of SFAS
No. 87 "Employers Accounting for Pensions", SFAS No. 88 "Employers' Accounting
for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," and SFAS No. 106 "Employers' Accounting for Post
Retirement Benefits Other Than Pensions." This statement also permits reduced
disclosure for nonpublic entities. SFAS No. 132 is effective for fiscal years
beginning after December 31, 1997 and restatement of disclosures for earlier
periods provided for comparative purposes is required unless the information for
comparative purposes is not readily available, in which case the notes to the
financial statements should include all available information and a description
of the information not available. The adoption of SFAS 132 is expected to expand
the disclosures about pension plans for the Company.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement established
accounting and reporting standards for derivative instruments, including certain
derivative instruments imbedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. Under this statement, an entity that elects to apply
hedge accounting is required to establish at the inception of the hedge the
method it will use for assessing the effectiveness of the hedging derivative and
the measurement approach for determining the ineffective aspect of the hedge.
Those methods must be consistent with the entity's approach to managing risk.
10
<PAGE>
This statement amends SFAS No. 52 "Foreign Currency Translation" and SFAS No.
107, "Disclosures about Fair Value of Financial Instruments". This statement
superseded SFAS No. 80, "Accounting for Futures Contracts", SFAS No. 105,
"Disclosure Information about Financial Instruments with Off-balance Sheet Risk
and Financial Instruments with Concentrations of Credit Risk" and SFAS No. 119,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments".
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of this statement should be as of the
beginning of an entity's fiscal quarter; on that date, hedging relationships
must be designated anew and documented pursuant to the provisions of this
statement. Early adoption is permitted, however, retroactive application is
prohibited. The adoption of SFAS 133 is not expected to have a material impact
for the Company.
NOTE 8 - COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components (such as changes in net unrealized
gain (loss) on securities). Comprehensive income includes net income and any
change in net equity of a business enterprise during a period from non-owner
sources that bypass the income statement. The purpose of reporting comprehensive
income is to report a measure of all changes in equity of an enterprise that
result from recognized transactions and other economic events of the period
other than transactions with owners in their capacity as owners. The Company's
one source of other comprehensive income is the net unrealized gain (loss) on
securities.
The components of comprehensive income for the three months ended September 30,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
<S> <C> <C>
Comprehensive income:
Net income $ 2,655 $ 1,910
Net unrealized gains (losses) (137) 199
on securities
------------------ ------------------
Comprehensive income $ 2,518 $ 2,109
================== ==================
</TABLE>
The following table represents the components and the related tax effects
allocated to other comprehensive income for the third quarter of 1998:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------- --------- --------
<S> <C> <C> <C>
Net unrealized gains (losses) on $ (271) $ 108 $ (163)
securities arising during the period
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 43 (17) 26
--------- --------- --------
Net unrealized gains (losses) on securities $ (228) $ 91 $ (137)
========= ========= ========
</TABLE>
11
<PAGE>
The following table represents components and the related tax effects allocated
to other comprehensive income for the third quarter of 1997:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------- --------- --------
<S> <C> <C> <C>
Net unrealized gains (losses) on $ 325 $ (136) $ 189
securities arising during the period
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 18 (8) 10
--------- --------- --------
Net unrealized gains (losses) on securities $ 343 $ (144) $ 199
========= ========= ========
</TABLE>
The components of comprehensive income for the nine months ended September 30,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
<S> <C> <C>
Comprehensive income:
Net income $ 7,345 $ 11,073
Net unrealized gains (losses)
on securities 82 475
------------------ ------------------
Comprehensive income $ 7,427 $ 11,548
================== ==================
</TABLE>
The following table represents components and the related tax effects allocated
to other comprehensive income for the nine months of 1998:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------- --------- --------
<S> <C> <C> <C>
Net unrealized gains (losses) on securities $ (27) $ 11 $ (16)
arising during the period
Less: reclassification adjustment for
gain realized in net income 4 (2) 2
Adjustment to tax rate on prior periods'
net unrealized gains on securities - 21 21
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 145 (66) 79
--------- --------- --------
Net unrealized gains (losses) on securities $ 114 $ (32) $ 82
========= ========= ========
</TABLE>
12
<PAGE>
The following table represents components and the related tax effects allocated
to other comprehensive income for the first nine months of 1997:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------- --------- --------
<S> <C> <C> <C>
Net unrealized gains (losses) on securities $ 774 $ (520) $ 254
arising during the period
Less: reclassification adjustment for
gain realized in net income 94 - 94
Change in tax rate on prior periods'
net unrealized gains on securities - 285 285
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 44 (14) 30
--------- --------- --------
Net unrealized gains (losses) on securities $ 724 $ (249) $ 475
========= ========= ========
</TABLE>
During the first quarter of 1997, the Company reversed the tax expense
associated with its unrealized net gain on securities due to its income tax
position at that time. During the second quarter of 1997, the Company recognized
a tax benefit of $10,330 primarily due to the full reversal of its deferred tax
asset valuation allowance. Based on three consecutive prior quarters of income
and projections that indicated continued profitability, the Bank determined that
it was more likely than not that it would realize its net deferred tax assets.
As a consequence of this action, the Company began recording a tax
asset/liability related to its unrealized gains and losses on securities in June
1997.
NOTE 9 - BRANCH PURCHASES
On March 18, 1998, the Bank announced the purchase of the East Hartford and West
Hartford branches of Chase Manhattan Bank. The transaction was approved by
state and federal agencies. The purchase included all retail and small business
deposits totaling approximately $23,000 and loans totaling approximately $700 of
the two branches. This purchase brings to 16 the number of full-service offices
Mechanics Savings Bank has in Central Connecticut. Mechanics converted the two
Chase Manhattan branches to Mechanics offices on July 11, 1998. Goodwill of
$810 was recorded as a result of the purchase and is being amortized over seven
years.
NOTE 10 - DIVIDENDS
On April 21, 1998, the Company declared its first quarterly dividend of $0.15
per share on its common stock. The dividend was paid on May 15, 1998 to
shareholders of record on May 1, 1998.
On July 21, 1998, the Company declared a quarterly dividend of $0.15 per share
on its common stock. The dividend was paid on August 17, 1998 to shareholders
of record on August 3, 1998.
On October 20, 1998, the Company declared a quarterly dividend of $0.15 per
share on its common stock. The dividend is payable on November 16, 1998 to
shareholders of record on November 2, 1998.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The statements in the following discussions and analysis concerning future
results, performance, expectations, or intentions are forward-looking
statements. Actual results, performance, or developments may differ materially
from forward-looking statements as a result of known or unknown risks,
uncertainties and other factors. Discussion regarding Year 2000 issues
necessarily involve uncertainties in terms of the future consequences to the
Bank of failure of the Bank's suppliers, vendors and customers to effectively
manage their computer issues regarding Year 2000.
OVERVIEW
On November 25, 1997, the shareholders of Mechanics Savings Bank (the "Bank")
approved the formation of a holding company, MECH Financial, Inc. (the
"Company"). MECH Financial, Inc. provides additional corporate structuring
opportunities and powers to respond to the changing and expanding needs of the
Bank's customers and to the competitive conditions in the financial services
industry. The holding company structure became effective January 1, 1998, as
approved by the appropriate regulatory agencies. Shares of common stock of
Mechanics Savings Bank were automatically converted into shares of MECH
Financial, Inc. on a one-for-one tax-free exchange basis on that date.
The Company reported net income of $2.66 million for the third quarter ended
September 30, 1998 compared to $1.91 million for the same period in 1997,
representing a 39.0% increase. There was a $754,000 increase in net interest
income, a $600,000 decrease in the provision for loan losses and a $123,000
increase in other income. During the nine months ended September 30, 1998 and
1997, the Company reported net income of $7.35 million and $11.07 million,
respectively. Income before income taxes was $11.87 million for the first
nine months of 1998 compared to $2.06 million for the same period in 1997.
During the second quarter of 1997, the Bank recognized a tax benefit of $10.33
million primarily due to the full reversal of its deferred tax asset valuation
allowance. Based on three consecutive prior quarters of income and projections
that indicated continued profitability, the Bank determined that it was more
likely than not that it would realize its net deferred tax assets. Also, during
the first nine months of 1997, the Bank recorded $8.80 million in provisions for
loan losses compared to $600,000 during the same period in 1998.
FINANCIAL CONDITION
Total assets as of September 30, 1998 were $960.02 million representing an
increase of $67.65 million or 7.6% from $892.37 million at December 31, 1997.
The Company's Tier 1 leverage ratio was 9.71% at September 30, 1998 compared to
9.74% at December 31, 1997. The Company's total risk-based capital ratio was
16.71% at September 30, 1998 compared to 17.76% at December 31, 1997.
Cash and cash equivalents decreased $14.06 million or 42.6% from $33.02 million
at December 31, 1997 to $18.96 million at September 30, 1998. The Company
continues to efficiently manage cash and cash equivalents to balance the need
for liquidity with the need for increased yields.
Investment securities increased $50.41 million or 22.2% from $227.40 million at
December 31, 1997 to $277.81 million at September 30, 1998 primarily due to an
increase in the mortgage-backed securities portfolio of $23.22 million and an
increase in U.S. Government and agency securities of $20.06 million. The
Company also diversified its portfolio with increases of $5.86 million in
corporate debt securities and $4.92 million in marketable equity securities.
Funds available for investment increased mainly due to increased Federal Home
Loan Bank ("FHLB") borrowings and deposits. At September 30, 1998, the Company
held $103.71 million in securities classified as held-to-maturity in accordance
with Statement of
14
<PAGE>
Financial Accounting Standards No. 115 "Accounting for Certain Investments in
Debt and Equity Securities".
Due to increased FHLB borrowings, the Company was required to purchase
additional shares of stock totaling $2.59 million from the FHLB during the first
nine months of 1998. The Company believes that these shares provide above
average dividend yields for the risk characteristics of such investments.
Net loans increased $32.98 million or 5.8% from $571.11 million at December 31,
1997 to $604.09 million at September 30, 1998. The majority of the increase
came from a $12.23 million increase in loans secured by commercial real estate,
an $11.11 million increase in the installment loan portfolio and a $3.95 million
increase in commercial and industrial loans. The allowance for loan losses
totaled $12.67 million at September 30, 1998 compared to $14.03 million at
December 31, 1997. Provisions for loan losses during the nine months ended
September 30, 1998 totaled $600,000 and net charge-offs totaled $1.96 million.
The allowance for loan losses as a percentage of non-performing loans was
495.80% and 341.01% at December 31, 1997 and September 30, 1998, respectively.
Foreclosed real estate owned decreased from $1.20 million at December 31, 1997
to $479,000 at September 30, 1998. The Company sold twenty-four properties
totaling $1.17 million during the nine months ended September 30, 1998. Write-
downs and net losses on sale of foreclosed real estate owned for the first nine
months of 1998 totaled $85,000 compared to $120,000 for the same period in 1997.
Non-performing assets totaled $4.20 million at September 30, 1998 compared to
$4.03 million at December 31, 1997. Charge-offs on non-performing loans and
write-downs and net losses on sale of foreclosed real estate owned reduced non-
performing assets by $2.39 million and $85,000, respectively. Sales of non-
performing loans and foreclosed real estate owned accounted for an additional
$3.44 million and $1.17 million of the reductions, respectively. There were
other reductions of non-performing assets of $1.94 million due to payoffs,
payments and loans returning to accrual status. These reductions were offset
by $9.20 million in additions to non-performing assets since December 31, 1997.
Non-performing assets as a percentage of total assets was 0.45% at December 31,
1997 and 0.44% at September 30, 1998. Non-performing assets as a percentage of
total loans and foreclosed real estate owned was 0.69% at December 31, 1997 and
0.68% at September 30, 1998.
Deposits increased 3.5% from $667.56 million at December 31, 1997 to $690.66
million at September 30, 1998. In July 1998, the Bank purchased two branches of
Chase Manhattan Bank with deposits totaling approximately $23 million.
Borrowings from the FHLB increased $37.81 million from December 31, 1997 to
September 30, 1998. These borrowings were mainly used to fund investments,
commercial real estate mortgages and installment loans. The Company's $166.81
million of FHLB advances carry a weighted average rate of 5.57% and have a
weighted average contractual maturity of 4.96 years. At December 31, 1997, FHLB
advances totaled $129.0 million and carried a weighted average rate of 5.98% and
a weighted average contractual maturity of 3.1 years. In addition, $85.0
million or 51% of the FHLB borrowings at September 30, 1998 were callable and
had initial call dates ranging from January 1999 to April 2003. During the
first quarter of 1998, the Bank prepaid an $8.0 million FHLB advance scheduled
to mature November 30, 2000 that carried an interest rate of 6.61%, thereby
incurring a $192,000 prepayment penalty. The Bank prepaid this advance in
anticipation of being able to extend its overall maturities of borrowings while
reducing its weighted average interest cost of borrowings. On April 8, 1998,
the Bank accomplished the objectives by taking out a $10.0 million advance
maturing in April 2013 carrying an interest rate of 5.49%. This advance is
callable April 2003 and on a quarterly basis thereafter. In addition, during the
third quarter of 1998, the Bank prepaid the $5.0 million advance scheduled to
mature March 1, 1999 that carried an interest rate of 6.35% thereby incurring a
$25,000 prepayment penalty. The Bank analyzes its borrowing portfolio on a
regular basis through its asset/liability and investment committees.
15
<PAGE>
LIQUIDITY
The Company's liquidity is dependent on dividends provided by the Bank.
Connecticut banking laws limit the amount of annual dividends that the Bank may
pay to an amount no greater than the Bank's net profit for the then current
year, plus the Bank's retained net profit for the prior two years, unless
specifically approved by the Banking Commissioner ("net profit" is defined as
the remainder of all earnings from current operations). The Bank is also
prohibited from paying a cash dividend if the effect thereof would reduce its
capital accounts below minimum regulatory requirements or below the amount
required to be maintained in the liquidation account.
The Bank manages its liquidity position to ensure that there is sufficient
funding available at all times to meet both anticipated and unanticipated
deposit withdrawals, new loan originations, securities purchases and other
operating cash outflows. The Bank monitors its liquidity in accordance with
guidelines established under its asset/liability management policy and
applicable regulatory requirements. On a monthly basis, management monitors the
Bank's liquidity position by analyzing the amount of securities available for
repurchase agreements, the Bank's borrowing capacity at the FHLB, the expected
level of cash flows from loans and mortgage-backed securities, the expected
prepayments from loans and mortgage-backed securities, and the Bank's levels of
cash and short-term investments. At September 30, 1998, management believes its
current liquidity level is sufficient to meet normal operating needs.
ASSET/LIABILITY MANAGEMENT
The Company's objective in managing interest rate risk is to produce a high and
stable net interest margin in varying interest rate environments while
maintaining the flexibility to take advantage of opportunities that may arise
from the fluctuations of interest rates. The Company's exposure to interest
rate risk is managed strategically through the use of balance sheet simulation.
The Company models its forecasted balance sheet using interest rate ramps,
shocks and a most likely interest rate scenario over a 24 month time horizon.
In accordance with its funds management policy, the Company measures its
interest rate sensitivity by ramping interest rates in one hundred basis point
increments from -400 to +400 basis points from the current rate environment.
From this 800 basis point grid, the asset/liability committee selects the most
likely 400 basis point interest rate range based on the current interest rate
environment, as well as other economic factors. The Company will accept equal
to or less than a 10% change in net interest income over the next 12 months
within the selected 400 basis point band. At September 30, 1998, the Company
was within its policy guideline, and the Company believes its level of interest
rate sensitivity was appropriate.
CAPITAL RESOURCES
At September 30, 1998, the Company's stockholders' equity totaled $94.42 million
representing a 6.6% increase over the $88.55 million in capital at December 31,
1997. At September 30, 1998, the Company had a Tier 1 leverage capital ratio of
9.71% and a total risk-based capital ratio of 16.71%. The Company's Tier 1
leverage capital ratio was 9.74% and its total risk-based capital ratio was
17.76% at December 31, 1997.
As of December 31, 1997 and September 30, 1998, the Company meets all capital
adequacy requirements to which it is subject and was classified, as of its most
recent notification, as "well capitalized". The Company believes its current
capital is adequate to support operations and anticipated future growth.
16
<PAGE>
YEAR 2000
MECH Financial, Inc. is committed to ensure that the Company will be well
prepared to handle the date change which will occur at midnight on December 31,
1999. The Board of Directors approved a plan for implementing and monitoring
Year 2000 ("Y2K") compliance. MECH Financial, Inc. expects to have all critical
systems renovated by year-end 1998, as well as have testing of these systems
well underway by that date. The Company expects all testing and implementation
of critical systems to be completed by June 30, 1999.
The Company has fully completed the awareness and assessment phases of its Y2K
project. During the assessment period, the Company identified over 140
vendors/systems (both information technology ("IT") and non-IT) that would
possibly need to be addressed concerning Y2K. Non-IT systems include equipment
with embedded technology such as elevators, fire safety, ventilation and
security systems. The Company received documentation from virtually all of
these vendors, designating timeframes consistent with the Company's timetable
for Y2K compliance. The Company maintains a Y2K inventory, which is updated
regularly, monitoring vendor compliance levels.
The Company has no internally developed software, therefore no internal
renovation has occurred. Renovation, the actual changing of computer code, is
being monitored closely through regular vendor correspondence. At September 30,
1998, the Company estimates its vendors' software was 90% renovated.
The Company's core processing system is outsourced to Fiserv, Inc., based in
Milwaukee, Wisconsin. Fiserv is a leading data processor for banks and services
approximately 7,000 financial services providers worldwide. The Company
maintains regular contact with Fiserv to ensure progress toward each stage of
completing the Y2K compliance process. Fiserv stated that they completed the
renovation of their system, and placed the system into production. Fiserv
tested the system internally, and determined it to be Y2K compliant. The
Company tested the system on a companywide basis in October 1998 and noted no
significant issues pertaining to Y2K. The Company expects to test its core
processing system again with a focus on multiple future date testing during
May 1999.
The completion of the successful Fiserv test constitutes a large part of the
Company's internal testing. The Company has also tested substantially all of
its computer hardware, as well as many of its other IT and non-IT systems. The
Company estimates its testing to be 60% complete after the Fiserv test.
The Company expects to be fully compliant with all of its IT and non-IT systems
and vendors by June 30, 1999. The most reasonably likely worst case Y2K
scenario would probably be a low priority vendor's software program's short term
malfunction. The Company has developed contingency plans to address such a
scenario. For a low priority vendor's software program malfunction, the Company
may choose to purchase and implement a Y2K compliant product from another
vendor, or await further renovation on the currently owned software; depending
on the Company's evaluation of the vendor and the software's day-to-day
criticality to the Company. In either case, the Company would attempt to use
other existing Y2K compliant software in its place until the non-compliant
software is successfully renovated or replaced.
The Company expects Y2K issues to have no material effects on results of
operations, liquidity or financial condition. The Company expects that
expenditures associated with the Y2K effort will not exceed $300,000 with
approximately $100,000 spent to date. These costs will consist primarily of
purchases of new equipment and software which will be depreciated over their
respective useful lives.
The Company, in its attempt to mitigate risk in its commercial loan portfolio,
will identify, evaluate and monitor the risks that Y2K poses on its "material"
commercial borrowers. The Company has determined that a "material" commercial
borrower is a borrower with a total relationship of $400,000 or more as well as
any loan with a risk rating warranting further review. Upon completion, the
Company will have reviewed over 75% (based on dollars) of its commercial
portfolio. As of September 30, 1998, this review
17
<PAGE>
was approximately 85% complete. This review included loan document reviews and
borrower interviews. The Company determined whether the borrower had a Y2K plan,
whether the borrower had the necessary resources to implement its plan, as well
as the borrowers' overall vulnerability to the Y2K issue. Based on the results
of these reviews, the Company did not identify material exposure to the Y2K
issue in its commercial loan portfolio at this time. The Company expects to
follow up with its borrowers concerning Y2K during Spring 1999.
RESULTS OF OPERATIONS
FOR THE QUARTER ENDED SEPTEMBER 30, 1998 AND 1997
For the quarter ended September 30, 1998, the Company reported net income of
$2.66 million or $0.50 per diluted share compared to $1.91 million or $0.36 per
diluted share for the same period in 1997. Income before income taxes was $4.29
million for the third quarter of 1998 compared to $3.10 million for the third
quarter in 1997. Comparing the third quarters, there was a $754,000 increase in
net interest income, a $600,000 decrease in the provision for loan losses and a
$123,000 increase in other income.
NET INTEREST INCOME
Net interest income totaled $8.07 million for the three months ended September
30, 1998 compared to $7.31 million for the same period in 1997, representing a
$754,000 or 10.3% increase. The net interest margin decreased from 3.86% for
the quarter ended September 30, 1997 to 3.58% for the same period in 1998.
Average interest-earning assets increased $142.64 million while average
interest-bearing liabilities increased $116.45 million. Average investment
securities and net loans increased $80.70 million and $51.18 million,
respectively. Mutual funds, U.S. government and agency securities and mortgage-
backed securities were the main reasons for the increase in average investment
securities. Average net loans increased primarily due to a $19.69 million
increase in consumer loans, a $14.97 million increase in average commercial real
estate mortgages and a $8.44 million increase in commercial and industrial
loans. Average borrowings and certificates of deposit increased $84.13 million
and $32.85 million, respectively, from quarter to quarter.
18
<PAGE>
The following table sets forth certain information relating to the Company's
average interest-earning assets and interest-bearing liabilities and net
interest income for the quarters ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
AVERAGE BALANCE INCOME / EXPENSE YIELDS
------------------------------ ------------------------- ------------------------
QUARTERS ENDED SEPT. 30 QUARTERS ENDED SEPT. 30, QUARTERS ENDED SEPT.30,
(in thousands) 1998 1997 1998 1997 1998 1997
------------ ----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Loans, net $ 591,066 $ 539,889 $ 11,870 $ 11,211 7.97% 8.24%
Investment securities 285,589 204,894 4,553 3,212 6.33 6.22
Short-term investments 16,881 6,118 233 84 5.48 5.45
------------ ----------- ---------- ---------- ---------- ----------
Total interest-earning assets 893,536 750,901 16,656 14,507 7.40 7.66
Other assets 66,145 70,876
============ ===========
Total assets $ 959,681 $ 821,777
============ ===========
Money market checking $ 37,987 $ 34,222 116 100 1.21 1.16
Money market savings 58,697 55,929 386 330 2.61 2.34
Savings and other 109,127 116,178 416 583 1.51 1.99
Certificates of deposit 412,835 379,989 5,242 4,998 5.04 5.22
------------ ----------- ---------- ---------- ---------- ----------
Total deposits 618,646 586,318 6,160 6,011 3.95 4.07
Borrowings 164,013 79,887 2,429 1,183 5.88 5.88
------------ ----------- ---------- ---------- ---------- ----------
Total interest-bearing funds 782,659 666,205 8,589 7,194 4.35 4.28
Demand deposits 79,003 65,506
Other liabilities 4,658 4,659
Capital 93,361 85,407
============ ===========
Total liabilities and capital $ 959,681 $ 821,777
============ ===========
Net interest income $ 8,067 $ 7,313
========== ==========
Spread on interest-bearing funds 3.05% 3.38%
Net interest margin 3.58% 3.86%
</TABLE>
19
<PAGE>
The following table presents the changes in interest and dividend income and the
changes in interest expense, attributable to changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
during the periods indicated:
<TABLE>
<CAPTION>
QUARTERS ENDED SEPTEMBER 30, 1998 VERSUS 1997
CHANGE IN INTEREST DUE TO
------------------------------------------------------------------
(in thousands) VOLUME RATE VOL/RATE NET
-------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Loans, net $ 1,063 $ (369) $ (35) $ 659
Investment securities 1,265 55 21 1,341
Short-term investments 148 - 1 149
-------------- ------------- ------------- -------------
Total 2,476 (314) (13) 2,149
-------------- ------------- ------------- -------------
Money market checking 11 5 - 16
Money market savings 16 38 2 56
Savings and other (35) (140) 8 (167)
Certificates of deposit 432 (173) (15) 244
Borrowings 1,246 - - 1,246
-------------- ------------- ------------- -------------
Total 1,670 (270) (5) 1,395
-------------- ------------- ------------- -------------
Net change to interest income $ 806 $ (44) $ (8) $ 754
============== ============= ============= =============
</TABLE>
INTEREST INCOME
Interest income increased $2.15 million or 14.8% due primarily to increased
average volumes of investment securities and net loans of $80.70 million and
$51.18 million, respectively. Overall average yields decreased from 7.66% for
the third quarter of 1997 to 7.40% for the same period in 1998. This was
primarily due to a 27 basis point decrease in the average yields for net loans
which was partially offset by a 11 basis point increase in the average yields on
investment securities.
INTEREST EXPENSE
Interest expense increased $1.40 million or 19.4% from the third quarter of 1997
to the same period in 1998. The increase was mainly due to higher average
balances of borrowings and certificates of deposit. These increases were
partially offset by lower cost of funds on certificates of deposit and savings
accounts. Overall average rates increased from 4.28% for the third quarter of
1997 to 4.35% for the same period in 1998. The increase in average rates was
mainly due to the increased usage of FHLB borrowings.
PROVISION FOR LOAN LOSSES
There was no provision for loan losses during the third quarter of 1998 compared
to $600,000 for the third quarter of 1997. The Company's percentage of allowance
for loan losses to non-performing loans was 341.01% at September 30, 1998
compared to 495.80% at December 31, 1997. The Company's allowance for loan
losses to gross loans was 2.40% at December 31, 1997 compared to 2.05% at
September 30, 1998.
20
<PAGE>
OTHER INCOME
The Company recorded $2.08 million in other income for the three months ended
September 30, 1998 compared to $1.95 million for the same period in 1997. The
following table shows the components of other income for the quarters ended
September 30, 1998 and 1997:
<TABLE>
<CAPTION>
(in thousands) QUARTERS ENDED SEPTEMBER 30, $ %
1998 1997 CHANGE CHANGE
------------------- -------------------- ---------- -----------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 673 $ 569 $ 104 18.28 %
Investment brokerage services commissions 576 648 (72) (11.11)
Loan servicing and other fees 238 192 46 23.96
Appreciation of cash surrender value life insurance 235 189 46 24.34
Income from investment in Real Estate Partnership 150 136 14 10.29
Net gain on sales of loans 1 19 (18) (94.74)
Other 203 200 3 1.50
=================== ==================== ==========
Total other income $ 2,076 $ 1,953 $ 123 6.30 %
=================== ==================== ========== ===========
</TABLE>
Service charges on deposit accounts increased mainly due to an increase in the
rates charged for overdraft fees. Investment brokerage services commissions
decreased primarily due to lower transactional and annuity sales in the third
quarter of 1998.
OTHER EXPENSES
Other expenses totaled $5.86 million for the three months ended September 30,
1998 compared to $5.57 million for the same period in 1997. The following table
details the significant components of other expenses for the periods presented:
<TABLE>
<CAPTION>
(in thousands) QUARTERS ENDED SEPTEMBER 30, $ %
1998 1997 Change Change
------------- -------------- ----------- ----------
<S> <C> <C> <C> <C>
Salaries, commissions and employee benefits $ 2,987 $ 2,994 $ (7) (0.23)%
Occupancy 856 801 55 6.87
Data processing 303 259 44 16.99
Furniture and equipment 245 238 7 2.94
Advertising 240 157 83 52.87
Legal and accounting 170 212 (42) (19.81)
Communications 127 125 2 1.60
Operation of foreclosed real estate owned 100 60 40 66.67
Amortization of goodwill 29 - 29 n/a
Other 799 719 80 11.13
============= ============== ===========
Total other expenses $ 5,856 $ 5,565 $ 291 5.23%
============= ============== =========== ==========
</TABLE>
Occupancy increased mainly due to the acquisition of the two branches from Chase
Manhattan Bank. Data processing increased mainly due to increases in fees from
the Bank's core system third party provider as a result of two new branches and
Year 2000 costs. Advertising increased mainly due to higher volumes of print and
direct mail expenses. Operation of foreclosed real estate owned increased mainly
due to higher costs associated with the commercial real estate. Amortization of
goodwill is a result of the July 1998 purchase of the two branches from Chase
Manhattan Bank. Other expenses increased due to higher expenses for security
services, donations and seminars.
21
<PAGE>
INCOME TAXES
During the third quarter of 1998, the Company recorded tax expense of $1.63
million compared to $1.19 million for the third quarter of 1997. The effective
tax rates for the three months ended September 30, 1998 and 1997 were 38.1% and
38.4%, respectively.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
For the nine months ended September 30, 1998, the Company reported net income of
$7.35 million or $1.38 per diluted share compared to $11.07 million or $2.12 per
diluted share for the same period in 1997. The Company recognized a tax benefit
of $9.01 million for the nine months ended September 30, 1997 primarily due to
the second quarter of 1997 full reversal of its deferred tax asset valuation
allowance. Also, during the first nine months of 1997, the Company recorded
$8.80 million in provisions for loan losses compared to $600,000 for the same
period in 1998.
NET INTEREST INCOME
Net interest income totaled $23.54 million for the nine months ended September
30, 1998 compared to $22.00 million for the same period in 1997, representing
$1.54 or a 7.0% increase. The net interest margin decreased from 3.99% for the
nine months ended September 30, 1997 to 3.62% for the same period in 1998. The
decrease was primarily a result of an increased use of FHLB borrowings to fund
loan and investment growth. Average interest-bearing assets increased $132.88
million while average interest-earning liabilities increased $125.48 million.
Average net loans and investment securities were $62.30 million and $59.63
million higher for the nine months ended September 30, 1998 compared to the same
period in 1997, respectively. Increases in average FHLB borrowings and
certificates of deposit were the main reasons for the increases in interest-
bearing liabilities.
22
<PAGE>
The following table sets forth certain information relating to the Company's
average interest-earning assets and interest-bearing liabilities and net
interest income for the quarters ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
AVERAGE BALANCES INCOME/EXPENSE YIELDS
---------------------------- --------------------------- ---------------------------
NINE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
(in thousands) 1998 1997 1998 1997 1998 1997
----------- ---------- ---------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Loans, net $ 585,965 $ 523,669 $ 35,490 $ 32,301 8.10% 8.25%
Investment securities 267,717 208,084 12,698 9,752 6.34 6.27
Short-term investments 15,865 4,919 647 198 5.45 5.38
----------- ---------- ---------- ----------- --------- --------
Total interest-earning assets 869,547 736,672 48,835 42,251 7.51 7.67
Other assets 68,155 55,248
----------- ----------
Total assets $ 937,702 $ 791,920
=========== ==========
Money market checking $ 36,789 $ 34,526 333 307 1.21 1.19
Money market savings 54,632 58,018 1,001 1,013 2.45 2.33
Savings and other 110,560 118,500 1,252 1,765 1.51 1.99
Certificates of deposit 406,416 374,143 15,599 14,637 5.13 5.23
----------- ---------- ---------- ----------- --------- --------
Total deposits 608,397 585,187 18,185 17,722 4.00 4.05
Securities sold under
agreements to repurchase - 5,974 - 243 n/a 5.44
Other borrowings 161,126 52,883 7,110 2,291 5.90 5.79
----------- ---------- ---------- ----------- -------- --------
Total interest-bearing funds 769,523 644,044 25,295 20,256 4.39 4.21
Demand deposits 72,026 64,335
Other liabilities 4,530 3,644
Capital 91,623 79,897
----------- ----------
Total liabilities and capital $ 937,702 $ 791,920
=========== ==========
Net interest income $ 23,540 $ 21,995
========= ===========
Spread on interest-bearing funds 3.12% 3.46%
Net interest margin 3.62% 3.99%
</TABLE>
23
<PAGE>
The following table presents the changes in interest and dividend income and the
changes in interest expense, attributable to changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
during the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS 1997
CHANGE IN INTEREST DUE TO
------------------------------------------------------------------
(in thousands) VOLUME RATE VOL/RATE NET
-------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Loans, net $ 3,843 $ (584) $ (70) $ 3,189
Investment securities 2,795 118 33 2,946
Short-term investments 441 3 5 449
-------------- ------------- ------------- -------------
Total 7,079 (463) (32) 6,584
-------------- ------------- ------------- -------------
Money market checking 20 6 - 26
Money market savings (59) 50 (3) (12)
Savings and other (118) (423) 28 (513)
Certificates of deposit 1,263 (277) (24) 962
Securities sold under
agreements to repurchase (243) - - (243)
Other borrowings 4,689 43 87 4,819
-------------- ------------- ------------- -------------
Total 5,552 (601) 88 5,039
-------------- ------------- ------------- -------------
Net change to interest income $ 1,527 $ 138 $ (120) $ 1,545
============== ============= ============= =============
</TABLE>
INTEREST INCOME
Interest income increased $6.58 million or 15.6% due primarily to average
increased volumes of net loans and investment securities. These increases were
partially offset by a 15 basis point decrease in the average yield on net loans.
Overall average yields decreased from 7.67% for the nine months ended September
30, 1997 to 7.51% for the same period in 1998.
INTEREST EXPENSE
Interest income increased $5.04 million or 24.9% from the nine months of 1997 to
the same period in 1998. The increase was due mainly to higher average balances
of FHLB borrowings and certificates of deposit. These increases were partially
offset by lower average volumes of securities sold under agreements to
repurchase, savings accounts and money market savings. In addition, lower
average cost of funds on savings accounts and certificates of deposit offset
some of the increases. Overall rates increased from 4.21% for the nine months
ended September 30, 1997 to 4.39% for the same period in 1998. The increase in
average rates was mainly due to the increased usage of FHLB borrowings.
PROVISION FOR LOAN LOSSES
The provision for loan losses decreased from $8.80 million for the nine months
ended September 30, 1997 to $600,000 for the same period in 1998. Although
previously considered adequate, the Company further strengthened the allowance
for loan losses during the second quarter of 1997 by adding $6.50 million in
provisions for loan losses. During 1997, with intense competition in a
continued sluggish Central Connecticut economy, management believed increasing
the allowance for loan losses and the reserve coverage ratios while maintaining
high credit quality were prudent strategies to implement.
24
<PAGE>
The Company's percentage of allowance for loan losses to non-performing loans
was 341.01% at September 30, 1998 and 495.80% at December 31, 1997. The
allowance for loan losses as a percentage of gross loans was 2.05% at September
30, 1998 and 2.40% at December 31, 1997.
OTHER INCOME
The Company recorded $6.58 million in other income for the nine months ended
September 30, 1998 compared to $6.37 million for the same period in 1997,
representing an increase of 3.4%. The following table shows the components of
other income for the nine months ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
(in thousands) Nine months ended September 30, $ %
1998 1997 Change Change
------------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 1,902 $ 1,701 $ 201 11.82%
Investment brokerage services commissions 1,871 2,542 (671) (26.40)
Loan servicing and other fees 728 594 134 22.56
Appreciation of cash surrender value life insurance 694 196 498 254.08
Income from investment in Real Estate Partnership 518 442 76 17.19
Net gain on sales of loans 46 26 20 76.92
Net gain on sales of investment securities 4 2 2 100.00
Other 821 865 (44) (5.09)
-------------- ------------- -----------
$ 6,584 $ 6,368 $ 216 3.39%
============== ============= =========== ==========
</TABLE>
Service charges on deposit accounts increased mainly due to an increase in the
fees on overdrafts. Investment brokerage services commissions decreased due
primarily to lower annuity and transactional sales. During the first quarter of
1997, there was a one time $4.55 million annuity sale resulting in $237,000 in
commissions. Appreciation of cash surrender value life insurance was higher
since the majority of that asset was purchased during late June 1997. Income
from the investment in Real Estate Partnership increased primarily due to higher
rental income and lower repairs and maintenance expenses.
OTHER EXPENSES
Other expenses totaled $17.66 million for the nine months ended September 30,
1998 compared to $17.50 million for the same period in 1997. The following
table details the significant components of other expenses for the periods
presented:
<TABLE>
<CAPTION>
(in thousands) Nine months ended September 30, $ %
1998 1997 Change Change
---------------- ---------------- ----------- ----------
<S> <C> <C> <C> <C>
Salaries, commissions and employee benefits $ 9,216 $ 9,254 $ (38) (0.41)%
Occupancy 2,426 2,398 28 1.17
Data processing 873 789 84 10.65
Furniture and equipment 719 715 4 0.56
Advertising 696 623 73 11.72
Legal and accounting 498 696 (198) (28.45)
Communications 384 377 7 1.86
Operation of foreclosed real estate owned 282 317 (35) (11.04)
Write-downs and net losses on sale
of foreclosed real estate owned 85 120 (35) (29.17)
Amortization of goodwill 29 - 29 n/a
Other 2,447 2,215 232 10.47
========= ======== =======
Total other expenses $ 17,655 $ 17,504 $ 151 0.86%
========= ======== ======= =======
</TABLE>
Data processing is higher due to higher expenses from the Bank's third party
provider and in MIS. Advertising is higher due to increased marketing activity
during 1998. Legal and accounting was lower due mainly to reduced legal
expenses in the Bank's commercial loan work out area. Operation of foreclosed
real estate owned expenses were lower due mainly to reduced expenses for one-to
four-family
25
<PAGE>
properties. Other expenses increased due mainly to prepayment penalties of
$217,000 associated with FHLB advances during the first and third quarters of
1998.
INCOME TAXES
During the nine months ended September 30, 1998, the Company recorded income tax
expense of $4.52 million, representing a 38.1% effective tax rate. During the
nine months ended September 30, 1997, the Bank recorded a $9.01 million tax
benefit due primarily to the second quarter 1997 full reversal of its valuation
allowance on its net deferred tax assets. Based on three consecutive prior
quarters of income and projections that indicated continued profitability, the
Bank determined that it was more likely than not that it would realize its net
deferred tax assets.
PART I. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Bank's objective in managing interest rate risk is to produce a high and
stable net interest margin in varying interest rate environments while
maintaining the flexibility to take advantage of opportunities that may arise
from the fluctuations of interest rates. The Bank's exposure to interest rate
risk is managed strategically through the use of balance sheet simulation.
The Bank models its forecasted balance sheet using interest rate ramps, shocks
and a most likely interest rate scenario over a 24 month time horizon. In
accordance with its asset/liability policy, the Bank measures its interest rate
sensitivity by ramping interest rates in one hundred basis point increments from
- -400 to +400 basis points from the current rate environment. From this 800 basis
point grid, the asset/liability committee selects the most likely 400 basis
point interest rate range based on the current interest rate environment, as
well as other economic factors. The Bank's policy is to achieve equal to or less
than a 10% change in net interest income over the next 12 months within the
selected 400 basis point band. At September 30, 1998, the Bank was within its
policy guideline, and the Bank believes its level of interest rate sensitivity
was appropriate.
At September 30, 1998 based upon various earnings simulations, which include 100
basis point to 200 basis point increases and decreases in interest rates,
management has projected the effect on net interest income for the next twelve
months as follows:
<TABLE>
<CAPTION>
Effect on Net Interest Income
------------------------------------
Shock Ramp
(in thousands) Scenario (a) Scenario (b)
----------------- ----------------
<S> <C> <C>
200 basis point increase in rates (c) $ 2,111 $ 693
100 basis point increase in rates (d) 1,076 346
100 basis point decrease in rates (d) (980) (333)
200 basis point decrease in rates (c) (1,560) (626)
</TABLE>
(a) Represents the dollar amount of change in net interest income caused by an
instantaneous repricing of market interest rates.
(b) Represents the dollar amount of change in net interest income caused by a
gradual repricing of market interest rates in equal monthly increments
throughout the next twelve months.
(c) No adjustments are made to the Bank's passbook rates. Money market rates are
shocked/ramped 50 basis points rather than 200 basis points.
(d) No adjustments are made to the Bank's passbook rates. Money market rates are
shocked/ramped 25 basis points, rather than 100 basis points.
26
<PAGE>
PART II. ITEM 1. LEGAL PROCEEDINGS
none
PART II. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
none
PART II. ITEM 3. DEFAULTS UPON SENIOR SECURITIES
none
PART II ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
none
PART II ITEM 5. OTHER INFORMATION
none
PART II ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
The following exhibit is included herein:
27 - Financial Data Schedule
b) Reports on Form 8-K:
none
27
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MECH Financial, Inc.
Date: 11/6/98 /S/ EDGAR C. GERWIG
------- ----------------------
Chairman, President and Chief Executive Officer
Date: 11/6/98 /S/ THOMAS M. WOOD
------- ----------------------
Executive Vice President and Treasurer
Date: 11/6/98 /S/ BRIAN A. ORENSTEIN
------- ----------------------
Senior Vice President and Controller
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 17,194
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 1,770
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 174,106
<INVESTMENTS-CARRYING> 103,707
<INVESTMENTS-MARKET> 104,803
<LOANS> 614,737
<ALLOWANCE> (12,672)
<TOTAL-ASSETS> 960,017
<DEPOSITS> 690,655
<SHORT-TERM> 26,062
<LIABILITIES-OTHER> 7,413
<LONG-TERM> 141,465
0
0
<COMMON> 53
<OTHER-SE> 94,369
<TOTAL-LIABILITIES-AND-EQUITY> 960,017
<INTEREST-LOAN> 35,490
<INTEREST-INVEST> 11,735
<INTEREST-OTHER> 1,610
<INTEREST-TOTAL> 48,835
<INTEREST-DEPOSIT> 18,185
<INTEREST-EXPENSE> 25,295
<INTEREST-INCOME-NET> 23,540
<LOAN-LOSSES> 600
<SECURITIES-GAINS> 4
<EXPENSE-OTHER> 17,655
<INCOME-PRETAX> 11,869
<INCOME-PRE-EXTRAORDINARY> 11,869
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,345
<EPS-PRIMARY> 1.41
<EPS-DILUTED> 1.38
<YIELD-ACTUAL> 7.51
<LOANS-NON> 3,716
<LOANS-PAST> 0
<LOANS-TROUBLED> 681
<LOANS-PROBLEM> 19,515
<ALLOWANCE-OPEN> 14,031
<CHARGE-OFFS> 2,389
<RECOVERIES> 430
<ALLOWANCE-CLOSE> 12,672
<ALLOWANCE-DOMESTIC> 6,065
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 6,607
</TABLE>
