<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 June 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 June 30, 1998)
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C>
Part I. Item 1. Financial Information
A. Consolidated Statements of Condition as of June 30, 1998 and 1
December 31, 1997
B. Consolidated Statements of Operations for the Three and Six Month Periods 2
Ended June 30, 1998 and June 30, 1997
C. Consolidated Statements of Changes in Stockholders' Equity for the Six 3
Month Periods Ended June 30, 1998 and June 30, 1997
D. Consolidated Statements of Cash Flows for the Six Month Periods Ended 4
June 30, 1998 and June 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 15
Part I. Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Part II. Other Information 26
Signatures 28
Exhibit 29
</TABLE>
<PAGE>
MECH FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)
<TABLE>
<CAPTION>
(dollars in thousands) JUNE 30, 1998 DECEMBER 31, 1997
----------------- -------------------
<S> <C> <C>
ASSETS
Cash and due from banks:
Non-interest-bearing deposits and cash $ 20,068 $ 22,884
Short-term investments 10,195 10,140
----------------- -------------------
Cash and cash equivalents 30,263 33,024
Investments:
Available-for-sale, at market value 177,885 152,200
Held-to-maturity (market value at June 30, 1998 - 94,726 75,199
$95,692; at December 31, 1997 - $76,186)
Federal Home Loan Bank stock, at cost 9,037 6,450
Loans, net 590,471 571,112
Loans held-for-sale 1,586 1,922
Bank premises and equipment 4,692 4,823
Investment in Real Estate Partnership 13,931 14,485
Accrued interest receivable 5,011 4,347
Foreclosed real estate owned 621 1,204
Cash surrender value life insurance 16,460 16,053
Other assets 9,988 11,552
----------------- -------------------
$ 954,671 $ 892,371
================= ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 684,907 $ 667,564
Borrowings 166,465 129,720
Mortgage escrow 5,747 1,388
Other liabilities 4,854 5,150
----------------- -------------------
Total liabilities 861,973 803,822
----------------- -------------------
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 June 30, 1998 and
5,293,266 issued at December 31, 1997
Additional paid in capital 50,961 50,927
Retained earnings 41,787 37,891
Net unrealized gains on securities 617 398
Less: Unallocated ESOP shares (72,000 shares) (720) (720)
----------------- -------------------
Total stockholders' equity 92,698 88,549
----------------- -------------------
$ 954,671 $ 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 SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998 JUNE 30, 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 11,934 $ 10,806 $ 23,620 $ 21,090
Interest and dividends on investment securities:
Interest on debt securities 3,746 3,277 7,228 6,381
Dividends on equity securities 201 79 346 147
-------- -------- -------- --------
3,947 3,356 7,574 6,528
Other interest income 594 61 985 126
-------- -------- -------- --------
Total interest income 16,475 14,223 32,179 27,744
-------- -------- -------- --------
Interest expense:
Interest on deposits:
Savings deposits 702 919 1,409 1,827
Time deposits 5,385 4,957 10,616 9,884
-------- -------- -------- --------
Total interest on deposits 6,087 5,876 12,025 11,711
Interest on securities sold under agreements to repurchase - 97 - 243
Interest on other borrowings 2,511 853 4,681 1,108
-------- -------- -------- --------
Total interest expense 8,598 6,826 16,706 13,062
-------- -------- -------- --------
Net interest income 7,877 7,397 15,473 14,682
Provision for loan losses 300 6,500 600 8,200
-------- -------- -------- --------
Net interest income after provision for loan losses 7,577 897 14,873 6,482
-------- -------- -------- --------
Other income:
Investment brokerage services commissions 613 839 1,295 1,894
Service charges on deposit accounts 631 580 1,229 1,132
Loan servicing and other fees 225 215 490 402
Appreciation of cash surrender value life insurance 225 7 459 7
Income from investment in Real Estate Partnership 189 163 368 306
Net gain on sales of loans 20 7 45 7
Net gain (loss) on sales of investment securities - (92) 4 2
Other 214 254 618 665
-------- -------- -------- --------
Total other income 2,117 1,973 4,508 4,415
-------- -------- -------- --------
Other expenses:
Salaries, commissions and employee benefits 3,030 3,188 6,229 6,260
Occupancy 787 793 1,570 1,597
Data processing 293 259 570 530
Furniture and equipment 234 233 474 477
Advertising 160 279 456 466
Legal and accounting 170 264 328 484
Communications 123 124 257 252
Operation of foreclosed real estate owned 88 113 182 257
Write-downs and net losses on sale
of foreclosed real estate owned 25 70 85 120
Other 706 751 1,648 1,496
-------- -------- -------- --------
Total other expenses 5,616 6,074 11,799 11,939
-------- -------- -------- --------
Income (loss) before income taxes 4,078 (3,204) 7,582 (1,042)
-------- -------- -------- --------
Income tax expense (benefit) 1,552 (10,328) 2,892 (10,205)
-------- -------- -------- --------
Net income $ 2,526 $ 7,124 $ 4,690 $ 9,163
======== ======== ======== ========
Earnings per share:
Basic $ 0.48 $ 1.37 $ 0.90 $ 1.76
Diluted $ 0.47 $ 1.37 $ 0.88 $ 1.76
Weighted average shares outstanding:
Basic 5,223 5,194 5,222 5,194
Diluted 5,364 5,202 5,333 5,194
</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 - - 9,163 - -
Change in net unrealized gains (losses) on securities - - - 276 -
--------- ------------ ---------- -------------- -----------
Balance at June 30, 1997 $ 53 $ 50,611 $ 33,978 $ 597 $ (960)
========= ============ ========== ============== ===========
Balance at December 31, 1997 $ 53 $ 50,927 $ 37,891 $ 398 $ (720)
Net income - - 4,690 - -
Change in net unrealized gains (losses) on securities - - - 219 -
Exercised stock options - 34 - - -
Dividends on common stock ($0.15 per share declared) - - (794) - -
--------- ------------ ---------- -------------- -----------
Balance at June 30, 1998 $ 53 $ 50,961 $ 41,787 $ 617 $ (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 SIX MONTHS ENDED
(in thousands) JUNE 30, 1998 JUNE 30, 1997
---------------------------------
<C> <C>
<S>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,690 $ 9,163
---------- ----------
Adjustments to reconcile net income to
cash provided by operating activities:
Provision for loan losses 600 8,200
Depreciation and amortization 471 471
Amortization of investment security premiums/discounts, net 82 77
Deferred loan costs, net of amortization (480) (307)
Net gain on sale of loans (45) (7)
Proceeds from loan sales 14,263 1,166
Originations of loans held for sale (13,882) (1,157)
Loss on retirement of bank premises and equipment 4 -
Decrease (increase) in deferred tax assets 1,392 (11,662)
Realized losses on available-for-sale securities - 92
Realized gains on available-for-sale securities (4) (94)
Increase in interest and dividend receivables (664) (386)
Income from investment in Real Estate Partnership (368) (306)
Write-downs and net losses on sale of foreclosed real estate owned 85 120
Increase in cash surrender value life insurance (407) (8,321)
Decrease (increase) in other assets 48 (673)
(Decrease) increase in other liabilities (295) 2,070
---------- ----------
Total adjustments 800 (10,717)
---------- ----------
Net cash provided by operating activities 5,490 (1,554)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of available-for-sale securities 15,753 17,003
Proceeds from principal payments on available-for-sale securities 42,510 17,392
Proceeds from principal payments on held-to-maturity securities 12,040 1,102
Proceeds from maturities of available-for-sale securities 6,847 10,000
Proceeds from maturities of held-to-maturity securities 11,005 -
Purchases of available-for-sale securities (90,618) (65,039)
Purchases of held-to-maturity securities (42,485) -
Purchases of Federal Home Loan Bank stock (2,587) (575)
Net originations and purchases of loans (19,855) (49,545)
Decrease in investment in Real Estate Partnership 922 335
Proceeds from sale of foreclosed real estate owned 875 534
Purchases of bank premises and equipment (344) (150)
---------- ----------
Net cash used in investing activities (65,937) (68,943)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, money market and savings accounts 5,787 1,103
Net increase in certificates of deposit 11,556 3,490
Net increase in mortgage escrow 4,358 2,799
Advances from FHLB 110,048 170,907
Repayments of FHLB borrowings (73,303) (112,918)
Issuance of common stock 34 -
Dividends paid (794) -
---------- ----------
Net cash provided by financing activities 57,686 65,381
---------- ----------
Net decrease in cash and cash equivalents (2,761) (5,116)
---------- ----------
Cash and cash equivalents at beginning of period 33,024 30,006
---------- ----------
Cash and cash equivalents at end of period $ 30,263 $ 24,890
========== ==========
</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 six months ended
June 30, 1998 June 30, 1997
--------------------- ---------------------
<S> <C> <C>
(in thousands)
Non-cash investing and financing activities
Change in net unrealized gain (loss) on securities available-for-sale $ 239 $ 355
Change in net unrealized gain (loss) on securities held-to-maturity 103 26
Transfer of loans to foreclosed real estate owned 426 1,550
Supplemental disclosures of cash flow information
Income taxes paid 1,788 232
</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 June 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 $ 8,974 $ 10 $ - $ 8,984
Mortgage-backed securities 131,391 1,076 24 132,443
Debt securities issued by foreign governments 350 - - 350
Corporate debt securities 5,000 62 - 5,062
Marketable equity securities 4,853 220 31 5,042
Mutual funds 26,034 37 67 26,004
--------------- ------------------ ------------------- ---------------
$176,602 $1,405 $122 $177,885
=============== ================== =================== ===============
</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 June 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 $11,995 $ 32 $ 2 $12,025
Mortgage-backed securities 81,731 970 36 82,665
Corporate debt securities 1,000 2 - 1,002
----------------- ----------------- ------------------ ---------------
$94,726 $1,004 $38 $95,692
================= ================= ================== ===============
</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 SIX MONTHS ENDING
JUNE 30, 1998 JUNE 30, 1997
--------------------- ----------------------
<S> <C> <C>
Balance at beginning of year $14,031 $ 7,983
Provision for loan losses 600 8,200
Loan charge-offs (1,916) (2,471)
Loan recoveries 255 447
--------------------- ----------------------
Balance $12,970 $14,159
===================== ======================
</TABLE>
NOTE 4 - NON-PERFORMING ASSETS
The components of non-performing assets were as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998 DECEMBER 31, 1997
---------------------- -------------------------
<S> <C> <C>
Non-accrual loans $ 3,072 $ 2,830
Accruing loans past due greater
than 90 days - -
---------------------- -------------------------
Total non-performing loans 3,072 2,830
Foreclosed real estate owned 621 1,204
---------------------- -------------------------
Total non-performing assets $ 3,693 $ 4,034
====================== =========================
Non-performing assets as a
percentage of total assets 0.39% 0.45%
====================== =========================
Non-performing assets as a
percentage of gross loans and
foreclosed real estate owned 0.61% 0.69%
====================== =========================
Allowance for loan losses
as a percentage of
non-performing loans 422.20% 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:
<TABLE>
<CAPTION>
MATURITY DATE INTEREST RATE JUNE 30, 1998 DECEMBER 31, 1997
- ---------------- -------------- ------------- ------------------
<S> <C> <C> <C>
January 6, 1998 5.59 % $ - $ 16,000
March 1, 1999 6.35 5,000 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 -
------------- -------------------
$ 165,745 $ 129,000
============= ===================
</TABLE>
* callable at 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.
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 June 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 5,222,739 and 5,194,000 for the
quarters ended June 30, 1998 and 1997, respectively. The weighted average
shares outstanding totaled 5,222,165 and 5,194,000 for the six months ended June
30, 1998 and 1997, respectively. The effect of dilutive stock options was
141,591 and 7,733 shares for the quarters ended June 30, 1998 and 1997,
respectively. The effect of dilutive stock options was 111,180 and -0- shares
for the six months ended June 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
impact 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 June 30, 1998
and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
------------- -------------
<S> <C> <C>
Comprehensive income:
Net income $2,526 $7,124
Net unrealized gains (losses) on securities 197 455
------- --------
Comprehensive income $2,723 $7,579
======= ========
</TABLE>
The following table represents the components and the related tax effects
allocated to other comprehensive income for the second quarter of 1998:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------------- --------------- -------------
<S> <C> <C> <C>
Net unrealized gains (losses) on securities $278 $(111) $167
arising during the period
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 51 (21) 30
--------------- --------------- -------------
Net unrealized gains (losses) on securities $329 $(132) $197
=============== =============== =============
</TABLE>
11
<PAGE>
The following table represents components and the related tax effects allocated
to other comprehensive income for the second quarter of 1997:
<TABLE>
<CAPTION>
BEFORE TAX NET OF
TAX (EXPENSE) TAX
AMOUNT BENEFIT AMOUNT
--------------- --------------- ---------------
<S> <C> <C> <C>
Net unrealized gains (losses) on securities $ 780 $ (345) $ 435
arising during the period
Less: reclassification adjustment for
losses realized in net income (92) 39 (53)
Changes of tax effect on prior periods'
net unrealized gains on securities - (41) (41)
Accretion of unrealized loss on securities
transferred from available-for-sale to
held-to-maturity 14 (6) 8
--------------- --------------- ---------------
Net unrealized gains (losses) on securities $ 886 $ (431) $ 455
=============== =============== ===============
</TABLE>
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.
The components of comprehensive income for the six months ended June 30, 1998
and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
---------------------- -----------------------
<S> <C> <C>
Comprehensive income:
Net income $ 4,690 $ 9,163
Net unrealized gains (losses) on securities 219 276
---------------------- -----------------------
Comprehensive income $ 4,909 $ 9,439
====================== =======================
</TABLE>
12
<PAGE>
The following table represents the components and the related tax effects
allocated to other comprehensive income for the first six 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 $244 $ (97) $147
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 102 (49) 53
------------- ------------- -------------
Net unrealized gains (losses) on securities $342 $(123) $219
============= ============= ==============
</TABLE>
The following table represents the components and the related tax effects
allocated to other comprehensive income for the first six 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 $449 $(384) $ 65
arising during the period
Less: reclassification adjustment for
gains realized in net income 94 - 94
Change in tax effect 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 26 (6) 20
------------- ------------- --------------
Net unrealized gains (losses) on securities $381 $(105) $276
============= ============= ==============
</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
13
<PAGE>
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 will be 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 is payable on August 17, 1998 to shareholders
of record on August 3, 1998.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. On April
21, 1998, the Company declared its first quarterly dividend of $0.15 per share
on its common stock. In addition, on July 21, 1998, the Company declared a
quarterly dividend of $0.15 per share on its common stock.
The Company reported net income of $2.53 million for the second quarter ended
June 30, 1998 compared to $7.12 million for the same period in 1997. Income
before income taxes was $4.08 million for the second quarter of 1998 compared to
a $3.20 million net loss for the second quarter of 1997. During the six months
ended June 30, 1998 and 1997, the Company reported net income of $4.69 million
and $9.16 million, respectively. Income before income taxes was $7.58 million
for the first six months of 1998 compared to a $1.04 million net loss 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 second quarter of 1997, the Bank recorded
$6.50 million in provisions for loan losses compared to $300,000 in the second
quarter of 1998.
FINANCIAL CONDITION
Total assets as of June 30, 1998 were $954.67 million representing an increase
of $62.30 million or 7.0% from $892.37 million at December 31, 1997. The
Company's Tier 1 leverage ratio was 9.61% at June 30, 1998 compared to 9.74% at
December 31, 1997. The Company's total risk-based capital ratio was 16.65% at
June 30, 1998 compared to 17.76% at December 31, 1997.
Cash and cash equivalents decreased $2.76 million or 8.4% from $33.02 million at
December 31, 1997 to $30.26 million at June 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 $45.21 million or 19.9% from $227.40 million at
December 31, 1997 to $272.61 million at June 30, 1998 primarily due to an
increase in the mortgage-backed securities portfolio of $16.79 million and an
increase in U.S. Government and agency securities of $12.98 million. The
Company also diversified its portfolio with increases of $5.36 million in mutual
funds and $5.02 million in marketable equity securities. Funds available for
investment increased mainly due to increased Federal Home Loan Bank ("FHLB")
borrowings and deposits. The main sources of the deposit increases were from
certificates of deposits and business checking. At June 30, 1998, the Company
held $94.73 million in securities classified as held-to-maturity in accordance
with Statement of 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
six months of 1998. The Company believes that these shares provide above
average dividend yields for the risk characteristics of such investments.
15
<PAGE>
Net loans increased $19.36 million or 3.4% from $571.11 million at December 31,
1997 to $590.47 million at June 30, 1998. The majority of the increase came
from an $8.26 million increase in the installment loan portfolio and an $8.10
million increase in the loans secured by commercial real estate. The allowance
for loan losses totaled $12.97 million at June 30, 1998 compared to $14.03
million at December 31, 1997. Provisions for loan losses during the six months
ended June 30, 1998 totaled $600,000 and net charge-offs totaled $1.66 million.
The allowance for loan losses as a percentage of non-performing loans was
495.80% and 422.20% at December 31, 1997 and June 30, 1998, respectively.
Foreclosed real estate owned decreased from $1.20 million at December 31, 1997
to $621,000 at June 30, 1998. The Company sold sixteen properties totaling
$812,000 during the six months ended June 30, 1998. Write-downs and net losses
on sale of foreclosed real estate owned for the first six months of 1998 totaled
$85,000 compared to $120,000 for the same period in 1997.
Non-performing assets totaled $3.69 million at June 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 $1.92 million and $85,000, respectively. Sales of non-
performing loans and foreclosed real estate owned accounted for an additional
$3.44 million and $837,000 of the reductions, respectively. There were other
reductions of non-performing assets of $1.35 million due to payoffs, payments
and loans returning to accrual status. These reductions were offset by $7.28
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 0.39% at June 30, 1998. Non-performing assets as a percentage of total loans
and foreclosed real estate owned was 0.69% at December 31, 1997 and 0.61% at
June 30, 1998.
Deposits increased 2.6% from $667.56 million at December 31, 1997 to $684.91
million at June 30, 1998. The increases were mainly in three month certificates
of deposit and in business checking.
Borrowings from the FHLB increased $36.75 million from December 31, 1997 to June
30, 1998. These borrowings were mainly used to fund investments, commercial
real estate mortgages and installment loans. The Company's $165.75 million of
FHLB advances carry a weighted average rate of 5.79% and have a weighted average
contractual maturity of 5.26 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 June 30, 1998 were callable at 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.
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 income for the then current
year, plus the Bank's retained net income for the prior two years, unless
specifically approved by the Banking Commissioner. 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
16
<PAGE>
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
June 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.
At June 30, 1998, the Company was slightly liability sensitive.
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 June 30, 1998, the Company was
within its policy guideline, and the Company believes its level of interest rate
sensitivity was appropriate.
CAPITAL RESOURCES
At June 30, 1998, the Company's stockholders' equity totaled $92.70 million
representing a 4.7% increase over the $88.55 million in capital at December 31,
1997. At June 30, 1998, the Company had a Tier 1 leverage capital ratio of
9.61% and a total risk-based capital ratio of 16.65%. 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 June 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.
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 identified over 140 vendors/systems that would possibly need to be
addressed concerning Y2K. The Company received documentation from virtually all
of these vendors, designating an acceptable timeframe for their Y2K compliance.
The Company maintains a Y2K inventory, which is updated regularly, monitoring
vendor compliance levels.
The Company's core processing system is outsourced to Fiserv, based in
Milwaukee, Wisconsin. The Company receives monthly updates from 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
17
<PAGE>
Company will have the opportunity to test the system on a systemwide basis in
October 1998 and then again during March 1999.
During the second quarter, the Company wrote a testing plan, contingency plan,
credit policy and customer awareness policy as they pertain to the upcoming
millennium. The Company also hired a law firm to perform a legal review of the
major contracts that the Company is a party to. The Company purchased a Y2K
test file server along with other appropriate hardware, in order to simulate its
current production environment. The Company expects that costs associated with
the Y2K effort will not exceed $300,000. These costs will consist primarily of
purchases of new equipment and software which will be depreciated over their
respective useful life.
RESULTS OF OPERATIONS
FOR THE QUARTER ENDED JUNE 30, 1998 AND 1997
For the quarter ended June 30, 1998, the Company reported net income of $2.53
million or $0.47 per diluted share compared to $7.12 million or $1.37 per
diluted share for the same period in 1997. Income before income taxes was $4.08
million for the second quarter of 1998 compared to a pretax loss on $3.20
million for the second quarter 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 second quarter of
1997, the Bank recorded $6.50 million in provisions for loan losses compared to
$300,000 in the second quarter of 1998.
NET INTEREST INCOME
Net interest income totaled $7.88 million for the three months ended June 30,
1998 compared to $7.40 million for the same period in 1997, representing a
$480,000 or 6.5% increase. The net interest margin decreased from 3.96% for the
quarter ended June 30, 1997 to 3.59% for the same period in 1998. Average
interest-earning assets increased $129.80 million while average interest-bearing
liabilities increased $127.99 million. Average net loans and investment
securities increased $61.65 million and $54.49 million, respectively. Average
net loans increased primarily due to a $25.71 million increase in one- to four-
family mortgages and a $22.14 million increase in average consumer loans. In
addition, average commercial real estate mortgages and commercial and industrial
loans increased $9.03 million and $9.02 million, respectively. Mutual funds and
mortgage-backed securities were the main reasons for the increase in average
investment securities. Average borrowing and certificates of deposit increased
$113.09 million and $34.98 million, respectively, from quarter to quarter. In
addition, average other assets were $19.60 million higher due mainly to a
reduction in the deferred tax asset valuation allowance and the purchase of cash
surrender value life insurance. During the second quarter of 1997, the Bank
fully reversed its valuation allowance on its net deferred tax assets.
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 June 30, 1998 and 1997:
<TABLE>
<CAPTION>
AVERAGE BALANCE INCOME / EXPENSE YIELD
--------------------------- ---------------------- -------------------
QUARTERS ENDED JUNE 30, QUARTERS ENDED QUARTERS ENDED
(in thousands) 1998 1997 1998 1997 1998 1997
--------------------------- ---------------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Loans, net $588,638 $526,991 $11,934 $10,806 8.13% 8.22%
Investment securities 273,185 218,697 4,299 3,360 6.31 6.16
Short-term investments 17,857 4,197 242 57 5.44 5.45
---------- ---------- ---------- --------- --------- ----------
Total interest-earning assets 879,680 749,885 16,475 14,223 7.51 7.61
Other assets 68,080 48,482
---------- ----------
Total assets $947,760 $798,367
========== ==========
Money market checking $ 37,429 $ 34,365 112 103 1.20 1.20
Money market savings 51,595 58,606 303 341 2.36 2.33
Savings and other 112,482 121,439 428 605 1.53 2.00
Certificates of deposit 407,720 372,745 5,244 4,827 5.16 5.19
Securities sold under
agreements to repurchase - 7,169 - 97 n/a 5.43
Other borrowings 171,685 58,599 2,511 853 5.87 5.84
---------- ---------- ---------- --------- --------- ----------
Total interest-bearing funds 780,911 652,923 8,598 6,826 4.42 4.19
Demand deposits 70,522 64,218
Other liabilities 4,706 3,247
Capital 91,621 77,979
---------- ----------
Total liabilities and capital $947,760 $798,367
========== ==========
Net interest income $ 7,877 $ 7,397
========== =========
Spread on interest-bearing funds 3.09% 3.42%
Net interest margin 3.59% 3.96%
</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 JUNE 30, 1998 VERSUS 1997
CHANGE IN INTEREST DUE TO
-----------------------------------------------------------------------
(in thousands) VOLUME RATE VOL/RATE NET
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Loans, net $1,264 $(122) $(14) $1,128
Investment securities 837 82 20 939
Short-term investments 186 - (1) 185
------------- ------------ ------------- ------------
Total 2,287 (40) 5 2,252
------------- ------------ ------------- ------------
Money market checking 9 - - 9
Money market savings (41) 3 - (38)
Savings and other (45) (143) 11 (177)
Certificates of deposit 453 (33) (3) 417
Securities sold under
agreements to repurchase (97) - - (97)
Other borrowings 1,646 4 8 1,658
------------- ------------ ------------- ------------
Total 1,925 (169) 16 1,772
------------- ------------ ------------- ------------
Net change to interest income $ 362 $ 129 $(11) $ 480
============= ============ ============= ============
</TABLE>
INTEREST INCOME
Interest income increased $2.25 million or 15.8% due primarily to increased
average volumes of net loans and investment securities of $61.65 million and
$54.49 million, respectively. Overall average yields decreased from 7.61% for
the second quarter of 1997 to 7.51% for the same period in 1998. This was
primarily due to a 9 basis point decrease in the average yields for net loans
which was partially offset by a 15 basis point increase in the average yields on
investment securities.
INTEREST EXPENSE
Interest expense increased $1.77 million or 26.0% from the second 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 average volumes of the securities purchased under
agreements to repurchase, savings accounts and money market savings. Overall
average rates increased from 4.19% for the second quarter of 1997 to 4.42% for
the same period in 1998. The increase in average rates was mainly due to
increased FHLB borrowings.
PROVISION FOR LOAN LOSSES
The provision for loan losses totaled $300,000 for the three months ended June
30, 1998 compared to $6.50 million for the same period in 1997. 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
20
<PAGE>
coverage ratios while maintaining high credit quality were prudent strategies to
implement. The Company's percentage of allowance for loan losses to non-
performing loans was 422.20% at June 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 2.15% at June 30, 1998.
OTHER INCOME
The Company recorded $2.12 million in other income for the three months ended
June 30, 1998 compared to $1.97 million for the same period in 1997. The
following table shows the components of other income for the quarters ended June
30, 1998 and 1997:
<TABLE>
<CAPTION>
(in thousands) QUARTERS ENDED JUNE 30, $ %
1998 1997 CHANGE CHANGE
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 631 $ 580 $ 51 8.79 %
Investment brokerage services commissions 613 839 (226) (26.94)
Loan servicing and other fees 225 215 10 4.65
Appreciation of cash surrender value life insurance 225 7 218 3,114.29
Income from investment in Real Estate Partnership 189 163 26 15.95
Net gain on sales of loans 20 7 13 185.71
Net gain on sales of investment securities - (92) 92 (100.00)
Other 214 254 (40) (15.75)
-------- -------- ----------
Total other income $2,117 $1,973 $ 144 7.30 %
======== ======== ========== =========
</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 second
quarter of 1998. The Bank began investing in cash surrender value life
insurance in late June 1997. The appreciation of these policies totaled
$225,000 during the second quarter of 1998 compared to $7,000 during the second
quarter of 1997. Income from the investment in Real Estate Partnership
increased primarily due to higher rental income and lower repairs and
maintenance expenses. Other income decreased mainly due to reduced income from
tax deferred annuity sales and the elimination of food stamp processing income.
OTHER EXPENSES
Other expenses totaled $5.62 million for the three months ended June 30, 1998
compared to $6.07 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 JUNE 30, $ %
1998 1997 CHANGE CHANGE
------------- -------------- ------------ ----------
<S> <C> <C> <C> <C>
Salaries, commissions and employee benefits $3,030 $3,188 $(158) (4.96) %
Occupancy 787 793 (6) (0.76)
Data processing 293 259 34 13.13
Furniture and equipment 234 233 1 0.43
Legal and accounting 170 264 (94) (35.61)
Advertising 160 279 (119) (42.65)
Communications 123 124 (1) (0.81)
Operation of foreclosed real estate owned 88 113 (25) (22.12)
Write-downs and net losses on sale
of foreclosed real estate owned 25 70 (45) (64.29)
Other 706 751 (45) (5.99)
------------- -------------- ------------
Total other expenses $5,616 $6,074 $(458) (7.54) %
============= ============== ============ =========
</TABLE>
21
<PAGE>
Salaries, commissions and employee benefits decreased mainly due to lower
commission expenses. Legal and accounting decreased primarily due to reduced
legal fees in the commercial loan work out area. Advertising expense decreased
due to reduced public relations and printing expenses. Operation of foreclosed
real estate owned decreased mainly due to reduced expenses for one- to four-
family properties. Other expenses decreased primarily due to reduced fees
associated with the establishment of MIS.
INCOME TAXES
During the second quarter of 1998, the Company recorded tax expense of $1.55
million compared to a $10.33 million tax benefit for the second quarter of 1997.
The effective tax rate for the three months ended June 30, 1998 was 38.1%.
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.
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
For the six months ended June 30, 1998, the Company reported net income of $4.69
million or $0.88 per diluted share compared to $9.16 million or $1.76 per
diluted share for the same period in 1997. The Company recognized a tax benefit
of $10.21 million for the six months ended June 30, 1997 primarily due to the
second quarter of 1997 full reversal of its deferred tax asset valuation
allowance. Also, during the first six months of 1997, the Company recorded
$8.20 million in provisions for loan losses compared to $600,000 for the same
period in 1998. 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.
NET INTEREST INCOME
Net interest income totaled $15.47 million for the six months ended June 30,
1998 compared to $14.68 million for the same period in 1997, representing
$791,000 or a 5.4% increase. The net interest margin decreased from 4.06% for
the six months ended June 30, 1997 to 3.64% 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 liabilities increased
$130.07 million while average interest-earning assets increased $127.92 million.
Increases in average FHLB borrowings and certificates of deposit were the main
reasons for the increases in interest-bearing liabilities. Average net loans
and investment securities were $67.95 million and $48.93 million higher for the
six months ended June 30, 1998 compared to the same period in 1997,
respectively.
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 six months ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
AVERAGE BALANCES INCOME/EXPENSE YIELDS
------------------------------ ----------------------------- ----------------------------
SIX MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1998 1997 1998 1997 1998 1997
------------ ---------- ---------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Loans, net $583,373 $515,424 $23,620 $21,090 8.16% 8.25%
Investment securities 258,633 209,706 8,145 6,540 6.35 6.29
Short-term investments 15,349 4,309 414 114 5.44 5.34
------------ ---------- ---------- --------- -------- -------
Total interest-earning
assets 857,355 729,439 32,179 27,744 7.57 7.67
Other assets 69,175 47,306
------------ ----------
Total assets $926,530 $776,745
============ ==========
Money market checking $ 36,180 $ 34,680 217 207 1.21 1.20
Money market savings 52,566 59,079 615 683 2.36 2.33
Savings and other 111,288 119,680 836 1,183 1.51 1.99
Certificates of deposit 403,153 371,172 10,357 9,639 5.18 5.24
Securities sold under
agreements to repurchase - 9,011 - 243 n/a 5.44
Other borrowings 159,659 39,158 4,681 1,107 5.91 5.70
------------ ---------- ---------- --------- -------- ------
Total interest-bearing
funds 762,846 632,780 16,706 13,062 4.42 4.16
Demand deposits 68,479 63,740
Other liabilities 4,465 3,128
Capital 90,740 77,097
------------ ----------
Total liabilities
and capital $926,530 $776,745
============ ==========
Net interest income $15,473 $14,682
========== =========
Spread on interest-bearing
funds 3.15% 3.51%
Net interest margin 3.64% 4.06%
</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>
SIX MONTHS ENDED JUNE 30, 1998 VERSUS 1997
CHANGE IN INTEREST DUE TO
----------------------------------------------------------------------
(in thousands) VOLUME RATE VOL/RATE NET
------------ ------------ -------------- ------------
<S> <C> <C> <C> <C>
Loans, net $2,780 $(221) $ (29) $2,530
Investment securities 1,526 64 15 1,605
Short-term investments 292 2 6 300
------------ ------------ ------------- ------------
Total 4,598 (155) (8) 4,435
------------ ------------ ------------- ------------
Money market checking 9 1 - 10
Money market savings (75) 8 (1) (68)
Savings and other (83) (284) 20 (347)
Certificates of deposit 831 (104) (9) 718
Securities sold under
agreements to repurchase (243) - - (243)
Other borrowings 3,407 41 126 3,574
------------ ------------ ------------- ------------
Total 3,846 (338) 136 3,644
------------ ------------ ------------- ------------
Net change to interest income $ 752 $ 183 $(144) $ 791
============ ============ ============= ============
</TABLE>
INTEREST INCOME
Interest income increased $4.44 million or 16.0% due primarily to average
increased volumes of loans and investment securities. Overall average yields
decreased from 7.67% for the six months ended June 30, 1997 to 7.57% for the
same period in 1998 primarily due to a 9 basis point decrease in the average
yield on loans.
INTEREST EXPENSE
Interest expense increased $3.64 million or 27.9% from the six 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 and lower rates on savings
accounts. Overall rates increased from 4.16% for the six months ended June 30,
1997 to 4.42% for the same period in 1998. The increase in average rates was
mainly due to the increase in the FHLB borrowings.
PROVISION FOR LOAN LOSSES
The provision for loan losses decreased from $8.20 million for the six months
ended June 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 422.20% at June 30, 1998 and 495.80% at December 31, 1997. The allowance for
loan losses as a percentage of gross loans was 2.15% at June 30, 1998 and 2.40%
at December 31, 1997.
OTHER INCOME
The Company recorded $4.51 million in other income for the six months ended June
30, 1998 compared to $4.42 million for the same period in 1997, representing an
increase of 2.1%. The following table shows the components of other income for
the six months ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
(in thousands) SIX MONTHS ENDED JUNE 30, $ %
1998 1997 CHANGE CHANGE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Investment brokerage services commissions $1,295 $1,894 $(599) (31.63)%
Service charges on deposit accounts 1,229 1,132 97 8.57
Loan servicing and other fees 490 402 88 21.89
Appreciation of cash surrender value life insurance 459 7 452 6,457.14
Income from investment in Real Estate Partnership 368 306 62 20.26
Net gain on sales of loans 45 7 38 542.86
Net gain on sales of investment securities 4 2 2 100.00
Other 618 665 (47) (7.07)
--------- --------- ---------
$4,508 $4,415 $93 2.11 %
========= ========= ========= =========
</TABLE>
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.
Service charges on deposit accounts were higher due mainly to increased rates
for overdrafts. Loan servicing and other fees increased due mainly to higher
application and letters of credit fees. 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 $11.80 million for the six months ended June 30, 1998
compared to $11.94 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) SIX MONTHS ENDED JUNE 30, $ %
1998 1997 CHANGE CHANGE
------------ -------------- ------------- ----------
<S> <C> <C> <C> <C>
Salaries, commissions and employee benefits $ 6,229 $ 6,260 $ (31) (0.50) %
Occupancy 1,570 1,597 (27) (1.69)
Data processing 570 530 40 7.55
Furniture and equipment 474 477 (3) (0.63)
Advertising 456 466 (10) (2.15)
Legal and accounting 328 484 (156) (32.23)
Communications 257 252 5 1.98
Operation of foreclosed real estate owned 182 257 (75) (29.18)
Write-downs and net losses on sale
of foreclosed real estate owned 85 120 (35) (29.17)
Other 1,648 1,496 152 10.16
------------ -------------- -------------
Total other expenses $11,799 $11,939 $(140) (1.17) %
============= ============== ============= ==========
</TABLE>
25
<PAGE>
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
properties. Other expenses increased due mainly to a prepayment penalty of
$192,000 associated with a FHLB advance during the first quarter of 1998.
INCOME TAXES
During the six months ended June 30, 1998, the Company recorded income tax
expense of $2.89 million, representing a 38.1% effective tax rate. During the
six months ended June 30, 1997, the Bank recorded a $10.21 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
There has been no material change in the nature of the quantitative and
qualitative disclosures about market risk since December 31, 1997.
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
MECH Financial, Inc. held its annual meeting of shareholders on April 29, 1998.
The items voted upon and the results are in the table below:
<TABLE>
<CAPTION>
ABSTENTIONS
VOTES VOTES VOTES NON-BROKER
FOR AGAINST WITHHELD VOTES
-------------- ----------- ------------ --------------
<S> <C> <C> <C> <C>
Director Election of David Freeman to a three year term 4,402,418 - 25,336 -
Director Election of Kevin A. North to a three year term 4,402,418 - 25,336 -
Director Election of Robert G. Rayve to a three year term 4,402,718 - 25,036 -
Director Election of Richard H. Booth to a two year term 4,402,718 - 25,036 -
Ratification of KPMG Peat Marwick, L.L.P. as independent auditors 4,407,508 7,924 - 12,322
</TABLE>
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
26
<PAGE>
b) Reports on Form 8-K:
Consistent with its Form 8-K filing on January 23, 1998, the Company filed
Form 8-KA on April 2, 1998 and April 27, 1998 concerning the change in the
registrant's certifying accountants. The Board of Directors and the Audit
Committee for MECH Financial, Inc. recommended and approved the engagement
of services of KPMG Peat Marwick LLP as the independent accountants for
MECH Financial, Inc. and its subsidiaries for the fiscal year ending
December 31, 1998.
KPMG Peat Marwick LLP will succeed Coopers and Lybrand, LLP, who declined
to stand for re-election, as independent auditors for the fiscal year
ending December 31, 1998. The report on the financial statements for the
two most recent fiscal years by Coopers & Lybrand, LLP did not contain an
adverse opinion or a disclaimer of opinion and was not qualified or
modified as to any uncertainty, audit scope or accounting principles. There
were no disagreements between Coopers & Lybrand, LLP and the management of
MECH Financial, Inc. or its subsidiaries including Mechanics Savings Bank
on accounting policies or procedures, financial statement disclosure or
auditing scope or procedure.
The Company filed a Form 8-K on April 27, 1998 regarding the Board of
Directors declaration of the Company's first quarterly dividend on April
21, 1998 of $0.15 per share on its common stock.
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: 8/5/98 /s/ EDGAR C. GERWIG
------ -------------------
Chairman, President and Chief Executive
Officer
Date: 8/5/98 /s/ THOMAS M. WOOD
------ ------------------
Executive Vice President and Treasurer
Date: 8/5/98 /s/ BRIAN A. ORENSTEIN
------ ----------------------
Senior Vice President and Controller
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 20,068
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 10,195
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 177,885
<INVESTMENTS-CARRYING> 94,726
<INVESTMENTS-MARKET> 95,692
<LOANS> 601,781
<ALLOWANCE> (12,970)
<TOTAL-ASSETS> 954,671
<DEPOSITS> 684,907
<SHORT-TERM> 5,000
<LIABILITIES-OTHER> 10,601
<LONG-TERM> 161,465
0
0
<COMMON> 53
<OTHER-SE> 92,645
<TOTAL-LIABILITIES-AND-EQUITY> 954,671
<INTEREST-LOAN> 23,620
<INTEREST-INVEST> 7,574
<INTEREST-OTHER> 985
<INTEREST-TOTAL> 32,179
<INTEREST-DEPOSIT> 12,025
<INTEREST-EXPENSE> 16,706
<INTEREST-INCOME-NET> 15,473
<LOAN-LOSSES> 600
<SECURITIES-GAINS> 4
<EXPENSE-OTHER> 11,799
<INCOME-PRETAX> 7,582
<INCOME-PRE-EXTRAORDINARY> 7,582
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,690
<EPS-PRIMARY> 0.90
<EPS-DILUTED> 0.88
<YIELD-ACTUAL> 7.57
<LOANS-NON> 3,072
<LOANS-PAST> 0
<LOANS-TROUBLED> 683
<LOANS-PROBLEM> 19,862
<ALLOWANCE-OPEN> 14,031
<CHARGE-OFFS> 1,916
<RECOVERIES> 255
<ALLOWANCE-CLOSE> 12,970
<ALLOWANCE-DOMESTIC> 6,798
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 6,172
</TABLE>
