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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Fiscal Year Ended December 31, 1998
Commission File Number 000-23557
MECH FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
State of Connecticut 06-1500984
(State or other jurisdiction of (I.R.S. employer Identification No.)
incorporation or organization)
100 Pearl Street, Hartford, CT 06103
(Address of principal office) (zip code)
Registrant's Telephone including area code: (860) 293-4000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of February 28, 1999, the aggregate market value of the 4,991,565 shares
of common stock of the registrant issued and outstanding on such date was $152
million . As of that same date, the aggregate market value of the voting stock
held by non-affiliates of the registrant was $148 million.
The following document and information are incorporated by reference herein
to the extent indicated under the appropriate item:
1. Management's definitive Proxy Statement for the 1999 Annual Meeting of
Shareholders (hereinafter referred to as the "1999 Proxy Statement")
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TABLE OF CONTENTS
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Page
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Part I
Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 9
Item 3. Legal Proceedings........................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......................... 9
Part II
Item 5. Market for Common Equity and Related Shareholder Matters.................... 10
Item 6. Selected Consolidated Financial Data........................................ 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations and Quantitative and Qualitative Disclosures about Market Risk... 14
Item 8. Financial Statements and Supplementary Data................................. 40
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................. 75
Part III
Item 10. Directors and Executive Officers of the Registrant.......................... 75
Item 11. Executive Compensation...................................................... 75
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 75
Item 13. Certain Relationships and Related Transactions.............................. 75
Part IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K...................... 76
Signatures.................................................................. 78
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PART I
Item 1. Business
General
MECH Financial, Inc., (the "Company"), a Connecticut corporation, is the
bank holding company for Mechanics Savings Bank (the "Bank"), a wholly owned
subsidiary. The Bank's shareholders approved the formation of the Company at a
special meeting held on November 25, 1997. The Company was formed on January 1,
1998 to provide additional corporate structuring opportunities and powers to
respond to the expanding needs of the Bank's customers and to the competitive
conditions in the financial services industry.
There were several significant initiatives the Company undertook in 1998. In
May, the Company began paying a quarterly dividend. In July, the Bank purchased
two branches from The Chase Manhattan Bank increasing its branch network from
14 to 16. The purchased branches are located in East Hartford and West
Hartford, both within the Bank's existing Greater Hartford market area. The
purchase included approximately $23 million in retail and small business
deposits. In December, the Company announced the formation of a passive
investment company called Mechanics Mortgage Company ("MMC"). This Bank
subsidiary will allow the Company to take advantage of a recent change in the
Connecticut tax statutes by exempting from the Connecticut Corporation Business
Tax the income earned from the mortgages transferred from the Bank to MMC and
the dividends paid by MMC to the Bank.
The Bank is a state chartered capital stock savings bank, which operates 16
banking offices in Hartford County and offers a full range of banking services
to individuals and corporate customers primarily located in Central
Connecticut. The Bank was organized in 1861 and is the largest banking
institution headquartered in the City of Hartford. The Bank completed its
subscription and community offerings of common stock on June 25, 1996, thereby
completing its conversion from a Connecticut-chartered mutual savings bank to a
Connecticut-chartered capital stock savings bank. The Bank sold the maximum
number of shares offered in the conversion, as adjusted, issuing 5.29 million
shares for total gross proceeds of $52.90 million.
The Bank is a community bank with a broad range of products and services.
The Bank's lending focus is on making commercial loans to small and medium
sized businesses as well as originating residential mortgages and consumer
loans. The Bank's results of operations depend primarily on net interest
income, which is the difference between the income earned on its loan and
securities portfolios, and its cost of funds, consisting of interest paid on
its deposits and borrowings. The Bank's results of operations also depend upon
the commissions and fees earned from the Bank's investment brokerage program,
as well as other banking fees which contribute to non-interest income. The
Bank's operating expenses consist principally of employee compensation,
occupancy expenses, data processing expenses and other general and
administrative expenses. The Bank's results of operations are also
significantly affected by general economic and competitive conditions, the real
estate market, changes in interest rates, government policies and actions of
regulatory authorities.
Market Area and Competition
The Bank has 16 retail banking offices, located in Hartford (3), and the
Greater Hartford communities of West Hartford (4), Avon, Bloomfield, Windsor,
Manchester, East Hartford (2), Glastonbury, Wethersfield and New Britain. All
of the Bank's office facilities and its primary market area are located in
Hartford County, Connecticut. According to the 1990 U.S. Census, the City of
Hartford and Hartford County had populations of 139,739 and 851,738,
respectively.
Hartford County is located halfway, approximately two hours driving time,
between Boston and New York City. The region serves as the governmental and
financial center of the state. Hartford County has a diversified mix of
industry groups, including insurance and financial services, manufacturing,
service, government and corporate offices, and retail. The City of Hartford is
the hub of the region and is a major employment center. Hartford is best noted
as the home office of several international and national insurance companies
and
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manufacturing companies. Hartford County employers include Fortune 500
companies, regional banks and the State of Connecticut.
Intense competition exists in all major lines of business in which the Bank
is presently engaged. The Bank's market area contains a significant number of
financial institutions, including commercial banks, thrift institutions, credit
unions, insurance companies, mortgage brokers and brokerage firms. The Bank
competes with a variety of other community banking institutions as well as
regional, super-regional and also several money center institutions which have
located branch offices in the Hartford County market. Many of the larger
institutions offer a full array of consumer and business products, which
compete directly with those products and services offered by the Bank. In
addition, the community banks compete directly with the Bank by attempting to
differentiate themselves from larger rivals in the same manner that the Bank
does, namely through providing first class, personalized service.
Lending Activities
General. The Bank concentrates primarily upon its traditional residential
mortgage, home equity and other consumer loan products, in addition to
commercial loans that meet the needs of small- to medium-sized businesses.
Commercial real estate lending is restricted to owner occupied business realty
and non-speculative, already improved investor properties owned by
creditworthy, substantive borrowers.
One- to Four-Family Residential Lending. The Bank continues to focus on the
origination of loans collateralized primarily by first mortgages on existing
one- to four-family residences, offering a variety of fixed and adjustable rate
mortgage loan products. At December 31, 1998, $423.31 million, or 64.0%, of the
Bank's gross loan portfolio consisted of one- to four- family mortgage loans,
substantially all of which are conventional loans (i.e., loans that are neither
insured by the Federal Housing Administration nor partially guaranteed by the
Veterans Administration).
The Bank actively solicits one- to four-family residential mortgage loan
applications primarily through its branches, loan originators and
correspondents. In addition, the Bank periodically conducts first-time home
buyer seminars in an effort to increase residential loan originations. The Bank
periodically purchases residential mortgage loans from correspondents.
The Bank originates residential mortgage loans which qualify for sale to the
Federal National Mortgage Association ("FNMA") and the Federal Home Loan
Mortgage Corporation ("FHLMC"). The Bank originates both fixed rate and
adjustable rate mortgage loans with loan terms of between 10 and 30 years. One-
year adjustable rate mortgage loans have interest rates that adjust annually
based upon an index tied to the weekly average yield on U. S. Treasury
securities, adjusted to a constant maturity of one year. These loans typically
provide that the amount of any increase or decrease in the interest rate is
limited to two percentage points per adjustment period and is limited to an
aggregate of six percentage points by which the rate can increase or decrease
over the life of the loan. In addition, the Bank offers a variety of other
adjustable rate mortgage programs.
Borrower demand for adjustable rate versus fixed rate mortgage loans is a
function of the level of interest rates, expectations as to future changes in
interest rates and pricing differences between fixed rate mortgage loans and
adjustable rate mortgage loans. The relative amount of fixed rate and
adjustable rate residential loans that are originated at any time is therefore
largely determined by market and financial conditions.
At December 31, 1998, $216.80 million, or 51.2%, of the Bank's one- to four-
family residential mortgage loan portfolio carried fixed interest rates.
Although these loans generally provide for repayment of principal over a fixed
period of 10 to 30 years, the Bank's experience, because of prepayments and
due-on-sale clauses, is that such loans generally remain outstanding for a
substantially shorter period of time. At December 31, 1998, $206.51 million or
48.8% of the Bank's residential mortgage portfolio carried adjustable interest
rates.
Adjustable rate loans tend to decrease the risks to the Bank's net interest
income associated with changes in interest rates, but involve credit risk,
primarily because if interest rates rise, the payment by the borrower
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rises to the extent permitted by the terms of the loan, thereby increasing the
potential for default. At the same time, the market value of the underlying
property may be adversely affected by higher interest rates. The Bank offers
introductory rates on its one-year adjustable rate residential mortgage loans,
which are lower than the fully indexed rate on adjustable rate loans but which
are competitive with other lenders in the Bank's market. The Bank underwrites
the ability of borrowers to service adjustable rate mortgage loans at interest
rates higher than the introductory rates.
The Bank's general practice is to lend up to 80% of the appraised value of
the property collateralizing a one- to four-family residential loan. Under
certain circumstances, the Bank will lend up to 97% of the appraised value. To
the extent that a loan exceeds 80% of the appraised value of the property, the
borrower generally must obtain private mortgage insurance, which effectively
reduces the loss exposure to a 75% loan-to-value ratio or less. Appraisals on
property collateralizing the Bank's one- to four-family residential loans are
made by independent licensed appraisers or the Bank's licensed, in-house
appraisal staff.
The Bank's policy also requires that appraisals be performed in accordance
with applicable federal and state laws and regulations. Borrowers must obtain
hazard and flood insurance, when required, prior to closing. The Bank generally
has required borrowers to pay funds, with each monthly payment of principal and
interest, to a loan escrow account from which the Bank makes disbursements for
items such as real estate taxes and hazard, flood and mortgage insurance
premiums as they become due.
Multi-family, Commercial Real Estate, Land and Construction Lending. Multi-
family, commercial real estate, land and construction lending to builders
involves a higher degree of risk than one- to four-family residential lending.
Construction financing is generally considered to involve a higher degree of
risk of loss than long-term financing on improved, owner-occupied real estate.
Commercial construction loans are made only if the borrower also seeks and
qualifies for a permanent loan from the Bank. The Bank's lending policy allows
for permanent commercial real estate loans collateralized by multi-family
properties and commercial real estate with a maximum loan-to-value ratio of
80%. The Bank typically offers maturities of 10 to 20 years and loan terms
which provide for both variable and fixed interest rates. The Bank generally
obtains personal guarantees from the principals of the borrowing entities.
Appraisals of the property collateralizing such loans are made by independent
licensed appraisers.
At December 31, 1998, $16.06 million, or 2.43%, of the Bank's gross loan
portfolio consisted of loans collateralized by multi-family properties. Multi-
family loans are comprised primarily of loans collateralized by income
producing properties with five or greater residential units.
At December 31, 1998, $117.37 million, or 17.7%, of the Bank's gross loan
portfolio consisted of loans collateralized by commercial real estate, of which
$51.73 million was for professional office buildings, $28.59 million for retail
stores, and $19.20 million for industrial/warehouse properties. The remaining
balance consisted of loans collateralized by various commercial properties.
Also at December 31, 1998, $4.48 million, or 0.7% of the Bank's gross loan
portfolio, were construction and land loans, $1.12 million which were for
construction of one- to four-family residential units and $3.36 million which
were for construction of commercial properties.
As of December 31, 1998, the Bank's largest loan outstanding was a $4.58
million performing commercial mortgage. The largest lending relationship
aggregated $7.00 million, which was also performing.
Commercial and Industrial Lending. The Bank has focused a major portion of
its business development on small- to medium-sized businesses within the
central Connecticut market. Such loans diversify the Bank's portfolio and
reduce the Bank's interest rate risk by originating loans that adjust with
changes in the prime rate. These loans typically generate fee income and often
have compensating deposit balances.
The Bank seeks to expand its current relationships with existing borrowers
that have a superior reputation and a consistent history of profitability. The
Bank also seeks to develop new relationships with creditworthy
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small- to medium-sized business customers in towns in which the Bank has
branches and within certain contiguous communities.
The Bank also cross sells depository, cash management and investment
products. The Bank's loan policy generally discourages transactional lending.
Potential customers include those customers that meet the Bank's risk tolerance
levels by industry, collateral type and debt service capacity.
At December 31, 1998, $41.52 million or 6.3% of the Bank's gross loan
portfolio consisted of commercial and industrial loans. At that date, the Bank
had outstanding unadvanced commitments on commercial lines of credit of $21.88
million.
Home Equity Lending. Originations of home equity lines of credit increased
during 1998, mainly due to increased marketing during the year. Gross new line
approvals increased from $3.13 million in 1997 to $9.96 million in 1998. At
December 31, 1998, the Bank had $14.34 million in approved home equity lines of
credit with $6.73 million outstanding.
The Bank offers amortizing second mortgage loans to enable homeowners to
access equity in their home. The Bank offers repayment schedules of up to 20
years. The Bank's loan policy permits home equity and second mortgage loans up
to 80% of the appraised value of the property collateralizing the loan, less
any existing encumbrances. Appraisals on the property collateralizing the
Bank's home equity and second mortgage loan products and lines are made by
independent licensed appraisers or the Bank's licensed, in-house appraisal
staff.
Consumer Lending. The Bank offers an expanding variety of consumer loan
products including both secured and unsecured loans. Interest rates are
generally competitive to those in the Bank's market. At December 31, 1998, the
Bank's consumer loans totaled $52.27 million or 7.9% of its gross loan
portfolio. The Bank pursued consumer lending more actively in 1998 through
various loan programs, and plans to continue to emphasize this expansion in
1999. New loan volume grew 39% from $29.14 million in 1997 to $40.53 million in
1998 which has accounted for an increase in outstanding loans of 51% at year
end 1998. Management believes that prudent underwriting, higher interest rates
and shorter maturities associated with this type of lending will complement
both earnings and asset/liability management objectives.
Residential Mortgage Loan Servicing. The Bank has historically serviced
loans sold to other institutions as a means of maintaining customer
relationships and generating fee income. These loans were originated by the
Bank and sold to private banking institutions or FNMA or FHLMC. The Bank
serviced 972 loans totaling $53.77 million as of December 31, 1998 compared to
1,024 loans totaling $53.39 million at December 31, 1997.
Asset Quality. Asset quality is of significant importance to the Bank. All
commercial loans are risk-rated at least annually by each loan officer and
reviewed by either internal or external loan review personnel. A review group
meets regularly to adopt action plans for all adversely graded loans and
reviews monthly compliance with previously agreed upon remediation programs.
Non-Performing, Delinquent and Classified Assets
General. Non-performing assets totaled $3.85 million, or 0.38% of total
assets, at December 31, 1998 compared to $4.03 million, or 0.45% of total
assets, at December 31, 1997. At December 31, 1998, non-performing assets were
comprised of $2.95 million of non-performing loans and $0.90 million of other
real estate owned ("OREO").
The Bank identifies certain Other Assets Especially Mentioned ("OAEM") that
include performing loans which management believes exhibit a higher than normal
degree of risk due to a variety of factors, such as geographic and industry
related weaknesses, a downturn in operations in recent years, bankruptcy of a
related company, or other loans from the same borrower that are classified as
non-performing. The OAEM list
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included loans totaling $20.52 million at December 31, 1998, an increase of
$3.11 million or 17.9% from $17.41 million at December 31, 1997.
The Bank also maintains lists of adversely classified credits (substandard,
doubtful or loss credits, referred to as the "Classified Asset Lists"). The
Classified Asset Lists included loans totaling $4.73 million at December 31,
1998, a decrease of $6.43 million or 57.6% from $11.16 million at December 31,
1997. Of the loans on the Classified Asset Lists, non-performing loans totaled
$2.95 million, at December 31, 1998, an increase of $0.12 million or 4.2% from
$2.83 million at December 31, 1997.
Non-Performing Assets. Management of the Bank regularly reviews delinquent
loans, which are placed on non-accrual status when, in its judgment, management
believes the probability of collection is uncertain. All loans 90 days or more
past due as to interest or principal are placed on non-accrual status unless,
in exceptional circumstances, the loan is both well collateralized and in the
process of collection. At December 31, 1998, the Bank had no loans accruing
interest which were 90 days or more past due.
Allowance for Loan Losses. The Bank uses various guidelines for determining
the allowance for loan losses. The Bank primarily relies on its internal risk
rating system as a means to derive loan reserves through the application of
loss experience ratios to individual risk rating categories. Management also
analyzes peer industry data, historical charge-off information and market data
to assess reserve adequacy. Management believes that the Bank's allowance for
loan losses is adequate considering the inherent uncertainty in estimating loan
losses.
The Bank regards its allowance for loan losses as a reserve which is
available to absorb losses from all types of loans. Various factors included in
the Bank's determination of appropriate levels of the allowance for loan losses
include the size and nature of troubled loans, collateral values, trends and
credit concentrations within the portfolio, general delinquency levels,
regional and national economic trends and regulatory policy.
Investment Activities
General. Under Connecticut law, the Bank has authority to purchase a wide
range of investment securities. In accordance with federal banking laws,
however, financial institutions such as the Bank may not engage in any
activities that are not permissible for a national bank, unless the Federal
Deposit Insurance Corporation ("FDIC") has determined that the activity would
pose no significant risk to the Bank Insurance Fund and the bank is in
compliance with applicable capital standards.
The Bank is engaged in the purchase and sale of mortgage-backed securities,
U.S. Treasury securities and obligations of other U.S. government agencies. The
Bank has not invested in derivative investments other than collateralized
mortgage obligations which are either guaranteed by FNMA or FHLMC or are rated
AAA by at least one nationally recognized rating agency. The Bank's investment
policy contemplates investments by the Bank in U.S. Treasury securities,
mortgage-backed securities, federal agency securities, corporate debt
securities, stock in the Federal Home Loan Bank of Boston ("FHLB"), federal
funds, common or preferred stock listed on a national securities exchange and
shares of investment companies registered under the Investment Company Act of
1940.
Mortgage-Backed Securities and Secondary Market Activities. Mortgage-backed
securities increase the Bank's asset quality, are more liquid than individual
mortgage loans, and may be more readily available to collateralize borrowings
or other obligations of the Bank. Mortgage-backed securities owned by the Bank
at December 31, 1998 had maturities of 1 to 30 years, although the Bank expects
the average lives will be significantly shorter due to principal amortization
and prepayments.
Sources of Funds
General. The principal sources of funds for the Company are proceeds from
stock offerings and dividends from the Bank. The principal sources of funds for
the Bank's activities are deposit accounts, amortization and prepayment of
loans and mortgage-backed securities, borrowings from the FHLB and funds
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provided from operations. Loan repayments and funds provided from operations
are relatively stable sources of funds, while deposit inflows and outflows are
significantly influenced by prevailing interest rates, competition and general
economic conditions.
The Bank offers a variety of deposit accounts having a wide range of
interest rates and terms. The Bank attempts to control the flow of funds in its
deposit accounts according to its need for funds and the cost of alternative
sources of funds primarily through the pricing of deposits and, to a lesser
extent, by promotional activities. The Bank's deposit accounts consist of
demand and money market accounts, statement and passbook savings, and time
accounts.
Borrowings. Although deposits are the Bank's primary source of funds, the
Bank also utilizes borrowings from the FHLB. The Federal Home Loan Bank System
functions in a reserve credit capacity for savings institutions and certain
other home financing institutions. The Bank is required to own capital stock in
the FHLB in order to access the System and is authorized to apply for advances
collateralized by residential mortgages and other qualified collateral. The
Bank has access to a pre-approved line of credit up to approximately $15
million and the capacity to borrow up to 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.
Retail, Non-Depository Products
Mechanics Investment Services, Inc. ("MIS"). The Bank offers investment
products and services to its customers through its wholly-owned subsidiary,
MIS. The program, which began in 1986, has evolved from its original emphasis
on transactional business to its current focus on relationship business
including asset allocation accounts with so-called wrap fees. In 1996, the Bank
hired additional staff and formed the subsidiary, MIS, with the intent of
becoming its own broker/dealer in 1997. On July 2, 1997, MIS became licensed as
a broker/dealer and registered investment advisor. MIS is regulated by the
National Association of Security Dealers ("NASD") and is a member of the
Security Investors Protection Corporation ("SIPC"). MIS offers a wide variety
of investment products, including mutual funds, stocks and bonds as well as
investment advisory services. MIS also offers fixed and variable annuity
products and is licensed as an insurance agency in the State of Connecticut.
MIS earns its commissions by selling investment products and by providing
investment advisory services to its customers. Commissions, salaries and
benefits expense related to this service approximated $1.76 million, $1.99
million, and $1.11 million in 1998, 1997 and 1996, respectively.
Savings Bank Life Insurance. The Bank offers Savings Bank Life Insurance
("SBLI") to customers which includes insurance and annuity products. The Bank
also offers mortgage life, disability and credit life insurance relating to
loans as part of its SBLI business. During 1998, 1997 and 1996, the Bank had
pre-tax income of $387,000, $317,000 and $284,000, respectively, from sales of
SBLI insurance and SBLI annuities.
Subsidiaries
The Company has one subsidiary, Mechanics Savings Bank. The Bank has six
wholly-owned subsidiaries, three of which facilitate the ownership, management
and disposition of OREO (at December 31, 1998 these three subsidiaries owned no
properties), one which owns a 50% interest in the Real Estate Partnership which
owned the building that houses the Bank's headquarters, one formed in 1996
(MIS) to enable the Bank to serve its customers with a wholly-owned
broker/dealer and one formed in 1998 (MMC) in order to take advantage of a
recent change in the Connecticut tax statutes. On February 9, 1999, the Bank
sold its interest in its headquarters building for $15.24 million in net
proceeds and a gain of $2.10 million. Refer to Note 23 of the Consolidated
Financial Statements.
Employees
The Bank had 216 full-time employees and 57 part-time employees as of
December 31, 1998.
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Item 2. Properties
At December 31, 1998, the Bank had 16 banking offices, each of which is a
full-service office. The following table lists information at December 31, 1998
for the properties of the Bank.
<TABLE>
<CAPTION>
(Dollars in thousands)
Year Office Area Amount of Owned or Lease
Location Opened by Square Feet Deposits Leased Expiration
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100 Pearl Street,
Hartford, CT(a).......... 1861 6,156 $91,329 Lease 2003
202 Farmington Ave.,
Hartford, CT............. 1951 5,200 16,032 Own N/A
680 Park Street, Hartford,
CT....................... 1957 5,400 25,072 Own N/A
1126 New Britain Ave.,
West Hartford, CT........ 1961 4,300 91,942 Lease 2003
124 LaSalle Road, West
Hartford, CT............. 1963 4,268 93,268 Own N/A
722 North Main Street,
West Hartford, CT........ 1976 2,662 62,630 Lease 2005
927 Farmington Ave., West
Hartford, CT............. 1998 2,436 15,341 Lease 2007
321 West Main Street,
Avon, CT................. 1978 2,639 22,994 Lease 2003
275 Cottage Grove Road,
Bloomfield, CT........... 1962 4,000 29,946 Lease 2002
1491 Silver Lane, East
Hartford, CT............. 1975 2,288 39,584 Lease 2005
1065 Main Street, East
Hartford, CT............. 1998 3,080 5,205 Lease 1999
156 Broad Street, Windsor,
CT....................... 1961 3,000 58,008 Lease 2001
1063 Silas Deane Highway,
Wethersfield, CT......... 1980 3,500 64,970 Lease 2004
341 Broad Street,
Manchester, CT........... 1989 2,760 36,074 Lease 2003
446 South Main Street, New
Britain, CT.............. 1989 2,964 27,451 Lease 2004
2450 Main Street,
Glastonbury, CT.......... 1991 2,594 26,349 Lease 2003
</TABLE>
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(a) In addition to the banking office at 100 Pearl Street, the Bank also
maintains its headquarters and executive offices at that location,
consisting of 41,714 square feet of office space on four floors leased from
the Real Estate Partnership.
Item 3. Legal Proceedings
The Company from time to time becomes involved in or is threatened with
legal proceedings occurring in the ordinary course of business. In the opinion
of management, final disposition of matters pending or threatened will not
individually or in the aggregate have a material adverse effect on the
financial condition or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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PART II
ITEM 5. Market for Common Equity and Related Shareholder Matters.
The common stock began trading on the National Association of Securities
Dealers Automated Quotations System ("NASDAQ") National Market on June 25, 1996
under the symbol "MECH". The following table indicates the high and the low
last sale prices of the Common Stock for the past two fiscal years, as reported
by NASDAQ.
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Cash Dividend
Quarter ended Declared ($) High ($) Low ($)
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<S> <C> <C> <C>
March 31, 1997.......................... -- 19 15 1/2
June 30, 1997........................... -- 19 17
September 30, 1997...................... -- 26 1/4 18 7/8
December 31, 1997....................... -- 28 24
March 31, 1998.......................... -- 30 1/2 24 1/8
June 30, 1998........................... 0.15 31 1/2 27 7/8
September 30, 1998...................... 0.15 31 13/16 21 7/8
December 31, 1998....................... 0.15 29 20 5/8
</TABLE>
As of December 31,1998 there were approximately 3,900 shareholders of
record.
The Company declared its first quarterly cash dividend of $0.15 per share to
shareholders of record as of May 1, 1998 payable on May 15, 1998.
Connecticut law generally provides that the Bank may pay cash dividends only
if the amount does not exceed the Bank's net profits from that year combined
with retained net profits from the previous two years. MECH Financial, Inc.,
cannot declare or pay a dividend if it were to reduce its capital below the
amount required to be maintained by federal and state laws and regulations. The
payment of dividends may be limited by other factors, including applicable
regulatory capital requirements and enforcement by the federal bank regulatory
agencies. The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") generally prohibits a depository institution from making any capital
distribution (including the payment of a dividend) or paying any management fee
to its holding company if any subsidiary depository institution would
thereafter be undercapitalized.
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ITEM 6. Selected Consolidated Financial Data
The following tables set forth certain selected consolidated financial and
other data of the Company at or for the dates indicated. This information
should be read in conjunction with the Consolidated Financial Statements and
notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
As of or for the years ended December 31,
--------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- -------- -------
(in thousands except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations:
Interest and dividend income..... $65,706 $57,315 $49,577 $ 47,540 $45,371
Interest expense................. 33,928 28,053 23,526 21,942 18,424
------- ------- ------- -------- -------
Net interest income.............. 31,778 29,262 26,051 25,598 26,947
Provision for loan losses........ 600 9,100 6,400 12,850 8,200
Other income:
Service charges on deposit
accounts and other............ 4,933 3,927 3,348 2,784 2,935
Investment brokerage services
commissions................... 2,412 2,927 1,136 1,455 1,802
Loan servicing and other fees.. 630 600 595 735 1,042
Income from investment in Real
Estate Partnership............ 606 579 272 504 558
Net gains (losses) on sales of
marketable equity securities.. (20) -- 61 140 17
Net gains (losses) on sales of
debt securities............... 4 209 (139) 222 170
Net gains on sales of loans.... 59 52 43 69 2,830
Other expenses:
Operating expenses (a)......... 23,379 22,642 19,999 20,572 20,365
Operation of foreclosed real
estate owned.................. 372 425 600 1,167 459
Write-down of investment in
Real Estate Partnership....... -- -- -- 6,697 --
Write-downs and net losses on
sale of foreclosed real estate
owned......................... 85 121 3,492 2,261 4,457
Write-down of real estate
agency subsidiary............. -- -- -- 700 --
------- ------- ------- -------- -------
Income (loss) before income
taxes........................... 15,966 5,268 876 (12,740) 2,820
Income tax expense (benefit)
(b)............................. 7,270 (7,808) (266) 1,540 (1,224)
------- ------- ------- -------- -------
Net income (loss)................ $ 8,696 $13,076 $ 1,142 $(14,280) $ 4,044
======= ======= ======= ======== =======
Diluted earnings and pro forma
diluted earnings (loss) per
share before income taxes (c)... $ 2.99 $ 1.00 $ 0.17 $ (2.46) $ 0.55
Diluted earnings and pro forma
diluted earnings (loss) per
share (c)....................... $ 1.63 $ 2.49 $ 0.22 $ (2.76) $ 0.78
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
As of or for the years ended December 31,
---------------------------------------------------
1998 1997 1996 1995 1994
---------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Financial Condition:
Total assets............. $1,019,369 $892,371 $746,685 $662,201 $684,219
Loans, net............... 651,858 571,112 494,291 517,789 536,868
Allowance for loan
losses.................. (12,301) (14,031) (7,983) (11,597) (7,108)
Securities (d)........... 296,504 233,849 194,863 39,315 51,049
Deposits................. 706,195 667,564 655,043 620,802 621,063
Borrowings............... 210,225 129,720 11,960 11,000 21,000
Stockholders' equity..... $ 95,368 $ 88,549 $ 74,840 $ 23,726 $ 37,440
Non-performing loans
(e)..................... $ 2,949 $ 2,830 $ 7,856 $ 16,355 $ 12,099
Foreclosed real estate
owned................... 902 1,204 679 5,393 7,845
Non-performing assets
(f)..................... $ 3,851 $ 4,034 $ 8,535 $ 21,748 $ 19,944
Performance Ratios:
Return (loss) on average
total assets (g)........ 0.92% 1.61% 0.16% (2.14)% 0.58%
Return (loss) on average
equity (g).............. 9.40 15.99 2.34 (39.13) 11.73
Interest rate spread
(h)..................... 3.10 3.38 3.63 4.03 4.20
Net interest margin (i).. 3.61 3.90 4.03 4.24 4.31
Efficiency ratio (j)..... 57.87 60.29 63.76 65.29 56.10
Efficiency ratio with
write-downs and OREO
expenses (k)............ 59.00% 61.74% 76.80% 99.65% 69.64%
Asset Quality Data:
Non-performing loans as a
% of gross
loans (e) (l)........... 0.44% 0.48% 1.56% 3.09% 2.23%
Non-performing assets as
a % of gross loans and
OREO (f)................ 0.58 0.69 1.70 4.07 3.62
Non-performing assets as
a % of total assets
(f)..................... 0.38 0.45 1.14 3.28 2.91
Allowance for loan losses
as a % of gross loans
(l) 1.85 2.40 1.59 2.19 1.31
Allowance for loan losses
as a % of non-performing
loans (e)............... 417.12 495.80 101.62 70.91 58.75
Net charge-offs as a % of
average gross
loans (g)............... 0.38% 0.56% 1.99% 1.54% 1.48%
Capital Ratios:
Tier 1 leverage capital
(m)..................... 9.63% 9.74% 10.20% 3.57% 5.46%
Tier 1 risk-based capital
(n)..................... 14.49 16.49 18.28 5.65 8.06
Total risk-based capital
(o)..................... 15.75% 17.76% 19.54% 6.90% 9.31%
Other Selected Financial
and Statistical Data:
Number of:
Deposit accounts....... 69,385 67,751 68,212 67,125 66,975
Bank offices........... 16 14 14 14 14
Full-time staff........ 216 202 192 203 246
Stockholders' equity to
assets.................. 9.36% 9.92% 10.02% 3.58% 5.47%
Cash dividends declared
per share (p)........... $ 0.45 $ -- $ -- n/a n/a
Dividend payout ratio.... 27.11% -- % -- % n/a n/a
</TABLE>
- --------
a) Operating expenses exclude write-downs and operating expenses related to
foreclosed real estate owned.
b) In 1994, a tax benefit of $1.50 million was recognized as management
determined it was more likely than not that $1.50 million of deferred tax
assets would be realized in the future. In 1995, based on then-current
operating and asset quality trends, management recorded an additional
deferred tax valuation reserve of $1.50 million thereby determining that as
of December 31, 1995, it was more likely than not that the
12
<PAGE>
deferred tax asset would not be realized. In the second quarter of 1997,
the Company 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 for the second half of
1997 and 1998 that indicated continued profitability, the Company
determined that it was more likely than not that it would realize its net
deferred tax assets. During 1998, the Company recorded $1.19 million in net
tax expense due to the tax implications of the creation of Mechanics
Mortgage Company, a passive investment company. This charge was the result
of establishing a deferred tax asset valuation allowance against the
Company's state deferred tax asset.
c) Diluted earnings and proforma diluted earnings (loss) 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. For earnings (loss) per
share purposes, the common stock has been assumed to be outstanding for all
periods presented.
d) Includes FHLB stock and excludes short-term investments classified as cash
equivalents.
e) Non-performing loans are loans that are contractually past due in excess of
90 days or loans that are not 90 days past due but which the Company has
decided to stop the accrual of interest based on management's assessment
regarding the full collectibility of principal and interest. Troubled debt
restructured loans which are performing in accordance with their
restructured terms are not included in non-performing loans.
f) Non-performing assets are the combination of non-performing loans and
foreclosed real estate owned.
g) Averages based on daily average balances.
h) Difference between the weighted average yield on loans, and the investment
securities and short-term investments and the weighted average cost of
funds.
i) Represents net interest income divided by average total interest-earning
assets.
j) Represents operating expenses divided by the sum of net interest income and
total other income.
k) Represents operating expenses, operation of foreclosed real estate owned,
write-down of investment in Real Estate Partnership, write-downs and net
losses on sale of foreclosed real estate owned and write-down of real
estate agency subsidiary divided by the sum of net interest income and
total other income.
l) Gross loans excludes loans held-for-sale.
m) The Tier 1 leverage capital ratio established by the Federal Reserve Board
("FRB") and the Federal Deposit Insurance Corporation ("FDIC") measures the
ratio of Tier 1 capital to average quarterly total assets. Tier 1 capital
is generally defined as common stock, additional paid in capital, surplus,
retained earnings, adjustments for unrealized losses on equity securities
classified as available-for-sale and unallocated Employee Stock Ownership
Plan ("ESOP") shares. Tier 1 capital excludes goodwill and other
intangibles.
n) The Tier 1 risk-based capital ratio established by the FRB and the FDIC
measures the ratio of Tier 1 leverage capital to total "risk-weighted"
assets. The Company's assets and certain off-balance sheet items are
assigned to broad risk categories. Basically, the higher percentage of
riskier assets an institution has, the more capital it must have to satisfy
the risk-based guidelines; the lower the risk, the lower the required
capital.
o) The total risk-based capital ratio established by the FRB and the FDIC is
calculated as described in (n) above but allows the Company to include Tier
II capital in addition to Tier 1 capital. Tier II capital generally
consists of the general allowance for loan losses. The Company recorded the
full amount of the general allowance for loan losses (1.25% of risk based
assets) in Tier II capital for the years presented, in accordance with FDIC
regulations. Not more than one-half of the capital used to calculate the
total risk-based capital ratio may come from Tier II capital.
p) The Bank completed its subscription and community offering of common stock
on June 25, 1996.
13
<PAGE>
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto, which are included
elsewhere herein.
MECH Financial, Inc. has one subsidiary, Mechanics Savings Bank. The Bank is
a state-chartered capital stock savings bank which operates 16 banking offices
in Hartford County and offers a full range of banking services to individuals
and corporate customers primarily located in Central Connecticut. The Bank was
organized in 1861 and is the largest banking institution headquartered in the
City of Hartford. The Bank completed its subscription and community offerings
of common stock on June 25, 1996, thereby completing its conversion from a
Connecticut-chartered mutual savings bank to a Connecticut-chartered capital
stock savings bank. The Bank sold the maximum number of shares offered in the
conversion, as adjusted, issuing 5.29 million shares for total gross proceeds
of $52.90 million.
On November 25, 1997, the shareholders of the Bank approved the formation of
a holding company, MECH Financial Inc. Effective January 1, 1998, the formation
of 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 Board of Directors believes the formation of MECH Financial, Inc. will
enhance the Bank's competitive position and result in greater long-term
shareholder value.
The Bank is a community bank with a broad range of products and services. The
Bank's lending focus is on making commercial loans to small and medium-sized
businesses as well as originating residential mortgages and consumer loans. The
Bank's results of operations depend primarily on net interest income, which is
the difference between the income earned on its loan and securities portfolios,
and its cost of funds, consisting of interest paid on its deposits and
borrowings. The Bank may set aside a provision for loan losses, which has had a
significant impact on its results of operations in recent years. The Bank's
results of operations also depend upon the commissions and fees earned from the
Bank's investment brokerage program, as well as other banking fees which
contribute to non-interest income. The Bank's operating expenses consist
principally of employee compensation, occupancy expenses, data processing
expenses and other general and administrative expenses. The Bank's results of
operations are also significantly affected by general economic and competitive
conditions, the real estate market, changes in interest rates, government
policies and actions of regulatory authorities.
During 1997, MIS became a licensed broker/dealer and insurance agency in the
State of Connecticut as well as a registered investment advisor. Effective
January 1, 1999, the Bank funded a passive investment company, MMC, to take
advantage of recent state legislation which is expected to reduce the Company's
state tax liability.
Overview
The Company reported net income of $8.70 million for the year ended December
31, 1998 compared to $13.08 million for the year ended December 31, 1997. In
the second quarter of 1997, the Company 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
for the second half of 1997 and for 1998 that indicated continued
profitability, the Company determined that it was more likely than not that it
would realize its net deferred tax assets. During 1998, the Company recorded a
net tax expense of $1.19 million for the tax implications of the creation of
MMC in January 1999.
14
<PAGE>
Net income before income taxes totaled $15.97 million for the year ended
December 31, 1998 compared to $5.27 million for the year ended December 31,
1997. Provision for loan losses totaled $9.10 million in 1997 compared to
$600,000 during 1998. In addition, net interest income increased 8.6% or $2.52
million from 1997 to 1998.
During 1998, the Company increased its assets to $1,019.37 million or 14.2%
over the $892.37 million at December 31, 1997. The increase in assets also
reflects increased activity in lending and investing which was funded primarily
with increased borrowings from the FHLB and deposit growth due in part to the
purchase of two branches during 1998.
Non-performing assets as a percentage of total assets was 0.38% at December
31, 1998 as compared to 0.45% at December 31, 1997. The Company's allowance for
loan losses represented 339.24% of non-performing and restructured loans at
December 31, 1998, compared to 351.65% at December 31, 1997.
Financial Condition
Total assets as of December 31, 1998 were $1,019.37 million, representing an
increase of $127.00 million or 14.2% from $892.37 million at December 31, 1997.
During the year, the Company emphasized increased lending and investing
activities which resulted in increases in one- to four-family and commercial
real estate mortgages, commercial and industrial and consumer loans and
mortgage-backed securities. The major source of funding these increases was the
expanded use of FHLB borrowings and increased deposits due in part to the
purchase of two branches.
Securities
The securities portfolio consists primarily of U.S. Treasury and Government
agency securities, mortgage-backed securities and mutual funds. There are no
derivative instruments (other than collateralized mortgage obligations, the
majority of which are guaranteed by the Federal National Mortgage Association,
the Government National Mortgage Association, and the Federal Home Loan
Mortgage Corporation), structured notes, inverse floating notes or interest or
principal only strips in the Company's securities portfolio.
The following table sets forth the composition of the Company's investment
portfolios at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
--------------------------------
1998 1997 1996
-------- -------------- --------
(in thousands)
<S> <C> <C> <C>
Securities held-to-maturity:
U.S. Treasury securities and other U.S.
Government agencies.......................... $ 22,994 $ 5,000 $ 5,820
Corporate debt securities..................... 1,000 -- --
Mortgage-backed securities.................... 56,312 70,199 37,398
-------- -------- --------
Total securities held-to-maturity, at
amortized cost............................. $ 80,306 $ 75,199 $ 43,218
======== ======== ========
Securities available-for-sale:
U.S. Treasury securities and other U.S.
Government agencies.......................... $ 5,029 $ 2,997 $ 14,487
Corporate debt securities..................... 5,912 1,002 --
Debt securities issued by foreign
governments.................................. 350 350 350
Mortgage-backed securities.................... 175,266 127,185 132,196
Marketable equity securities.................. 3,000 23 15
Mutual funds.................................. 16,154 20,643 308
-------- -------- --------
Total securities available-for-sale, at fair
value...................................... $205,711 $152,200 $147,356
======== ======== ========
FHLB stock.................................... $ 10,487 $ 6,450 $ 4,289
======== ======== ========
</TABLE>
15
<PAGE>
Investment securities increased $58.62 million or 25.8% from $227.40 million
at December 31, 1997 to $286.02 million at December 31, 1998 due primarily to a
$34.19 million increase in the mortgage-backed securities portfolio and a
$20.03 million increase in U.S. Treasury and other U.S. Government agency
securities. Funds available for investment increased mainly from additional
FHLB borrowings and increased deposits due in part to the purchase of two
branches.
Due to increased FHLB borrowings, the Company was required to purchase
additional shares of stock totaling $4.04 million from the FHLB. The Company
believes that these shares provide above average dividend yields for the risk
characteristics of such investments.
At December 31, 1998, the Company had a net unrealized gain of $444,000
included in its $205.71 million available-for-sale securities portfolio and a
net unrealized gain of $567,000 on its $80.31 million held-to-maturity
securities portfolio. Fluctuations in fair market value caused by movements in
interest rates and market conditions will not necessarily have a significant
effect on future earnings.
16
<PAGE>
The following table sets forth the contractual maturities of investment
securities (excluding equity securities and mutual funds) at December 31, 1998,
and the weighted average yields of such securities. The weighted average yields
are calculated based on the cost and the effective yields to maturity of each
security.
<TABLE>
<CAPTION>
Carrying Amount
--------------------------------------------------------------------------------------------------
Less than After One After Five After
One Year Through Five Years Through Ten Years Ten Years Totals
---------------- --------------------- ----------------------- ----------------- -----------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------- -------- ---------- ---------- -------------- -------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities held-to-
maturity:
U.S. Treasury and
other U.S. Government
agencies............. $ -- -- $ -- -- $19,994 6.39% $ 3,000 6.75% $ 22,994 6.44%
Mortgage-backed
securities........... -- -- -- -- -- -- 56,312 6.69 56,312 6.69
Corporate debt
securities........... -- -- -- -- -- -- 1,000 7.65 1,000 7.65
------- ---------- ------- -------- --------
Total securities held-
to-maturity.......... $ -- -- $ -- -- $19,994 6.39% $ 60,312 6.71% $ 80,306 6.63%
======= ========== ======= ======== ========
Securities available-
for-sale:
U.S. Treasury and
other U.S. Government
agencies............. $ -- -- $ -- -- $ 3,029 6.76% $ 2,000 5.07% $ 5,029 6.09%
Debt securities issued
by foreign
governments.......... 250 8.00% 100 8.00% -- -- -- -- 350 8.00
Corporate debt
securities........... 3,000 4.30 994 7.32 -- -- 1,918 6.46 5,912 5.51
Mortgage-backed
securities........... -- -- 12,578 6.81 5,374 6.52 157,314 6.61 175,266 6.62
------- ---------- ------- -------- --------
Total securities
available-for-sale... $ 3,250 4.58% $ 13,672 6.85% $ 8,403 6.61% $161,232 6.59% $186,557 6.57%
------- ---------- ------- -------- --------
Total................ $ 3,250 4.58% $ 13,672 6.85% $28,397 6.45% $221,544 6.62% $266,863 6.59%
======= ==== ========== ======= ======= ==== ======== ==== ======== ====
</TABLE>
Refer to Note 4 of the consolidated financial statements for information
related to unrealized gains and losses on the available-for-sale investment
securities.
Loans
The following table details the composition of the loan portfolio as of the
periods presented.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Real estate mortgages:
One- to four-family......... $423,308 $396,390 $341,372 $348,783 $355,510
Multi-family................ 16,056 13,497 14,187 19,803 23,364
Commercial real estate...... 117,373 99,252 95,923 111,836 118,048
Construction and land
development................ 4,480 3,602 6,173 4,485 5,976
Commercial and industrial.... 41,516 33,699 26,072 26,435 24,427
Home equity lines of credit.. 6,736 3,003 2,302 2,237 3,914
Other consumer loans......... 52,269 34,620 15,818 15,135 12,312
-------- -------- -------- -------- --------
Total loans, gross.......... 661,738 584,063 501,847 528,714 543,551
Deferred loan origination
costs, net.................. 2,421 1,080 427 672 425
Allowance for loan losses.... (12,301) (14,031) (7,983) (11,597) (7,108)
-------- -------- -------- -------- --------
Total loans, net............ $651,858 $571,112 $494,291 $517,789 $536,868
======== ======== ======== ======== ========
</TABLE>
Gross loans increased $77.68 million or 13.3% from $584.06 million at
December 31, 1997 to $661.74 million at December 31, 1998. The increase was due
primarily to increases of $26.92 million of one- to four-family mortgages,
$18.12 million of commercial real estate mortgages and $17.65 million of
consumer loans due to increased origination
17
<PAGE>
activity which was partially offset by amortization and prepayments. The
increased origination activity during 1998 was due mainly to increased
marketing campaigns and the expansion of the network of automotive dealers
offering the Company's lending programs as well as favorable market interest
rate conditions. Loans held-for-sale decreased from $1.92 million at December
31, 1997 to $-0- at December 31, 1998 since the Company is now maintaining most
originated loans for its own portfolio.
The following table sets forth certain information at December 31, 1998
regarding the dollar amount of loans maturing in the Company's loan portfolio.
Demand loans and loans having no stated schedule of repayments and no stated
maturity are reported in the maturing within one year category.
<TABLE>
<CAPTION>
After One After Five
Within through through After
Amount One Year Five Years Ten Years Ten Years
-------- -------- -------------- ---------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Real estate mortgages:
One- to four-family.... $423,308 $ 572 $ 8,429 $ 38,573 $375,734
Multi-family........... 16,056 -- 1,619 3,181 11,256
Commercial real
estate................ 117,373 3,546 20,444 51,600 41,783
Construction and land
development........... 4,480 184 396 -- 3,900
Commercial and
industrial.............. 41,516 18,775 15,875 6,108 758
Home equity lines of
credit.................. 6,736 261 173 6,302 --
Other consumer loans..... 52,269 1,973 47,044 3,149 103
-------- ------- ------- -------- --------
Total loans, gross..... $661,738 $25,311 $93,980 $108,913 $433,534
======== ======= ======= ======== ========
</TABLE>
At December 31, 1998, $329.29 million of the Company's loans with
contractual maturities after December 31, 1999 were fixed rate loans and
$307.14 million had adjustable interest rates. The following table sets forth
the dollar amount of all loans maturing after December 31, 1999 by fixed or
adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
-------- ----------
(in thousands)
<S> <C> <C>
Real estate mortgages:
One- to four-family................................... $207,499 $215,237
Multi-family.......................................... 7,666 8,390
Commercial real estate................................ 47,143 66,684
Construction and land development..................... 3,345 951
Commercial and industrial............................... 13,387 9,354
Home equity lines of credit............................. -- 6,475
Other consumer loans.................................... 50,251 45
-------- --------
Total loans, gross.................................... $329,291 $307,136
======== ========
</TABLE>
The allowance for loan losses totaled $12.30 million at December 31, 1998
compared to $14.03 million at December 31, 1997. Provisions for loan losses
during 1998 totaled $600,000 and net charge-offs totaled $2.33 million.
Provisions for loan losses during the year ended December 31, 1997 totaled
$9.10 million and net charge-offs totaled $3.05 million. The allowance for loan
losses as a percentage of non-performing loans decreased from 495.8% at
December 31, 1997 to 417.1% at December 31, 1998.
18
<PAGE>
The following table sets forth an analysis of activity in the allowance for
loan losses at and during the periods indicated.
<TABLE>
<CAPTION>
At or for the years ended December 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $ 14,031 $ 7,983 $ 11,597 $ 7,108 $ 7,324
Add:
Provision charged to
operations........... 600 9,100 6,400 12,850 8,200
Recoveries............ 516 960 430 744 448
Less:
Charge-offs:
Real estate
mortgages:
One- to four-
family............. 2,132 1,840 2,966 1,829 620
Multi-family........ 71 694 1,677 2,083 629
Commercial real
estate............. 62 987 4,878 4,549 6,751
Construction and
land development... -- -- 15 -- 283
Consumer and
commercial and
industrial.......... 581 491 908 644 581
-------- -------- -------- -------- --------
Total charge-offs...... 2,846 4,012 10,444 9,105 8,864
-------- -------- -------- -------- --------
Balance at end of
period................. $ 12,301 $ 14,031 $ 7,983 $ 11,597 $ 7,108
======== ======== ======== ======== ========
Net charge-offs......... $ 2,330 $ 3,052 $ 10,014 $ 8,361 $ 8,416
======== ======== ======== ======== ========
Total loans, gross...... $661,738 $584,063 $501,847 $528,714 $543,551
======== ======== ======== ======== ========
Net charge-offs to gross
loans.................. 0.35% 0.52% 2.00% 1.58% 1.55%
</TABLE>
The following table shows the allocation of the allowance for loan losses
to various types of loans at December 31.
<TABLE>
<CAPTION>
% of Loan % of Loan % of Loan % of Loan % of Loan
Type to Type to Type to Type to Type to
1998 Total Loans 1997 Total Loans 1996 Total Loans 1995 Total Loans 1994 Total Loans
------- ----------- ------- ----------- ------ ----------- ------- ----------- ------ -----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate
mortgages:
One- to
four-family........ $ 1,679 63.97% $ 2,549 67.87% $1,724 68.02% $ 1,302 65.97% $1,166 65.40%
Multi-family........ 435 2.42 399 2.31 592 2.83 806 3.75 511 4.30
Commercial
real estate........ 2,661 17.74 2,397 16.99 2,935 19.11 2,114 21.15 1,955 21.72
Construction and
land development... 82 0.68 36 0.62 239 1.23 90 0.85 134 1.10
Commercial and
industrial.......... 1,262 6.27 1,085 5.77 848 5.20 3,397 5.00 1,418 4.49
Home equity lines of
credit and consumer
loans............... 365 8.92 423 6.44 395 3.61 366 3.28 288 2.99
Unallocated.......... 5,817 n/a 7,142 n/a 1,250 n/a 3,522 n/a 1,636 n/a
------- ------ ------- ------ ------ ------ ------- ------ ------ ------
Total allowance for
loan losses........ $12,301 100.00% $14,031 100.00% $7,983 100.00% $11,597 100.00% $7,108 100.00%
======= ====== ======= ====== ====== ====== ======= ====== ====== ======
</TABLE>
The Company allocates the allowance for loan losses based on historic loss
ratios for its one- to four-family mortgages, home equity lines of credit and
consumer loans. The allocation for the remaining loans is done on a loan-by-
loan basis. With intense competition in a continued sluggish Central
Connecticut economy during 1997, management believed that increasing the
allowance for loan losses and the reserve coverage ratios while maintaining
high credit quality were prudent strategies to implement. Although improving,
the Central Connecticut economy continued to lag both the New England and
National economies. In addition, 83% of the Company's loans and commitments
are collateralized by real estate in Connecticut. Management considers any
allocation of the allowance to be subjective. Therefore, the entire allowance
is available to absorb loan losses for any category of loans.
19
<PAGE>
Depending upon the Company's asset/liability position, the Company may sell
fixed rate one- to four-family real estate mortgages on a servicing-retained
basis. At December 31, 1998 and 1997, loans serviced for others totaled $53.77
million and $53.39 million, respectively.
Adverse market interest rate changes, between the time the customer receives
a rate-lock commitment and the time the fully-funded mortgage loan is sold to
an investor, can erode the value of that mortgage. Therefore, the Company
enters into forward sales contracts, generally for periods not exceeding ninety
days, to mitigate the interest rate risk associated with the origination and
sale of mortgage loans. The Company accepts credit risk in forward sales
contracts to the extent of nonperformance by a counterparty, in which case the
Company would be compelled to sell the mortgages to another party at the
current market price. The credit exposure of forward sales contracts represents
the aggregate value of contracts with a positive fair value. These credit
exposures at both December 31, 1998 and December 31, 1997 were not significant.
If the Company did not have sufficient loans to fulfill the contract, it would
purchase mortgages from others at the prevailing market rates to satisfy the
contracts. The cost of forward sales contracts, and any related gain or loss,
are deferred and recognized when the mortgages are sold and were not material
in 1998, 1997 and 1996.
Non-Performing Assets
The following table summarizes changes in non-performing assets during the
periods presented.
<TABLE>
<CAPTION>
For the years ended
December 31,
---------------------------
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Balance, beginning of year...................... $ 4,034 $ 8,535 $21,748
Loans placed on non-accrual status.............. 10,152 12,194 20,663
Payments on non-performing assets............... (1,671) (8,308) (6,594)
Loans returned to accrual status................ (941) (2,988) (3,887)
Loans charged-off............................... (2,846) (3,052) (10,014)
Sales of loans and foreclosed real estate
owned.......................................... (4,792) (2,226) (9,889)
Write-downs and net losses on sale of foreclosed
real estate owned.............................. (85) (121) (3,492)
------- ------- -------
Total reductions.............................. (10,335) (16,695) (33,876)
------- ------- -------
Balance, end of year............................ $ 3,851 $ 4,034 $ 8,535
======= ======= =======
Percent of total assets......................... 0.38 % 0.45 % 1.14 %
</TABLE>
20
<PAGE>
The following table details the composition of non-performing assets and
troubled debt restructuring as of the dates presented.
<TABLE>
<CAPTION>
Foreclosed
Accruing Loans Real Total Troubled
Non-Accrual Past Due 90 or Estate Non-Performing Debt
Loans More Days Owned Assets Restructurings
----------- -------------- ---------- -------------- --------------
(in thousands)
<S> <C> <C> <C> <C> <C>
December 31, 1998
Real estate mortgages:
One- to four-family.... $ 1,810 $-- $ 809 $ 2,619 $ --
Multi-family........... 300 -- -- 300 677
Commercial real
estate................ 150 -- 93 243 --
Construction and land
development........... -- -- -- -- --
Commercial and
industrial............. 469 -- -- 469 --
Home equity lines of
credit and consumer
loans.................. 220 -- -- 220 --
------- ---- ------ ------- -------
Total............... $ 2,949 $-- $ 902 $ 3,851 $ 677
======= ==== ====== ======= =======
December 31, 1997
Real estate mortgages:
One- to four-family.... $ 1,713 $-- $ 828 $ 2,541 $ --
Multi-family........... 78 -- -- 78 1,160
Commercial real
estate................ 681 -- 164 845 --
Construction and land
development........... 2 -- 212 214 --
Commercial and
industrial............. 286 -- -- 286 --
Home equity lines of
credit and consumer
loans.................. 70 -- -- 70 --
------- ---- ------ ------- -------
Total............... $ 2,830 $-- $1,204 $ 4,034 $ 1,160
======= ==== ====== ======= =======
December 31, 1996
Real estate mortgages:
One- to four-family.... $ 3,636 $-- $ 653 $ 4,289 $ 178
Multi-family........... 187 -- -- 187 1,259
Commercial real
estate................ 2,103 -- -- 2,103 3,214
Construction and land
development........... 895 -- 26 921 --
Commercial and
industrial............. 887 -- -- 887 --
Home equity lines of
credit and consumer
loans.................. 148 -- -- 148 --
------- ---- ------ ------- -------
Total............... $ 7,856 $-- $ 679 $ 8,535 $ 4,651
======= ==== ====== ======= =======
December 31, 1995
Real estate mortgages:
One- to four-family.... $ 3,304 $-- $ 593 $ 3,897 $ 340
Multi-family........... -- -- -- -- 3,355
Commercial real
estate................ 11,964 -- 1,748 13,712 8,981
Construction and land
development........... 622 -- 3,052 3,674 1,017
Commercial and
industrial............. 431 -- -- 431 554
Home equity lines of
credit and consumer
loans.................. 34 -- -- 34 --
------- ---- ------ ------- -------
Total............... $16,355 $-- $5,393 $21,748 $14,247
======= ==== ====== ======= =======
December 31, 1994
Real estate mortgages:
One- to four-family.... $ 4,194 $144 $1,995 $ 6,333 $ 326
Multi-family........... -- -- -- -- 6,065
Commercial real
estate................ 7,384 -- 2,320 9,704 7,675
Construction and land
development........... 252 -- 3,530 3,782 1,022
Commercial and
industrial............. 57 -- -- 57 800
Home equity lines of
credit and consumer
loans.................. 68 -- -- 68 --
------- ---- ------ ------- -------
Total............... $11,955 $144 $7,845 $19,944 $15,888
======= ==== ====== ======= =======
</TABLE>
The Company places a loan on non-accrual status when it is 90 days or more
past due or based on management's assessment that the full collectibility of
principal and interest is uncertain. Non-performing
21
<PAGE>
assets as a percentage of total assets decreased from 0.45% at December 31,
1997 to 0.38% at December 31, 1998. Non-performing assets as a percentage of
total loans and foreclosed real estate owned decreased from 0.69% at December
31, 1997 to 0.58% at December 31, 1998. The Company also maintains lists of
adversely classified credits (substandard, doubtful, or loss credits) as
defined by the FDIC. The Classified Asset Lists included loans totaling $4.73
million at December 31, 1998, a decrease of $6.43 million or 57.6% from $11.16
million at December 31, 1997. Of the loans on the Classified Asset Lists, non-
performing loans totaled $2.95 million, at December 31, 1998, an increase of
$0.12 million or 4.2% from $2.83 million at December 31, 1997. The Company,
through its workout department, pursues the resolution of all classified and/or
non-performing assets through restructuring, credit modifications or
collections. When these procedures do not bring a loan into performing or
restructured status, the Company generally initiates action to foreclose the
collateral or to acquire it by deed in lieu of foreclosure.
As part of its loan workout efforts, the Company periodically enters into
troubled debt restructurings. As of December 31, 1998, 1997 and 1996, the
Company had $677,000, $1.16 million and $4.65 million, respectively, in
troubled debt restructurings. At December 31, 1998, interest rates on these
restructurings were at 9.25%.
The foregoing tables do not include OAEM loans. Although not impaired, OAEM
loans, in the opinion of management, exhibit a higher than normal degree of
risk and warrant monitoring due to various considerations, including (i) the
degree of documentation supporting the borrower's current financial position,
(ii) potential weaknesses in the borrowers' ability to service the loan, (iii)
possible collateral value deficiency, and (iv) other risk factors such as
geographic location, industry focus and negatively trending financial results.
These OAEM loans approximated $20.52 million at December 31, 1998 and $17.41
million at December 31, 1997. Properties collateralizing these loans are
located in Connecticut, primarily in Hartford County, and consist primarily of
commercial real estate mortgages. The above mentioned deficiencies have created
some uncertainty, but not serious doubt, as to the borrowers' ability to comply
with the loan repayment terms in the future. Management believes the reserves
for these loans are adequate.
Foreclosed real estate owned decreased from $1.20 million at December 31,
1997 to $902,000 at December 31, 1998. The Company foreclosed upon 23
properties totaling $1.28 million during 1998. The Company sold 28 properties
totaling $1.35 million during the year ended December 31, 1998. Write-downs and
net losses on sale of foreclosed real estate owned for the year ended December
31,1998 totaled $85,000 compared to $121,000 for the year ended December 31,
1997.
Cash and Cash Equivalents
Cash and cash equivalents decreased $11.03 million or 33.4% from $33.02
million at December 31, 1997 to $21.99 million at December 31, 1998. The
Company's short-term investments decreased $8.72 million and its non-interest-
bearing deposits and cash decreased $2.31 million from December 31, 1997 to
December 31, 1998.
Cash Surrender Value Life Insurance
Cash surrender value life insurance totaled $16.87 million at December 31,
1998 compared to $16.05 million at December 31, 1997. During 1997, twenty
policies were acquired on the lives of seven executive officers and six
directors and are designed to recover the costs of the Company's Long Term
Deferred Incentive Plan ("LTDIP") and Outside Director Deferred Compensation
Plan ("DDCP"). The policy death benefit also will enable the Company to fund
the death benefit provision of these benefit plans. The policies were paid with
a single premium and have a combined death benefit of $41.3 million. Policy
cash values earn interest at a current tax-free rate of between 5.4%--6.0% and
policy mortality costs are charged against the cash value monthly. There are no
loads or surrender charges associated with the policies.
Other Assets
Other assets decreased $4.20 million or 36.3% from $11.55 million at
December 31, 1997 to $7.35 million at December 31, 1998 due primarily to a
$4.15 million decrease in the Company's deferred tax asset. This
22
<PAGE>
decrease is due to both the income earned for the year and the valuation
allowance established against the state deferred asset as a result of the
creation of MMC which resulted in a net decrease of $1.19 million in the
deferred tax asset. Income of this passive investment company subsidiary and
its dividend to the parent are exempt from the Connecticut Corporation Business
Tax. Due to the creation of this passive investment company, the Company no
longer expects to recognize the state deferred asset.
On February 9, 1999, the Bank sold its interest in its headquarters building
for $15.24 million in net proceeds and a gain of $2.10 million. See Note 23 of
the Consolidated Financial Statements.
Deposits and Borrowings
Deposits increased $38.63 million or 5.8% from $667.56 million at December
31, 1997 to $706.19 million at December 31, 1998. During 1998, the Bank
purchased two branches of Chase Manhattan Bank with deposits totaling
approximately $23 million. Demand deposits, money market accounts and
certificates of deposit increased $17.12 million, $13.60 million and $10.02
million, respectively, from December 31, 1997 to December 31, 1998.
The following table presents the amounts of certificates of deposit of the
Company at December 31, 1998 maturing during the periods reflected below and
the weighted average interest rates of such accounts.
<TABLE>
<CAPTION>
Weighted Average
Amount Interest Rate
-------- ----------------
(in thousands)
<S> <C> <C>
Certificates of deposit maturing during the 12
months ending:
December 31, 1999.................................. $318,410 4.74%
December 31, 2000.................................. 60,566 5.50
December 31, 2001.................................. 10,929 5.67
Thereafter......................................... 18,546 5.82
--------
Total............................................... $408,451 4.93%
======== =====
</TABLE>
The following table presents the maturities of the Company's certificates of
deposit in amounts of $100,000 or more at December 31, 1998 by time remaining
to maturity.
<TABLE>
<CAPTION>
Maturing
--------------
(in thousands)
<S> <C>
Three months or less............................................. $42,102
Over three through six months.................................... 14,332
Over six through twelve months................................... 10,796
Over twelve months............................................... 14,158
-------
Total........................................................... $81,388
=======
</TABLE>
Borrowings increased $80.51 million from December 31, 1997 to December 31,
1998 due to additional FHLB borrowings primarily to fund the increases in the
loan and investment portfolios. At December 31, 1998, the FHLB borrowings had a
weighted average rate of 5.38% and a weighted average remaining term of 5.2
years. During 1996, the Company financed the purchase of the Company's common
stock for the ESOP. There were 48,000 and 72,000 unallocated ESOP shares at
December 31, 1998 and December 31, 1997, respectively.
During 1998, the Bank prepaid four FHLB advances totaling $33.00 million
carrying a weighted average rate of 6.26% which resulted in $392,000 in
prepayment penalties. The Bank is committed to borrow $10.00 million from the
FHLB in March 1999 which carries an interest rate of 3.99% with an original
maturity date of March 24, 2014. This advance is callable beginning in March
2000 and quarterly thereafter. In addition, the Bank is committed to borrow
$20,000 from the FHLB in November 1999 with an interest rate of 5.12% and a
scheduled maturity date of February 2000.
23
<PAGE>
The following table sets forth, at the dates indicated, information
regarding the weighted average cost of funds and the highest and average month
end balances of the Company's total borrowings.
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------
1998 1997 1996
-------- -------- -------
(in thousands)
<S> <C> <C> <C>
Weighted average interest rate of total
borrowings...................................... 5.39% 6.00% 5.00%
Highest outstanding balance of total borrowings.. $210,465 $129,960 $12,200
Average month end balance of total borrowings.... $168,202 $ 76,865 $11,680
</TABLE>
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 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 primary sources of liquidity for the Bank are
principal payments and maturities of securities and loans, short-term
borrowings through repurchase agreements and FHLB advances, net deposit growth
and funds provided by operations. Liquidity can also be provided through sales
of loans and available-for-sale securities.
The Company's most liquid assets are cash and cash equivalents, which
include investments in liquid short-term instruments, such as federal funds
sold. The level of these liquid assets is dependent upon the Company's
operating, financing and investing activities during any given period. At
December 31, 1998, the Company's primary liquidity, consisting of cash and
federal funds sold, was $21.99 million, or 2.2% of total assets, compared to
$33.02 million, or 3.7% of total assets, at December 31, 1997.
The Bank monitors its liquidity in accordance with guidelines established
under its asset/liability management policy and applicable regulatory
requirements. Management believes its current liquidity level, which is within
policy guidelines, is sufficient to meet normal operating needs. As part of its
asset/liability management strategy as well as to meet unexpected demands, the
Bank has available a line of credit with the FHLB. At December 31, 1998, the
Bank had no borrowings under its line of credit. The Bank may borrow
approximately $15 million under that line of credit. Additional borrowings may
be made upon the pledge of additional qualifying collateral.
Asset/Liability Management and Interest Rate Sensitivity
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 several interest rate scenarios over a 24-month time horizon. In
accordance with its asset/liability 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's policy is to
achieve equal to or less than a
24
<PAGE>
10% change in net interest income over the next 12 months within the selected
400 basis point band. At December 31, 1998, the Company was within its policy
guideline, and the Company believes its level of interest rate sensitivity was
appropriate.
The Company analyzes its interest rate sensitivity position to manage the
risk associated with interest rate movements through the use of gap analysis
and balance sheet simulation. Interest rate risk arises from mismatches in the
repricing of assets and liabilities within a given time period. Gap analysis is
an approach used to quantify these differences.
With a positive gap, in which interest-earning assets maturing or repricing
exceed interest-bearing liabilities maturing or repricing within the same
period, earnings will generally increase in a rising interest rate environment
and decrease in a declining interest rate environment. Conversely, with a
negative gap, in which interest-bearing liabilities maturing or repricing
exceed interest-earning assets maturing or repricing within the same period,
earnings will generally decrease in a rising interest rate environment and
increase in a declining interest rate environment.
While gap analysis is a general indicator of the potential effect that
changing interest rates may have on net interest income, the gap itself does
not present a comprehensive view of interest rate sensitivity. First, changes
in the general level of interest rates do not affect all categories of assets
and liabilities equally or simultaneously. Second, assumptions must be made to
construct a gap table. Money market deposits, for example, which have no
contractual maturity, are assigned a repricing interval of within one year.
Management can influence the actual repricing of these deposits independent of
the gap assumption. Third, the gap table represents a one-day position and
cannot incorporate a changing mix of assets and liabilities over time as
interest rates change. For those reasons, the Company primarily uses simulation
techniques derived from interest rate risk management computer models, to
analyze and project future net interest income streams, incorporating the
current gap position, the forecasted balance sheet mix, and the anticipated
spread relationships between market rates and Company products, under varying
interest rate scenarios.
25
<PAGE>
The following table sets forth the Company's interest rate sensitivity
position at December 31, 1998, measured in terms of the volume of interest rate
sensitive assets and liabilities that are subject to repricing in future time
periods. For purposes of this analysis, money market deposits have been
presented in the within one year category and savings and other deposits have
been presented in the one to five year category, although the interest rate
elasticity of money market, savings and other deposits cannot be tied to any
one time category. Non-accrual loans have been presented in the repricing over
five years category. Significant variations may exist in the degree of interest
rate sensitivity between individual asset and liability types within the
repricing periods presented due to differences in the repricing elasticity
relative to changes in the general level of interest rates. No assurance can be
made that these assumptions will be indicative of future withdrawals of
deposits or repayments.
<TABLE>
<CAPTION>
Repricing Repricing Repricing
Total Percent of Within Within Over
Amount Total One Year 1-5 Years 5 Years
---------- ---------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Assets:
Securities.............. $ 296,504 29.08% $132,746 $132,722 $ 31,036
Short-term investments.. 1,420 0.14 1,420 -- --
Loans, net.............. 651,858 63.95 255,361 169,923 226,574
---------- ------ -------- -------- --------
Total rate sensitive
assets............... 949,782 93.17 389,527 302,645 257,610
Other assets............ 69,587 6.83
---------- ------
Total assets.......... $1,019,369 100.00%
========== ======
Liabilities and
Stockholders' Equity:
Deposits:
Savings and other..... $ 105,205 10.32% -- 105,205 --
Money market.......... 103,565 10.16 103,565 -- --
Certificates of
deposit.............. 408,451 40.07 318,410 90,041 --
Demand deposits....... 88,974 8.73 -- -- 88,974
Borrowings:
FHLB advances......... 209,745 20.58 57,000 70,745 82,000
Other borrowings...... 480 0.05 480 -- --
---------- ------ -------- -------- --------
Total rate sensitive
liabilities............ 916,420 89.91 479,455 265,991 170,974
Other liabilities....... 7,581 0.74
Stockholders' equity.... 95,368 9.35
---------- ------
Total liabilities and
equity................. $1,019,369 100.00%
========== ======
Period repricing
difference (gap)....... $(89,928) $ 36,654 $ 86,636
======== ======== ========
Cumulative repricing
difference............. $(89,928) $(53,274) $ 33,362
Cumulative repricing
difference to total
assets................. (8.82)% (5.23)% 3.27%
</TABLE>
At December 31, 1998, the Company was liability sensitive as measured by a
negative cumulative one year gap of $89.93 million, or 8.82% of total assets.
As a result according to the gap analysis, the Company's net interest income
could be adversely affected by a sudden increase in interest rates.
26
<PAGE>
Based upon various earnings simulations, which include 100 basis point to
200 basis point increases and decreases in interest rates, management projected
the effect on 1999 and 1998 net interest income as follows:
<TABLE>
<CAPTION>
Effect on 1999 net interest income Effect on 1998 net interest income
as projected on December 31, 1998 as projected on December 31, 1997
---------------------------------- -----------------------------------
Shock Ramp Shock Ramp
Scenario (a) Scenario (b) Scenario (a) Scenario (b)
-------------- ------------ -------------- --------------
(in thousands)
<S> <C> <C> <C> <C>
200 basis point increase
in rates (c)........... $ 984 $ 306 $ (324) $ (99)
100 basis point increase
in rates (d)........... 519 156 42 (36)
100 basis point decrease
in rates (d)........... (450) (144) (256) 32
200 basis point decrease
in rates (c)........... (553) (270) (478) 58
</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 year.
(c) No adjustments are made to the Company's passbook rates. Money market rates
are shocked/ramped 50 basis points rather than 200 basis points.
(d) No adjustments are made to the Company's passbook rates. Money market rates
are shocked/ramped 25 basis points, rather than 100 basis points.
During 1998, the Company changed an assumption relating to the future
pricing of its certificates of deposit accounts in its simulation model. The
Company believes the assumption change forecasts future certificates of
deposits rates in a more accurate manner. This assumption change affected the
shock and ramp scenarios as shown above. Due to the inherent weaknesses of the
gap analysis explained earlier, the Company uses simulation analysis for
asset/liability management and interest rate sensitivity purposes.
Net interest margin decreased from 3.90% in 1997 to 3.61% in 1998. Overall
average yields decreased 18 basis points due mainly to lower average yields on
the loan portfolio. In addition, the Company's overall cost of funds increased
10 basis points due mainly to increased borrowings from the FHLB.
Management believes some of the potential effects of the Company's interest
rate risk will be mitigated as essentially all of the Company's deposit base is
composed of local retail deposit accounts which tend to be somewhat less
sensitive to moderate interest fluctuations than other funding sources and,
therefore, provide a reasonably stable and cost-effective source of funds.
Managing these core deposits is a significant factor in determining the
Company's ability to maintain its net interest margin in a changing interest
rate environment. The entry of additional competitors into the Company's market
area may create additional competitive pressures on the Company to raise rates
on its deposit accounts, which may negatively affect the Company's net interest
margin. The Company structures its loan and securities portfolio to provide for
portfolio repricing consistent with its interest rate risk objectives.
Capital Resources
At December 31, 1998, stockholders' equity totaled $95.37 million,
representing a 7.7% increase over the $88.55 million in capital at December 31,
1997. At December 31, 1998, the Company's Tier 1 leverage capital ratio was
9.63% and its total risk-based capital ratio was 15.75%. At December 31, 1997,
the Company's Tier 1 leverage capital ratio was 9.74% and its total risk-based
capital ratio was 17.76%. The Company was classified as "well capitalized" at
December 31, 1998 and December 31, 1997.
In order to address concerns arising out of an examination conducted by the
FDIC as of August 30, 1993, the Bank entered into a Cease and Desist Order (the
"Order") issued by the FDIC. The Order was issued on February 22, 1994 pursuant
to a Stipulation with the Bank in which the Connecticut State Banking
Department concurred. Effective June 25, 1996, Mechanics Savings Bank completed
its subscription and community offerings of common stock and converted from a
Connecticut-chartered mutual to a Connecticut-chartered
27
<PAGE>
capital stock savings bank. Shares totaling 5.29 million were sold at $10.00
per share. As a result, the Bank significantly increased its capital levels. On
December 27, 1996, the FDIC removed the Order and the Bank was operating under
a Memorandum of Understanding ("MOU"). Under this agreement, the Bank agreed to
update its strategic plan and improve reporting systems relative to interest
rate risk and problem asset identification. On September 30, 1997, the FDIC and
the State Department of Banking terminated the MOU. Therefore, at December 31,
1998, the Bank is not operating under any regulatory enforcement action. The
Bank believes its current capital is adequate to support operations and
anticipated future growth.
On January 20, 1999, the Company announced its adoption of a stock
repurchase program. The program authorized the Company to repurchase up to 5%
of its issued and outstanding common stock at prevailing market prices in
negotiated and/ or open market purchases. On February 23, 1999, the program was
completed.
Impact of Recent Accounting Pronouncements
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.
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.
Impact of Inflation and Changing Prices
The Company's consolidated financial statements and related notes thereto
presented elsewhere herein have been prepared in accordance with generally
accepted accounting principles which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effect of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services. Notwithstanding this, inflation can directly
affect the value of loan collateral, in particular, real estate. Sharp
decreases in real estate prices, as discussed previously, have resulted in
significant loan losses and losses on foreclosed real estate owned in the past.
Inflation, or disinflation, could significantly affect the Company's earnings
in future periods.
Recent Tax Legislation
The State of Connecticut enacted tax law changes in May 1998, allowing for
the formation of Passive Investment Companies by financial institutions. This
new legislation exempts Passive Investment Companies
28
<PAGE>
from state income taxation in Connecticut, as well as exempting from taxation
the dividends paid from a Passive Investment Company to a related financial
institution. The law permits the Bank to contribute certain mortgage assets to
its Passive Investment Company so as to achieve the tax benefits. The Bank
qualifies as a financial institution under the new statute and formed MMC, as a
Passive Investment Company, in 1998. The legislation is effective for tax years
beginning on or after January 1, 1999. The formation of MMC is expected to
reduce the Company's state income tax expense. A deferred tax charge of $1.19
million was taken in the fourth quarter of 1998 in connection with the
formation of MMC.
Other Risks and Uncertainties
The Company's financial performance is influenced significantly by interest
rate movements. The Company has traditionally been able to retain its core
depositors despite offering lower rates on deposits than some savings
institutions in surrounding markets. However, in recent years, the Company has
had to offer more competitive rates to retain core deposits, some of which have
moved into higher cost time deposit accounts. In addition, the entry of
additional competitors into the Company's market area may create additional
competitive pressures on the Company to raise rates on its deposit accounts or
accept lower yields on its loan products, which may negatively affect the
Company's net interest margin in the future. While interest rate spreads remain
high by historical measures, management believes it is likely that they will
continue to narrow in the near future. The Company attempts to manage this
interest rate risk by monitoring interest rate movements, making investments,
and adjusting its deposit and asset pricing accordingly. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Asset/Liability Management and Interest Rate Sensitivity."
Intense competition exists in all major lines of business in which the
Company is presently engaged. The City of Hartford and the surrounding
communities in which the Company maintains branches constitutes the Company's
principal market area. This market also includes numerous national, regional,
and local financial institutions of various types. Competition for the Company,
and the banking industry in general, has also increased dramatically from non-
bank competitors such as mortgage and finance companies, insurance companies,
mutual funds, and securities firms. Recent bank consolidations affecting the
Company's market area have brought to the area new institutions against whom
the Bank has not previously competed. This consolidation and expected future
consolidation activity has and is expected to continue to produce a dynamic and
challenging competitive environment for the Company. Economic conditions at the
local and national levels, as well as government policies and regulations
concerning, among other things, monetary and fiscal policies, significantly
affect the operations of financial institutions such as the Company. In
particular, local real estate values affect institutions like the Company,
which have substantial amounts of loans collateralized by real estate. Excess
real estate inventory, coupled with a previous general economic decline,
adversely affected real estate markets in general and the Company's market area
in particular in recent years and contributed to increases in the Company's
non-performing assets during such years. Although Connecticut and Hartford
County continue to reflect personal wealth characteristics above national
averages, the economies of both continue to lag behind many areas of the
country which have shown strong recoveries in recent years.
Year 2000
The following paragraphs include Year 2000 ("Y2K") readiness disclosures and
forward-looking statements concerning the Company's efforts to prepare for
potential problems related to the Year 2000 date change. The following
paragraphs describe the Company's efforts and current expectations regarding
the likely consequences to the Company of those efforts. The actual
consequences may differ materially from the Company's current expectations due
to circumstances beyond the Company's control (such as Y2K problems involving
the Bank's vendors, customers or its customers' customers) or due to
unanticipated problems with the Company's software vendors.
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 has approved a plan for implementing and
monitoring Y2K compliance. MECH Financial, Inc. has renovated all critical
systems
29
<PAGE>
needing renovation and has testing of these systems well underway as of
December 31, 1998. 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 December 31,
1998, the Company estimates its vendors' software was 90% renovated based on
the vendors representations.
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 65% complete at December 31, 1998.
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 $350,000 with
approximately $150,000 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
outstanding) of its commercial portfolio. As of December 31, 1998, this review
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 material commercial borrowers concerning Y2K during Spring
1999.
30
<PAGE>
Results of Operations
For the year ended December 31, 1998 compared to the year ended December 31,
1997
For the year ended December 31, 1998, the Company reported net income of
$8.70 million or $1.63 per diluted share compared to $13.08 million or $2.49
per diluted share for the same period in 1997. The results in both years were
effected by one time income tax events. In the second quarter of 1997, the
Company 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 for the second half of
1997 and for 1998 that indicated continued profitability, the Company
determined that it was more likely than not that it would realize its net
deferred tax assets. During 1998, the Company recorded an additional $1.19
million in net tax expense due to the tax implications of the January 1, 1999
funding of Mechanics Mortgage Company, a passive investment company.
The Company recorded $600,000 in provisions for loan losses during 1998
compared to $9.10 million during 1997. Also contributing to the 1998 results,
was an 8.6% increase in net interest income as compared to the year ended
December 31, 1997.
Net Interest Income
Net interest income totaled a record $31.78 million for the year ended
December 31, 1998 compared to $29.26 million for the same period in 1997,
representing a $2.52 million or 8.6% increase. The increase was primarily a
result of a $130.76 million or 17.4% increase in average interest-earning
assets. Average investment securities increased $62.59 million primarily due to
increased investments in mortgage-backed securities and mutual funds. Average
net loans increased $62.27 million due mainly to increased one- to four-family
and commercial mortgages and consumer loans as a result of increased
origination activity in excess of prepayments and amortization during 1998.
Funding the increases in interest-earning assets, average balances of
borrowings and certificates of deposit increased $99.72 million and $27.30
million, respectively. The net interest margin decreased from 3.90% for the
year ended December 31, 1997 to 3.61% for the same period in 1998. The decrease
was mainly due to a decrease in the average yields on loans and to the changed
composition of interest-bearing liabilities which resulted in a higher overall
average cost of funds by 10 basis points.
31
<PAGE>
The following table sets forth certain information relating to the Company's
average interest-earning assets, interest-bearing liabilities and net interest
income for the years ended December 31, 1998 and 1997. Non-accrual loans have
been included in the appropriate average balance loan category but unpaid
interest on non-accrual loans has not been included for purposes of determining
interest income. For investment securities, the yield calculations are based on
the average amortized cost. Included in loan interest income is $837,000 and
$369,000 of amortization of net deferred costs for the years ended December 31,
1998 and 1997, respectively.
<TABLE>
<CAPTION>
Average Balance Income/Expense Yield
----------------- --------------- ----------
1998 1997 1998 1997 1998 1997
-------- -------- ------- ------- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Loans, net...................... $594,997 $532,726 $47,758 $43,799 8.03% 8.22%
Investment securities........... 271,637 209,044 17,192 13,067 6.33 6.25
Short-term investments.......... 14,154 8,261 756 449 5.34 5.44
-------- -------- ------- -------
Total interest-earning
assets....................... 880,788 750,031 65,706 57,315 7.46 7.64
------- -------
Other assets.................... 67,853 59,978
-------- --------
Total assets.................. $948,641 $810,009
======== ========
Money market checking........... $ 37,653 $ 34,306 435 408 1.16 1.19
Money market savings............ 56,117 57,066 1,409 1,334 2.51 2.34
Savings and other............... 110,364 117,242 1,671 2,247 1.51 1.92
Certificates of deposit......... 406,305 379,006 20,684 19,854 5.09 5.24
-------- -------- ------- -------
Total interest-bearing
deposits..................... 610,439 587,620 24,199 23,843 3.96 4.06
Securities sold under agreements
to repurchase.................. -- 4,468 -- 243 n/a 5.44
Other borrowings................ 166,894 67,177 9,729 3,967 5.83 5.91
-------- -------- ------- -------
Total interest-bearing
liabilities.................. 777,333 659,265 33,928 28,053 4.36 4.26
------- -------
Demand deposits................. 74,111 64,921
Other liabilities............... 4,686 4,039
Stockholders' equity............ 92,511 81,784
-------- --------
Total liabilities and equity.. $948,641 $810,009
======== ========
Net interest income............. $31,778 $29,262
======= =======
Spread on interest-bearing
funds.......................... 3.10% 3.38%
Net interest margin............. 3.61% 3.90%
</TABLE>
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>
Years ended December 31, 1998 versus 1997
Change in interest due to
------------------------------------------------
Volume Rate Vol/Rate Net
----------- ----------- -----------------------
(in thousands)
<S> <C> <C> <C> <C>
Loans, net.................. $5,120 $(1,039) $(122) $3,959
Investment securities....... 3,913 163 49 4,125
Short-term investments...... 320 (8) (5) 307
---------- ----------- --------- ----------
Total..................... 9,353 (884) (78) 8,391
---------- ----------- --------- ----------
Money market checking....... 40 (12) (1) 27
Money market savings........ (22) 99 (2) 75
Savings and other........... (132) (472) 28 (576)
Certificates of deposit..... 1,430 (560) (40) 830
Securities sold under
agreements to repurchase... (243) -- -- (243)
Other borrowings............ 5,889 (51) (76) 5,762
---------- ----------- --------- ----------
Total..................... 6,962 (996) (91) 5,875
---------- ----------- --------- ----------
Net change to interest
income..................... $2,391 $ 112 $ 13 $2,516
========== =========== ========= ==========
</TABLE>
32
<PAGE>
Interest Income
Interest income increased $8.39 million or 14.6% due primarily to increased
average volume of investment securities and net loans of $62.59 million and
$62.27 million, respectively, for the year ended December 31, 1998. Partially
offsetting these increases, overall average yields decreased 18 basis points
from 7.64% for the year ended December 31, 1997 to 7.46% for the year ended
December 31, 1998. The decrease was mainly a result of a 19 basis point
decrease in the average yields on loans as a result of the lower interest rate
environment during 1998 compared to 1997.
Interest Expense
Interest expense increased $5.88 million or 20.9% for the year ended
December 31, 1998 as compared to the same period in 1997. The increase was
primarily due to an increase in average volume of borrowings and certificates
of deposit of $99.72 million and $27.30 million, respectively. Overall, the
average cost of funds increased to 4.36% for the year ended December 31, 1998
from 4.26% for the year ended December 31, 1997. This increase was mainly due
to the shift in the composition of interest-bearing liabilities to higher cost
FHLB borrowings.
Provision And Allowance For Loan Losses
The Company determines its allowance and provision for loan losses based
upon a detailed evaluation of the loan portfolio through a process which
considers numerous factors, including estimated credit losses based upon
internal and external portfolio reviews and credit risk ratings, delinquency
levels and trends, estimates of the current value of underlying collateral,
concentrations, portfolio volume and mix, changes in lending policy, historical
loan loss experience, current economic conditions and examinations performed by
regulatory authorities. Determining the level of the allowance at any given
period is difficult, particularly during deteriorating or uncertain economic
periods. Management must make estimates using assumptions and information which
is often subjective and rapidly changing. The review of the loan portfolio is a
continuing process in the light of a changing economy and the dynamics of the
banking and regulatory environment. In management's judgment, based upon an
analysis of the above factors and considering recent charge-offs and
delinquency activity, the allowance for loan losses at December 31, 1998 is
adequate. Should the economic climate deteriorate, borrowers could experience
difficulty in repaying their obligations, and the level of non-performing
loans, charge-offs and delinquencies could rise and require increased
provisions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses. Such agencies could require the Company to recognize additions to the
allowance based on their judgments of information available to them at the time
of their examination.
The provision for loan losses decreased from $9.10 million for the year
ended December 31, 1997 to $600,000 for the same period in 1998. At December
31, 1998, the allowance for loan losses now represents 339.2% of non-performing
and restructured loans compared to 351.7% at December 31, 1997. 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.
33
<PAGE>
The following table shows the activity in the Company's allowance for loan
losses for the three years ended December 31.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Balance, beginning of year........................... $14,031 $ 7,983 $11,597
Provision for loan losses............................ 600 9,100 6,400
Charge-offs.......................................... (2,846) (4,012) (10,444)
Recoveries........................................... 516 960 430
------- ------- -------
Balance, end of year................................. $12,301 $14,031 $ 7,983
======= ======= =======
Ratio of allowance for loan losses:
To non-performing loans............................ 417.12% 495.80% 101.62%
To total gross loans............................... 1.85% 2.40% 1.59%
</TABLE>
While all segments of the Company's loan portfolio are subject to continuous
quality evaluation, a precise method for predicting loan losses does not exist.
Many of the components of the evaluation require the exercise of management's
judgment. While management believes that actions taken with respect to the
provision and the allowance for loan losses have been adequate, there are many
factors which may influence future provisions.
Other Income
The Company recorded $8.62 million in other income for the year ended
December 31, 1998 compared to $8.29 million for the same period in 1997,
representing a 4.0% increase. The following table shows the components of other
income for the years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
$ %
1998 1997 Change Change
------ ------ ------ -------
(in thousands)
<S> <C> <C> <C> <C>
Service charges on deposit accounts............ $2,621 $2,246 $375 16.70%
Investment brokerage services commissions...... 2,412 2,927 (515) (17.59)
Appreciation of cash surrender value life
insurance..................................... 929 421 508 120.67
Loan servicing and other fees.................. 630 600 30 5.00
Income from investment in Real Estate
Partnership................................... 606 579 27 4.66
Net (loss) gain on sales of investment
securities.................................... (16) 209 (225) (107.66)
Other.......................................... 1,442 1,312 130 9.91
------ ------ ----
Total other income........................... $8,624 $8,294 $330 3.98%
====== ====== ==== =======
</TABLE>
Service charges increased mainly due to higher overdraft fees. Investment
brokerage services commissions decreased primarily due to lower annuity and
transactional sales. During 1997, the Company invested in universal cash
surrender value life insurance to recover costs of the Company's LTDIP and
DDCP. Appreciation of cash surrender value life insurance was higher in 1998
since the majority of that asset was purchased during June 1997. During 1998,
the Company reported gross losses of $20,000 on the sale of equity securities
and gross gains of $4,000 from the sale of mortgage-backed securities. During
1997, the Company reported gross gains and gross losses on the sale of
mortgage-backed securities of $301,000 and $92,000, respectively.
34
<PAGE>
Other Expenses
Other expenses totaled $23.84 million for the year ended December 31, 1998,
compared to $23.19 million for the same period in 1997, representing a 2.8%
increase. The following table shows the components of other expenses for the
years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
$ %
1998 1997 Change Change
------- ------- ------ ------
(in thousands)
<S> <C> <C> <C> <C>
Salaries, commissions and employee benefits... $12,335 $12,172 $ 163 1.34%
Occupancy..................................... 3,238 3,196 42 1.31
Data processing............................... 1,194 1,083 111 10.25
Furniture and equipment....................... 1,012 953 59 6.19
Advertising................................... 840 835 5 0.60
Legal and accounting.......................... 708 880 (172) (19.55)
Communications................................ 519 502 17 3.39
Operation of foreclosed real estate owned..... 372 425 (53) (12.47)
Write-downs and net losses on sale of
foreclosed real estate owned................. 85 121 (36) (29.75)
FDIC insurance................................ 81 270 (189) (70.00)
Amortization of goodwill...................... 58 -- 58 n/a
Other......................................... 3,394 2,751 643 23.37
------- ------- -----
Total other expenses........................ $23,836 $23,188 $ 648 2.79%
======= ======= ===== ======
</TABLE>
Salaries, commissions and benefits were higher due mainly to increased costs
for the Company's ESOP. Data processing increased mainly due to the purchase of
the two branches from Chase Manhattan Bank and Year 2000 costs. Legal and
accounting fees were lower mainly due to reduced legal expenses in the
commercial loan work-out area. Due to the Company's improved capital position
and classification, FDIC insurance premiums were lower. The 1998 expense for
goodwill relates to the purchase of the two branches. During 1998, the Company
recorded $818,000 of goodwill which is being amortized over seven years. Other
expenses increased 23.4% mainly due to $392,000 in penalties from the FHLB for
prepaying $33.00 million in advances that carried a weighted average rate of
6.26%.
Income Taxes
The Company recognized income tax expense of $7.27 million for the year
ended December 31, 1998 compared to an income tax benefit of $7.81 million for
the year ended December 31, 1997. Both years results include one time tax
events. During 1998, the Company recorded $1.19 million in net tax expense due
to the tax implications of the January 1, 1999 creation of MMC, a passive
investment company. Income of this passive investment company subsidiary and
its dividends to the parent are exempt from the Connecticut Corporation
Business Tax. Due to the creation of the passive investment company, the
Company no longer expects to recognize its previously recorded state deferred
tax asset.
During 1997, the Company recorded a tax benefit of $10.33 million and fully
reversed its valuation allowance on its net deferred tax assets. Based on three
consecutive prior quarters of income and projections for the second half of
1997 and for 1998 that indicated continued profitability, the Company
determined that it was more likely than not that it would realize its net
deferred tax assets.
Results Of Operations
For the year ended December 31, 1997 compared to the year ended December 31,
1996
For the year ended December 31, 1997, the Company reported net income of
$13.08 million or $2.49 per diluted share compared to $1.14 million or $0.22
per diluted share for the same period in 1996. In the second quarter of 1997,
the Company 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 for the second half of
1997 and for 1998 that indicated continued profitability, the Company
determined that it was more likely than not that it would realize its net
deferred tax assets. The Company recorded $9.10 million in
35
<PAGE>
provisions for loan losses during 1997 compared to $6.40 million during 1996.
Also contributing to the 1997 results, was a 12.3% increase in net interest
income, a 56.0% increase in other income and a 3.7% decrease in other expenses
as compared to the year ended December 31, 1996.
Net Interest Income
Net interest income totaled $29.26 million for the year ended December 31,
1997 compared to $26.05 million for the same period in 1996, representing a
$3.21 million or 12.3% increase. The increase was primarily a result of a
$104.02 million or 16.1% increase in average interest-earning assets. Average
investment securities increased $79.25 million primarily due to increased
investments in mortgage-backed securities and mutual funds. Average net loans
increased $37.91 million due mainly to increased one-to four-family mortgages
and consumer loans as a result of increased origination activity in excess of
prepayments and amortization during 1997. Funding the increases in interest-
earning assets, average balances of borrowings and certificates of deposit
increased $55.53 million and $34.68 million, respectively. The net interest
margin decreased from 4.03% for the year ended December 31, 1996 to 3.90% for
the same period in 1997. The decrease was mainly due to the changed composition
of interest-bearing liabilities which resulted in a higher overall average cost
of funds by 22 basis points. During the year, increases in FHLB borrowings and
certificates of deposit were combined with a decrease in the lower cost
deposits of money market accounts and savings accounts.
The following table sets forth certain information relating to the Company's
average interest-earning assets, interest-bearing liabilities and net interest
income for the years ended December 31, 1997 and 1996. Non-accrual loans have
been included in the appropriate average balance loan category but unpaid
interest on non-accrual loans has not been included for purposes of determining
interest income. For investment securities, the yield calculations are based on
the average amortized cost. Included in loan interest income is $369,000 and
$224,000 of amortization of net deferred costs for the years ended December 31,
1997 and 1996, respectively.
<TABLE>
<CAPTION>
Average Balance Income/Expense Yield
----------------- --------------- ----------
1997 1996 1997 1996 1997 1996
-------- -------- ------- ------- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Loans, net...................... $532,726 $494,820 $43,799 $40,730 8.22% 8.23%
Investment securities........... 209,044 129,791 13,067 7,721 6.25 5.95
Short-term investments.......... 8,261 21,394 449 1,126 5.44 5.26
-------- -------- ------- -------
Total interest-earning
assets....................... 750,031 646,005 57,315 49,577 7.64 7.67
------- -------
Other assets.................... 59,978 50,472
-------- --------
Total assets.................. $810,009 $696,477
======== ========
Money market checking........... $ 34,306 $ 37,357 408 488 1.19 1.31
Money market savings............ 57,066 65,453 1,334 1,528 2.34 2.34
Savings and other............... 117,242 123,543 2,247 2,469 1.92 2.00
Certificates of deposit......... 379,006 344,331 19,854 18,459 5.24 5.36
-------- -------- ------- -------
Total interest-bearing
deposits..................... 587,620 570,684 23,843 22,944 4.06 4.02
Securities sold under agreements
to repurchase.................. 4,468 -- 243 -- 5.44 --
Other borrowings................ 67,177 11,644 3,967 582 5.91 5.00
-------- -------- ------- -------
Total interest-bearing
liabilities.................. 659,265 582,328 28,053 23,526 4.26 4.04
-------- -------- ------- -------
Demand deposits................. 64,921 62,144
Other liabilities............... 4,039 3,299
Stockholders' equity............ 81,784 48,706
-------- --------
Total liabilities and equity.. $810,009 $696,477
======== ========
Net interest income............. $29,262 $26,051
======= =======
Spread on interest-bearing
liabilities.................... 3.38% 3.63%
Net interest margin............. 3.90% 4.03%
</TABLE>
36
<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>
Years ended December 31, 1997 versus 1996
Change in interest due to
----------------------------------------------
Volume Rate Vol/Rate Net
----------- --------- -----------------------
(in thousands)
<S> <C> <C> <C> <C>
Loans, net.................... $3,120 $ (48) $ (3) $3,069
Investment securities......... 4,715 392 239 5,346
Short-term investments........ (691) 37 (23) (677)
---------- --------- --------- ----------
Total....................... 7,144 381 213 7,738
---------- --------- --------- ----------
Money market checking......... (40) (44) 4 (80)
Money market savings.......... (196) 2 -- (194)
Savings and other............. (126) (101) 5 (222)
Certificates of deposit....... 1,859 (421) (43) 1,395
Securities sold under
agreements to repurchase..... 243 -- -- 243
Other borrowings.............. 2,776 106 503 3,385
---------- --------- --------- ----------
Total....................... 4,516 (458) 469 4,527
---------- --------- --------- ----------
Net change to interest
income....................... $2,628 $ 839 $ (256) $3,211
========== ========= ========= ==========
</TABLE>
Interest Income
Interest income increased $7.74 million or 15.6% due primarily to average
increased volume of investment securities and net loans of $79.25 million and
$37.91 million, respectively, for the year ended December 31, 1997. Partially
offsetting these increases, the average balance of short-term investments
decreased $13.13 million. Overall average yields decreased 3 basis points from
7.67% for the year ended December 31, 1996 to 7.64% for the year ended December
31, 1997. The decrease was mainly a result of the increased ratio of investment
securities to total interest-earning assets from 20.1% for the year ended
December 31, 1996 to 27.9% for the same period in 1997.
Interest Expense
Interest expense increased $4.53 million or 19.3% for the year ended
December 31, 1997 as compared to the same period in 1996. The increase was
primarily due to an increase in average volume of borrowings and certificates
of deposit of $55.53 million and $34.68 million, respectively. Overall, the
average cost of funds increased to 4.26% for the year ended December 31, 1997
from 4.04% for the year ended December 31, 1996. This increase was mainly due
to the shift in the composition of interest-bearing liabilities to higher cost
FHLB borrowings and certificates of deposit from savings and money market
accounts.
Provision And Allowance For Loan Losses
The provision for loan losses increased from $6.40 million for the year
ended December 31, 1996 to $9.10 million for the same period in 1997. The 1997
increase strengthened the allowance for loan losses which represented 351.7% of
non-performing and restructured loans, up from 63.8% at December 31, 1996 and
495.8% of only non-performing loans, up from 101.6% at December 31, 1996. 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.
37
<PAGE>
Other Income
The Company recorded $8.29 million in other income for the year ended
December 31, 1997 compared to $5.32 million for the same period in 1996,
representing a 56.0% increase. The following table shows the components of
other income for the years ended December 31, 1997 and 1996.
<TABLE>
<CAPTION>
$ %
1997 1996 Change Change
------ ------ ------ -------
(in thousands)
<S> <C> <C> <C> <C>
Investment brokerage services commissions..... $2,927 $1,136 $1,791 157.66%
Service charges on deposit accounts........... 2,246 2,287 (41) (1.79)
Loan servicing and other fees................. 790 724 66 9.12
Income from investment in Real Estate
Partnership.................................. 579 272 307 112.87
Appreciation of cash surrender value life
insurance.................................... 421 -- 421 n/a
Net gain (loss) on sales of investment
securities................................... 209 (78) 287 (367.95)
Other......................................... 1,122 975 147 15.08
------ ------ ------
Total other income........................... $8,294 $5,316 $2,978 56.02%
====== ====== ====== =======
</TABLE>
Investment brokerage services commissions increased $1.79 million from 1996
to 1997 primarily due to MIS' new ability to sell annuities and earn investment
advisory fees during 1997. MIS, which began in 1986, has evolved from its
original emphasis on transactional business to its current focus on
relationship business, including asset allocation programs with wrap fees. In
addition, during late 1996, the Company hired eight additional staff members to
better meet customer demands. During 1996, the Bank formed a subsidiary,
Mechanics Investments Services, Inc., to enable the Bank to better serve its
customers by providing a broader range of competitive investment products in a
more timely manner as a wholly-owned, fully disclosed broker/dealer. In July
1997, MIS became a licensed broker/dealer and a registered investment advisor.
MIS also offers fixed and variable annuity products and is licensed as an
insurance agency in the State of Connecticut. Commissions from annuity sales
and investment advisory fees totaled $1.04 million and $517,000, respectively,
for the year ended December 31, 1997.
Income from investment in Real Estate Partnership increased $307,000 due to
higher rental income and to the December 31, 1996 expiration of a lease
incentive for an existing tenant which decreased the Real Estate Partnership's
expenses during 1997. During 1997, the Company invested in universal cash
surrender value life insurance to recover costs of the Company's LTDIP and
DDCP. These cash surrender value policies appreciated $421,000 during 1997,
representing a tax-free 6% gross yield before mortality charges. During 1997,
the Company reported gross gains and gross losses on the sale of mortgage-
backed securities of $301,000 and $92,000, respectively. Other income increased
$147,000 due mainly to reduced expenses in the subsidiaries that facilitate the
ownership, management and disposition of foreclosed real estate owned and from
reduced losses from the real estate agency subsidiary which was sold during the
first quarter of 1996.
38
<PAGE>
Other Expenses
Other expenses totaled $23.19 million for the year ended December 31, 1997,
compared to $24.09 million for the same period in 1996, representing a 3.7%
decrease. The following table shows the components of other expenses for the
years ended December 31, 1997 and 1996.
<TABLE>
<CAPTION>
$ %
1997 1996 Change Change
------- ------- ------- ------
(in thousands)
<S> <C> <C> <C> <C>
Salaries, commissions and employee
benefits................................... $12,172 $ 9,012 $ 3,160 35.06%
Occupancy................................... 3,196 3,211 (15) (0.47)
Data processing............................. 1,083 993 90 9.06
Furniture and equipment..................... 953 942 11 1.17
Legal and accounting........................ 880 709 171 24.12
Advertising................................. 835 463 372 80.35
Communications.............................. 502 491 11 2.24
Operation of foreclosed real estate owned... 425 600 (175) (29.17)
FDIC insurance.............................. 270 1,351 (1,081) (80.01)
Write-downs and net losses on sale of
foreclosed real estate owned............... 121 3,492 (3,371) (96.53)
Other....................................... 2,751 2,827 (76) (2.69)
------- ------- -------
Total other expenses....................... $23,188 $24,091 $ (903) (3.75)%
======= ======= ======= ======
</TABLE>
Salaries, commissions and benefits were $3.16 million higher in 1997
primarily due to $2.09 million in increased commissions due to the performance
of MIS and excellent overall Company results. Benefit plan expenses increased
$605,000 as pension and ESOP expenses increased. Advertising increased $372,000
during the year due to a renewal and expansion of marketing efforts to support
the MIS, lending and deposit activities of the Company. Due to the Company's
improved capital position and classification, FDIC insurance premiums were
lower, resulting in a 80.0% decrease in FDIC insurance expense. Due to
decreased levels of non- performing assets, operation of foreclosed real estate
and write-downs and net losses on sale of foreclosed real estate owned combined
to lower expenses by $3.55 million. During 1996, the Company recorded a $2.65
million write-down on foreclosed real estate owned in anticipation of the
Accelerated Asset Disposition Plan, disposing of $18.13 million in problem
assets.
Income Taxes
The Company recognized an income tax benefit of $7.81 million for the year
ended December 31, 1997 as compared to a benefit of $266,000 for the same
period in 1996. During the second quarter of 1997, the Company recorded a tax
benefit of $10.33 million and fully reversed its valuation allowance on its net
deferred tax assets. Based on three consecutive prior quarters of income and
projections for the second half of 1997 and for 1998 that indicated continued
profitability, the Company determined that it was more likely than not that it
would realize its net deferred tax assets. During the fourth quarter of 1996,
the Company received a tax refund from the IRS relating to the carrying back of
1995 deductions.
39
<PAGE>
Item 8. Financial Statements and Supplementary Data
Consolidated Statements of Condition
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
----------- --------
(dollars in
thousands)
ASSETS
<S> <C> <C>
Cash and due from banks:
Non-interest-bearing deposits and cash................ $ 20,567 $ 22,884
Short-term investments................................ 1,420 10,140
----------- --------
Cash and cash equivalents........................... 21,987 33,024
Investments:
Available-for-sale, at market value................... 205,711 152,200
Held-to-maturity (market value at December 31, 1998--
$80,873; at December 31, 1997--$76,186).............. 80,306 75,199
Federal Home Loan Bank stock, at cost................... 10,487 6,450
Loans, net.............................................. 651,858 571,112
Loans held-for-sale..................................... -- 1,922
Bank premises and equipment............................. 4,633 4,823
Investment in Real Estate Partnership (Note 23)......... 13,541 14,485
Accrued interest receivable............................. 4,957 4,347
Foreclosed real estate owned............................ 902 1,204
Cash surrender value life insurance..................... 16,873 16,053
Goodwill................................................ 759 --
Other assets............................................ 7,355 11,552
----------- --------
$ 1,019,369 $892,371
=========== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Deposits.............................................. $ 706,195 $667,564
Borrowings............................................ 210,225 129,720
Mortgage escrow....................................... 1,652 1,388
Other liabilities..................................... 5,929 5,150
----------- --------
Total liabilities................................... 924,001 803,822
----------- --------
Commitments and contingencies (Notes 9, 14 and 16)
Stockholders' Equity:
Preferred stock--par value $.01; 1,000,000 shares
authorized, none issued.............................. -- --
Common stock--par value $.01; 15,000,000 shares
authorized; 5,297,932 issued at December 31, 1998 and
5,293,266 issued at December 31, 1997................ 53 53
Additional paid in capital............................ 51,430 50,927
Retained earnings..................................... 44,205 37,891
Accumulated other comprehensive income................ 160 398
Less: Unallocated ESOP shares (48,000 at December 31,
1998 and 72,000 shares at December 31, 1997)......... (480) (720)
----------- --------
Total stockholders' equity.......................... 95,368 88,549
----------- --------
$ 1,019,369 $892,371
=========== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
40
<PAGE>
Consolidated Statements of Operations
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(in thousands except
for earnings per share)
<S> <C> <C> <C>
Interest income:
Interest and fees on loans......................... $47,758 $43,799 $40,730
Interest and dividends on investment securities:
Interest on debt securities...................... 15,267 12,403 6,852
Dividends on equity securities................... 737 320 276
------- ------- -------
16,004 12,723 7,128
Other interest income.............................. 1,944 793 1,719
------- ------- -------
Total interest income............................ 65,706 57,315 49,577
------- ------- -------
Interest expense:
Interest on deposits:
Savings deposits................................. 3,000 3,503 3,922
Time deposits.................................... 21,199 20,340 19,022
------- ------- -------
Total interest on deposits....................... 24,199 23,843 22,944
Interest on securities sold under agreements to
repurchase........................................ -- 243 --
Interest on other borrowings....................... 9,729 3,967 582
------- ------- -------
Total interest expense........................... 33,928 28,053 23,526
------- ------- -------
Net interest income.............................. 31,778 29,262 26,051
Provision for loan losses........................... 600 9,100 6,400
------- ------- -------
Net interest income after provision for loan
losses............................................. 31,178 20,162 19,651
------- ------- -------
Other income:
Service charges on deposit accounts................ 2,621 2,246 2,287
Investment brokerage services commissions.......... 2,412 2,927 1,136
Appreciation of cash surrender value life
insurance......................................... 929 421 --
Loan servicing and other fees...................... 630 600 595
Income from investment in Real Estate
Partnership....................................... 606 579 272
Net (loss) gain on sales of investment
securities........................................ (16) 209 (78)
Other.............................................. 1,442 1,312 1,104
------- ------- -------
Total other income............................... 8,624 8,294 5,316
------- ------- -------
Other expenses:
Salaries, commissions and employee benefits........ 12,335 12,172 9,012
Occupancy.......................................... 3,238 3,196 3,211
Data processing.................................... 1,194 1,083 993
Furniture and equipment............................ 1,012 953 942
Advertising........................................ 840 835 463
Legal and accounting............................... 708 880 709
Communications..................................... 519 502 491
Operation of foreclosed real estate owned.......... 372 425 600
Write-downs and net losses on sale of foreclosed
real estate owned................................. 85 121 3,492
FDIC insurance..................................... 81 270 1,351
Amortization of goodwill........................... 58 -- --
Other.............................................. 3,394 2,751 2,827
------- ------- -------
Total other expenses............................. 23,836 23,188 24,091
------- ------- -------
Income before income taxes....................... 15,966 5,268 876
------- ------- -------
Income tax expense (benefit):
Current............................................ 2,939 1,602 (266)
Deferred........................................... 4,331 (9,410) --
------- ------- -------
Income tax expense (benefit)..................... 7,270 (7,808) (266)
------- ------- -------
Net income......................................... $ 8,696 $13,076 $ 1,142
======= ======= =======
Earnings per share:
Basic.............................................. $ 1.66 $ 2.52 $ 0.22
Diluted............................................ $ 1.63 $ 2.49 $ 0.22
Weighted average shares outstanding:
Basic.............................................. 5,223 5,195 5,170
Diluted............................................ 5,332 5,242 5,170
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
41
<PAGE>
Consolidated Statements of Changes in Stockholders' Equity
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Accumulated
Additional Other Unallocated
Common Paid in Retained Comprehensive ESOP
Stock Capital Earnings Income Shares Surplus Total
------ ---------- -------- ------------- ----------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... $ -- $ -- $ 8,944 $ 53 $ -- $14,729 $23,726
Comprehensive income:
1996 net income........ -- -- 1,142 -- -- -- 1,142
Net unrealized gains
(losses) on
securities, net of
reclassification
adjustment............ -- -- -- 268 -- -- 268
-------
Comprehensive income.... 1,410
-------
Issuance of common
stock.................. 53 50,514 -- -- -- -- 50,567
Unallocated ESOP
shares................. -- -- -- -- (1,200) -- (1,200)
Reclass of surplus to
retained earnings upon
issuance of common
stock.................. -- -- 14,729 -- -- (14,729) --
Allocation of ESOP
shares................. -- 97 -- -- 240 -- 337
------ ------- ------- ---- ------ ------- -------
Balance at December 31,
1996................... 53 50,611 24,815 321 (960) -- 74,840
Comprehensive income:
1997 net income........ -- -- 13,076 -- -- -- 13,076
Net unrealized gains
(losses) on
securities, net of
reclassification
adjustment............ -- -- -- 77 -- -- 77
-------
Comprehensive income.... 13,153
-------
Exercise of stock
options................ -- 58 -- -- -- -- 58
Allocation of ESOP
shares................. -- 258 -- -- 240 -- 498
------ ------- ------- ---- ------ ------- -------
Balance at December 31,
1997................... 53 50,927 37,891 398 (720) -- 88,549
Comprehensive income:
1998 net income........ -- -- 8,696 -- -- -- 8,696
Net unrealized gains
(losses) on
securities, net of
reclassification
adjustment............ -- -- -- (238) -- -- (238)
-------
Comprehensive income.... 8,458
-------
Dividends paid ($0.45
per common share)...... -- -- (2,382) -- -- -- (2,382)
Exercise of stock
options................ -- 81 -- -- -- -- 81
Allocation of ESOP
shares................. -- 422 -- -- 240 -- 662
------ ------- ------- ---- ------ ------- -------
Balance at December 31,
1998................... $ 53 $51,430 $44,205 $160 $ (480) $ -- $95,368
====== ======= ======= ==== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
42
<PAGE>
Consolidated Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------------- --------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating
activities:
Net income......................... $ 8,696 $ 13,076 $ 1,142
-------- -------- --------
Adjustments to reconcile net income
to cash provided by operating
activities:
Provision for loan losses....... 600 9,100 6,400
Depreciation and amortization... 987 944 989
Amortization of investment
security premiums/discounts,
net............................ 79 186 204
Deferred loan costs, net of
amortization................... (1,017) (681) (331)
Net gain on sale of loans....... (59) (52) (43)
Proceeds from loan sales........ 15,285 7,987 15,215
Originations of loans held for
sale........................... (14,892) (9,769) (4,465)
Loss on retirement of bank
premises and equipment......... 5 -- 9
Decrease (increase) in deferred
tax assets..................... 4,331 (9,410) --
Realized losses on available-
for-sale securities............ 20 92 230
Realized gains on available-for-
sale securities................ (4) (301) (152)
(Increase) decrease in interest
and dividend receivables....... (610) 121 (1,004)
Income from investment in Real
Estate Partnership............. (606) (579) (272)
Gain on sale of real estate
agency subsidiary.............. -- -- (7)
Write-downs and net losses on
sale of foreclosed real estate
owned.......................... 85 121 3,492
Increase in cash surrender value
life insurance................. (820) (16,053) --
(Increase) decrease in other
assets......................... (712) (527) 1,071
Increase (decrease) in other
liabilities.................... 779 2,723 (2,239)
Allocation of Employee Stock
Ownership Plan shares.......... 662 498 337
-------- -------- --------
Total adjustments............. 4,113 (15,600) 19,434
-------- -------- --------
Net cash provided by (used in)
operating activities............... 12,809 (2,524) 20,576
-------- -------- --------
Cash flows from investing
activities:
Proceeds from sale of available-
for-sale securities............... 43,151 41,675 110,125
Proceeds from principal payments on
available-for-sale securities..... 78,209 37,445 13,435
Proceeds from principal payments on
held-to-maturity securities....... 31,931 3,982 445
Proceeds from maturities and calls
of available-for-sale securities.. 22,847 19,513 500
Proceeds from maturities and calls
of held-to-maturity securities.... 27,598 5,820 4,000
Purchases of available-for-sale
securities........................ (198,395) (103,458) (257,193)
Purchases of held-to-maturity
securities........................ (64,471) (41,741) (26,569)
Purchases of Federal Home Loan Bank
stock............................. (4,037) (2,161) --
Net originations and purchases of
loans............................. (79,977) (88,134) 4,038
Decrease in investment in Real
Estate Partnership................ 1,550 1,295 919
Proceeds from sale of real estate
agency subsidiary................. -- -- 424
Proceeds from sale of foreclosed
real estate owned................. 1,451 2,248 5,565
Purchases of bank premises and
equipment......................... (802) (254) (255)
-------- -------- --------
Net cash used in investing
activities......................... (140,945) (123,770) (144,566)
-------- -------- --------
Cash flows from financing
activities:
Net increase (decrease) in demand
deposits, money market and savings
accounts.......................... 28,613 (11,174) (15,592)
Net increase in certificates of
deposit........................... 10,018 23,695 49,833
Net increase (decrease) in mortgage
escrow............................ 264 (1,027) 1,109
Increase in FHLB borrowings........ 247,747 368,188 --
Repayments of FHLB borrowings...... (167,002) (250,188) --
Financing of Employee Stock
Ownership Plan.................... -- -- 1,200
Repayment of financing of Employee
Stock Ownership Plan.............. (240) (240) (240)
Issuance of common stock........... 81 58 49,367
Dividends paid..................... (2,382) -- --
-------- -------- --------
Net cash provided by financing
activities......................... 117,099 129,312 85,677
-------- -------- --------
Net increase (decrease) in cash and
cash equivalents................... (11,037) 3,018 (38,313)
-------- -------- --------
Cash and cash equivalents at
beginning of period................ 33,024 30,006 68,319
-------- -------- --------
Cash and cash equivalents at end of
period............................. $ 21,987 $ 33,024 $ 30,006
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
43
<PAGE>
Consolidated Statements of Cash Flows (Continued)
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ -------
(in thousands)
<S> <C> <C> <C>
Non-cash investing and financing activities
Change in net unrealized gain (loss) on securities
available-for-sale................................. $ (599) $ (36) $ 1,006
Change in net unrealized gain (loss) on securities
held-to-maturity................................... 180 74 (432)
Transfer of loans to foreclosed real estate owned... 1,283 3,042 3,723
Transfer of available-for-sale securities to held-
to-maturity........................................ -- -- 21,076
Supplemental disclosures of cash flow information
Income taxes paid................................... 3,492 641 57
Income tax refunds received......................... 40 54 1,330
Interest paid....................................... 33,623 27,471 23,525
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Business
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 changing and expanding needs of the
Bank's customers and to the competitive conditions in the financial services
industry. The Board of Directors believes the formation of MECH Financial, Inc.
will enhance the Bank's competitive position and result in greater long-term
shareholder value. The new structure became effective January 1, 1998, as
approved by the appropriate regulatory agencies. Shares of common stock of the
Bank were automatically converted into shares of the Company on a one-for-one,
tax-free exchange basis on that date.
Mechanics Savings Bank provides a full range of banking and financial
services to individuals and small to medium-sized businesses located primarily
in Central Connecticut. The Company competes with banks, brokerage firms,
mortgage bankers and other financial institutions. The Company and its
subsidiaries are subject to the regulations of certain state and federal
agencies and receives periodic examinations by these authorities.
The Bank completed its subscription and community offerings of common stock
on June 25, 1996, thereby completing its conversion from a Connecticut-
chartered mutual savings bank to a Connecticut-chartered capital stock savings
bank (the "Conversion"). The Bank sold the maximum number of shares offered in
the Conversion, as adjusted, issuing 5.29 million shares for total gross
proceeds of $52.90 million.
Basis of Financial Statement Presentation
The preparation of the consolidated financial statements, in accordance with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ
significantly from those estimates.
Material estimates that are particularly susceptible to change in the near-
term relate to the determination of the allowance for loan losses and the
valuation of foreclosed real estate owned. In connection with the determination
of the allowance for loan losses and valuation of foreclosed real estate owned,
management obtains independent appraisals for significant relationships.
A substantial portion (83%) of the Company's loans and commitments are
collateralized by real estate in Connecticut. In addition, all of the
foreclosed real estate owned is located in that same market. Accordingly, a
substantial portion of the Company's loan portfolio and foreclosed real estate
owned are susceptible to changes in market conditions in Connecticut.
Management believes that the allowance for loan losses is adequate and that
foreclosed real estate owned is properly valued. While management uses
available information to recognize losses on loans and foreclosed real estate
owned, future additions to the allowance for loan losses or write-downs on
foreclosed real estate owned may be necessary based on changes in economic
conditions, particularly in Connecticut. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses and the valuation of foreclosed real
estate owned. Such agencies may require the Company to recognize additions to
the allowance for loan losses or additional write-downs on foreclosed real
estate owned based on their judgments of information available to them at the
time of their examination.
45
<PAGE>
Principles of Consolidation
The 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
Corp., Alliance Realty (sold February 1, 1996), and Mechanics Investment
Services, Inc. ("MIS"). 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.
Effective January 1, 1999, the Bank funded a passive investment company,
Mechanics Mortgage Company ("MMC"), to take advantage of recent changes in the
Connecticut tax statutes. Connecticut enacted a law which allows state-
chartered banks and thrifts to transfer mortgages into passive investment
subsidiaries. Income of the subsidiaries and its dividends to the parent are
exempt from the Connecticut Corporation Business Tax. Intercompany accounts and
transactions have been eliminated in consolidation.
Investments
The Company accounts for its securities in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS 115"). Securities that the Company has the
ability and positive intent to hold to maturity are classified as held-to-
maturity and carried at amortized cost. Securities that may be sold as part of
the Company's asset/liability or liquidity management or in response to or in
anticipation of changes in interest rates and resulting prepayment risk, or for
other similar factors, are classified as available-for-sale and carried at fair
market value. Unrealized gains and losses on available-for-sale securities are
reported as a separate component of stockholders' equity, net of taxes. From
time to time, the Company may classify a security as a trading security when
the intent is to sell the security in the near future to generate profits.
Unrealized gains and losses on such securities are reported in earnings.
Realized gains and losses on the sales of all securities are reported in
earnings and computed using the specific identification cost basis. Premiums
are amortized and discounts are accreted into interest income using the level
yield method. On a periodic basis, management reviews securities for impairment
due to other than temporary declines in value. If any other than temporary
impairment is identified, the security is written down to fair value.
Loans
Loans are generally recorded at the contractual amounts owed by borrowers,
less unearned discounts, deferred origination fees and costs, the undisbursed
portion of any loans in process, and the allowance for loan losses. Fixed rate
one- to four-family mortgages that were originated with the intent to sell in
the secondary mortgage market or those loans which have been identified as
assets which may be sold prior to maturity or for which there is not a positive
intent to hold to maturity, based on foreseeable conditions, are classified as
held-for-sale and carried at the lower of cost or market value on an aggregate
basis.
Allowance for Loan Losses
The Company adopted Statement of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114"), and Statement
of Financial Accounting Standards No. 118, "Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures" ("SFAS 118"),
effective January 1, 1995. Under these standards, a loan is considered
impaired, based on current information and events, if it is probable that the
Company will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement. The
measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the loan's historical effective
interest rate, except that all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. Smaller balance,
homogeneous loans, considered to be other consumer loans, are excluded from the
Company's individual impairment measurement assessment, as loans within this
scope are collectively evaluated for impairment. Such loans are collectively
evaluated for impairment using historical charge-off data, industry data and
other trend analysis.
46
<PAGE>
Factors which affect management's judgment in determining when a loan is
impaired include the length of the loan's current delinquency and the
historical number of times delinquent, the nature of the customer's industry
focus, the customer's financial stability as documented by its financial
records, and historical financial facts and estimates observed as part of the
Company's relationship with the customer. However, another factor which may
affect management's judgment in determining impairment is a continuing
insignificant delay or shortfall in the amount of payments by the customer.
Management considers an insignificant delay in payment to be a delay of thirty
days or less, and considers an insignificant shortfall in payment amount of
less than 10% of the required payment amount. However, an insignificant delay
or shortfall in the amount of payment is not an event that, when considered in
isolation, would automatically cause a loan to be considered impaired.
A loan continues to be classified as impaired until it is brought fully
current and the collection of scheduled interest and principal is considered
probable. Management reviews all loans classified as loss, doubtful,
substandard and other assets especially mentioned ("OAEM") to determine
impairment. Other risk categories used to identify impaired loans include non-
accrual loans and chronically delinquent loans. Loans restructured prior to the
Company's adoption of SFAS 114 are not evaluated for impairment, as allowed by
that Statement, unless such loans exhibit other impairment characteristics.
The adequacy of the allowance for loan losses is periodically evaluated by
the Company in order to maintain the allowance at a level that is sufficient to
absorb probable credit losses. Management's evaluation of the adequacy of the
allowance is based on a review of the Company's historical loss experience,
known and inherent risks in the loan portfolio, including adverse circumstances
that may affect the ability of the borrower to repay interest and/or principal,
the estimated value of collateral, and an analysis of the levels and trends of
delinquencies, charge-offs, and the risk ratings of the various loan
categories. Such factors as the level and trend of interest rates and the
condition of the national and local economies are also considered.
The allowance for loan losses is established through charges to earnings in
the form of a provision for loan losses. Increases and decreases in the
required allowance, based on management's periodic evaluation of various risk
factors and due to changes in the measurement of impaired loans, are included
in the provision for loan losses.
When a loan or portion of a loan, including impaired loans, is determined to
be uncollectible, the portion deemed uncollectible is charged against the
allowance and subsequent recoveries, if any, are credited to the allowance.
Income Recognition on Accruing, Impaired and Non-Accrual Loans
Interest on loans is credited to income as earned based on outstanding
principal balances. Nonrefundable loan origination fees and certain direct loan
origination costs are deferred and the net amounts are amortized over the
contractual life of the related loans using the level-yield method. Loans,
including impaired loans, are generally classified as non-accrual if they are
past due as to maturity or payment of principal or interest for a period of 90
days or more, unless such loans are well-collateralized and in the process of
collection. If collection of a loan or a portion of a loan is in doubt, the
loan is classified as non-accrual and is considered impaired. Loans that are
current or past due less than 90 days may also be classified as non-accrual and
impaired if repayment in full of principal and/or interest is in doubt.
Management generally considers non-accrual and impaired loans to be one and the
same. Loans which are determined to be impaired but which are not yet past due
greater than 90 days, are placed on non-accrual at management's discretion.
Loans may be returned to accrual status when all principal and interest
amounts contractually due (including arrearages) have been brought current, and
there is a sustained period of repayment performance (generally a minimum of
six months) by the borrower in accordance with the contractual terms of
interest and principal payment.
47
<PAGE>
While a loan is classified as non-accrual and impaired and the future
collectibility of the recorded loan balance is doubtful, collections of
interest and principal are generally applied as a reduction to principal
outstanding. When the recorded loan balance is expected to be collected,
interest income may be recognized on a cash basis. In the case where a non-
accrual or an impaired loan had been partially charged off, recognition of
interest on a cash basis is limited to that which would be recognized on the
recorded loan balance at the contractual interest rate. Cash interest receipts
in excess of that amount are recorded as recoveries to the allowance for loan
losses until prior charge-offs have been fully recovered.
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated
depreciation, computed by the straight-line method over the estimated useful
lives of the assets. Accumulated depreciation is reduced upon the sale of Bank
premises and equipment and any resulting gain or loss is recorded as income or
expense. The depreciable lives of major classifications of assets range from
three years to fifteen years.
Effective January 1, 1996, the Company implemented Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment Of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121
establishes accounting standards for the impairment of long-lived assets and
certain identifiable intangibles to be held and used by an entity or disposed
of. The implementation of the statement did not have any impact on the
Company's financial condition or results of operations.
Foreclosed Real Estate Owned
Foreclosed real estate owned consists principally of properties acquired
through mortgage loan foreclosure proceedings. These properties are recorded at
the lower of the carrying value of the related loans, including costs of
foreclosure, or the estimated fair value of the real estate acquired, less the
estimated selling expenses.
Goodwill
Goodwill is the excess of cost over the fair value of tangible net assets
acquired in bank acquisitions accounted for using the purchase accounting
method and not allocated to any specific asset or liability category. The
Company's goodwill is amortized on a straight-line basis over seven years. The
Company also reviews goodwill on a periodic basis for events or changes in
circumstances that may indicate that the carrying amount of goodwill may not be
recoverable.
Loan Sales
From time to time, the Company sells residential mortgage loans in the
secondary market and retains the servicing rights. The Company implemented
Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage
Servicing Rights" ("SFAS 122") effective January 1, 1996. SFAS 122 is
superseded by Statement of Financial Accounting Standards No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities" ("SFAS 125"). The Company recognizes an asset for rights to
service mortgage loans for others, however those servicing rights are acquired.
The Company also assesses its capitalized mortgage servicing rights for
impairment based on the fair value of those servicing rights. The
implementation of this statement did not have a material effect on the
Company's financial condition or results of operations.
Effective January 1, 1997, the Company adopted the provisions of SFAS 125.
SFAS 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishing of liabilities occurring after
December 31, 1996, on a prospective basis. The adoption of this standard did
not have a material effect on the Company's financial condition or its results
of operations.
48
<PAGE>
Income Taxes
The Company and its subsidiaries file consolidated federal and state income
tax returns. In accordance with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes" ("SFAS 109"), the Company uses the
asset/liability method of accounting for income taxes. Deferred income taxes
and tax benefits are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The Company provides deferred taxes for the estimated
future tax effects attributable to temporary differences and carryforwards. The
deferred tax asset is subject to reduction by a valuation allowance in certain
circumstances. This valuation allowance is recognized if, based on an analysis
of available evidence, management determines that it is more likely than not
that some portion or all of the deferred tax asset will not be realized. The
valuation allowance is subject to ongoing adjustment based on changes in
circumstances that affect management's judgment about the realization of the
deferred tax asset. Adjustments to increase or decrease the valuation allowance
are charged or credited, respectively, to income tax expense.
Earnings Per Share
Effective December 31, 1997, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 establishes standards for computing and presenting earnings per share
("EPS"). It replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures.
This statement was effective for financial statements issued for periods ending
after December 15, 1997 and has been applied for all periods presented.
Diluted 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
granted stock options. For EPS purposes, the common stock has been assumed to
be outstanding for all periods presented. Unallocated shares held for the
Employee Stock Option Plan ("ESOP") are not considered outstanding until such
shares are committed to be allocated to the ESOP.
For the years ended December 31, 1998 and 1997, the actual stock option
exercise prices were used in the earnings per share calculation. For the year
ending December 31, 1996, the option exercise price used in the earnings per
share calculation was the closing price of $15.75 on December 31, 1996.
In October 1995, the FASB issued Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-based Compensation" ("SFAS 123"). SFAS 123
encourages, but does not require, the Company to recognize compensation expense
for grants of stock, stock options and other equity instruments to employees
based on fair value accounting rules. That Statement also allows the Company to
account for stock-based compensation under Accounting Principles Board Opinion
No. 25 ("APB 25"), under which no compensation expense is recognized in certain
circumstances. However, SFAS 123 requires the Company to disclose pro forma net
income and earnings per share using the fair value based method. SFAS 123 was
required for years beginning after December 15, 1995. The Company did not adopt
the expense recognition provisions of SFAS 123 but rather elected to follow APB
25 upon the implementation of stock-based compensation programs.
Since the grant price of the options issued on June 25, 1996 was not
determined until the April 23, 1997 stockholders' meeting, the Company could
not determine the fair value estimate of these shares and the subsequent pro
forma effect on net income at December 31, 1996. Therefore, the earnings per
share for the year ended December 31, 1996 under SFAS 123 was the same as that
disclosed in the consolidated financial statements. The fair value estimate of
these shares and the subsequent pro forma effect on net income and EPS for the
years ended December 31, 1998 and 1997 are contained herein.
49
<PAGE>
Cash Equivalents
Cash equivalents include non-interest bearing amounts due from banks and
short-term investments with original maturities of 90 days or less.
Segments of an Enterprise and Related Information
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131 "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"). SFAS 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 131 is effective for
financial statements for periods beginning after December 15, 1997 and requires
presentation of comparative information for prior periods presented. The
Company does not have operating segments, as defined by SFAS 131, and
therefore, has not disclosed the additional information.
Reclassifications
Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform with the current year's presentation. These
reclassifications had no effect on earnings in 1997 or 1996. Dollars are
presented in thousands, except for per share data, in the following footnotes.
2. Restrictions on Cash and Due From Banks:
The Bank is required by the Federal Reserve Bank to maintain reserves
against its respective transaction accounts and non-personal time deposits. At
December 31, 1998, the Company was required to have cash and liquid assets of
approximately $774 to meet these requirements.
As a broker/dealer, MIS is required to maintain a minimum amount of net
capital as defined by the National Association of Securities Dealers ("NASD").
MIS can maintain its capital requirements in the form of cash or marketable
securities. At December 31, 1998, MIS held $127 at a non-affiliated financial
institution to meet this requirement.
3. Short-Term Investments:
Short-term investments consisted of:
<TABLE>
<CAPTION>
December 31,
--------------
1998 1997
------ -------
<S> <C> <C>
Federal funds sold......................................... $1,420 $10,140
====== =======
</TABLE>
50
<PAGE>
4. Investment Securities:
The amortized cost amounts and market values of investment securities as of
December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Available-for-Sale
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
United States Government obligations
(due after five years through ten
years).............................. $ 3,000 $ 29 $ -- $ 3,029
United States Government obligations
(due after ten years)............... 1,995 5 -- 2,000
Debt securities issued by foreign
governments
(due in one year or less)........... 250 -- -- 250
Debt securities issued by foreign
governments (due after one year
through five years)................. 100 -- -- 100
Corporate debt securities (due in one
year or less)....................... 3,000 -- -- 3,000
Corporate debt securities (due after
one year
through five years)................. 1,000 -- 6 994
Corporate debt securities (due after
ten years).......................... 1,996 -- 78 1,918
Mortgage-backed securities (due after
one year
through five years)................. 12,424 154 -- 12,578
Mortgage-backed securities (due after
five years
through ten years).................. 5,332 45 3 5,374
Mortgage-backed securities (due after
ten years).......................... 156,787 684 157 157,314
Marketable equity securities......... 3,187 85 272 3,000
Mutual funds......................... 16,196 60 102 16,154
--------- ------- ----- ---------
$ 205,267 $ 1,062 $ 618 $ 205,711
========= ======= ===== =========
<CAPTION>
Held-to-Maturity
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
United States Government obligations
(due after five years through ten
years).............................. $ 19,994 $ 67 $ 95 $ 19,966
United States Government obligations
(due after ten years)............... 3,000 -- 25 2,975
Corporate debt securities (due after
ten years).......................... 1,000 -- 39 961
Mortgage-backed securities (due after
ten years).......................... 56,312 689 30 56,971
--------- ------- ----- ---------
$ 80,306 $ 756 $ 189 $ 80,873
========= ======= ===== =========
</TABLE>
51
<PAGE>
The amortized cost amounts and market values of investment securities as of
December 31, 1997 were as follows:
<TABLE>
<CAPTION>
Available-For-Sale
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
United States Government obligations
(due in one year or less)........... $ 2,996 $ 1 $ -- $ 2,997
Debt securities issued by foreign
governments (due after one year
through five years)................. 350 -- -- 350
Corporate debt securities (due after
one year through five years)........ 999 3 -- 1,002
Mortgage-backed securities (due in
one year or less)................... 1,788 14 -- 1,802
Mortgage-backed securities (due after
one year through five years)........ 8,267 29 -- 8,296
Mortgage-backed securities (due after
five years through ten years)....... 21,304 297 -- 21,601
Mortgage-backed securities (due after
ten years).......................... 94,788 705 7 95,486
Marketable equity securities......... 3 20 -- 23
Mutual funds......................... 20,662 20 39 20,643
--------- ------- ----- ---------
$ 151,157 $ 1,089 $ 46 $ 152,200
========= ======= ===== =========
<CAPTION>
Held-to-Maturity
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
United States Government obligations
(due after one year through five
years).............................. $ 3,000 $ 3 $ -- $ 3,003
United States Government obligations
(due after five years through ten
years).............................. 2,000 4 -- 2,004
Mortgage-backed securities (due after
ten years).......................... 70,199 989 9 71,179
--------- ------- ----- ---------
$ 75,199 $ 996 $ 9 $ 76,186
========= ======= ===== =========
</TABLE>
Actual maturities of certain available-for-sale and held-to-maturity
securities will differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
There were no derivative instruments (other than collateralized mortgage
obligations, the majority of which are guaranteed by the Federal National
Mortgage Association, the Government National Mortgage Association and the
Federal Home Loan Mortgage Corporation), structured notes, inverse floating
rate notes or interest or principal only strips in the Company's investment
securities portfolio at December 31, 1998 or 1997.
The proceeds from sales of mortgage-backed securities classified as
available-for-sale in 1998 were $5,567, including gross realized gains of $4
and gross realized loss of $-0-. Proceeds from the sale of available-for-sale
equity securities and mutual funds in 1998 totaled $36,980, including gross
realized gains of $-0- and gross realized losses of $20. During 1997, proceeds
from sales of mortgage-backed securities classified as available-for-sale were
$34,675, including gross realized gains of $301 and gross realized losses of
$92. The proceeds from sales of mutual funds in 1997 totaled $7,000, with no
realized gain or loss. During 1996, proceeds from sales of mortgage-backed
securities classified as available-for-sale were $33,819, including gross
realized gains of $91 and gross realized losses of $230. During 1996, proceeds
from the sale of available-for-sale equity securities totaled $430, including
gross realized gains of $61 and gross realized losses of $-0-. There were no
sales of U.S. Government, foreign government or corporate debt securities in
1998, 1997 or 1996.
52
<PAGE>
At December 31, 1998, investment securities with a carrying amount of $4,847
were pledged as collateral for Treasury Tax and Loan accounts and public
deposits and $887 were pledged as collateral for borrowings.
5. Loans:
The composition of the loan portfolio was as follows:
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Real estate mortgages:
One- to four-family............................... $ 423,308 $ 396,390
Multi-family...................................... 16,056 13,497
Commercial........................................ 117,373 99,252
Construction and land development................. 4,480 3,602
Commercial and industrial........................... 41,516 33,699
Home equity lines of credit......................... 6,736 3,003
Other consumer loans................................ 52,269 34,620
--------- ---------
Total loans, gross................................ 661,738 584,063
Deferred loan origination costs, net................ 2,421 1,080
Allowance for loan losses........................... (12,301) (14,031)
--------- ---------
Total loans, net.................................. $ 651,858 $ 571,112
========= =========
</TABLE>
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year................ $ 14,031 $ 7,983 $ 11,597
Provision for loan losses................... 600 9,100 6,400
Loan charge-offs............................ (2,846) (4,012) (10,444)
Loan recoveries............................. 516 960 430
-------- -------- --------
Balance at end of year...................... $ 12,301 $ 14,031 $ 7,983
======== ======== ========
</TABLE>
The following table summarizes the Company's impaired loans.
<TABLE>
<CAPTION>
Measured by the Measured by the
Present Value of Fair Value of
Expected Cash Flows the Collateral Total
------------------- --------------- -------
<S> <C> <C> <C>
At December 31, 1998.............. $ 126 $ 845 $ 971
Commercial loans and mortgages....
Residential mortgages and other
loans measured collectively...... -- 1,978 1,978
------ ------- -------
Total impaired loans............ $ 126 $ 2,823 $ 2,949
====== ======= =======
At December 31, 1997.............. $ 183 $ 927 $ 1,110
Commercial loans and mortgages....
Residential mortgages and other
loans measured collectively...... -- 1,720 1,720
------ ------- -------
Total impaired loans............ $ 183 $ 2,647 $ 2,830
====== ======= =======
</TABLE>
Impaired loans with no valuation allowance because the loans' fair value
exceeds their carrying value totaled $2,070 at December 31, 1998 and $2,518 at
December 31, 1997. Impaired loans with a corresponding valuation allowance
totaled $879 at December 31, 1998 and $312 at December 31, 1997. The valuation
allowance allocated to impaired loans was $290 at December 31, 1998 and $53 at
December 31, 1997.
The average recorded investment in impaired loans was approximately $3,216,
$5,983 and $11,405 for the years ended December 31, 1998, 1997 and 1996,
respectively. During 1998, the Company recognized $22 of
interest on impaired loans (during the portion of the year that they were
impaired), all of which related to
53
<PAGE>
impaired loans for which interest income is recognized on the cash basis. In
1997 and 1996, the Company recognized $14 and $8 of interest on impaired loans
(during the portion of the year that they were impaired), all of which related
to impaired loans for which interest income is recognized on the cash basis.
6. Non-Performing Assets:
The components of non-performing assets were as follows:
<TABLE>
<CAPTION>
December 31,
-------------
1998 1997
------ ------
<S> <C> <C>
Non-accrual loans................................................ $2,949 $2,830
Accruing loans past due 90 days or more.......................... -- --
------ ------
Total non-performing loans..................................... 2,949 2,830
Foreclosed real estate owned, net................................ 902 1,204
------ ------
Total non-performing assets.................................... $3,851 $4,034
====== ======
</TABLE>
Non-accrual loans are defined as loans past due ninety days or more, loans
which management believes will not be repaid in full, and loans which are
ninety days or more past contractual maturity.
The Company completed its Accelerated Asset Disposition Plan ("ADP") on July
17, 1996, disposing of $18.13 million in problem assets. As part of the ADP,
the Company added $3.60 million in additional loan loss provisions and had
additional write-downs of $2.65 million on foreclosed real estate owned during
the second quarter of 1996.
The reductions in interest income associated with non-accrual loans were as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income in accordance with original terms............ $ 188 $ 217 $ 517
Income recognized................................... 22 14 8
-------- -------- --------
Reduction in interest income........................ $ 166 $ 203 $ 509
======== ======== ========
</TABLE>
The components of foreclosed real estate owned expenses (including
subsidiaries holding foreclosed properties) were as follows:
<TABLE>
<CAPTION>
Years ended December
31,
----------------------
1998 1997 1996
------- -------------
<S> <C> <C> <C>
Expenses of holding and operating foreclosed real
estate owned.......................................... $ 372 $ 425 $ 600
Net (gains) losses on sale of foreclosed real estate
owned................................................. (103) 67 48
Write-downs and provisions............................. 188 54 3,444
------- ----- -------
Total foreclosed real estate owned expense........... $ 457 $ 546 $ 4,092
======= ===== =======
</TABLE>
Changes in the foreclosed real estate owned valuation reserve were as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Valuation reserve at beginning of year.............. $ -- $ -- $ --
Write-downs and net losses on sale.................. 15 121 3,492
Provision........................................... 85 121 3,492
-------- -------- --------
Valuation reserve at end of year.................... $ 70 $ -- $ --
======== ======== ========
</TABLE>
54
<PAGE>
7. Bank Premises and Equipment:
Cost and accumulated depreciation and amortization of the various categories
of Company premises and equipment were as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------- -------------------------
Accumulated Accumulated
Depreciation and Depreciation and
Cost Amortization Cost Amortization
-------- ---------------- -------- ----------------
<S> <C> <C> <C> <C>
Bank premises and land..... $ 1,976 $ 1,239 $ 1,976 $ 1,172
Leasehold improvements..... 5,665 3,200 5,272 2,900
Furniture and equipment.... 6,216 4,785 5,929 4,282
-------- ------- -------- -------
$ 13,857 $ 9,224 $ 13,177 $ 8,354
======== ======= ======== =======
</TABLE>
The Bank, through its wholly-owned subsidiary, Eighty Pearl Street Corp.
(the "Corporation"), has a 50% interest in the Pearl Street Associates Limited
Partnership (the "Partnership") which owns the building that houses the Bank's
headquarters. The Bank's investment in the Partnership is accounted for under
the equity method of accounting. During 1998 and 1997, the Bank received
dividend distributions from the Partnership of $1,613 and $1,375, respectively.
Refer to Note 23 "Subsequent Events" for additional information.
8. Deposits:
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1997
-------- --------
<S> <C> <C>
Savings:
Regular........................................... $105,067 $107,146
Other............................................. 138 161
Certificates of deposit............................. 408,451 398,433
Money Market:
Checking.......................................... 43,087 36,361
Savings........................................... 60,478 53,609
-------- --------
Total savings and time deposits................. 617,221 595,710
Demand deposits..................................... 88,974 71,854
-------- --------
Total............................................. $706,195 $667,564
======== ========
</TABLE>
The following table presents the amounts of certificates of deposit of the
Company at December 31, 1998 maturing during the periods reflected below and
the weighted average rates of such accounts.
<TABLE>
<CAPTION>
Weighted Average
Amount Interest Rate
--------- ----------------
<S> <C> <C>
Certificates of deposit maturing during the 12
months ending:
December 31, 1999................................ $ 318,410 4.74 %
December 31, 2000................................ 60,566 5.50
December 31, 2001................................ 10,929 5.67
Thereafter....................................... 18,546 5.82
---------
Total.............................................. $ 408,451 4.93 %
========= =======
</TABLE>
55
<PAGE>
The following table presents the maturities of the Company's certificates of
deposit in amounts of $100,000 or more at December 31, 1998 by time remaining
to maturity.
<TABLE>
<CAPTION>
Maturing
--------
<S> <C>
Three months or less............................................. $42,102
Over three through six months.................................... 14,332
Over six through twelve months................................... 10,796
Over twelve months............................................... 14,158
-------
Total........................................................... $81,388
=======
</TABLE>
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 operates in Central Connecticut. Mechanics
converted the two Chase Manhattan branches to Mechanics offices on July 11,
1998. Goodwill of $818 was recorded as a result of the purchase and is being
amortized over seven years.
9. Borrowings:
Descriptions of the advances from the Federal Home Loan Bank of Boston and
the repayment schedule were as follows:
<TABLE>
<CAPTION>
Maturity Date Interest Rate December 31, 1998 December 31, 1997
------------- ------------- ----------------- -----------------
<S> <C> <C> <C>
January 6, 1998.............. 5.59% $ -- $ 16,000
March 1, 1999................ 6.35 -- 5,000
March 3, 1999................ 5.13 10,000 --
July 1, 1999................. 6.15 -- 13,000
August 19, 1999.............. 4.94 10,000 --
August 25, 1999.............. 6.00 -- 7,000
November 15, 1999............ 4.94 7,000 --
June 7, 2000................. 4.85 10,000 --
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 --
October 21, 2003............. 4.19 5,000 --
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 --
October 6, 2008.............. 4.49 7,000 --
December 8, 2008............. 4.33 20,000 --
April 8, 2013 *.............. 5.49% 10,000 --
--------- --------
$ 209,745 $129,000
========= ========
</TABLE>
- --------
* initial call dates ranging from January 1999 to April 2003
During 1998, the Bank prepaid four FHLB advances totaling $33,000 carrying a
weighted average rate of 6.26% which resulted in $392 in prepayment penalties.
The Bank has committed to borrow $10,000 from the FHLB in March 1999 at an
interest rate of 3.99% with an original maturity date of March 24, 2014. This
advance is callable beginning in March 2000 and quarterly thereafter. In
addition, the Bank has committed to borrow $20,000 from the FHLB in November
1999 at an interest rate of 5.12% with a term of three months.
The Bank has access to a pre-approved line of credit up to approximately
$15,000 and the capacity to borrow up to 40% of the Bank's total assets. In
accordance with an agreement with the Federal Home Loan
56
<PAGE>
Bank of Boston, 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 ESOP borrowed $1,200 from an unaffiliated institution to
purchase shares of the Company's stock for the ESOP in conjunction with the
Conversion. This borrowing had an outstanding balance of $480 at December 31,
1998 and $720 at December 31, 1997. 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.
10. Investment Brokerage Services:
The Bank offers investment products and services to its customers through
its wholly-owned subsidiary, MIS. The program, which began in 1986, has evolved
from its original emphasis on transactional business to its current focus on
relationship business including asset allocation accounts with wrap fees. In
1996, the Bank hired additional staff and formed the subsidiary, MIS, with the
intent of becoming its own broker/dealer in 1997. On July 2, 1997, MIS became
licensed as a broker/dealer and registered investment advisor. MIS is regulated
by the NASD and is a member of the Security Investors Protection Corporation
("SIPC"). MIS offers a wide variety of investments products, including mutual
funds, stock and bonds as well as investment advisory services. MIS also offers
fixed and variable annuity products and is licensed as an insurance agency in
the State of Connecticut. MIS earns its commissions by selling investment
products and by providing investment advisory services to its customers.
Commissions, salaries and benefits expense related to this service approximated
$1,764, $1,994 and $1,113 in 1998, 1997 and 1996, respectively.
11. Employee Benefits:
In February 1998, the 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 has not impacted the Company's disclosures about pension plans for the
Company, as SFAS 132 did not change the disclosures for defined contribution
pension plans.
On November 1, 1990, the Company instituted a defined contribution pension
plan including all employees who have completed one year of service, have
attained age 21, and have worked a minimum of 1,000 hours during the plan year.
The Company makes annual contributions based on a percentage of the total
payroll for eligible employees. Pension expense related to the plan for the
years ended December 31, 1998, 1997 and 1996 was $546, $480 and $110,
respectively.
Effective January 1, 1987, the Company adopted the Mechanics Savings Bank
401(k) Plan. The Bank is also the trustee for the 401(k) Plan. Employees of the
Bank who have attained age 21, completed one year of service and worked a
minimum of 1,000 hours during the plan year are eligible for the 401(k) Plan.
Each employee who elects to participate in the 401(k) Plan authorizes a payroll
deduction of an amount not less than 2% or greater than 15%, in increments of
1% of compensation (as defined), for contribution to his or her account in the
401(k) Plan. The employer's matching contribution of each participant's
contribution up to 5% of the participant's compensation was 25% in 1998, 25% in
1997 and -0-% in 1996.
57
<PAGE>
The Company's contribution to the 401(k) Plan was $82, $73, and $-0- for the
years ended December 31, 1998, 1997 and 1996, respectively. As directed by each
individual participant, the 401(k) Plan's investments are in a certificate of
deposit held at the Bank, MECH Financial, Inc. common stock and several mutual
funds.
On December 14, 1987 the Company adopted a non-qualified Long Term Deferred
Incentive Plan ("LTDIP") for its executive officers. The LTDIP, as amended,
awards a bonus to executive officers based upon a formula approved by the Board
of Directors. Amounts are awarded after the end of each fiscal year and can be
deferred into the plan or paid out. During 1998, all executives chose a direct
payout. Therefore, no deferrals occurred during 1998. Deferred awards under the
LTDIP recorded as compensation expense were $151 and $78 in 1997 and 1996,
respectively. If a participant dies while serving as an executive of the
Company, the amount payable to the participant's beneficiary is the amount
equal to the participant's projected retirement benefit (as defined in the
LTDIP) if the Company has acquired and continues to maintain a corporate life
insurance policy on the life of the participant at the time of death (see
below).
Effective July 1, 1997, the Company adopted an Outside Director Deferred
Compensation Plan ("DDCP"). The DDCP allows a director to defer the receipt of
all or a specified amount or percentage of director and retainer fees, and have
earnings accrue on such amounts at the prime rate or at a rate equivalent to
the appreciation in the Company's stock price over the period of time for which
the fees are in the DDCP. All amounts in the DDCP are fully vested and
nonforfeitable at all times. If a participant dies while serving as an outside
director of the Company, the amount payable to the participant's beneficiary is
the amount equal to the participant's projected retirement benefit (as defined
in the DDCP) if the Company has acquired and continues to maintain a corporate
life insurance policy on the life of the participant at the time of death (see
below).
During 1997, the Company invested $15.7 million in universal cash surrender
value life insurance. Twenty polices were acquired on the lives of seven
executive officers and six directors and are designed to recover the costs of
the Company's LTDIP and DDCP. The policy death benefit also indemnifies the
Company against the death benefit provision of these benefit plans. The
policies were paid with a single premium and have a combined death benefit of
$41.3 million. Policy cash values earn interest at a current rate of between
5.4%--6.0% and policy mortality costs are charged against the cash value
monthly. There are no loads or surrender charges associated with the policies.
As part of the Conversion from a mutual to a capital stock savings bank, the
Board of Directors adopted a leveraged ESOP. The ESOP purchased 120,000 shares
of stock issued as part of the Conversion. The ESOP is subject to the
eligibility, funding, participation, fiduciary, reporting and disclosure
requirements of ERISA. Under existing circumstances all Company employees are
eligible to participate in the ESOP once they have attained age 21 and
completed one year of service (which requires employment for 1,000 or more
hours in a period of twelve consecutive months, including pre-Conversion
service). The stock will be allocated to the accounts of the Company's
employees participating in the ESOP over five years. At both December 31, 1998
and December 31, 1997, 24,000 shares were allocated to employees in connection
with the ESOP. The Company recognized expense of $662, $498 and $377 during
1998, 1997 and 1996, respectively, relating to the ESOP. The expenses were
calculated based on the average closing stock price for the years ended
December 31, 1998 and December 31, 1997. Cash dividends are allocated to the
individual participants based on the number of allocated common shares in each
participants account.
During 1996, the Board of Directors of the Company adopted the 1996 Officer
Stock Option Plan (the "Officer Option Plan") and a separate 1996 Director
Stock Option Plan (the "Director Option Plan") which is similar in many
respects to the Officer Option Plan. Both plans were approved by the
stockholders of the Company at the first annual meeting of stockholders which
was held on April 23, 1997. Because the Director Option Plan contains many of
the same provisions as the Officer Option Plan, the following description of
the Officer Option Plan is applicable to the Director Option Plan, except as
otherwise indicated.
The number of shares of authorized but unissued stock to be reserved under
the Officer Option Plan and the Director Option Plan is 423,200 and 105,800
respectively. The option exercise price will not be less than
58
<PAGE>
the greater of par value or the "fair market value" of the Company's Stock (as
defined) on the date of grant. The maximum option term will be 10 years from
the date of grant. However, upon the occurrence of various changes in
capitalization, including a change in control of the Company, and unless
otherwise provided for in such transaction, all options outstanding shall fully
vest. The options are exercisable over a ten-year period, and generally vest
over four to five years. However, all of the 145,000 shares granted in 1998
were exercisable at December 31, 1998.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net income and basic and diluted EPS
for the years ended December 31, would have been reduced to the pro forma
amounts indicated below.
<TABLE>
<CAPTION>
1998
-----------------------
Net Basic Diluted
Income EPS EPS
-------- ------ -------
<S> <C> <C> <C>
As reported............................................. $ 8,696 $ 1.66 $ 1.63
Pro forma............................................... $ 7,888 $ 1.51 $ 1.48
<CAPTION>
1997
-----------------------
Net Basic Diluted
Income EPS EPS
-------- ------ -------
<S> <C> <C> <C>
As reported............................................. $ 13,076 $ 2.52 $ 2.49
Pro forma............................................... $ 12,761 $ 2.52 $ 2.43
</TABLE>
At December 31, 1996, the Company could not determine the fair value
estimate of these shares and the subsequent pro forma effect on net income
since the grant price of the options issued was not determined until the
April 23, 1997 stockholders' meeting. Therefore, net income and EPS for the
year ended December 31, 1996 under SFAS 123 were the same as that disclosed in
the consolidated financial statements.
The fair value of each stock option is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions: an expected option term of 4 years, expected volatility of 30%,
dividend yield of 3.6% and a risk-free interest rate of 5.4--5.6% for the year
ended December 31, 1998. For the year ended December 31, 1997, the assumptions
were an expected option term of 5 years, expected volatility of 25%, dividend
yield of 2.5% and a risk-free interest rate of 6.2%.
A summary of the status of the Company's stock option plans as of December
31, 1998 and 1997 and the changes during the year ending on those dates is
presented below.
<TABLE>
<CAPTION>
For the year Average Price For the year Average Price
ended 1998 Per Share ended 1997 Per Share
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Balance at January 1,... 335,666 $17.59 265,000 $17.50
Granted................. 145,000 27.05 81,666 17.89
Exercised............... (4,666) 17.50 (3,266) 17.50
Canceled................ (4,000) 17.50 (7,734) 17.50
-------- --------
Balance at year end..... 472,000 $20.50 335,666 $17.59
======== ========
Options exercisable at
year end .............. 338,534 $21.63 132,134 $17.55
Weighted average fair
value of options
granted................ $ 5.38 $ 4.68
</TABLE>
As of December 31, 1998, there were 472,000 options outstanding. There were
320,334 options at $17.50, 6,666 options at $22.25, 124,500 options at $26.625
and 20,500 options at $29.625. The outstanding options had a weighted average
remaining contractual life of 8.10 years. An additional 49,068 and 190,068
shares were available for future grants at December 31, 1998 and December 31,
1997, respectively.
59
<PAGE>
12. Earnings Per Share:
The following is a reconciliation of the denominators of the basic and
diluted EPS computations.
<TABLE>
<CAPTION>
For the years ended December 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Basic EPS......................................... 5,222,968 5,195,224 5,170,066
Effect of dilutive stock options.................. 109,231 47,197 --
--------- --------- ---------
Diluted EPS....................................... 5,332,199 5,242,421 5,170,066
========= ========= =========
</TABLE>
There were no adjustments to net income and no antidilutive stock options
for the years ended December 31, 1998, 1997 and 1996.
13. Comprehensive Income:
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 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 years ended December 31, 1998,
1997 and 1996 are included in the Consolidated Statement of Changes in
Stockholders' Equity.
The following table represents components and the related tax effects
allocated to other comprehensive income for the years ended December 31, 1998,
1997 and 1996:
<TABLE>
<CAPTION>
For the year ended December 31, 1998
--------------------------------------
Before Tax Net of
Tax (Expense) Tax
Amount Benefit Amount
----------- -------------- ---------
<S> <C> <C> <C>
Net unrealized gains (losses) on
securities arising during the
period........................... $ (594) $ 238 $ (356)
Less: reclassification adjustment
for gains 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......................... 179 (80) 99
----------- ------------ -----------
Other comprehensive income........ $ (419) $ 181 $ (238)
=========== ============ ===========
<CAPTION>
For the year ended December 31, 1997
------------------------------------
Before Tax Net of
Tax (Expense) Tax
Amount Benefit Amount
----------- -------------- -----------
<S> <C> <C> <C>
Net unrealized gains (losses) on
securities arising during the
period........................... $ 245 $ (338) $ (93)
Less: reclassification adjustment
for gains realized in net
income........................... 281 (118) 163
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......................... 75 (27) 48
----------- ------------ -----------
Other comprehensive income........ $ 39 $ 38 $ 77
=========== ============ ===========
</TABLE>
60
<PAGE>
<TABLE>
<CAPTION>
For the year ended December 31, 1996
----------------------------------------
Before Tax Net of
Tax (Expense) Tax
Amount Benefit Amount
------------- -------------- ----------
<S> <C> <C> <C>
Net unrealized gains
(losses) on securities
arising during the
period................. $ 1,129 $ (472) $ 657
Less: reclassification
adjustment for gains
realized in net
income................. 122 (50) 72
Transfer of losses on
available-for-sale
securities to held-to-
maturity securities.... (449) 121 (328)
Accretion of unrealized
loss on securities
transferred from
available-for-sale to
held-to-maturity....... 16 (5) 11
------------- ------------ -----------
Other comprehensive
income................. $ 574 $ (306) $ 268
============= ============ ===========
</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.
During 1996, the Company reclassified certain securities from available-for-
sale to held-to-maturity.
14. Leases:
Rental expense for operating leases amounted to $1,734, $1,710 and $1,673 in
1998, 1997 and 1996, respectively. Future minimum lease payments, by year and
in the aggregate, under noncancelable operating leases with initial or
remaining terms of one year or more consisted of the following at December 31,
1998:
<TABLE>
<S> <C>
1999................................................................ $1,448
2000................................................................ 1,385
2001................................................................ 1,349
2002................................................................ 1,306
2003................................................................ 975
Thereafter.......................................................... 148
------
$6,611
======
</TABLE>
Renewal options are available for periods ranging from five to fifteen
years.
15. Income Taxes:
The components of income tax expense (benefit) for the years ended December
31, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------- -----
<S> <C> <C> <C>
Current:
Federal................................................ $2,797 $1,437 $(316)
State.................................................. 142 165 50
------ ------- -----
Total current.......................................... 2,939 1,602 (266)
------ ------- -----
Deferred:
Federal................................................ 2,070 919 175
State.................................................. 1,076 (667) 317
Valuation allowance.................................... 1,185 (9,662) (492)
------ ------- -----
Total deferred......................................... 4,331 (9,410) --
------ ------- -----
$7,270 $(7,808) $(266)
====== ======= =====
</TABLE>
61
<PAGE>
The following is a reconciliation of the expected federal income tax expense
to the actual income tax expense (benefit) for the years ended December 31.
<TABLE>
<CAPTION>
1998 1997 1996
------ ------- -----
<S> <C> <C> <C>
Income tax expense at statutory rate of 34%............ $5,429 $1,791 $298
Increase (decrease) resulting from:
Connecticut corporation tax, net of federal tax
benefit............................................. 804 (331) 33
Dividends received deduction......................... (43) (4) (4)
Change in deferred tax valuation allowance........... 1,185 (9,662) (492)
Amendment of prior years' tax returns ............... -- 501 --
Other items, net..................................... (105) (103) (101)
------ ------- -----
Income tax expense (benefit)........................... $7,270 $(7,808) $(266)
====== ======= =====
</TABLE>
The significant components of the Company's net deferred tax assets (tax
effected) at December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
------ -------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses................................ $4,900 $ 6,133
Alternative minimum tax credits.......................... 1,169 1,256
Net operating loss carryforwards......................... 729 3,169
Deferred compensation.................................... 623 454
Investments in real estate............................... 64 133
Securities mark to market................................ -- 295
Accrued and other items.................................. 376 221
------ -------
Total deferred tax assets............................... 7,861 11,661
------ -------
Deferred tax liabilities:
Deferred mortgage fees................................... 959 464
Bad debt recapture....................................... 372 538
Unrealized net gains on securities....................... 107 288
State taxes.............................................. -- 994
Other.................................................... 266 255
------ -------
Total deferred tax liabilities.......................... 1,704 2,539
------ -------
Net deferred tax assets before valuation allowance........ 6,157 9,122
Valuation allowance....................................... 1,185 --
------ -------
Net deferred tax assets................................. $4,972 $ 9,122
====== =======
</TABLE>
The Company only recognizes a deferred tax asset when, based upon available
evidence, realization is more likely than not. During 1998, the Company
recorded a valuation allowance of $1,185 against its state deferred tax asset
in connection with the creation of MMC which will qualify and operate as a
Connecticut passive investment company pursuant to legislation enacted in May
1998. Because it is expected to earn sufficient income from the passive
investment company subsidiary and its dividends to the parent are exempt from
Connecticut Corporation Business Tax, the Company no longer expects to
recognize its state deferred tax assets. At December 31, 1997 the Company
recorded no valuation allowance against its deferred tax assets based on
sufficient expected taxable income to realize the recorded amounts.
At December 31, 1996, the Company had fully reserved net deferred tax assets
of $9,662. Management concluded a 100% valuation against the net deferred tax
asset was deemed necessary, as the recency of operating losses, caused
primarily by credit costs, more than offset the impact of improved earnings and
lower non-performing assets in the last six months of 1996. In the second
quarter of 1997, the Company recorded a
62
<PAGE>
deferred tax benefit of $10.33 million primarily attributable to the reversal
of its valuation allowance on its net deferred tax assets. Based on three
consecutive prior quarters of income and projections for the second half of
1997 and 1998 that indicated continued profitability, the Company determined
that it was more likely than not that it would realize its net deferred tax
assets. The Company reviews the net deferred tax asset and its valuation
allowance on a quarterly basis.
The allocation of total tax expense (benefit) involving items charged to
current year income and items charged directly to capital for the years ended
December 31, are as follows:
<TABLE>
<CAPTION>
1998 1997
------ -------
<S> <C> <C>
Tax expense allocated to capital......................... $ 107 $ 288
Tax expense (benefit) allocated to income................ 7,270 (7,808)
------ -------
Total tax expense (benefit).............................. $7,377 $(7,520)
====== =======
</TABLE>
Pursuant to the Small Business Job Protection Act of 1997, the Company has
changed its method of accounting with respect to its tax bad debt reserves. The
change resulted in taxable income of approximately $1,880 which will be
recognized ratably over a six year period. A deferred tax liability has been
established for the unrecognized portion.
The Company has not provided deferred taxes for the tax reserve for bad
debts of approximately $9,050 that arose in tax years beginning before 1988
because it expected that the requirements of Section 593, as amended by the
Small Business Protection Act of 1997, will be met in the foreseeable future.
At December 31, 1998, the Company has $475 in federal net operating loss
carryforwards which expire in 2006. At December 31, 1998, the Company had
$10,123 in state net operating loss carryforwards for tax return purposes of
which $4,766 expires in 2000 and $5,357 expires in 2001. Due to the
establishment of the passive investment company, the Company does not expect to
recognize the benefits of the state net operating loss carryforwards and
recorded a valuation allowance in 1998. The net operating loss carryforwards
reflect the utilization of approximately $4,402 and $12,068 of federal and
state net operating losses, respectively, for the year ended December 31, 1998.
16. Commitments and Contingencies:
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These instruments expose the Company to credit risk in excess of the amount
recognized in the Statement of Condition.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses
the same credit policies in making commitments and conditional obligations as
it does for on-balance sheet instruments. Total credit exposure related to
these items is summarized below.
<TABLE>
<CAPTION>
Contract Amount
---------------
1998 1997
------- -------
<S> <C> <C>
Loan commitments:
Mortgage and equity loan commitments..................... $29,386 $11,733
Unadvanced portion of construction loans................. 1,777 1,284
Unadvanced portion of:
Commercial lines of credit............................. 21,875 17,483
Home equity lines of credit............................ 7,901 3,754
Overdraft protection................................... 121 325
Standby letters of credit................................ 350 742
------- -------
$61,410 $35,321
======= =======
</TABLE>
63
<PAGE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Company evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the counter party. Collateral held is
primarily residential property. Interest rates on home equity lines of credit
are variable for a term of 10 years. All other commitments are a combination of
fixed and variable rates with maturities of one year or more.
Commitments to sell to investors are contracts for delayed delivery of first
mortgage loans in which the Company agrees to make delivery at a specified
future date at a specified price or yield. The Company controls the risk of
nonperformance of investors by periodically monitoring the investors' financial
condition. The Company controls the interest rate risk of commitments to extend
credit to mortgagors by receiving purchase commitments at yields which
fluctuate with interest rates. As of December 31, 1998 and 1997, the Company
had -$0- and $914 in commitments to sell to investors, respectively.
The Company and its subsidiaries are defendants in proceedings arising out
of, and incidental to, activities conducted in the normal course of business.
In the opinion of management, resolution of these matters will not have a
material effect on the Company's financial condition, results of operations or
cash flows.
17. Dividends:
During 1998, the Company issued three quarterly dividends of $0.15 per share
of its common stock. These dividends were paid on May 15, 1998 to shareholders
of record on May 1, 1999, on August 17, 1998 to shareholders of record on
August 3, 1998 and on November 16, 1998 to shareholders on record on November
2, 1998. In addition, on January 19, 1999, the Company declared a dividend of
$0.15 per share of its common stock. This dividend was paid on February 8, 1999
to shareholders of record on January 25, 1999.
18. Recent Accounting Pronouncements:
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.
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.
64
<PAGE>
19. Regulatory Matters:
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional and discretionary actions by the regulators that, if undertaken,
could have a direct material effect on the Company's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company must meet specific guidelines that involve
quantitative measures of the Company's assets, liabilities, and certain off-
balance-sheet items as calculated under regulatory accounting practices. The
Company's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in the
table below) of Tier 1 capital (as defined) to average assets (as defined) and
total and Tier 1 capital (as defined) to risk-weighted assets (as defined). As
of December 31, 1998, the Company meets all capital adequacy requirements to
which it is subject.
At December 31, 1998 and December 31, 1997, the Company was classified, as
of its most recent notification, as "well capitalized".
The Company's capital position is outlined below.
<TABLE>
<CAPTION>
To Be Well Capitalized
Under Prompt Corrective
Actual For Capital Adequacy Purposes Action Provisions
-------------- ---------------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- ---------------- -------------- ------------ -----------
As of December 31, 1998
<S> <C> <C> <C> <C> <C> <C>
Tier one leverage...... $ 94,304 9.63% >= $39,190 >= 4.00% >= $48,987 >= 5.00%
Tier one risk-based.... $ 94,304 14.49% >= $26,037 >= 4.00% >= $32,546 >= 5.00%
Total risk-based....... $102,492 15.75% >= $52,073 >= 8.00% >= $65,091 >= 10.00%
As of December 31, 1997
Tier one leverage...... $ 84,027 9.74% >= $34,512 >= 4.00% >= $43,140 >= 5.00%
Tier one risk-based.... $ 84,027 16.49% >= $20,381 >= 4.00% >= $25,477 >= 5.00%
Total risk-based....... $ 90,491 17.76% >= $40,762 >= 8.00% >= $50,953 >= 10.00%
</TABLE>
On a regular basis, the Company and /or its subsidiaries are examined by the
Connecticut State Banking Department, the Federal Reserve Bank and the FDIC.
The Federal Deposit Insurance Corporation Insurance Act ("FDICIA") was
signed into law on December 19, 1991. Regulations implementing the prompt
corrective action provisions of FDICIA became effective on December 19, 1992.
In addition to the prompt corrective action requirements, FDICIA includes
significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions, and new regulations
concerning internal controls, accounting and operations.
On June 25, 1996, the Bank converted from mutual to stock ownership. At the
time of the Conversion, the Bank established a liquidation account in an amount
equal to the Bank's capital accounts at May 31, 1996 ($25,476). The liquidation
account is being maintained for the benefit of those deposit account holders
who qualified as eligible account holders at the time of the Conversion and who
have continued to maintain their eligible deposit accounts with the Bank
following the Conversion. The liquidation account, which totaled $17,944 at
December 31, 1998 and $18,884 at December 31, 1997, is reduced annually by an
amount proportionate to the decrease in eligible deposit accounts. In the event
of the complete liquidation of the Bank, each eligible deposit account holder
will be entitled to receive their proportionate interest in the liquidation
account, after the payment of all creditor's claims, but before any
distributions on the Bank's common stock.
65
<PAGE>
Connecticut banking laws limit the amount of annual dividends that the Bank
may pay to an amount which approximates the Bank's net income for the then
current year, plus the Bank's net income for the prior two years. The Bank is
also prohibited from paying a cash dividend or repurchasing any of its common
stock 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.
20. Disclosures About Fair Value Of Financial Instruments:
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments"("SFAS 107"), requires that the Company
disclose the estimated fair values for certain of its financial instruments.
Financial instruments include items such as loans, deposits, securities,
Federal Home Loan Bank advances and other items as defined in SFAS 107.
Fair value estimates are intended to represent estimates of the amounts at
which a financial instrument could be exchanged between willing parties in a
current transaction other than in a forced liquidation. However, in many
instances current exchange prices are not available for certain of the
Company's financial instruments. Accordingly, the Company uses other valuation
techniques to estimate the fair values of its financial instruments such as
discounted cash flow methodologies and other methods allowable under SFAS 107.
Fair value estimates are subjective in nature and are dependent on a number
of significant assumptions based on management's judgment regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments and other factors. In addition, because SFAS 107
allows a wide range of valuation techniques, it may be difficult to compare
the Company's fair value information to independent markets or to other
financial institutions' fair value information.
The Company generally holds its earning assets to maturity and settles its
liabilities at maturity. However, fair value estimates are made at a specific
point in time and are based on relevant market information and information
about the financial instrument. These estimates do not reflect any premium or
discount that could result from offering for sale at one time the Company's
entire holdings of a particular instrument. Accordingly, as assumptions
change, such as interest rates, fair value estimates change and these amounts
could not necessarily be realized in an immediate sale. In addition,
differences between carrying values under historical cost accounting and fair
value estimates can be significant and, in particular, such differences arise
in the loan portfolio, where the net carrying value represents management's
estimate of ultimate recoverable amounts versus fair value estimates that
represent a theoretical exchange value based on current market conditions.
SFAS 107 does not require disclosures about fair value information for
items that do not meet the definition of a financial instrument or certain
other financial instruments specifically excluded from its requirements. These
items include core deposit intangibles and other customer relationships,
premises and equipment, leases, income taxes, foreclosed properties,
investments accounted for under the equity method of accounting and capital
accounts. Furthermore, SFAS 107 does not attempt to value future income or
business. These items are material and, accordingly, the fair value
information presented does not purport to represent, nor should it be
construed to represent the underlying "market" or franchise value of the
Company.
The methods and assumptions used to estimate the fair values of each class
of financial instruments are as follows:
Cash And Due From Banks, Accrued Interest Receivable, Short-Term Investments
And Federal Home Loan Bank Stock
These items are generally short-term in nature; accordingly, the carrying
amounts are reasonable approximations of fair values.
Available-For-Sale Securities
Available-for-sale securities are carried at market value. Such values are
generally based on quoted market prices.
66
<PAGE>
Held-To-Maturity Securities
Fair values for held-to-maturity securities are based upon quoted market
prices. For items in which no quoted market price exists, the carrying amount
is a reasonable estimate of fair value.
Loans
For commercial loans whose interest rates adjust at time intervals greater
than one year or are fixed, fair value is estimated by discounting the expected
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and remaining maturities. For
commercial loans whose interest rates adjust at time intervals of less than one
year, the carrying amounts are a reasonable estimate of fair value.
For residential real estate mortgages and loans held-for-sale, the fair
values are based upon quoted market prices for securities backed by similar
loans, adjusted for differences in loan characteristics.
For installment loans, fair value is estimated by discounting the expected
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and remaining maturities.
For non-accrual loans which are not collateral dependent, fair value is
estimated by discounting the expected future cash flows using the interest rate
at the time the loan went into non-accrual status. For non-accrual loans which
are collateral dependent, the fair value of the collateral is obtained from
independent appraisals.
Cash Surrender Value Life Insurance
Cash surrender value life insurance is carried at market value. Such value
is calculated as the initial premium plus appreciation, less mortality costs.
Deposits
The fair value of demand deposits, savings accounts, money market deposits
and fixed-maturity certificates of deposit of six months or less is the amount
payable on demand on the balance sheet date. The fair value of fixed-maturity
certificates of deposit of greater than six months and individual retirement
accounts is estimated by discounting the expected future cash flows using the
rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank Borrowings
The fair value of advances maturing in six months or less is the amount
payable to the Federal Home Loan Bank. The fair value of advances maturing in
greater than six months is estimated by discounting the expected future cash
flows using the rates currently offered for advances with similar remaining
maturities.
Commitments To Extend Credit And Standby Letters Of Credit
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of
the agreements and the present credit worthiness of the counter-parties or on
the estimated cost to terminate them or to otherwise settle with the counter-
parties. The fair value of commitments was immaterial at December 31, 1997 and
1998.
67
<PAGE>
The estimated fair values of the Company's financial instruments at December
31, were as follows:
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and due from banks............... $ 20,567 $ 20,567 $ 22,884 $ 22,884
Short-term investments................ 1,420 1,420 10,140 10,140
Available-for-sale securities......... 205,711 205,711 152,200 152,200
Held-to-maturity securities........... 80,306 80,873 75,199 76,186
Federal Home Loan Bank stock.......... 10,487 10,487 6,450 6,450
Loans, net............................ 651,858 684,009 571,112 596,378
Loans held-for-sale................... -- -- 1,922 1,922
Accrued interest receivable........... 4,957 4,957 4,347 4,347
Cash surrender value life insurance... 16,873 16,873 16,053 16,053
Financial Liabilities:
Deposits.............................. 706,195 709,554 667,564 653,311
Borrowings............................ 210,225 205,496 129,720 114,175
Accrued interest payable.............. 978 978 673 673
</TABLE>
68
<PAGE>
21. Selected Quarterly Consolidated Financial Information (unaudited):
The following table presents quarterly financial information of the Company
for 1998 and 1997.
<TABLE>
<CAPTION>
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
1998 1998 1998 1998 1997 1997 1997 1997
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest and dividend
income................. $16,871 $16,656 $16,475 $15,704 $15,064 $14,507 $14,223 $13,521
Interest expense........ 8,633 8,589 8,598 8,108 7,797 7,194 6,826 6,236
------- ------- ------- ------- ------- ------- ------- -------
Net interest income..... 8,238 8,067 7,877 7,596 7,267 7,313 7,397 7,285
Provision for loan
losses................. -- -- 300 300 300 600 6,500 1,700
------- ------- ------- ------- ------- ------- ------- -------
Net interest income
after provision for
loan losses............ 8,238 8,067 7,577 7,296 6,967 6,713 897 5,585
Other income............ 2,040 2,076 2,117 2,391 1,926 1,953 1,973 2,442
Write-downs and net
losses on sale of
foreclosed real estate
owned.................. -- -- 25 60 1 -- 70 50
Other expenses.......... 6,181 5,856 5,591 6,123 5,683 5,565 6,004 5,815
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before
income taxes........... 4,097 4,287 4,078 3,504 3,209 3,101 (3,204) 2,162
Income tax expense
(benefit).............. 2,746 1,632 1,552 1,340 1,206 1,191 (10,328) 123
------- ------- ------- ------- ------- ------- ------- -------
Net income.............. $ 1,351 $ 2,655 $ 2,526 $ 2,164 $ 2,003 $ 1,910 $ 7,124 $ 2,039
======= ======= ======= ======= ======= ======= ======= =======
Earnings per share
Basic................. $ 0.26 $ 0.51 $ 0.48 $ 0.41 $ 0.39 $ 0.37 $ 1.37 $ 0.39
Diluted............... $ 0.25 $ 0.50 $ 0.47 $ 0.41 $ 0.38 $ 0.36 $ 1.37 $ 0.39
Weighted average
outstanding shares
Basic................. 5,224 5,223 5,223 5,222 5,198 5,195 5,194 5,194
Diluted............... 5,321 5,303 5,364 5,300 5,305 5,268 5,202 5,198
</TABLE>
During the fourth quarter of 1998, the Company recorded a $1,185 valuation
allowance on its deferred state tax assets due to the creation of a passive
investment company. During the second quarter of 1997, the Company recorded
$6,500 in provisions for loan losses. With intense competition in a continued
sluggish Central Connecticut economy, management believed that increasing the
allowance for loan losses and the reserve coverage ratios while maintaining
high credit quality were prudent strategies to implement. In addition during
the second quarter of 1997, the Company 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 projection
for the second half of 1997 and 1998 that indicated continued profitability,
the Company determined that it was more likely than not that it would realize
its net deferred tax assets.
69
<PAGE>
22. Parent Company Only Financials:
On November 25, 1997, the shareholders of the Bank approved the formation of
a holding company, MECH Financial, Inc. which became effective January 1, 1998.
The Statement of Condition for December 31, 1998 and the Statements of Income
and Cashflows for the year ended December 31, 1998 are presented below:
Statement of Condition
<TABLE>
<CAPTION>
December 31, 1998
-----------------
<S> <C>
ASSETS
Cash and due from banks:
Non-interest-bearing deposits and cash...................... $ 160
Short-term investments...................................... 995
-------
Cash and cash equivalents................................. 1,155
Investment in Mechanics Savings Bank.......................... 94,220
-------
Total assets................................................ $95,375
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities............................................. $ 7
Stockholders' equity.......................................... 95,368
-------
Total liabilities and stockholders' equity.................. $95,375
=======
</TABLE>
Statement of Operations
<TABLE>
<CAPTION>
For the year ended
December 31, 1998
------------------
<S> <C>
Interest income............................................. $ 127
Other expenses.............................................. 10
------
Income before income taxes and undistributed income from
Mechanics Savings Bank................................... 117
Income tax expense.......................................... 47
------
Income before undistributed income from Mechanics Savings
Bank..................................................... 70
Undistributed income from Mechanics Savings Bank.......... 8,626
------
Net income................................................ $8,696
======
</TABLE>
70
<PAGE>
Statement of Cash Flows
<TABLE>
<CAPTION>
For the year ended
December 31, 1998
------------------
<S> <C>
Cash flows from operating activities:
Net income................................................. $ 8,696
--------
Adjustments to reconcile net income to cash provided by
operating activities:
Undistributed income from Mechanics Savings Bank......... (8,626)
Amortization of investment security premiums/discounts,
net..................................................... (49)
Increase in other liabilities............................ 7
--------
Total adjustments...................................... (8,668)
--------
Net cash provided by operating activities.................. 28
--------
Cash flows from investing activities:
Proceeds from sale of available-for-sale securities...... 3,300
Purchases of available-for-sale securities............... (3,251)
--------
Net cash provided by investing activities.................. 49
--------
Cash flows from financing activities:
Original capitalization, net of expenses................. 3,379
Exercise of stock options................................ 82
Dividends paid........................................... (2,383)
--------
Net cash provided by financing activities.................. 1,078
--------
Net decrease in cash and cash equivalents.................. $ 1,155
--------
Cash and cash equivalents at beginning of period........... $ --
--------
Cash and cash equivalents at end of period................. $ 1,155
========
</TABLE>
23. Subsequent Events:
On January 20, 1999, the Company announced its adoption of a stock
repurchase program. The program authorized the Company to repurchase up to 5%
of its issued and outstanding common stock at prevailing market prices in
negotiated and/or open market purchases. This program was completed on February
23, 1999.
On February 11, 1999, the Bank announced the sale of their banking and
office complex at 100 Pearl Street in Hartford, CT. to New Boston Pearl Limited
Partnership, an independent third party. The Bank received proceeds of $15,237
and recognized a $2,096 one-time gain on the sale. The Bank will continue to
occupy its banking and office space at 100 Pearl Street under a long-term
lease.
71
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of MECH Financial, Inc.:
We have audited the accompanying consolidated statement of condition of MECH
Financial, Inc. and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of MECH Financial, Inc. and subsidiaries as of December 31, 1998, and the
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
Hartford, Connecticut
January 19, 1999
except as to Note 17 which is as of February 8, 1999
and Note 23 which is as of February 23, 1999
72
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Mechanics Savings Bank:
We have audited the accompanying consolidated statement of condition of
Mechanics Savings Bank and subsidiaries as of December 31, 1997, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for each of the two years in the period ended December 31, 1997.
These financial statements are the responsibility of the Bank's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Mechanics Savings Bank and subsidiaries as of December 31, 1997, and the
consolidated results of their operations and their cash flows for each of the
two years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
Hartford, Connecticut
January 20, 1998
73
<PAGE>
STATEMENT OF MANAGEMENT'S RESPONSIBILITY
To Our Stockholders:
The accompanying consolidated financial statements of MECH Financial, Inc.
and subsidiaries have been prepared by management, which is responsible for the
accuracy and reliability of the financial statements and other information in
this Annual Report. The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles appropriate in the
circumstances and, of necessity, include certain amounts that are based on
management's best judgments and estimates.
Management is responsible for maintaining internal control and has
established internal control components designed to provide reasonable
assurance that transactions are recorded properly to permit preparation of
financial statements, that transactions are executed in accordance with
management's authorizations, and that assets are safeguarded from significant
loss or unauthorized use. During 1998, management believes internal control was
adequate to accomplish these objectives.
The Audit Committee of the Board of Directors, composed of non-management
directors, meets periodically with the independent external auditors, the
internal auditors and management to discuss auditing, accounting control and
financial reporting matters and to ensure that each is properly discharging its
responsibilities. In addition, the Audit Committee annually recommends to the
Board of Directors the selection of independent auditors.
/s/ Edgar C. Gerwig /s/ Thomas M. Wood
- ------------------------- --------------------------
Edgar C. Gerwig Thomas M. Wood
Chairman, President and Executive Vice President
Chief Executive Officer and Treasurer
74
<PAGE>
Item 9. Changes and Disagreements With Accountants on Accounting and Financial
Disclosure
There were no disagreements between KPMG 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.
Certain other required information under this item is included in the
Company's 1999 Proxy Statement under "Item 2. Ratification of Appointment of
Auditors" and is incorporated herein by reference.
PART III
Item 10. Directors and Executive Officers of the Registrant
Director and Executive Officer information is incorporated by reference
beginning in" Item 1. Election of Directors" in the Company's 1999 Proxy
Statement and is supplemented by the following information about Executive
Officers.
<TABLE>
<CAPTION>
Business Experience
Name Age Position Term of Office (last 5 years)
---- --- -------- -------------- --------------------------
<S> <C> <C> <C> <C>
Thomas M. Wood.......... 46 Executive Vice President, 1986 same
Treasurer
Richard W. Stout, Jr.... 54 Executive Vice President 1987 same
Brian A. Orenstein...... 38 Senior Vice President, 1988 same
Controller
Eugene B. Marinelli..... 48 Senior Vice President, 1994 same
Commercial Lending
Gary J. Roman........... 44 Senior Vice President 1996 Senior Vice President
Credit Administration Commercial Lending Officer
Advest Bank 1991-1995
Mary D. Negro........... 57 Senior Vice President, 1987 same
President of MIS
Gregory A. White........ 34 Senior Vice President, 1993 same
Investments
</TABLE>
Item 11. Executive Compensation
Management Compensation and Transactions are incorporated by reference in "
Item 1. Executive Compensation" of the Company's 1999 Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
As of February 28, 1999, there were no persons or groups (as that term is
used in Section 13(d) (3) of the Exchange Act) known to the Company who may be
deemed to own beneficially more than 5% of the Common Stock.
Certain other required information under this item is included in the
Company's 1999 Proxy Statement in "Item 1. Security Ownership of Certain
Principal Beneficial Owners", "Item 1. Stock Ownership of Directors and
Officers" and "Item 1. Compliance with Section 16(a) of the Exchange Act" and
is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The required information is included in the Company's 1999 Proxy Statement
in "Item 1. Transactions with Related Persons" and is incorporated herein by
reference.
75
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements
The following documents filed as part of this report are incorporated herein
by reference from the indicated pages of the 1998 Annual Report on Form 10-K.
(1) Financial Statements Page(s) Page(s)
<TABLE>
<S> <C>
Report of Independent Accountants 72-73
Consolidated Statements of Condition 40
Consolidated Statements of Operations 41
Consolidated Statements of Stockholders' Equity 42
Consolidated Statements of Cash Flows 43-44
Notes to Consolidated Financial Statements 45-71
</TABLE>
(2) Financial Statement Schedules
All Schedules are not required or inapplicable and have been omitted.
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<C> <S>
2 Agreement and Plan of Reorganization dated November 25, 1997 between
Mechanics Savings Bank and the Registrant (incorporated by reference
from Exhibit 2 to Form 8-A filed by the Registrant on December 29,
1997).
3.1(i) Certificate of Incorporation of MECH Financial, Inc. (incorporated by
reference from Exhibit 3(i) to Form 8-A filed by the Registrant on
December 29, 1997).
3.1(ii) Bylaws of MECH Financial, Inc. (incorporated by reference from
Exhibit 3(ii) to Form 8-A filed by the Registrant on December 29,
1997).
10.1 1996 Mechanics Savings Bank Officer Stock Option Plan (incorporated
by reference from Exhibit 10.1 to the 1997 Annual Report on Form 10-K
filed by the registrant on March 30, 1998).
10.2 1996 Mechanics Savings Bank Director Stock Option Plan (incorporated
by reference from Exhibit 10.2 to the 1997 Annual Report on Form 10-K
filed by the registrant on March 30, 1998).
10.3 Change of Control Agreement between Mechanics Savings Bank and Edgar
C. Gerwig (incorporated by reference from Exhibit 10.1 to Form 8-A
filed by the Registrant on December 29, 1997).
10.4 Change of Control Agreement between Mechanics Savings Bank and Thomas
M. Wood (incorporated by reference from Exhibit 10.2 to Form 8-A
filed by the Registrant on December 29, 1997).
10.5 Change in Control Agreement between Mechanics Savings Bank and
Richard W. Stout Jr. (incorporated by reference from Exhibit 10.3 to
Form 8-A filed by the Registrant on December 29, 1997).
10.6 Change in Control Agreement between Mechanics Savings Bank and Eugene
B. Marinelli (incorporated by reference from Exhibit 10.4 to Form 8-A
filed by the Registrant on December 29, 1997).
10.7 Change in Control Agreement between Mechanics Savings Bank and Mary
D. Negro (incorporated by reference form Exhibit 10.5 to Form 8-A
filed by the Registrant on December 29, 1997).
10.8 Change in Control Agreement between Mechanics Savings Bank and Brian
A. Orenstein (incorporated by reference from Exhibit 10.6 to Form 8-A
filed by the Registrant on December 29, 1997).
</TABLE>
76
<PAGE>
<TABLE>
<C> <S>
10.9 Change in Control Agreement between Mechanics Savings Bank and Gary J.
Roman (incorporated by reference from Exhibit 10.7 to Form 8-A filed by
the Registrant on December 29, 1997).
10.10 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Edgar C. Gerwig (incorporated by reference
from Exhibit 10.10 to the 1997 Annual Report on Form 10-K filed by the
registrant on March 30, 1998).
10.11 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Thomas M. Wood. (incorporated by reference
from Exhibit 10.11 to the 1997 Annual Report on Form 10-K filed by the
registrant on March 30, 1998).
10.12 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Richard W. Stout Jr. (incorporated by
reference from Exhibit 10.12 to the 1997 Annual Report on Form 10-K
filed by the registrant on March 30, 1998).
10.13 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Eugene B. Marinelli (incorporated by
reference from Exhibit 10.13 to the 1997 Annual Report on Form 10-K
filed by the registrant on March 30, 1998).
10.14 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Mary D. Negro (incorporated by reference from
Exhibit 10.14 to the 1997 Annual Report on Form 10-K filed by the
registrant on March 30, 1998).
10.15 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Brian A. Orenstein. (incorporated by
reference from Exhibit 10.15 to the 1997 Annual Report on Form 10-K
filed by the registrant on March 30, 1998).
10.16 Amendment No. 1 to Change of Control Agreement between the Registrant,
Mechanics Savings Bank and Gary J. Roman (incorporated by reference from
Exhibit 10.16 to the 1997 Annual Report on Form 10-K filed by the
registrant on March 30, 1998).
10.17 Employment Agreement between Mechanics Savings Bank and Edgar C. Gerwig
(incorporated by reference from Exhibit 10.8 to Form 8-A filed by the
Registrant on December 29, 1997).
10.18 Change in Control Agreement between Mechanics Savings Bank and Gregory
A. White dated May 19, 1998.
11 Statement regarding computation of earnings per share is hereby
incorporated by reference from pages 33-34 and 44 from the 1997 Annual
Report on Form 10-K filed by the registrant on March 30, 1998 and from
pages 49 and 60 in this Form 10-K .
16 Letter from Coopers & Lybrand L.L.P. regarding declination to stand for
re-election (incorporated by reference from Item #4 of Form 8-K filed by
the Registrant on January 26, 1998).
21 Information regarding subsidiaries of Mechanics Savings Bank is hereby
incorporated by reference from "Item 1 Business-Subsidiaries" of this
Form 10-K.
23.1 Consent of KPMG LLP
23.2 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K:
On December 8, 1998, the Company filed a Form 8-K that announced its plans
to form a passive investment company called Mechanics Mortgage Company, to take
advantage of recent changes in the Connecticut tax statutes. As a result of the
formation of the passive investment company, the Company announced that it
would establish a valuation allowance against its remaining state deferred tax
asset of approximately $1.25 million.
(c) The exhibits required by Item 601 of Regulation S-K are filed as a
separate part of this report.
77
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed
on behalf by the undersigned, thereunto duly authorized.
MECH Financial, Inc.
Registrant
By: /s/ Edgar C. Gerwig By: /s/ Thomas M. Wood
_________________________________ ___________________________________
Edgar C. Gerwig Thomas M. Wood
Chairman, President and Chief Executive Vice President and
Executive Officer Treasurer
By: /s/ Brian A. Orenstein
_________________________________
Brian A. Orenstein
Senior Vice President and
Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Edgar C. Gerwig Chairman, President and March 16, 1999
____________________________________ Chief Executive Officer
Edgar C. Gerwig
/s/ David Freeman Director March 16, 1999
____________________________________
David Freeman
/s/ John J. Meehan Director March 16, 1999
____________________________________
John J. Meehan
/s/ Kevin A. North Director March 16, 1999
____________________________________
Kevin A. North
/s/ Robert G. Rayve Director March 16, 1999
____________________________________
Robert G. Rayve
/s/ Alfred R. Rogers Director March 16, 1999
____________________________________
Alfred R. Rogers
/s/ Donald K. Wilson, Jr. Director March 16, 1999
____________________________________
Donald K. Wilson, Jr.
/s/ Barbara Brown Zikmund Director March 16, 1999
____________________________________
Barbara Brown Zikmund
</TABLE>
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MECH FINANCIAL, INC.
EXHIBITS 10.18
CHANGE IN CONTROL AGREEMENT
THIS CHANGE IN CONTROL AGREEMENT (the "Agreement"), made as of May 19,
1998, by and among MECHANICS SAVINGS BANK, a banking corporation organized and
existing by virtue of the laws of the State of Connecticut (the "Bank"), MECH
FINANCIAL, INC., a Connecticut stock corporation which owns all of the
outstanding capital stock of the Bank (the "Company"), and Gregory A. White (the
"Executive").
WHEREAS, the Executive is currently rendering services to the Bank as a
Senior Vice President;
WHEREAS, the Bank considers the performance and dedication of its
management team to be significant for its overall corporate strategy and to be
essential to protecting and enhancing the best interests of the Bank;
WHEREAS, the banking industry is a dynamic one with independent public
institutions such as the Bank, subject to unexpected changes in ownership;
WHEREAS, the performance by the Executive of services to the Bank may be
negatively affected by his uncertainty over the possibility of a change in
ownership of the Bank or the Company and possible affect thereof on his
employment with the Bank; and
WHEREAS, the Bank wishes to mitigate the fears of the Executive regarding a
potential ownership change, so as to avoid a negative effect on his performance
of services to the Bank, and in that interest the Bank desires to afford certain
protection to the Executive in the event of dismissal or substantial change in
duties or compensation upon the occurrence of certain events as specified
herein.
NOW, THEREFORE, to further the above recited corporate objective, and for
other good and valuable consideration, the receipt and adequacy of which each
party hereby acknowledges, the Bank, the Company and the Executive agree as
follows:
1. (a) If, at any time while the Executive is a full-time officer of the
Bank, there is a "Change of Control" (as hereinafter defined), the
Executive shall be entitled to receive a severance payment (the "Severance
Amount") in consideration of services previously rendered to the Bank. The
Severance Amount shall be made as a lump sum cash payment and shall be
equal to three (3) times the greater of the following: (A) the Executive's
compensation (the "Compensation") from the Bank for services rendered for
the last full calendar year immediately preceding the Change of Control, or
(B) the Executive's average annual Compensation with respect to the three
(3) most recent taxable years ending before the date on which the Change of
Control occurs. Compensation as described above shall include the amount of
base salary and bonus, if any, paid to the Executive for services rendered
for the time period in question, including any and all of said amounts as
may have been deferred by the Executive under Bank deferral plans, if any,
and shall include long-term compensation which, by its terms, is
accelerated upon a Change of Control or, if not, shall by this Agreement be
so accelerated and determined as the present value (determined at the
discount rate provided in Section 280G(d)(4) of the Internal Revenue Code
of 1986, as amended, or its successor provision) of any cash or non-cash
long-term incentive compensation (whether in the form of performance units
or otherwise) previously awarded to the Executive but not yet paid,
measured at the time of award with the assumption that the award would be
100% earned over the performance period. Notwithstanding the provisions
hereof, in no event shall the Severance Amount (taken together with all
other payments, rights, options and benefits payable to the Executive under
this or any other agreement or arrangement which is payable contingent upon
a change in the ownership or effective control of the Bank, as contemplated
by Section 280G) exceed one dollar ($1.00) less than an aggregate amount
which would
79
<PAGE>
cause all or any portion of the Severance Amount to be deemed a "parachute
payment" under Section 280G.
(b) Payment under this Section 1 shall be paid in full within ninety (90)
days following the date of the Change of Control and shall not be reduced
by any compensation which the Executive may receive from the Bank or from
other employment with another employer should Executive's employment with
the Bank terminate.
(c) "Change of Control" shall be deemed to have occurred if:
(1) a Person (as defined below and other than the Bank, the
Company or any trustee or other fiduciary holding securities
under an employee benefit plan of the Bank or the Company)
beneficially owns (i.e. directly, indirectly or acting
through one or more other persons owns, controls or has
power to vote) 25% or more of any class of voting securities
of Bank or the Company, without the prior approval of at
least 75% of the members of the Bank's or the Company's
Board of Directors prior to such Person attaining such
percentage interest;
(2) a proxy contest to which the Bank or the Company is a party
takes place, as a consequence of which members of the Bank's
or the Company's Board of Directors in office immediately
prior to such event constitute less than 75% of such Board
of Directors after such event;
(3) the Bank or the Company shall consummate a merger or
consolidation with another bank, corporation, association or
business entity ("Party"), or the Bank or the Company shall
sell, exchange, liquidate or transfer all or substantially
all of their respective assets to a Party, except in any
such case in a transaction in which immediately after such
merger or consolidation or such sale, exchange, liquidation
or transfer, the shareholders of the Bank or the Company, in
their capacities as such and as a result thereof, shall own
at least 50 percent in voting power of the then outstanding
securities of the Bank, the Company or of any surviving
corporation or business entity pursuant to any such merger
(or of its parent), the consolidated corporation or business
entity in any such consolidation, or of the Party to which
such sale, liquidation, exchange or transfer of assets is
made; or
(4) the Board of Directors of Bank or the Company otherwise
determines that a Person directly or indirectly exercises a
controlling influence over the management or policies of
Bank or the Company.
A "Change of Control" shall be deemed not to have occurred if
such event is mandated or directed by a regulatory body having jurisdiction
over the Bank's operations.
A "Person" shall include a natural person, corporation, or other
entity. When two or more persons act as a partnership, limited partnership,
syndicate, or other group for the purpose of acquiring, holding or
disposing of Bank or Company capital stock, such partnership, syndicate or
group shall be considered a Person. Beneficial ownership shall be
determined under the then current provisions of Rule 13d-3 of the
Securities Exchange Act of 1934, as amended, Reg. Section 240.13d-3, or
their successor provision(s). The filing of a Form F-11 or F-11A by a
Person shall not in and of itself be deemed a Change of Control.
(d) If, after a Change of Control of the Bank or the Company, the
Executive incurs any fees and expenses of counsel to enforce this
Agreement, the Bank agrees to pay such fees and expenses to the Executive.
The
80
<PAGE>
Executive's choice of counsel and his decision to retain counsel shall be
in his discretion, provided any such fees and expenses must be reasonable.
(e) Notwithstanding any other provision of this Agreement or of any other
agreement, understanding or compensation plan, the Bank and the Company
shall not be obligated to pay any amounts the payment of which violate
restrictions imposed, or which may in the future be imposed, on such
payments by the Bank pursuant to Section 18(k)(1) of the Federal Deposit
Insurance Act, or any regulations or orders which are or may be promulgated
thereunder; nor shall any payments be made which would constitute an
"unsafe or unsound banking practice" pursuant to 12 U.S.C. Section 1818(b).
(f) It is expressly understood and agreed that payment of the Severance
Amount may not include amounts which are deemed to be "excess parachute
payments" under Section 280G of the Internal Revenue Code of 1986, as
amended. The calculation of the maximum Severance Amount shall be
performed by the Bank's independent auditing firm at the time of Change of
Control, or such other qualified party in the Bank's discretion; provided
that, if the maximum Severance Amount so determined is later challenged
successfully by Executive, by court decision or negotiation with the Bank,
the Bank and the Company shall be additionally liable for all costs and
expenses incurred by Executive in that challenge, including reasonable
attorney fees.
(g) This Agreement shall survive and continue for as long as the Executive
is a full-time officer of the Bank.
2. This Agreement contains the entire agreement between the parties with
respect to the subject matter herein, and there are no other representations,
warranties, conditions or agreements relating to the subject matter of this
Agreement.
3. This Agreement may not be changed orally but only by an agreement in
writing duly executed on behalf of the party against which enforcement of any
waiver, change, modification, consent or discharge is sought.
4. This Agreement shall be binding upon and inure to the benefit of the Bank,
the Company and the Executive and their respective successors, assigns, heirs
and legal representatives. Without otherwise limiting the foregoing, "Bank" and
"Company" as used herein shall refer to any successor institution whether by
merger, consolidation, acquisition or otherwise, and/or, except with respect to
the definition of "Change of Control", to any wholly-owned subsidiary of the
Bank or the Company.
5. Each of the parties agrees to execute all further instruments and documents
and to take all further action as the other parties may reasonably request in
order to effectuate the terms and purposes of this Agreement.
6. This Agreement may be executed in one or more counterparts, all of which
taken together shall constitute one and the same instrument.
7. This Agreement shall be construed pursuant to and in accordance with the
laws of the State of Connecticut.
8. If any term or provision of this Agreement is held or deemed to be invalid
or unenforceable, in whole or in part, by a court of competent jurisdiction,
such term or provision shall be ineffective to the extent of such invalidity or
unenforceability without rendering invalid or unenforceable the remaining terms
and provisions of this Agreement.
81
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement on the date
first above written.
MECHANICS SAVINGS BANK
By_____________________________________
Name: Edgar C. Gerwig
Title: President
MECH FINANCIAL, INC.
By_____________________________________
Name: Edgar C. Gerwig
Title: President
EXECUTIVE
_______________________________________
Gregory A. White
82
<PAGE>
MECH FINANCIAL, INC.
EXHIBIT 23.1
CONSENT OF PRICEWATERHOUSECOOPERS LLP
Consent of Independent Accountants
We consent to the incorporation by reference in the registration statement of
MECH Financial, Inc. on Form S-8 of our report dated January 20, 1998, on our
audit of the consolidated financial statements of Mechanics Savings Bank and
subsidiaries as of December 31, 1997, and for the years ended December 31, 1997
and 1996, which report is included in this Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
Hartford, Connecticut
March 23, 1999
83
<PAGE>
MECH FINANCIAL, INC.
EXHIBIT 23.2
CONSENT OF KPMG LLP
Consent of Independent Auditors
We consent to the incorporation by reference in the registration statement (No.
333-49191) on Form S-8 of MECH Financial, Inc. of our report dated January 19,
1999, except as to Note 17 which is as of February 8, 1999 and Note 23 which is
as of February 23, 1999, relating to the consolidated statement of condition of
MECH Financial, Inc. and subsidiaries as of December 31, 1998 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended, which report appears in the December 31, 1998 annual report
on Form 10-K of MECH Financial, Inc.
/s/ KPMG LLP
Hartford, Connecticut
March 23, 1999
84
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 20,567
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 1,420
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 205,711
<INVESTMENTS-CARRYING> 80,306
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<LOANS> 661,738
<ALLOWANCE> (12,301)
<TOTAL-ASSETS> 1,019,369
<DEPOSITS> 706,195
<SHORT-TERM> 27,000
<LIABILITIES-OTHER> 7,581
<LONG-TERM> 183,225
0
0
<COMMON> 53
<OTHER-SE> 95,315
<TOTAL-LIABILITIES-AND-EQUITY> 1,019,369
<INTEREST-LOAN> 47,758
<INTEREST-INVEST> 16,004
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<INTEREST-DEPOSIT> 24,199
<INTEREST-EXPENSE> 33,928
<INTEREST-INCOME-NET> 31,778
<LOAN-LOSSES> 600
<SECURITIES-GAINS> (16)
<EXPENSE-OTHER> 23,836
<INCOME-PRETAX> 15,966
<INCOME-PRE-EXTRAORDINARY> 15,966
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,696
<EPS-PRIMARY> 1.66
<EPS-DILUTED> 1.63
<YIELD-ACTUAL> 7.46
<LOANS-NON> 2,949
<LOANS-PAST> 0
<LOANS-TROUBLED> 677
<LOANS-PROBLEM> 20,517
<ALLOWANCE-OPEN> 14,031
<CHARGE-OFFS> 2,846
<RECOVERIES> 516
<ALLOWANCE-CLOSE> 12,301
<ALLOWANCE-DOMESTIC> 6,484
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 5,817
</TABLE>
