SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the fiscal year ended October 31, 1998
or
[ ] TRANSITIONAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
COMMISSION FILE NUMBER: 000-25077
SEACOAST FINANCIAL SERVICES CORPORATION
------------------------------------------------------
(Exact name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
Massachusetts 04-1659040
------------------------ ------------------------------------
(State of Incorporation) (IRS Employer Identification Number)
791 Purchase Street, New Bedford, Massachusetts 02740
- ----------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
(508) 984-6000
-------------------------------
(Registrant's Telephone Number)
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
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price on January 22, 1999, on the Nasdaq
National Market was $283,807,876. Although directors and executive officers of
the Registrant were assumed to be "affiliates" of the Registrant for the
purposes of this calculation, this classification is not to be interpreted as an
admission of such status.
As of January 22, 1999, 26,758,471 shares of the Registrant's common stock were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
<PAGE>
PART I
ITEM 1. BUSINESS
General
Until the completion of a mutual to stock conversion and initial public
offering of its stock on November 20, 1998, Seacoast Financial Services
Corporation (the "Company" or "Seacoast Financial") was a mutual holding company
created in connection with Compass Bank for Savings' (the "Bank" or "Compass")
reorganization into a mutual holding company form of organization in 1994. The
Company is registered with the Board of Governors of the Federal Reserve System
(the "FRB") as a bank holding company under the Bank Holding Company Act of
1956, as amended (the "BHCA"). Since its formation, the Company has owned 100%
of Compass's outstanding capital stock.
On December 4, 1998, the Company acquired by merger all of the issued and
outstanding capital stock of Sandwich Bancorp, Inc. ("Sandwich") in a
stock-for-stock exchange. Sandwich was a one-bank holding company with total
assets of $547.4 million as of October 31, 1998. This acquisition is being
accounted for as a pooling of interests. Since this transaction occurred
subsequent to the Company's fiscal year end of October 31, Sandwich's assets and
liabilities, stockholders' equity and results of operations are not reflected in
the historical financial statements and other financial data of the Company
presented herein.
Compass was organized in 1855 as a Massachusetts-chartered mutual savings
bank, and reorganized into mutual holding company form in 1994. Compass's
principal business has been, and continues to be, gathering deposits from
customers within its market area and investing those funds in residential and
commercial real estate loans, indirect automobile loans, commercial loans,
construction loans, home equity loans and other consumer loans and investment
securities. With an emphasis on commercial and commercial real estate lending as
well as its indirect auto loan program, management believes that Compass differs
from the typical savings bank. Savings banks normally concentrate to a greater
degree on residential mortgage lending. Compass's investment portfolio consists
primarily of U.S. Government and Agency securities, corporate debt obligations,
mortgage-backed securities and, to a lesser extent, marketable equity
securities. Individual and business customers of Compass have a variety of
deposit accounts with Compass, including NOW (checking) and other demand deposit
accounts, passbook savings accounts, money market deposit accounts, Individual
Retirement Accounts ("IRAs") and various certificates of deposit.
Compass's deposits are insured by the Bank Insurance Fund (the "BIF"), as
administered by the Federal Deposit Insurance Corporation (the "FDIC"), up to
the maximum amount permitted by law, except that certain deposits that Compass
acquired from a savings association are insured by the Savings Association
Insurance Fund (the "SAIF"), also administered by the FDIC. Deposit amounts in
excess of FDIC insurance limits are insured by the Depositors Insurance Fund
(the "DIF"), a deposit insuring entity for Massachusetts savings banks. Compass
is a voluntary member of the Federal Home Loan Bank of Boston (FHLB), which
serves principally as a credit source in providing funds for residential loans.
On January 28, 1999, the Board of Directors voted to change the Company's
yearend from October 31 to December 31.
Market Area and Competition
During the year ended October 31, 1998, Compass conducted business from its
corporate headquarters in New Bedford, Massachusetts and 23 full-service banking
offices, six of which are located in New Bedford and the remaining 17 of which
are located in the Massachusetts communities of Fall River (two offices),
Plymouth (three offices), Fairhaven, North Dartmouth, Somerset, Swansea,
Westport, Assonet and Carver and the island of Martha's Vineyard (five offices).
Compass also has two limited service high school branches and four remote
service ATMs. In addition, Compass's indirect auto lending business extends into
the state of Rhode Island through its subsidiary, Compass Credit Corporation.
Compass's merger with Sandwich Co-operative Bank ("Sandwich Bank") on December
4, 1998 added eleven full service branches, located primarily on Cape Cod.
1
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Compass faces significant competition both in generating loans and in
attracting deposits. Compass's primary market area is highly competitive and
Compass faces direct competition from a significant number of financial
institutions, many with a state-wide, a regional and, in some cases, a national
presence. Many of these financial institutions are significantly larger and have
greater financial resources than Compass. Compass's competition for loans comes
principally from commercial banks, savings banks, credit unions, mortgage
brokers, mortgage banking companies and insurance companies. Its most direct
competition for deposits has historically come from savings, cooperative and
commercial banks and credit unions, particularly in Fall River and New Bedford.
In addition, Compass faces increasing competition for deposits from non-bank
institutions, such as brokerage firms and insurance companies which offer
instruments like short-term money-market funds, corporate and government
securities funds, mutual funds and annuities. Competition may also increase as a
result of the lifting of restrictions on the interstate operations of financial
institutions. Finally, credit unions do not pay federal or state income taxes
and are generally subject to fewer regulatory constraints than savings banks.
Numerous credit unions are located in Fall River, New Bedford and Rhode Island
and, because of their tax and regulatory status, they enjoy a competitive
advantage over Compass.
Personnel
As of October 31, 1998, Compass had 324 full-time employees and 47
part-time employees. None of the Bank's employees are represented by a labor
union and management considers its relationship with its employees to be good.
Lending Activities
General. Compass's gross loan portfolio totaled $960.9 million as of
October 31, 1998, representing 76.0% of Compass's total assets on that date.
Compass primarily makes residential real estate loans secured by one- to
four-family residences, indirect auto loans and commercial real estate loans.
Such loans (net of unearned discounts) represented 40.1%, 31.7% and 13.1%,
respectively, of Compass's loan portfolio as of October 31, 1998. Compass
started making indirect auto loans in 1985 and, between October 31, 1995 and
October 31, 1998, that portion of Compass's loan portfolio grew by 118.7%.
Compass also makes home equity line of credit loans, residential and commercial
construction loans, commercial loans, fixed rate home equity loans, personal
installment loans, education loans and passbook loans. Real estate secures a
majority of Compass's loans as of October 31, 1998, including some loans
classified as commercial loans.
Compass makes loans throughout its market area and originated $363.7
million in loans during 1997 and $593.7 million in loans during 1998. It sold,
on a servicing retained basis, $33.7 million and $99.1 million in residential
loans in the secondary market during those same periods, respectively.
The types of loans that Compass may originate are subject to federal and
state law and regulations. Interest rates charged by Compass on loans are
affected primarily by the demand for such loans, the supply of money available
for lending purposes, secondary mortgage market rates and the rates offered by
competitors. These factors are, in turn, affected by national, regional and
local economic conditions, the levels of federal government spending and
revenue, monetary policies of the FRB and tax policies.
2
<PAGE>
The following table summarizes the composition of Compass's loan portfolio as of
the dates indicated:
<TABLE>
<CAPTION>
At October 31,
-----------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ----------------- ----------------- ----------------
Percent Percent Percent Percent Percent
Amount of total Amount of total Amount of total Amount of total Amount of total
---------------- ---------------- ------------------ ----------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential (one- to four-family)......$385,233 40.09% $363,030 44.26% $343,204 45.88% $336,489 49.78% $268,010 52.56%
Commercial (1)......................... 125,870 13.10 124,059 15.13 128,707 17.20 103,096 15.25 67,784 13.30
Home equity............................ 16,106 1.68 15,133 1.85 17,288 2.31 18,857 2.79 11,448 2.25
Construction, net...................... 41,042 4.27 33,894 4.13 25,007 3.34 15,877 2.35 14,844 2.91
-------- ------ -------- ------- -------- ------ -------- ------ -------- ------
Total real estate loans............ 568,251 59.14 536,116 65.37 514,206 68.73 474,319 70.17 362,086 71.02
-------- ------ -------- ------- -------- ------ -------- ------ -------- ------
Commercial loans......................... 59,916 6.24 51,371 6.26 46,211 6.18 43,402 6.42 20,763 4.07
-------- ------ -------- ------- -------- ------ -------- ------ -------- ------
Consumer loans:
Indirect auto loans.................... 342,266 35.62 238,114 29.03 189,865 25.38 159,433 23.58 125,667 24.65
Other.................................. 27,618 2.87 24,662 3.01 22,063 2.95 18,764 2.78 15,433 3.03
-------- -------- -------- -------- --------
Consumer loans..................... 369,884 262,776 211,928 178,197 141,100
Less: unearned discount................ 37,201 30,066 24,232 19,911 14,081
-------- -------- -------- -------- --------
Total consumer loans, net.......... 332,683 34.62 232,710 28.37 187,696 25.09 158,286 23.41 127,019 24.91
-------- ------ -------- ------- -------- ------ -------- ------ -------- ------
Total loans........................$960,850 100.00% $820,197 100.00% $748,113 100.00% $676,007 100.00% $509,868 100.00%
======== ====== ======== ======= ======== ====== ======== ====== ======== ======
</TABLE>
(1) In September 1996, Compass reclassified approximately $28.0 million in
multifamily loans from residential real estate to commercial real estate loans.
Corresponding prior-period reclassifications have not been made.
3
<PAGE>
Loan Origination and Underwriting. Loan officers based in each of Compass's
four regions -- Plymouth, Fall River, New Bedford and Martha's Vineyard --
originate and underwrite Compass's mortgage and commercial loans. Compass
recently added a fifth region (Cape Cod) as a result of its merger with Sandwich
Bank. Compass underwrites consumer loans at its main office, although it
originates such loans at its branches and, in the case of indirect auto loans,
through a network of car dealers. Compass also employs traveling loan
originators, based in each of the regions, who originate residential mortgage
loans. In August 1998, Compass began to fund adjustable rate residential
mortgage loans originated by loan correspondents. Through October 31, 1998,
Compass had funded $8.6 million of such loans.
Compass relies on print, radio, television and cable advertising, on
referrals from existing customers, accountants, attorneys and real estate
professionals and on relationships with existing borrowers to originate loans.
In addition, Compass solicits consumer loans, including home equity loans, by
direct mail to existing deposit and residential mortgage loan customers. Compass
tries to develop relationships with its customers in which customers see Compass
as a source of support in the management of their personal finances or in the
conduct of their businesses. Based on those relationships, many customers have
more than one account with and/or loan from Compass. Finally, Compass relies on
relationships with automobile dealers operating throughout its current market
area, Rhode Island and on Cape Cod to generate new indirect auto loans. The
dealers originate the loans, send loan applications to Compass and Compass
underwrites them.
Compass's underwriting of loans varies depending on the types of loan
underwritten. It generally includes the use of credit applications, property
appraisals and verification of an applicant's credit history, employment and
banking relationships to the extent management deems appropriate in each case.
Additional information concerning the underwriting of specific types of loans is
set forth in sections that discuss those loans and in the discussion of
environmental factors that affect lending. See "-- Lending Activities," "--
Residential Real Estate Loans," "-- Indirect Auto and Other Consumer Loans," "--
Commercial Real Estate Loans," "-- Commercial Loans," "-- Construction Loans"
and "-- Environmental Issues."
Four senior loan officers oversee loan origination and underwriting.
Individual loan officers may originate loans within certain approved lending
limits. A credit committee, consisting of senior loan officers, must approve all
commercial and commercial real estate loans that exceed $300,000 ($500,000
effective in December 1998) and Compass's Board of Directors or the executive
committee thereof must approve all loans over $750,000 ($1.5 million effective
in December 1998). Pursuant to its loan policy, Compass generally will not make
loans aggregating more than $5.0 million ($10 million effective in December
1998) to any one borrower. Exceptions to this "house" lending limit are approved
by the Board. At October 31, 1998, two customers had aggregate borrowing
capacity with Compass which exceeded the $5.0 limit, with outstanding loans (all
of which were performing in accordance with their terms), commitments and
amounts available under lines of credit totaling $7.6 million and $5.6 million
at that date.
4
<PAGE>
The following table sets forth certain information concerning Compass's
origination of loans:
<TABLE>
<CAPTION>
Year ended October 31,
------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Loans outstanding at beginning of period ...... $820,197 $748,113 $676,007
Loans originated:
Mortgage loans:
Residential (1) .............. 201,301 94,743 104,856
Commercial real estate (1) ... 19,330 12,292 21,761
Construction ................. 61,932 46,659 26,784
Home equity .................. 13,321 7,644 5,934
-------- -------- --------
Total mortgage loans . 295,884 161,338 159,335
Commercial loans ...................... 77,464 61,333 53,462
Indirect auto loans ................... 203,923 128,117 100,305
Other consumer loans .................. 16,444 12,877 13,518
-------- -------- --------
Total loans originated 593,715 363,665 326,620
-------- -------- --------
Purchases of mortgage loans ................... 11,911 4,461 8,859
Less:
Principal repayments .................. 362,938 257,049 224,612
Loans sold or securitized ............. 99,148 33,726 35,260
Transfers to other real estate owned .. 1,474 3,333 2,430
Principal charged-off ................. 1,413 1,934 1,071
-------- -------- --------
Loans outstanding at end of period ............ $960,850 $820,197 $748,113
======== ======== ========
</TABLE>
- --------------------------------------
(1) In September 1996, Compass reclassified as commercial real estate loans
approximately $28.0 million in multi-family loans that previously had been
classified as residential real estate.
Compass charges origination fees, or points, and collects fees to cover the
costs of appraisals and credit reports on most new residential mortgage loans.
Compass also collects late charges on real estate loans and prepayment premiums
on commercial mortgage loans. Compass generally charges availability fees on
lines of credit. For information regarding Compass's recognition of loan fees
and costs, see Note 1 of the Notes to the Consolidated Financial Statements of
Seacoast Financial and Subsidiary presented elsewhere herein.
Loan Purchases. Compass occasionally purchases participation interests in
commercial and residential real estate loans originated by other banks. Compass
underwrites such loans as if it had originated them itself. Compass's interest
in participation loans as of October 31, 1998 totaled $14.9 million, of which
$11.1 million was acquired from a bank located on the island of Nantucket,
Massachusetts.
5
<PAGE>
Loan Maturity and Repricing. The following table shows the contractual
maturity and repricing dates of Compass's loan portfolio at October 31, 1998.
The table does not reflect prepayments or scheduled principal amortization.
<TABLE>
<CAPTION>
At October 31, 1998
--------------------------------------------------------------------------------------
Real estate mortgage loans
---------------------------------------------- Other
Home Indirect consumer Total
Residential Commercial Construction equity Commercial auto loans loans loans
----------- ---------- ------------ --------- ----------- --------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Amounts due (1):
Within one year......................... $ 59,051 $ 40,504 $10,918 $13,233 $38,399 $ 6,062 $ 3,235 $171,402
-------- -------- ------- ------- ------- -------- ------- --------
After one year:
More than one year to three years.... 105,775 54,352 10,550 164 9,959 76,412 4,966 262,178
More than three years to five years.. 50,066 20,183 9,269 483 6,082 199,847 7,418 293,348
More than five years to ten years.... 45,856 7,573 1,503 2,041 5,378 22,744 9,816 94,911
More than ten years.................. 124,485 3,258 8,802 185 98 -- 2,183 139,011
-------- -------- ------- ------- ------- -------- ------- --------
Total due after October 31, 1999 326,182 85,366 30,124 2,873 21,517 299,003 24,383 789,448
-------- -------- ------- ------- ------- -------- ------- --------
Total amount due............... $385,233 $125,870 $41,042 $16,106 $59,916 $305,065 $27,618 960,850
======== ======== ======= ======= ======= ======== =======
Less:
Allowance for loan losses............ (11,006)
Net loans.......................... --------
$949,844
========
</TABLE>
- ------------------
(1) Amounts due are net of unadvanced funds on loans.
The following table sets forth, at October 31, 1998, the dollar amount of
gross loans, net of unadvanced funds on loans, contractually due or scheduled to
reprice after October 31, 1999 and whether such loans have fixed interest rates
or adjustable interest rates:
<TABLE>
<CAPTION>
Due after October 31, 1999
-------------------------------------
Fixed Adjustable Total
-------- ------------- ---------
(In thousands)
<S> <C> <C> <C>
Real estate mortgage loans:
Residential ................................... $168,259 $ 157,923 $ 326,182
Commercial .................................... 13,960 71,406 85,366
Construction .................................. 16,080 14,044 30,124
Home equity ................................... 2,873 -- 2,873
-------- --------- ---------
Total real estate mortgage loans ........... 201,172 243,373 444,545
-------- --------- ---------
Commercial loans ................................. 14,339 7,178 21,517
Indirect auto loans .............................. 299,003 -- 299,003
Other consumer loans ............................. 24,383 -- 24,383
-------- --------- ---------
Total loans ................................ $538,897 $ 250,551 $ 789,448
======== ========= =========
</TABLE>
Residential Real Estate Loans. As of October 31, 1998, adjustable rate
mortgage loans represented approximately 60% and fixed-rate mortgage loans
represented approximately 40% of Compass's portfolio of residential mortgage
loans secured by one- to four-family owner-occupied properties. Compass
originated $104.9 million, $94.7 million and $201.3 million of residential real
estate loans in 1996, 1997 and 1998, respectively. Compass's portfolio of
residential loans totaled $385.2 million, which represented 40.1% of Compass's
total loan portfolio at October 31, 1998. Over 90% of this portfolio is secured
by single-family owner-occupied homes and the remainder is secured primarily by
two-, three- or four-family owner-occupied homes.
Compass has generally sold most of the fixed-rate residential mortgage
loans it originates with terms of 15 years or longer to the Federal Home Loan
Mortgage Corporation ("FHLMC"). Compass is also authorized to sell loans to the
Federal National Mortgage Association ("FNMA") and to service those loans but
has not done so to date. Compass continues to service loans that it sells to
FHLMC and receives a monthly fee for servicing such loans equal to .25% per
6
<PAGE>
annum of the amounts outstanding on them. Compass serviced loans for others
aggregating $263.2 million as of October 31, 1998 and $204.2 million as of
October 31, 1997 and it earned $491,000 and $571,000 in servicing fees, net of
the amortization of capitalized mortgage servicing rights, representing 6.97%
and 9.61% of its non-interest income in 1998 and 1997, respectively.
Compass generally retains for its own portfolio fixed-rate residential
mortgage loans with terms of less than 15 years and fixed-rate residential
mortgage loans that are amortized on a bi-weekly basis and have terms between 10
and 30 years. Compass had $68.1 million of such loans in its portfolio as of
October 31, 1998. Compass also retains in its portfolio fixed-rate mortgage
loans that exceed the size limits of FHLMC's underwriting criteria, and loans
made under its program for low-to-moderate income borrowers, as described below.
Beginning in November 1998, Compass temporarily changed its practice and is
currently no longer selling its fixed rate residential mortgage loans. This
change was based on the Bank's assessment of the impact which the Sandwich
acquisition would have on the sensitivity of its balance sheet to changes in
interest rates. In assessing its options, the Bank concluded that, at this time,
the retention of fixed rate mortgages offered the best alternative as to yield
and duration. The Bank intends to continue this strategy so long as it does not
result in an interest rate risk exposure inconsistent with its stated policies.
Compass's asset liability strategy is reviewed quarterly and changes are
expected to be made to this practice when circumstances warrant. Based on the
current level of loan production, management believes that it will begin to sell
fixed rate mortgage originations later in 1999.
Compass originates adjustable-rate residential mortgage loans mostly for
its own portfolio. Compass originated $45.1 million and $42.1 million in such
loans during 1997 and 1998, respectively, and had $222.6 million of such loans
in its residential loan portfolio, representing approximately 60% of such
portfolio, as of October 31, 1998. Compass offers adjustable-rate mortgage loans
that reprice annually, every three years or after five years and annually
thereafter. The interest rate adjustments on these loans are indexed to the
applicable one-year or three-year U.S. Treasury CMT Index with corresponding
add-on margins of varying amounts. Such loans are subject to certain
requirements and limitations set forth in guidelines issued by the Commissioner
of Banks, including limitations on the amount and frequency of interest rate
changes. Rates adjust by no more than one or two percentage points in each
adjustment period and by no more than five or six points over the life of a
loan. Adjustable rate loans are generally originated at a discount, generally
ranging from 1.25% to 2.75%, from the fully margined index rate.
Compass's residential mortgage loans are generally written in amounts up to
95% of the appraised value or selling price, whichever is less, of the property
securing the loan, although the majority of such loans are written with ratios
of 80% or less. Compass generally requires borrowers to obtain private mortgage
insurance with respect to loans with a greater than 80% loan-to-value ratio.
In 1994, Compass initiated a program to originate residential mortgage
loans to low-to-moderate income borrowers. The loans have fixed or adjustable
interest rates that are typically lower than prevailing market rates, are closed
without points, have substantially lower closing costs than Compass's other
residential loans and have terms of up to 30 years. The loans may have up to a
95% loan-to-value ratio, although borrowers must obtain private mortgage
insurance if the loan-to-value ratio exceeds 80%. Compass does not sell these
loans in the secondary market. Compass partially funds the loans with borrowings
under the Community Investment Program ("CIP") and the New England Fund ("NEF")
housing programs of the FHLB. These programs permit Compass to borrow from the
FHLB at below market rates to finance the loans. Compass had $22.6 million of
CIP-funded loans and $18.4 million of NEF-funded loans in its residential loan
portfolio, representing 10.6% of such portfolio, as of October 31, 1998.
Commercial Real Estate Loans. Compass makes commercial real estate loans
throughout its market area. Compass originated $12.3 million and $19.3 million
in commercial real estate loans in 1997 and 1998, respectively, and had $125.9
million in commercial real estate loans in its loan portfolio, representing
13.1% of such portfolio, as of October 31, 1998.
Properties that are used for borrowers' businesses, such as small office
buildings, restaurants, inns, retail facilities or multi-family income
properties, normally collateralize Compass's commercial real estate loans. The
loans typically have terms of up to 20 years and interest rates which adjust
over periods of one to five years based on one of various
7
<PAGE>
rate indices. Commercial real estate loans with fixed interest rates have terms
ranging from one to ten years, with the most frequent term lasting from three to
five years.
Compass primarily considers the quality of the borrower's management and
the borrower's cash flows when it underwrites commercial real estate loans.
Compass generally makes commercial real estate loans in an amount equal to no
more than 80% of the appraised value of the property securing the loan. Compass
generally requires the owners of businesses seeking commercial real estate loans
to personally guarantee those loans.
At October 31, 1998, $23.1 million of the commercial real estate loans in
Compass's portfolio were secured by multi-family income properties. A majority
of these properties are located in Fall River and New Bedford and contain
between five and twelve units.
Commercial real estate lending entails greater credit risks than
residential mortgage lending to owner occupants. The repayment of commercial
real estate loans depends on the business and financial condition of the
borrower. Economic events and changes in government regulations, which Compass
and its borrowers cannot control, could have an adverse impact on the cash flows
generated by properties securing Compass's commercial real estate loans and on
the value of such properties. Commercial properties tend to decline in value
more rapidly than residential owner-occupied properties during economic
recessions.
Construction Loans. Compass makes both residential and commercial
construction loans, primarily in Plymouth County, in and around New Bedford and
on Martha's Vineyard. Compass typically makes the loans to owner-borrowers who
will occupy the properties (residential construction) and to licensed and
experienced developers for the construction of single-family home developments
(commercial construction). Developers build homes in Plymouth County to
accommodate a growing population that commutes to work in the Boston area. There
are few developments on Martha's Vineyard but individuals regularly build
secondary residences there.
Compass makes construction loans only to developers who have successful
track records. Compass generally increases the loan-to-value ratios on such
loans as construction progresses. Before any work has commenced, and while a
construction loan's only collateral is a plot of land, Compass will finance only
up to 70% of the value of that land. Once construction has begun, Compass will
generally make residential construction loans in amounts up to 90% (for primary
homes) and 80% (for secondary homes) of the lesser of the appraised value of the
property, as completed, or the property's cost of construction. Compass
generally makes commercial construction loans in amounts up to 75% of the lesser
of the property's appraised value, as completed, or construction cost and
generally requires developers seeking commercial construction loans to
personally guarantee them. Compass typically makes commercial construction loans
only to finance construction on developments that have no more than 20 housing
lots.
Compass disburses the proceeds of construction loans in stages and requires
developers to pre-sell a certain percentage of the properties they plan to build
before Compass will advance any construction financing. Compass officials
inspect each project's progress before Compass disburses additional funds to
verify that borrowers have completed project phases.
Residential construction loans to owner-borrowers generally convert to a
fully amortizing long-term mortgage loan upon completion of construction.
Commercial construction loans generally have terms of six months to a maximum of
two years. Some construction loans have fixed interest rates but Compass
originates mostly adjustable-rate construction loans.
Compass originated $46.7 million and $61.9 million in construction loans
during 1997 and 1998, respectively, and had $41.0 million in construction loans
in its loan portfolio, representing 4.3% of such portfolio, as of October 31,
1998.
Construction lending, particularly commercial construction lending, entails
greater credit risk than residential mortgage lending to owner occupants. The
repayment of construction loans depends on the business and financial condition
of the borrower and on the economic viability of the project financed. A number
of Compass's borrowers have more than one construction loan outstanding with the
Bank. Economic events and changes in government regulations, which Compass and
its borrowers cannot control, could have an adverse impact on the value of
properties securing
8
<PAGE>
construction loans and on the borrowers' ability to complete projects financed
and, if not the borrower's residence, sell them for expected amounts at the time
the projects were commenced.
Home Equity Loans. Compass has a portfolio of home equity lines of credit
secured by one- to four-family owner-occupied properties. These loans are
revolving lines of credit and are typically secured by second mortgages.
Interest rates on home equity loans normally adjust based on Compass's prime
rate of interest. The lines of credit are available for up to ten years, at the
end of which they become term loans which are amortized for the same amount of
time as the original loan. Compass originates home equity line of credit loans
in amounts from $10,000 to $150,000 but not, in any event, more than the
difference between 80% (for primary homes) or 70% (for secondary homes) of the
appraised value of the property securing the loan, or 70% (for primary homes) or
60% (for secondary homes) of the value of such property as assessed for tax
purposes, and the outstanding balance of the first mortgage on such property.
Compass had $16.1 million in home equity loans in its loan portfolio,
representing 1.7% of the portfolio, as of October 31, 1998. The undrawn portion
of home equity lines of credit totaled $18.1 million at October 31, 1998.
Commercial Loans. Compass primarily makes commercial loans to businesses
that operate in and around New Bedford and on Martha's Vineyard. During 1998,
Compass increased its efforts to originate more such loans in Plymouth and Fall
River by adding a commercial loan officer dedicated to each of those markets. As
a result of its recent merger with Sandwich Bank, Compass now also has
commercial loan officers dedicated to the Cape Cod market.
Compass reviews the financial resources, debt-to-equity ratios, cash flows
and its own experience with businesses when underwriting commercial loans.
Compass generally requires business owners to personally guarantee commercial
loans.
Compass's commercial loans are generally collateralized by equipment,
leases, inventory and/or accounts receivable. Many of Compass's commercial loans
are also collateralized by real estate, but are not classified as commercial
real estate loans because such loans are not made for the purpose of acquiring,
refinancing or constructing the real estate securing the loan. Commercial loans
provide, among other things, working capital, equipment financing, financing for
leasehold improvements and financing for acquisitions. Compass offers both term
and revolving commercial loans. The former have either fixed or adjustable rates
of interest and, generally, terms of between four and seven years. Term loans
generally amortize during their life, although some loans require a lump sum
payment at maturity. Revolving commercial lines of credit typically have
one-year terms, renewable annually, and rates of interest which adjust on a
daily basis. Such rates are normally indexed to Compass's prime rate of
interest.
Compass's commercial borrowers are not concentrated in any one particular
industry. As of October 31, 1998, Compass's outstanding commercial loans
included, among others, floor plan loans to auto dealerships, loans to hotels,
inns and other tourism-related businesses on Martha's Vineyard, loans to
building trade companies and loans to liquor stores.
Compass originated $61.3 million and $77.5 million in commercial loans
during 1997 and 1998, respectively, and had $59.9 million in commercial loans in
its loan portfolio, representing 6.2% of such portfolio, as of October 31, 1998.
Commercial lending entails greater credit risks than residential mortgage
lending to owner occupants. Repayment of both secured and unsecured commercial
loans depends substantially on the borrower's underlying business, financial
condition and cash flows. Unsecured loans generally involve a higher degree of
risk of loss than do secured loans because, without collateral, repayment is
wholly dependent upon the success of the borrower's business. Secured commercial
loans are generally collateralized by equipment, leases, inventory and/or
accounts receivable. Compared to real estate, such collateral is more difficult
to monitor, its value is harder to ascertain, it may depreciate more rapidly and
it may not be as readily saleable if repossessed.
Indirect Auto and Other Consumer Loans. Compass emphasizes indirect auto
lending through a network of automobile dealers, and was actively doing business
with approximately 100 dealers at October 31, 1998. Compass has been in the
indirect auto lending business since 1985 and has increased its portfolio of
indirect auto loans from $139.5 million at October 31, 1995 to $305.1 million at
October 31, 1998, or 31.7% (net of unearned discount) of the loan portfolio on
the latter date. No one dealership originated more than $12.9 million of the
loan balances outstanding in
9
<PAGE>
Compass's loan portfolio at October 31, 1998. In developing its network, Compass
has continued to focus on dealers in its primary market areas (including its new
market area of Cape Cod) and in Rhode Island. Since November 1996, a consumer
lending sales officer has been dedicated full time to serving existing dealers
in order to expand on those relationships and to develop potential new dealer
relationships. The growth of the dealer network has been achieved through an
emphasis on quality service and the development of long-term relationships with
the owners and managers of the dealerships. Since the program began, no dealer
has voluntarily ceased doing business with Compass. Compass does not currently
engage in auto lease financing.
Management believes that indirect auto lending has several advantages,
including the following: (i) the dealer network creates numerous "loan centers"
throughout Compass's market area; (ii) Compass can increase the network without
increasing its operating expenses significantly; and (iii) the network develops
a pool of customers to whom Compass can cross-sell other products and services.
Compass makes indirect auto loans to purchase both new and used cars. The
loans have terms of up to six years for those secured by new vehicles and five
and a half years for those secured by used vehicles. As of October 31, 1998,
approximately half of Compass's indirect auto loans were secured by new cars and
the other half by used cars. Compass originated $128.1 million and $203.9
million in indirect auto loans during 1997 and 1998, respectively.
To underwrite its indirect auto loans, Compass reviews the credit history
of applicants and determines appropriate debt-to-equity and loan-to-value
ratios. Compass also believes that the quality of its indirect auto portfolio is
positively affected by its efforts to build and maintain relationships with auto
dealers who attract creditworthy customers. Compass tries to identify such
dealers based on Compass's knowledge of car dealers in its market area.
In connection with the origination of indirect auto loans, the interest
rate charged to the borrower on the underlying loan is generally one to two
percentage points higher than the "buy rate" or rate earned by Compass. The
difference between the two rates is referred to as the "spread". At loan
inception, the dollar value of the spread over the contractual term of the loan
is prepaid by Compass to the auto dealer. Such prepaid amounts are generally
subject to rebate to Compass in the event the underlying loan is prepaid or
becomes delinquent. The risk of loss of amounts previously advanced to the
dealer is primarily dependent upon loan performance but is also dependent upon
the financial condition of the dealer. Consequently, the dealer's ability to
refund any portion of the prepaid interest which is unearned is subject to
economic conditions, generally, and the financial condition of the dealer. To
mitigate this risk, Compass withholds a portion of the spread at loan
origination as a dealer reserve. The amount withheld, in the aggregate,
generally approximates 1% of the outstanding balance of loans originated by each
dealer. At October 31, 1998, the balance of the dealer reserve was $4.2 million,
or 1.4% of the balance of indirect auto loans. Since its inception of indirect
auto lending in 1985, Compass has written-off interest spread prepaid to an auto
dealer on only one occasion and the loss was less than $50,000.
Beginning in January 1999, Compass implemented a new "tiered rate program"
wherein the buy rate offered to auto dealers is based on the credit bureau's
credit score for each borrower. Previously, the Bank offered a single rate for
all borrowers. This program is also being used by certain of the Bank's
competitors. By making this change, Compass intends to offer competitive rates
to attract lower risk credits while charging higher rates for higher risk
credits.
Indirect auto lending entails greater risks than residential mortgage
lending to owner occupants. Although Compass has not experienced significant
delinquencies in this portfolio to date, borrowers may be more likely to become
delinquent on an automobile loan than on a residential mortgage loan secured by
their primary residence. Moreover, automobiles depreciate rapidly and, in the
event of default, principal loss as a percent of the loan balance depends upon
the mileage and condition of the vehicle at the time of repossession, over which
Compass has no control.
Compass makes a variety of other consumer loans, including personal
installment loans, education loans, fixed-rate home equity loans, auto loans
directly to customers and passbook loans. Compass does not have any credit card
loans. Other consumer loans represented 2.9% of Compass's gross loan portfolio
as of October 31, 1998. Compass's fixed-rate home equity loans are
collateralized generally by second mortgages on residential properties. The
loans have terms of up to 15 years and are available in amounts up to $50,000.
Compass generally makes fixed-rate home equity loans that, together with any
first mortgage loans on the properties collateralizing such loans, have a
loan-to-value ratio of 80% or less (if the first mortgage is with another bank)
or up to 90% (if the first mortgage is with Compass).
10
<PAGE>
Environmental Issues
Compass encounters certain environmental risks in its lending. Under
federal and state environmental laws, lenders may become liable for the costs of
cleaning up hazardous materials found on properties securing their loans. In
addition, the presence of hazardous materials on such properties may make it
unattractive for Compass to foreclose on them. Also, the presence of
environmentally hazardous materials near but not on properties in which Compass
has a security interest may have a negative effect on the values of those
properties. Commercial real estate loans typically involve such risks but
multi-family and other residential real estate loans are also subject to them.
Compass has procedures for the assessment of environmental risks and it
believes that those procedures are adequate. Generally, before originating
commercial real estate loans in excess of $250,000, Compass requires prospective
borrowers to make a preliminary assessment of whether environmentally hazardous
materials are located on the properties that would collateralize such loans. If
a preliminary assessment raises concerns, Compass requires borrowers to conduct
further environmental analyses of the properties. Before originating a
commercial real estate loan below $250,000, a loan officer must review the
appraisal of the property that will collateralize the loan to make sure that the
borrower does not need to undertake a preliminary assessment of its
environmental condition.
Compass does not know of any environmental problems that might expose it to
any material liabilities. No assurance can be given, however, that the values of
properties securing loans in Compass's portfolio will not be adversely affected
by environmental risks.
Delinquent Loans, Other Real Estate Owned, Classification of Assets and Loan
Review
Delinquent Loans. Management performs a monthly review of all delinquent
loans with a principal balance in excess of $150,000. Compass's Collection
Department Manager discusses the status of each account with Lending Department
Managers, the Executive Vice President of Lending and Account Officers. In
addition, Compass's Board of Directors reviews delinquency statistics by loan
class on a monthly basis.
The actions taken with respect to delinquencies vary depending upon the
nature of the delinquent loans and the period of delinquency. Compass's
collection philosophy is predicated upon early detection and response to
delinquent and default situations. Compass seeks to make arrangements to cure
the entire default over the shortest time frame. Generally, Compass requires
that a delinquency notice be mailed no later than the 10th day of delinquency. A
second notice is mailed on the 15th day of delinquency. A late charge is usually
assessed on loans where the scheduled payment is unpaid after 15 days. After
mailing the delinquency notices, Compass's loan collection personnel call the
borrower to ascertain the reasons for delinquency and the prospects for payment.
On loans secured by one- to four-family owner occupied properties, Compass
attempts to work out a payment schedule with the borrower in order to avoid
foreclosure. If these efforts do not achieve a satisfactory arrangement, Compass
generally refers the loan to legal counsel and counsel initiates foreclosure
proceedings. At any time prior to a sale of the property at foreclosure, Compass
will terminate foreclosure proceedings if the borrower and Compass are able to
work out a satisfactory payment plan. On loans secured by commercial real estate
properties, Compass also seeks to reach a satisfactory payment plan so as to
avoid foreclosure. Prior to foreclosure, Compass will generally obtain an
updated appraisal of the property.
11
<PAGE>
The following table sets forth delinquencies in Compass's loan portfolio as of
the dates indicated:
<TABLE>
<CAPTION>
At October 31, 1998 At October 31, 1997
------------------------------------------ ----------------------------------------------
60-89 days 90 days or more 60-89 days 90 days or more
------------------ ------------------- ------------------- --------------------
Principal Principal Principal Principal
Number balance Number balance Number balance Number balance
of loans of loans of loans of loans of loans of loans of loans of loans
------- ------ ------- ------- ------- ------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential................... 13 $ 776 20 $1,372 6 $306 18 $1,463
Commercial real estate........ 3 350 6 601 1 116 8 1,205
Construction.................. -- -- -- -- -- -- 1 148
Home equity................... 2 46 3 125 -- -- 2 34
Commercial loans................ 5 33 3 7 1 75 2 344
Indirect auto loans............. 67 536 48 418 33 223 40 435
Other consumer loans............ 33 76 27 49 13 19 14 20
------- ------ ------- ------- ------- ------- -------- ------
Total........................ 123 $1,817 107 $2,572 54 $739 85 $3,649
======= ====== ======= ======= ======= ======= ======== ======
Delinquent loans to total loans. 0.19% 0.27% 0.09% 0.44%
====== ======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
At October 31, 1996
---------------------------------------------
60-89 days 90 days or more
---------------------- ----------------------
Principal Principal
Number balance Number balance
of loans of loans of loans of loans
------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage loans:
Residential................... 17 $ 885 31 $2,100
Commercial real estate........ 3 613 11 1453
Construction.................. -- -- 1 147
Home equity................... 2 72 1 16
Commercial loans................ 1 102 8 620
Indirect auto loans............. 24 180 43 339
Other consumer loans............ 10 14 5 9
------- ------ ------- -------
Total........................ 57 $1,866 100 $4,684
======= ====== ======= =======
Delinquent loans to total loans. 0.25% 0.63%
====== =======
</TABLE>
Other Real Estate Owned. Compass classifies property acquired through
foreclosure or acceptance of a deed in lieu of foreclosure as OREO in its
financial statements. When a property is placed in OREO, the excess of the loan
balance over the estimated fair market value of the collateral is charged to the
allowance for loan losses. Estimated fair value usually represents the sales
price a buyer would be willing to pay on the basis of current market conditions,
including normal loan terms from other financial institutions, less estimated
costs to sell the property. Management inspects all OREO properties
periodically. Subsequent write down in the carrying value of OREO are charged to
expense if the carrying value exceeds the OREO's fair value less estimated
selling costs.
At October 31, 1998, OREO totaled $1.0 million, the majority of which
consisted of properties sold by Compass from its OREO portfolio to buyers,
financed by Compass, whose cash down payments were insufficient under GAAP to
permit such transactions to be accounted for as a sale. There were eleven loans
in this category all of which were substantially current at October 31, 1998.
12
<PAGE>
Classification of Assets and Loan Review. Compass uses an internal rating
system to monitor and evaluate the credit risk inherent in its loan portfolio.
At the time of loan approval, all commercial, commercial real estate and
commercial construction loans are assigned a rating based on all of the factors
considered in originating the loan. The initial loan rating is recommended by
the loan officer who originated the loan and approved by the individuals or
committee responsible for approving it.
Loan quality ratings are utilized as major criteria in the compilation of
Compass's Asset Watch List. All loans with loan ratings of 4 (Special Mention),
5 (Substandard) or 6 (Doubtful) are included in a monthly Asset Watch List.
Watch List ratings are an integral part of the evaluation of the adequacy of
Compass's loan loss reserve. Loan officers are expected to submit appropriate
rating changes to the Lending Administration Officer when facts come to their
attention that warrant an upgrade or downgrade in a loan rating. In addition,
loan ratings are generally reviewed on an annual basis.
Loans that are rated Substandard or Doubtful coincide with the
classifications used by federal regulators in their examination of financial
institutions. Generally, an asset is considered Substandard if it is
inadequately protected by the current net worth and paying capacity of the
obligors and/or the collateral pledged. Substandard assets include those
characterized by the distinct possibility that Compass will sustain some loss if
the deficiencies are not corrected. Assets classified as Doubtful have all the
weaknesses inherent in those classified Substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, highly questionable and
improbable. Assets classified as Loss are those considered uncollectible and of
such little value that their continuance as assets without establishment of a
specific loss reserve and/or charge-off is not warranted. Assets which do not
currently expose Compass to sufficient risk to warrant classification in one of
the aforementioned categories but possess weaknesses are designated "Special
Mention."
Compass has established a policy that an independent third party conduct a
semi-annual credit analysis of its commercial and commercial real estate loan
portfolios. The level of Classified Assets as determined by Compass is
reconciled to the level of Classified Assets as determined by the independent
loan review. The independent loan review also analyzes trends in loan
delinquency and non-performing loans.
On a quarterly basis, a management group comprised of the Senior Vice
President and Treasurer, the Executive Vice President of Lending and other key
officers reviews the status and classification of each loan assigned a rating of
Substandard, Doubtful or Loss. Loans, or portions of loans, classified Loss are
charged off against the reserve for loan losses. This group also assesses the
overall adequacy of the allowance for loan losses, including the general
valuation allowance established to recognize the inherent risk associated with
each specific category of lending.
Compass's classification of its loans and the amount of the valuation
allowances it sets aside for estimated losses is subject to review by the FDIC
and the Commissioner. Based on their reviews, these agencies can order the
establishment of additional general or specific loss allowances. The FDIC, in
conjunction with the other federal banking agencies, has adopted an interagency
policy statement on allowances for loan and lease losses. The policy statement
provides guidance for banks on both the responsibilities of management for the
assessment and establishment of adequate allowances and guidance for banking
agency examiners to use in determining the adequacy of a bank's valuation
methodology. Generally, the policy statement recommends that banks have
effective systems and controls to identify, monitor and address asset quality
problems; that management analyze all significant factors that affect the
collectibility of loans in a reasonable manner; and that management establish
acceptable valuation processes that meet the objectives set forth in the policy
statement. While Compass believes that it has established adequate specific and
general allowances for losses on loans, there can be no assurance that the
regulators, in reviewing Compass's loan portfolio, will not request Compass to
materially increase its allowances for losses, thereby negatively affecting
Compass's financial condition and earnings. Moreover, actual losses are
dependent upon future events and, as such, further additions to the allowance
for loan losses may become necessary. See "-- Allowance for Loan Losses."
At October 31, 1998, loans designated as Substandard and Special Mention
totaled $5.1 million and $6.5 million, respectively. No loans were designated
Doubtful or Loss. The Substandard loans include 7 commercial loans with
individual borrower balances ranging from $1,000 to $600,000 and a total
outstanding principal balance of $885,000 and 20 commercial real estate loans
with individual borrower balances ranging from $52,000 to $770,000 and a total
outstanding principal balance of $4.2 million. All of the commercial loans
classified as Substandard at October 31, 1998 were substantially current. The
delinquency status of the commercial real estate loans classified as Substandard
was
13
<PAGE>
as follows: current -- $3,407,000; 30-60 days past due -- $191,000; 60-90 days
past due -- $0; and >90 days past due -- $559,000.
Included in Special Mention loans at October 31, 1998 were 13 commercial
loans with individual borrower balances ranging from $15,000 to $2.8 million and
a total outstanding principal balance of $3.7 million. The largest borrower was
an auto dealership whose floor plan loans were current. There were 15 commercial
real estate loans with individual borrower balances ranging from $35,000 to
$570,000 and a total outstanding principal balance of $2.8 million classified as
Special Mention at October 31, 1998. Of these, all but $243,000 were either
current or less than 60 days past due.
Non-Accrual Loans, Non-Performing Assets and Restructured Loans
The following table sets forth information regarding non-accrual loans,
other real estate owned and restructured loans:
<TABLE>
<CAPTION>
At October 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual loans (1):
Mortgage loans:
Residential................................... $ 2,060 $ 1,531 $ 2,330 $ 3,123 $ 6,827
Commercial real estate........................ 2,056 8,501 6,835 4,115 6,997
Construction.................................. -- 148 147 107 269
Home equity................................... -- -- -- 63 --
Commercial loans.................................. 309 745 1,014 1,098 1,078
Indirect auto loans (4)........................... -- -- -- -- --
Other consumer loans (4).......................... -- -- -- -- --
------- ------- ------- ------- -------
Total non-accrual loans....................... 4,425 10,925 10,326 8,506 15,171
Other real estate owned.............................. 1,011 1,707 2,598 3,918 5,798
------- ------- ------- ------- -------
Total non-performing assets................... $ 5,436 $12,632 $12,924 $12,424 $20,969
======= ======= ======= ======= =======
Restructured loans (2)............................... $ -- $ 130 $ 4,267 $ 3,119 --
======= ======= ======= ======= =======
Allowance for loan losses as a percent of total loans 1.15% 1.30% 1.38% 1.46% 1.37%
Allowance for loan losses as a percent of total
non-performing loans (3).......................... 248.72% 97.41% 100.08% 115.80% 46.15%
Non-performing loans as a percent of total loans..... 0.46% 1.33% 1.38% 1.26% 2.98%
Non-performing assets as a percent of total assets... 0.43% 1.14% 1.26% 1.26% 2.65%
</TABLE>
(1) Non-accrual loans include all loans 90 days or more past due and other
loans which have been identified by Compass as presenting uncertainty with
respect to the collectibility of interest or principal. See Note 4 for
exception to this policy.
(2) Restructured loans represent performing loans for which concessions (such
as reductions of interest rates to below market terms and/or extension of
repayment terms) have been granted due to borrower's financial condition.
(3) Non-performing loans are comprised of non-accrual loans.
(4) Consumer loans, including indirect auto loans, are not placed on
non-accrual status due to the expedited manner in which these loans are
resolved and the immaterial balance of individual loans.
During 1998, the balance of non-accrual loans decreased by $6.5 million.
The majority of this decrease is attributable to two loan relationships. In one
instance, the loan was repaid and, in the other, the borrower, whose payments
have been current, has shown improved operating performance sufficient to
warrant an upgrade in loan classification and placement on accrual status.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan
losses based on management's on-going evaluation of the risks inherent in
Compass's loan portfolio. Factors considered in the evaluation process include
14
<PAGE>
growth of the loan portfolio, the risk characteristics of the types of loans in
the portfolio, geographic and large borrower concentrations, current regional
economic and real estate market conditions that could affect the ability of
borrowers to pay, the value of underlying collateral and trends in loan
delinquencies and charge-offs. The allowance for loan losses is maintained at an
amount management considers adequate to cover estimated losses in its loan
portfolio which are deemed probable and estimable based on information currently
know to management. See "-Delinquent Loans, Other Real Estate Owned,
Classification of Assets and Loan Review."
The following table sets forth the activity in Compass's allowance for
loan losses for the periods indicated:
<TABLE>
<CAPTION>
Year ended October 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ -------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.................... $10,642 $10,334 $ 9,850 $7,002 $ 6,000
Provision (credit) for loan losses................ 1,402 1,865 1,166 (351) 2,524
Acquired allowance................................ -- -- -- 3,541 --
Charge-offs:
Mortgage loans:
Residential................................ 213 137 130 721 1,033
Commercial................................. 358 761 250 150 661
Home equity................................ -- -- 121 -- --
Construction............................... -- -- -- -- --
Commercial loans............................. 142 442 134 51 33
Indirect auto loans.......................... 614 546 373 227 191
Other consumer loans......................... 86 48 63 83 93
------- ------- ------- ------ -------
Total charge-offs...................... 1,413 1,934 1,071 1,232 2,011
------- ------- ------- ------ -------
Recoveries:
Mortgage loans:
Residential................................ 27 30 17 271 335
Commercial................................. 31 117 174 485 34
Home equity................................ -- -- -- -- --
Construction............................... -- -- -- -- --
Commercial loans............................... 164 57 96 2 28
Indirect auto loans............................ 113 144 70 93 69
Other consumer loans........................... 40 29 32 39 23
------- ------- ------- ------ -------
Total recoveries....................... 375 377 389 890 489
------- ------- ------- ------ -------
Net charge-offs................................... (1,038) (1,557) (682) (342) (1,522)
------- ------- ------- ------ -------
Balance at end of period.......................... $11,006 $10,642 $10,334 $9,850 $ 7,002
======= ======= ======= ====== =======
Ratio of net charge-offs
to average loans............................... 0.12% 0.20% 0.10% 0.05% 0.32%
======= ======= ======= ====== =======
</TABLE>
15
<PAGE>
The following tables set forth the allocation of Compass's allowance for
loan losses, the percent of allowance by loan category and the percent of loans
to total loans in each of the categories listed at the dates indicated:
<TABLE>
<CAPTION>
At October 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- ------------------------------ ------------------------------
Percent Percent Percent
of loans of loans of loans
Percent of in each Percent of in each Percent of in each
allowance category allowance category allowance category
to total to gross to total to gross to total to gross
Amount allowance loans Amount allowance loans Amount allowance loans
------ --------- ----- ------ --------- ----- ------ --------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential............ $ 1,992 18.10% 40.09% $ 1,929 18.13% 44.26% $ 2,171 21.01% 45.88%
Commercial real estate. 3,619 32.88 13.10 4,313 40.53 15.13 4,036 39.06 17.20
Construction........... 431 3.92 4.27 338 3.18 3.34
Home equity............ 146 1.33 1.68 136 1.28 1.85 149 1.44 2.31
Commercial loans.......... 1,620 14.72 6.24 1,785 16.77 6.26 1,972 19.08 6.18
Indirect auto loans....... 2,837 25.77 31.75 1,837 17.26 25.36 1,498 14.50 22.14
Other consumer loans...... 361 3.28 2.87 304 2.85 3.01 257 2.48 2.95
--------- -------- -------- -------- -------- ------- --------- -------- ---------
Total.................. $ 11,006 100.00% 100.00% $ 10,642 100.00% 100.00% $ 10,334 100.00% 100.00%
========= ======== ======== ======== ======== ======= ========= ======== =========
</TABLE>
<TABLE>
<CAPTION>
At October 31,
----------------------------------------------------------------
1995 1994
-------------------------------- ------------------------------
Percent Percent
of loans of loans
Percent of in each Percent of in each
allowance category allowance category
to total to gross to total to gross
Amount allowance loans Amount allowance loans
------ --------- ----- ------ --------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential............ $ 2,764 28.06% 49.78% $ 2,384 34.05% 52.56%
Commercial real estate. 2,808 28.51 15.25 1,827 26.09 13.30
Construction........... 318 3.23 2.35 315 4.50 2.91
Home equity............ 418 4.25 2.79 170 2.43 2.25
Commercial loans.......... 1,883 19.11 6.42 975 13.92 4.07
Indirect auto loans....... 1,403 14.25 20.63 1,123 16.04 21.88
Other consumer loans...... 255 2.59 2.78 208 2.97 3.03
-------- -------- -------- ------- -------- -------
Total.................. $ 9,850 100.00% 100.00% $ 7,002 100.00% 100.00%
======== ======== ======== ======= ======== =======
</TABLE>
16
<PAGE>
Investment Activities
The investment policy of Compass is reviewed and updated by senior management
and submitted to the Board of Directors for their approval on an annual basis.
The primary objective of the investment portfolio is to achieve a competitive
rate of return on the investments over a reasonable period of time based on
prudent management practices and sensible risk taking. In view of Compass's
lending capacity and generally higher rates of return on loans, management
prefers lending activities as its primary source of revenue with the securities
portfolio serving a secondary role. The investment portfolio, however, is
expected to continue to represent a significant portion of Compass's assets,
with such portfolio consisting of U.S. Government and Agency securities,
mortgage-backed securities, high quality corporate debt obligations and a
limited amount of corporate equities. The portfolio will continue to serve
Compass's liquidity needs as projected by management and as required by
regulatory authorities.
Compass's current investment strategy, developed with the assistance of an
outside professional advisor, has emphasized the purchase of U.S. Government and
Agency obligations and corporate debt obligations generally maturing within two
to three years and with weighted average lives of 7-10 years. Compass's
investment policy permits investments in mortgage-backed securities which are
traditionally long-term assets. However, the policy limits Compass's investment
in these types of securities to 25% of total assets. A substantial portion of
the mortgage-backed securities held at October 31, 1998 were backed by loans
originated by and securitized by Compass and placed in the securities portfolio
for the purpose of providing liquidity.
The investment policy prohibits the use of hedging with such instruments as
financial futures, interest rate options and swaps without specific approval
from Compass's Board of Directors. The President and Chief Executive Officer,
the Executive Vice President and Chief Operating Officer and the Senior Vice
President and Treasurer are authorized to execute portfolio transactions but are
limited in the amount they can purchase without Board approval. Portfolio sales
require the approval of any two of these three officers regardless of the
amount. It is the responsibility of Compass's Board of Directors to ensure
compliance with the investment policy and report such activity to Seacoast
Financial's Board. The status of Compass's investment portfolio is reviewed by
Compass's Board of Directors on a monthly basis and by Seacoast Financial's
Board on a quarterly basis.
At October 31, 1998, Compass had $196.7 million, or 15.56% of total assets,
in securities consisting primarily of U.S. Government and Agency obligations
($96.6 million), corporate obligations ($47.4 million), mortgage-backed
securities ($33.3 million), other bonds and obligations ($1.0 million) and
marketable common and preferred equity securities ($13.1 million). Also included
in investments is $5.3 million in restricted equity securities, $4.9 million of
which is in the stock of the FHLB. To avail itself of services offered by that
organization, in particular the ability to borrow funds, Compass is required to
invest in the stock of the FHLB in an amount determined on the basis of
Compass's residential mortgage loans and borrowings from the FHLB. The stock is
redeemable at par and earns dividends at the discretion of the FHLB.
SFAS No. 115 requires Compass to designate its securities as held to
maturity, available for sale or trading depending on Compass's intent regarding
its investments at the time of purchase. As of October 31, 1998, $177.7 million,
or 90.35% of the portfolio, was classified as available for sale, $13.7 million,
or 6.96% of the portfolio, was classified as held for investment and $5.3
million, or 2.69% of the portfolio, was invested in restricted equity
securities. The net unrealized gain on securities classified as available for
sale was $4.1 million, with $1.7 million of that amount attributable to
marketable equity securities as of October 31, 1998.
U.S. Government and Agency Obligations. At October 31, 1998, Compass's U.S.
Government and Agency securities portfolio totaled $96.6 million, $82.9 million
of which was classified as available for sale and $13.7 million of which was
classified as held to maturity. There were no structured notes in the portfolio.
Corporate Obligations. At October 31, 1998, Compass's portfolio of
corporate obligations totaled $47.4 million, all of which was classified as
available for sale. Compass policy requires that investments in corporate
obligations be restricted only to those obligations rated "A" or better by a
nationally recognized rating agency at the time of purchase and are confined
only to those obligations that are readily marketable. As of October 31, 1998,
$36.0 million of Compass's investments in corporate obligations were invested in
finance bonds, $7.4 million in industrial bonds, $2.0 million in public utility
bonds and $2.0 million in bank and trust company bonds. As of October 31, 1998,
all corporate obligations were rated "A" or better.
17
<PAGE>
Mortgage-Backed Securities. At October 31, 1998, Compass's portfolio of
mortgage-backed securities totaled $33.3 million. Such securities are guaranteed
by the Government National Mortgage Association, FNMA and FHLMC. All
mortgage-backed securities were classified as available for sale.
Mortgage-backed securities generally yield less than the loans that underlie
such securities because of the cost of payment guarantees or credit enhancements
that reduce credit risk. Mortgage-backed securities are more liquid than
individual mortgage loans and may be used to collateralize borrowings.
Other Bonds and Obligations. At October 31, 1998, Compass's portfolio of
other bonds and obligations totaled $1.0 million, which was invested in a U.S.
dollar denominated bond of a Canadian issuer having a quality rating of "A."
Marketable Equity Securities. At October 31, 1998, Compass's marketable
equity securities portfolio totaled $13.1 million, $7.2 million of which was in
common stock, $5.4 million in preferred stock and $468,000 in mutual funds.
Compass's policy requires that investments in common stock be confined to
quality issuers that have a past record of profitability and growth with the
prospect of continued performance. The policy requires that Compass makes
investments in common stocks that are liquid and traded on major exchanges, and
that a reasonable and prudent industry distribution of common stocks be
maintained in the portfolio and held for the long-term. Compass does not view
short-term trading, short sales, margin transactions and option speculation as
prudent investment policy objectives and does not permit them. Investments in
preferred stocks, including money market preferred, auction preferred and
adjustable-rate preferred, are subject to similar quality ratings and activities
as common stocks. As of October 31, 1998, Compass held 90,000 shares of Sandwich
common stock in its portfolio having a market value of $4.8 million and an
unrealized gain of $515,000. In connection with the acquisition of Sandwich by
Seacoast Financial in December 1998, these shares were canceled. Included in
surplus at October 31, 1998 is $309,000 in unrealized gain, net of taxes, on
such shares of Sandwich common stock.
18
<PAGE>
The following table sets forth certain information regarding the amortized
cost and market value of Seacoast Financial's investment portfolio at the dates
indicated:
<TABLE>
<CAPTION>
At October 31,
-------------------------------------------------------------
1998 1997 1996
------------------ ------------------- ------------------
Amortized Market Amortized Market Amortized Market
cost value cost value cost value
-------- -------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale:
Debt securities:
U.S. Government and
Agency obligations................... $ 81,638 $ 82,918 $113,231 $113,496 $111,861 $111,613
Corporate obligations.................. 46,771 47,424 44,773 44,966 22,632 22,520
Mortgage-backed
securities........................... 32,840 33,288 45,652 46,157 64,760 64,650
Other bonds and
obligations.......................... 1,000 1,001 1,001 1,001 --- ---
-------- -------- -------- -------- -------- --------
Total debt securities.............. 162,249 164,631 204,657 205,620 199,253 198,783
-------- -------- -------- -------- -------- --------
Marketable equity securities:
Common stocks.......................... 5,466 7,190 859 2,391 762 1,450
Preferred stocks....................... 5,400 5,400 1,000 1,000 --- ---
Mutual funds........................... 472 468 305 305 73 73
-------- -------- -------- -------- -------- --------
Total marketable
equity securities.................. 11,338 13,058 2,164 3,696 835 1,523
-------- -------- -------- -------- -------- --------
Total securities
available for sale................. $173,587 $177,689 $206,821 $209,316 $200,088 $200,306
======== ======== ======== ======== ======== ========
Securities held to maturity:
U.S. Government and
Agency obligations................... $ 13,694 $ 13,980 $ 12,633 $ 12,694 $ 11,752 $ 11,744
-------- -------- -------- -------- -------- --------
Total securities held
to maturity....................... $ 13,694 $ 13,980 $ 12,633 $ 12,694 $ 11,752 $ 11,744
======== ======== ======== ======== ======== ========
Restricted equity securities:
Federal Home Loan Bank
of Boston stock...................... $ 4,856 $ 4,856 $ 4,726 $ 4,726 $ 4,215 $ 4,215
Massachusetts Savings Bank
Life Insurance Company stock......... 251 251 251 251 251 251
Depositors Insurance Fund.............. 179 179 179 179 179 179
-------- -------- -------- -------- -------- --------
Total restricted equity
securities......................... $ 5,286 $ 5,286 $ 5,156 $ 5,156 $ 4,645 $ 4,645
======== ======== ======== ======== ======== ========
</TABLE>
19
<PAGE>
The following table sets forth certain information regarding the amortized
cost and market value of Seacoast Financial's investment portfolio at the dates
indicated:
<TABLE>
<CAPTION>
At October 31,
-----------------------------------------------------------
1998 1997 1996
----------------- ----------------- -------------------
Carrying Percent Carrying Percent Carrying Percent
value of total value of total value of total
-------- ------ -------- ------ -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Debt securities:
U.S. Government and
agency obligations................ $ 96,612 49.12% $126,129 55.54% $123,365 56.93%
Corporate obligations................. 47,424 24.11 44,966 19.80 22,520 10.39
Mortgage-backed
securities........................ 33,288 16.93 46,157 20.32 64,650 29.83
Other bonds and
obligations....................... 1,001 0.51 1,001 0.44 --- ---
-------- ------ -------- ------ -------- ------
Total debt securities......... 178,325 90.67 218,253 96.10 210,535 97.15
Marketable equity securities............. 13,058 6.64 3,696 1.63 1,523 0.71
Restricted equity securities............. 5,286 2.69 5,156 2.27 4,645 2.14
-------- ------ -------- ------ -------- ------
Total securities.............. $196,669 100.00% $227,105 100.00% $216,703 100.00%
======== ====== ======== ====== ======== ======
Debt and equity securities
available for sale.................... $177,689 90.35% $209,316 92.17 $200,306 92.43%
Debt securities held to
maturity.............................. 13,694 6.96 12,633 5.56 11,752 5.43
Restricted equity securities............. 5,286 2.69 5,156 2.27 4,645 2.14
-------- ------ -------- ------ -------- ------
Total securities.............. $196,669 100.00% $227,105 100.00% $216,703 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
20
<PAGE>
The following table sets forth certain information regarding the carrying
value, weighted average yield and contractual maturities of Seacoast Financial's
investment portfolio as of October 31, 1998:
<TABLE>
<CAPTION>
After one year After five years
One year or less through five years through ten years After ten years Total
------------------ ---------------- ----------------- ---------------- -----------------
Weighted Weighted Weighted Weighted Weighted
Carrying average Carrying average Carrying average Carrying average Carrying average
value yield value yield value yield value yield value yield
-------- --------- ---------------- -------- -------- -------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
Debt securities:
U.S. Government and
Agency obligations......... $ 17,758 5.78% $ 44,868 6.06% $ 20,292 6.20% $ -- -- $ 82,918 6.03 %
Corporate obligations........ 12,063 6.09 33,296 6.35 2,065 6.09 -- -- 47,424 6.28
Mortgage-backed securities... 1,196 6.77 9,545 6.67 94 9.43 22,453 6.27 33,288 6.41
Other bonds and obligations.. -- -- 1,001 6.39 -- -- -- -- 1,001 6.39
-------- -------- -------- -------- ---------
Total debt securities...... 31,017 5.94 88,710 6.24 22,451 6.20 22,453 6.27 164,631 6.18
Marketable equity securities:
Common stocks................ 7,190 4.18
Preferred stocks............. 5,400 6.11
Mutual Funds................. 468 4.70
---------
Total marketable
equity securities....... 13,058 4.99
-------- -------- -------- -------- ---------
Total securities available
for sale................ 31,017 5.94 88,710 6.24 22,451 6.20 22,453 6.27 177,689 6.10
-------- -------- -------- -------- ---------
Securities held to maturity:
U.S. Government and
Agency obligations......... 2,329 6.11 11,365 5.82 -- -- -- -- 13,694 5.87
-------- -------- -------- -------- ---- ---------
Total securities held to
maturity................... 2,329 6.11 11,365 5.82 -- -- -- -- 13,694 5.87
-------- -------- -------- -------- ---- ---------
Restricted equity securities:
Federal Home Loan
Bank of Boston stock....... 4,856 6.30
Massachusetts Savings
Bank Life Insurance .......
Company stock.............. 251 2.98
Depositors Insurance Fund.... 179 5.60
---------
Total restricted equity
securities............. 5,286 6.12
Total securities............. $ 33,346 5.96% $100,075 6.19% $ 22,451 6.20% $ 22,453 6.27% $ 196,669 6.08 %
======== ======== ======== ======== =========
</TABLE>
Sources of Funds
- ----------------
General. Compass uses deposits, repayments and prepayments of loans,
proceeds from sales of loans and securities and proceeds from maturing
securities, borrowings and cash flows generated by operations to fund its
lending, investing and general operations. Deposits represent Compass's primary
source of funds.
Deposits. Compass offers a variety of deposit accounts with a range of
interest rates and other terms. The accounts include passbook savings accounts,
NOW accounts (checking), demand deposit accounts, money market deposit accounts,
club accounts and certificates of deposit. Compass also offers IRA's, Roth/IRA,
Education IRA and Simple IRA accounts and SEP accounts. Both individuals and
commercial enterprises maintain accounts with Compass. The FDIC insures deposits
up to certain limits (generally, $100,000 per depositor). The DIF fully insures
amounts in excess of such limits.
21
<PAGE>
At October 31, 1998, Compass's deposits of $1,064.5 million were comprised
of $70.8 million of non-interest-bearing checking accounts and $993.7 million of
interest-bearing deposit accounts, of which $527.3 million, or 53.1% were
certificates of deposit. Of this total of certificates of deposit at October 31,
1998, $437.0 million, or 82.9% were scheduled to mature within one year.
However, based on Compass's monitoring of historical trends, its current pricing
strategy for deposits and its avoidance of brokered deposits, management
believes that Compass will retain a significant portion of its certificates of
deposit accounts upon maturity.
Deposit flows are influenced greatly by economic conditions, the general
level of interest rates and the relative attractiveness of competing deposit and
investment alternatives. During the past few years, the strength of the stock
market has affected deposit flows within the banking industry as some customers
have opted to place their funds in instruments -- such as mutual funds -- not
directly offered by Compass (other than through its affiliation with INVEST
Financial Corporation), rather than in deposit accounts which they perceive to
have less attractive returns.
Compass competed for deposits in four distinct market areas during 1998 --
New Bedford, Fall River, Plymouth and Martha's Vineyard. Compass has experienced
steady deposit inflows during the last three years, primarily influenced by
regional bank consolidations and its strong community bank image. Compass's
strategy has been to grow deposit levels through targeted promotions, branch
expansion and bank acquisition. Compass has expanded its presence in Plymouth
with one new branch opened in 1995 and another in May 1998. In addition, Compass
improved its presence in the town of Westport with an upgraded branch in July
1998. Compass's merger with Sandwich Bank in December 1998 added eleven new
branches, nine of which are on Cape Cod.
Compass places emphasis on sales of its products and quality of its service
to attract and retain customers. Management measures the sales performance of
customer service personnel based on the cross-sales of additional products and
services above the initial product that the customer requests. Branch managers
in all four markets actively participate in a business development call program
to develop new banking relationships.
In the interest of customer convenience and product alternatives, in 1995
Compass introduced a "call center" with extended hours, staffed with individuals
who are trained to answer telephone inquiries about customer accounts and about
Compass's various products and services. Compass also introduced in 1995 a
24-hour automated touch-tone telephone voice response system, which allows
customers to obtain information about their accounts, to make account transfers
and to receive information about Compass's products and services. In 1996 and
1997, Compass introduced relationship-based checking account products, entitled
Flagship Checking and Preferred Checking, respectively, which offer a package of
select benefits. The increase in certificates of deposit is partially
attributable to attractive pricing and bonus CD programs offered to select
customers participating in these and other packaged checking account programs.
Services to commercial customers have also been enhanced through the
introduction of a Sweep Account, Simple IRA accounts and an electronic tax
filing service.
Compass uses direct mail and customer service personnel at each of its
branches and at its main office to solicit deposits and advertises its deposits
through the print media, on billboards and through radio and television. Compass
began to offer its services, including a new bill payment service, over the
Internet in October 1998.
Compass has a contract with INVEST Financial Corporation ("Invest")
pursuant to which Invest offers Compass's customers investments in mutual funds
and securities. Invest representatives work out of Compass's main office and
branches and Compass's customer service personnel refer to Invest customers who
are looking for such investments. Compass receives a portion of commissions
earned by Invest from Invest's operations on Compass's premises.
22
<PAGE>
The following table sets forth certain information regarding the
distribution of the average balance of Compass's deposit accounts and the
weighted average interest rate on each category of deposits during the periods
indicated:
<TABLE>
<CAPTION>
Year ended October 31, 1998 Year ended October 31, 1997
----------------------------------- ----------------------------------
Percent Percent
of total Weighted of total Weighted
Average average average Average average average
balance deposits rate balance deposits rate
---------- ---------- --------- -------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW accounts.................... $ 84,087 8.59% 1.42% $ 72,837 8.02% 1.46%
Savings accounts................ 175,036 17.87 2.59 171,157 18.86 2.59
Money market savings accounts... 150,635 15.38 2.76 140,413 15.47 2.82
Non-interest-bearing demand
checking accounts............ 60,457 6.17 -- 56,284 6.20 --
--------- ------ --------- -------
Total transaction deposit
accounts.................. 470,215 48.01 2.10 440,691 48.55 2.15
--------- ------ --------- -------
Certificate of deposit accounts:
Six months or less........... 146,398 14.95 5.36 122,934 13.54 5.39
Over six months through
12 months.................. 223,594 22.83 5.71 209,668 23.10 5.70
Over 12 months through
24 months.................. 58,294 5.95 5.81 52,157 5.75 5.83
Over 24 months............... 80,828 8.26 6.14 82,183 9.06 6.12
--------- ------ --------- -------
Total certificates
of deposit accounts...... 509,114 51.99 5.69 466,942 51.45 5.71
--------- ------ --------- -------
Total average deposits..... $ 979,329 100.00% 3.97% $ 907,633 100.00% 3.98%
========= ====== ========= =======
</TABLE>
<TABLE>
<CAPTION>
Year ended October 31, 1996
-------------------------------------
Percent
of total Weighted
Average average average
balance deposits rate
---------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
NOW accounts.................... $ 68,156 7.84% 1.48%
Savings accounts................ 176,311 20.28 2.64
Money market savings accounts... 136,322 15.68 2.85
Non-interest-bearing demand
checking accounts........ 53,684 6.17 ---
--------- ------
Total transaction deposit
accounts.............. 434,473 49.97 2.20
--------- ------
Certificate of deposit accounts:
Six months or less........... 113,341 13.04 5.24
Over six months through
12 months.................... 167,178 19.23 5.81
Over 12 months through
24 months.................... 63,617 7.32 6.21
Over 24 months............... 90,794 10.44 6.01
--------- ------
Total certificates
of deposit accounts... 434,930 50.03 5.76
--------- ------
Total average deposits.... $ 869,403 100.00% 3.98%
========= ======
</TABLE>
23
<PAGE>
Compass had $103.2 million in certificates of deposit of $100,000 or more
outstanding as of October 31, 1998, maturing as follows:
<TABLE>
<CAPTION>
Weighted
average
Amount rate
---------- -----------
Maturity Period (Dollars in thousands)
- ---------------
<S> <C> <C>
Three months or less ............................... $ 30,465 5.38%
Over three months through six months ............... 30,758 5.46
Over six months through twelve months............... 24,631 5.57
Over twelve months.................................. 17,314 5.91
--------
$103,168 5.54%
========
</TABLE>
Borrowings. Compass borrows funds from the FHLB. FHLB loans finance
Compass's loans to low- and moderate-income borrowers and other funding needs.
FHLB loans are collateralized primarily by certain of Compass's mortgage loans
and mortgage-backed securities and by Compass's holdings of FHLB stock. The
maximum amount that the FHLB will loan fluctuates from time to time based on the
FHLB's policies.
Compass had $59.4 million in advances from the FHLB as of October 31, 1998.
The FHLB charges a fixed rate of interest on its loans. Compass may borrow up to
$358.6 million from the FHLB, including under a preapproved line of credit of
$20,000,000.
The following table sets forth certain information regarding borrowed funds
during the periods indicated:
<TABLE>
<CAPTION>
Year ended October 31,
------------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Short term borrowings:
Securities sold under agreements to repurchase:
Average balance outstanding..................................... $10,875 $ 3,923 $ 120
Maximum amount outstanding at any month end during the period... 14,830 9,533 1,925
Balance outstanding at end of period............................ 14,830 9,533 1,925
Weighted average interest rate during the period................ 4.73% 4.70% 4.09%
Weighted average interest rate at end of period................. 4.20% 4.75% 4.75%
Treasury Tax and Loan Notes:
Average balance outstanding..................................... $ 1,186 $ 1,163 $ 1,078
Maximum amount outstanding at any month end during the period... 2,070 2,117 2,175
Balance outstanding at end of period............................ 971 164 2,000
Weighted average interest rate during the period................ 5.21% 5.00% 4.90%
Weighted average interest rate at end of period................. 5.04% 5.41% 5.10%
Total short term borrowings:
Average balance outstanding..................................... $12,061 $ 5,086 $ 1,198
Maximum amount outstanding at any month end during the period... 15,801 9,742 3,925
Balance outstanding at end of period............................ 15,801 9,697 3,925
Weighted average interest rate during the period................ 4.78% 4.77% 4.82%
Weighted average interest rate at end of period................. 4.25% 4.76% 4.93%
Federal Home Loan Bank of Boston advances:
Average balance outstanding..................................... $61,815 $51,490 $37,288
Maximum amount outstanding at any month end during the period... 67,456 54,942 45,375
Balance outstanding at end of period............................ 59,420 51,006 45,375
Weighted average interest rate during the period................ 6.55% 6.68% 6.77%
Weighted average interest rate at end of period................. 6.47% 6.63% 6.50%
</TABLE>
24
<PAGE>
Subsidiary Activities
CB Securities Corporation. CB Securities Corporation ("CBS Corporation") is
a wholly-owned subsidiary of Compass established in 1990 as a Massachusetts
securities corporation. CBS Corporation engages exclusively in buying, selling
and holding investment securities on its own behalf and not as a broker. The
income earned on CBS Corporation's investment securities is subject to a
significantly lower rate of state tax than that assessed on income earned on
investment securities maintained at Compass. At October 31, 1998, CBS
Corporation had total assets of $138.3 million, consisting primarily of cash and
investment securities.
Compass Credit Corp. Compass Credit Corp. ("CC Corporation") is a
wholly-owned subsidiary of Compass established in 1997 as a Massachusetts
corporation. CC Corporation originates auto loans in Rhode Island through a
network of auto dealers. CC Corporation is a licensed lender in Rhode Island. At
October 31, 1998, CC Corporation had total assets of $41.7 million, consisting
primarily of cash and auto loans.
Buffinton Brook Realty Corporation. Buffinton Brook Realty Corporation
("BBR Corporation") is a wholly-owned subsidiary of Compass established in 1977
as a Massachusetts corporation. BBR Corporation purchases and holds real estate
and is the owner of 100% of the common stock of Compass Preferred Capital
Corporation ("Compass Preferred"). At October 31, 1998, BBR Corporation had
total assets of $161.2 million, consisting primarily of its investment in
Compass Preferred.
Compass Preferred Capital Corporation. Compass Preferred is a subsidiary of
BBR Corporation. It was established in 1998 to engage in real estate business
activities (including the acquisition and holding of securities and real estate
loans) that enable it to be taxed as a "real estate investment trust" under
federal and Massachusetts tax laws. Compass Preferred had total assets of $163.5
million at October 31, 1998, $138.2 million of which were mortgage loans
originated by and acquired from Compass.
The 1855 Corporation. The 1855 Corporation ("1855 Corporation") is a
wholly-owned subsidiary of Compass established in 1971 as a Massachusetts
corporation. 1855 Corporation is principally engaged in the acquisition and
holding of real estate which is used for banking purposes. At October 31, 1998,
1855 Corporation had total assets of $7.4 million of which $2.4 million
consisted of real estate used for banking purposes and $4.0 million consisted of
investments in subsidiaries.
Purchase Corporation. Purchase Corporation, a wholly-owned subsidiary of
1855 Corporation, was established in 1981 as a Massachusetts corporation.
Purchase Corporation acquires, manages and develops real estate, purchases
equipment and makes investments. At October 31, 1998, Purchase Corporation had
total assets of $2.4 million which consisted solely of cash.
North Front Street, Inc. North Front Street, Inc. ("NFS Inc.") is a
wholly-owned subsidiary of 1855 Corporation established in 1991 as a
Massachusetts corporation. NFS, Inc. acquires, manages, develops, rehabilitates,
leases, finances, holds and makes real estate investments. At October 31, 1998,
NFS Inc. had total assets of $1.1 million which consisted solely of cash.
In December 1998, the Company formed a new subsidiary, Lighthouse
Securities Corporation which was established to become a Massachusetts
securities corporation.
Supervision and Regulation
General
As a Massachusetts-chartered stock savings bank, Compass is subject to
extensive regulation by the Massachusetts Division of Banks (the "Division"),
and by the FDIC. Compass is required to file reports with, and is periodically
examined by, the FDIC and the Division concerning its activities and financial
condition and must obtain regulatory approvals prior to entering into certain
transactions, including, but not limited to, mergers with or acquisitions of
other financial institutions. Compass is a member of the FHLB and is subject to
certain limited regulation by the FRB. Seacoast Financial, as a bank holding
company, is subject to regulation by the FRB and is required to file reports
with the FRB.
25
<PAGE>
Massachusetts Bank Regulation
General. As a Massachusetts-chartered savings bank, Compass is subject to
supervision, regulation and examination by the Division and to various
Massachusetts statutes and regulations which govern, among other things,
investment powers, lending and deposit-taking activities, borrowings,
maintenance of surplus and reserve accounts, distribution of earnings and
payment of dividends. In addition, Compass is subject to Massachusetts consumer
protection and civil rights laws and regulations. The Commissioner's approval is
required for a Massachusetts bank to establish or close branches, merge with
other banks, organize a holding company, issue stock, engage in insurance agency
activities and undertake certain other activities.
In response to a Massachusetts law enacted in 1996, the Commissioner
adopted rules that generally give Massachusetts banks powers equivalent to those
of national banks. The Commissioner also has adopted procedures reducing
regulatory burdens and expense and expediting branching by well-capitalized and
well-managed banks.
Regulatory Enforcement Authority. Any Massachusetts bank that does not
operate in accordance with the regulations, policies and directives of the
Commissioner may be subject to sanctions for non-compliance, including seizure
of the property and business of the bank and suspension or revocation of its
charter. The Commissioner may under certain circumstances suspend or remove
officers or directors who have violated the law, conducted Compass's business in
a manner which is unsafe, unsound or contrary to the depositors' interests or
been negligent in the performance of their duties. In addition, upon finding
that a bank has engaged in an unfair or deceptive act or practice, the
Commissioner may issue an order to cease and desist and impose a fine on the
bank concerned. Finally, Massachusetts consumer protection and civil rights
statutes applicable to Compass permit private individual and class action
lawsuits and provide for the rescission of consumer transactions, including
loans, and the recovery of statutory and punitive damages and attorney's fees in
the case of certain violations of those statutes.
DIF. All Massachusetts-chartered savings banks are required to be members
of the DIF, a corporation that insures savings bank deposits not covered by
federal deposit insurance. The DIF is authorized to charge savings banks an
annual assessment of up to 1/16th of 1% of a savings bank's deposits.
Insurance of Accounts and Regulation by the FDIC
As an insurer, the FDIC charges deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity that the FDIC determines by regulation or order to pose a risk to
the insurance fund. The FDIC also has the authority to initiate enforcement
actions against savings banks, after giving the Commissioner an opportunity to
take such action, and may terminate deposit insurance if it determines that the
institution has engaged or is engaging in unsafe or unsound practices or is in
an unsafe or unsound condition.
As a result of legislation passed in 1996 relating to the recapitalization
of the SAIF, FDIC-insured institutions will pay an insurance premium of
approximately 1.3 basis points of their BIF-assessable deposits and 6.4 basis
points of their SAIF-assessable deposits from 1997 through 1999. Based upon
assessable deposits in 1998, Compass paid $35,000 in FDIC insurance premiums per
quarter during calendar year 1998.
Regulatory Capital Requirements
FDIC-insured savings banks are subject to risk-based capital guidelines
that establish a framework for making regulatory capital requirements more
sensitive to the risk profiles of each institution. Compass is required to
maintain certain levels of regulatory capital in relation to risk-weighted
assets. The ratio of such regulatory capital to risk- weighted assets is
referred to as Compass's "risk-based capital ratio." Risk-based capital ratios
are determined by allocating assets and specified off-balance sheet items to
four risk-weighted categories ranging from 0% to 100%, with higher levels of
capital being required for the categories perceived as representing greater
risk.
These guidelines divide a bank's capital into two tiers. The first tier
("Tier 1") includes common equity, retained earnings, certain non-cumulative
perpetual preferred stock (excluding auction rate issues) and minority interests
in equity accounts of consolidated subsidiaries, less goodwill and other
intangible assets (except mortgage servicing rights
26
<PAGE>
and purchased credit card relationships subject to certain limitations).
Supplementary ("Tier 2") capital includes, among other items, cumulative
perpetual and long-term limited-life preferred stock, mandatory convertible
securities, certain hybrid capital instruments, term subordinated debt and the
allowance for loan and lease losses, subject to certain limitations, less
required deductions. Banks are required to maintain a total risk-based capital
ratio equal to at least 8% of risk-weighted assets, and at least half of such
capital must be Tier 1 capital.
In addition, the FDIC has established regulations prescribing a minimum
Tier 1 leverage capital ratio (Tier 1 capital to adjusted total assets as
specified in the regulations). These regulations provide for a minimum Tier 1
leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis
points. The FDIC may, however, set higher leverage and risk-based capital
requirements on individual institutions when particular circumstances warrant.
Savings banks experiencing or anticipating significant growth are expected to
maintain capital ratios, including tangible capital positions, well above the
minimum levels.
Limitations on Dividends and Other Capital Distributions
The FDIC has the authority to use its enforcement powers to prohibit a bank
from paying dividends if, in its opinion, the payment of dividends would
constitute an unsafe or unsound practice. Federal law also prohibits the payment
of dividends by a bank that will result in the bank failing to meet its
applicable capital requirements on a pro forma basis. Massachusetts law also
restricts Compass from declaring a dividend which would reduce its capital below
(i) the amount required to be maintained by state and federal law and
regulations or (ii) the amount of Compass's liquidation account established in
connection with the conversion of the Company from mutual to stock form.
Prompt Corrective Action
The federal banking agencies have promulgated regulations to implement a
system of prompt corrective action required by federal law. Under the
regulations, a bank is deemed to be: (i) "well capitalized" if it has total
risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of
6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not
subject to any written capital order or directive; (ii) "adequately capitalized"
if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based
capital ratio of 4.0% or more and Tier 1 leverage capital ratio of 4.0% or more
(3.0% under certain circumstances) and does not meet the definition of "well
capitalized"; (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less
than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances); (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less
than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. Federal law and
regulations also specify circumstances under which a federal banking agency may
reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution to comply with supervisory actions
as if it were in the next lower capitalization category (except that the FDIC
may not reclassify a significantly undercapitalized institution as critically
undercapitalized).
Based on the foregoing, Compass is currently classified as a "well
capitalized" bank.
Activities and Investments of Insured State-Chartered Banks
Federal law generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for national
banks, notwithstanding state laws. Under regulations dealing with equity
investments, an insured state bank generally may not, directly or indirectly,
acquire or retain any equity investment of a type, or in an amount, that is not
permissible for a national bank. Federal law and FDIC regulations permit certain
exceptions to this restriction. For example, certain state-chartered banks, such
as Compass, may continue to invest, up to certain limits, in common or preferred
stock listed on a national securities exchange or the National Market System of
Nasdaq, and in the shares of an investment company registered under the
Investment Company Act of 1940, as amended. Such banks may also continue to sell
savings bank life insurance. As of October 31, 1998, Compass held marketable
equity securities with a carrying value of $12.6 million pursuant to this
exception.
27
<PAGE>
Holding Company Regulation
General. Seacoast Financial, as a bank holding company, is subject to
comprehensive regulation and regular examinations by the FRB. The FRB also has
extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement actions
may be initiated for violations of law and regulations and unsafe or unsound
practices.
Seacoast Financial is subject to capital adequacy guidelines for bank
holding companies (on a consolidated basis) which are substantially similar to
those of the FDIC for Compass.
Under FRB policy, a bank holding company must serve as a source of strength
for its subsidiary banks. Under this policy, the FRB may require, and has
required in the past, a holding company to contribute additional capital to an
undercapitalized subsidiary bank.
Seacoast Financial must obtain Massachusetts Board of Bank Incorporation
and FRB approval before: (i) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by FRB regulation or order, have been identified as
activities closely related to the business of banking or managing or controlling
banks. The list of activities permitted by the FRB includes, among other things:
(i) operating a savings institution, mortgage company, finance company, credit
card company or factoring company; (ii) performing certain data processing
operations; (iii) providing certain investment and financial advice; (iv)
underwriting and acting as an insurance agent for certain types of
credit-related insurance; (v) leasing property on a full-payout, non-operating
basis; (vi) selling money orders, travelers' checks and United States Savings
Bonds; (vii) appraising real estate and personal property; (viii) providing tax
planning and preparation services; and (ix) subject to certain limitations,
providing securities brokerage services for customers.
Interstate Banking and Branching. Federal law allows the FRB to approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a bank located in a state other than such holding company's home state,
without regard to whether the transaction is prohibited by the laws of any
state. The FRB may not approve the acquisition of a bank that has not been in
existence for the minimum time period (not exceeding five years) specified by
the statutory law of the host state. The FRB is prohibited from approving an
application if the applicant (and its depository institution affiliates)
controls or would control more than 10% of the insured deposits in the United
States or 30% or more of the deposits in the target bank's home state or in any
state in which the target bank maintains a branch. Individual states continue to
have authority to limit the percentage of total insured deposits in the state
which may be held or controlled by a bank or bank holding company to the extent
such limitation does not discriminate against out-of-state banks or bank holding
companies. Individual states may also waive the 30% state-wide concentration
limit referred to above.
Additionally, beginning on June 1, 1997, the federal banking agencies were
authorized to approve interstate merger transactions without regard to whether
such transactions are prohibited by the law of any state, unless the home state
of one of the banks "opted out" by adopting a law which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
In 1996, the Massachusetts legislature enacted a new interstate banking
statute pursuant to which an out-of-state bank may (subject to various
regulatory approvals and to reciprocity in its home state) establish and
maintain bank branches in Massachusetts by (i) merging with a Massachusetts bank
that has been in existence for at least three years,
28
<PAGE>
(ii) acquiring a branch or branches of a Massachusetts bank without acquiring
the entire bank or (iii) opening such branches de novo. Massachusetts banks'
ability to exercise similar interstate banking powers in other states depend
upon the laws of those other states.
Dividends. The FRB has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the FRB's view that a bank
holding company should pay cash dividends only to the extent that the holding
company's net income for the past year is sufficient to cover both the cash
dividends and a rate of earning retention that is consistent with the holding
company's capital needs, asset quality and overall financial condition. The FRB
also indicated that it would be inappropriate for a company experiencing serious
financial problems to borrow funds to pay dividends. Furthermore, under the
prompt corrective action regulations adopted by the FRB, the FRB may prohibit a
bank holding company from paying any dividends if the holding company's bank
subsidiary is classified as "undercapitalized."
Bank holding companies are required to give the FRB prior written notice of
any purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the consolidated net worth of the bank
holding company. The FRB may disapprove such a purchase or redemption if it
determines that the proposal would constitute an unsafe or unsound practice or
would violate any law, regulation, FRB order or any condition imposed by, or
written agreement with, the FRB.
This notification requirement does not apply to any company that meets the
well-capitalized standard for banks, is "well managed" within the meaning of the
FRB regulations and is not subject to any unresolved supervisory issues.
Federal Reserve System
The FRB requires all depository institutions to maintain
noninterest-bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW and Super NOW checking accounts). Banks are
authorized to borrow from the Federal Reserve Bank's "discount window," but FRB
regulations require banks to exhaust other reasonable alternative sources of
funds, including FHLB borrowings, before borrowing from the Federal Reserve
Bank.
Community Reinvestment Act
Under the Community Reinvestment Act, as amended (the "CRA"), as
implemented by FDIC regulations, a bank has a continuing and affirmative
obligation, consistent with its safe and sound operation, to help meet the
credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA does
require the FDIC, in connection with its examination of a bank, to assess the
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such
institution, including applications to acquire or build branches and to acquire
other financial institutions. The CRA requires the FDIC to provide a written
evaluation of an institution's CRA performance utilizing a four-tiered
descriptive rating system. Compass's latest FDIC CRA rating was "satisfactory".
Massachusetts has its own statutory counterpart to the CRA which is also
applicable to Compass. The Massachusetts version is generally similar to the CRA
but utilizes a five-tiered descriptive rating system. Massachusetts law requires
the Commissioner of Banks to consider, but not be limited to, a bank's record of
performance under Massachusetts law in considering any application by the bank
to establish a branch or other deposit-taking facility, to relocate an office or
to merge or consolidate with or acquire the assets and assume the liabilities of
any other banking institution. Compass's most recent rating under Massachusetts
law was "outstanding".
Consumer Protection and Fair Lending Regulations
Compass is subject to a variety of federal and Massachusetts statutes and
regulations that are intended to protect consumers and prohibit discrimination
in the granting of credit. These statutes and regulations provide for a range of
sanctions for non-compliance with their terms, including imposition of
administrative fines and remedial orders, and
29
<PAGE>
referral to the Attorney General for prosecution of a civil action for actual
and punitive damages and injunctive relief. Certain of these statutes authorize
private individual and class action lawsuits and the award of actual, statutory
and punitive damages and attorneys' fees for certain types of violations.
Federal Home Loan Bank System
Compass is a member of the FHLB, which is one of 12 regional Federal Home
Loan Banks, that administer the home financing credit function of savings
institutions. Each Federal Home Loan Bank serves as a reserve or central bank
for its members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the Federal Home Loan Bank
system. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the board of directors of each Federal Home Loan
Bank. These policies and procedures are subject to the regulation and oversight
of the Federal Housing Finance Board. All advances to Compass from the FHLB are
required to be fully secured by sufficient collateral as determined by the FHLB.
.
As a member, Compass is required to purchase and maintain stock in the
FHLB. At October 31, 1998, Compass owned $4.9 million of FHLB stock.
Item 2. Properties
At October 31, 1998 Compass conducted its business through 23 full-service
branches, two seasonal high school offices, four remote ATMs and five non-branch
properties, including its corporate headquarters, an operations center, a
mortgage office and two other back-office facilities. Through its merger with
Sandwich Bank on December 4, 1998, Compass added eleven full-service branches,
and a loan operations office (which will be closed during 1999).
In the Greater New Bedford market, Compass operates eight full service
branches, including six branches in the City of New Bedford (five of which are
owned by Compass or a subsidiary and one of which is operated under a land
lease), one owned branch in the town of Fairhaven and one leased branch and an
operations center in the town of Dartmouth. Compass's corporate headquarters are
also located in the City of New Bedford, as are two other back-office
facilities. All of these buildings are owned by Compass or a subsidiary. Two of
Compass's remote ATMs are located in the City of New Bedford. One of Compass's
limited service high school branches is located in the City of New Bedford.
In the Greater Fall River market, Compass operates six full service
branches, including one owned and one leased branch in the City of Fall River,
one leased branch in Assonet and owned branches in each of Somerset, Swansea and
Westport. One of Compass's remote ATMs is also located in the City of Fall
River, as is one of Compass's limited service high school branches.
In the Greater Plymouth market, Compass operates six full service branches,
including two owned and two leased branches in the town of Plymouth and leased
branches in each of Carver and Wareham. Compass also leases a non-branch
mortgage office in the town of Lakeville, located in the Greater Plymouth
market.
In the Martha's Vineyard market, Compass operates five full service
branches, including one owned and one leased branch in the town of Edgartown,
and three owned branches in the towns of Chilmark, Vineyard Haven and Oak
Bluffs. One of Compass's remote ATMs is located in the Martha's Vineyard town of
West Tisbury.
In the Cape Cod market, Compass operates nine full-service branches,
including two leased offices in Sandwich, leased offices in Buzzards Bay and
South Yarmouth and owned offices in Pocasset, Falmouth, Hyannis, Chatham and
Orleans. Compass also owns commercial condominiums in Sandwich primarily used
for loan operations which will be consolidated in 1999 in Sandwich Bank's former
main office. These condominiums will be marketed for sale in 1999.
Compass believes that its existing executive office facilities are not
sufficient, in either size or physical design, to efficiently support its recent
growth, including the impact of the December 1998 acquisition of Sandwich. The
management and Directors of Seacoast Financial and Compass have been evaluating
their alternatives and in December 1998 acquired several parcels of land in
downtown New Bedford from the New Bedford Redevelopment Authority.
30
<PAGE>
Management intends to construct a five story office building with approximately
147,000 square feet of space to house all employees other than branch personnel.
Compass's New Bedford main office will be located in the lobby of the new
building. At the present time, no construction contract has been negotiated,
however, management estimates that the total cost of the new building, including
the purchase of the land, equipment, furniture, fixtures and related costs, will
be approximately $20 million.
Item 3. Legal Proceedings
Compass is not involved in any pending legal proceedings other than routine
legal proceedings occurring in the ordinary course of business. Management
believes that those routine proceedings involve, in the aggregate, amounts which
are immaterial to the consolidated financial condition and results of operations
of Seacoast Financial.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
Seacoast Financial's common stock is traded on the Nasdaq National Market
System under the symbol "SCFS". At January 22, 1999, there were 26,758,471
shares of common stock issued and outstanding and approximately 7,318
shareholders of record. This does not reflect the number of persons or entities
who hold their stock in nominee or street name through various brokerage firms.
As of that date, the closing sales price, as reported by Nasdaq, was $11.
Seacoast Financial completed its conversion from mutual to stock form and
initial public offering of common stock on November 20, 1998, and issued
additional shares of common stock on December 4, 1998 in connection with the
consummation of its acquisition of Sandwich. Prior to November 20, 1998,
Seacoast Financial had no stockholders and, accordingly, has no historical stock
price or dividend information to report for the fiscal year ended October 31,
1998 or earlier.
The Board of Directors of Seacoast Financial has the authority to declare
dividends on Seacoast Financial's common stock, subject to statutory and
regulatory requirements. Although no decision has been made whether to pay
dividends, Seacoast Financial will consider a policy of paying quarterly cash
dividends with the first such dividend to be declared no sooner than April 1999.
There can be no assurance that dividends will be paid or, if paid, what the
amounts of dividends will be, or whether such dividends, once paid, will
continue to be paid. Declaration of dividends by the Board of Directors will be
dependent upon a number of factors, including capital requirements, regulatory
limitations, operating results and financial condition and general economic
conditions.
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<PAGE>
Item 6. Selected Consolidated Financial Data
Set forth below are the selected consolidated financial data of Seacoast
Financial. The financial data are derived in part from, and should be read in
conjunction with, the Consolidated Financial Statements of Seacoast Financial
and Subsidiary and notes thereto presented elsewhere herein.
<TABLE>
<CAPTION>
At October 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total assets................................... $ 1,264,103 $ 1,106,590 $1,027,764 $ 983,975 $ 791,989
Loans (1)...................................... 960,850 820,197 748,113 676,007 509,868
Allowance for loan losses...................... 11,006 10,642 10,334 9,850 7,002
Debt securities (2):
Available for sale........................ 164,631 205,620 198,783 77,562 68,472
Held to maturity.......................... 13,694 12,633 11,752 153,805 160,856
Marketable equity securities (2)............... 13,058 3,696 1,523 1,064 2,631
Deposits....................................... 1,064,483 937,948 882,608 859,723 687,291
Borrowed funds................................. 75,505 60,703 49,948 41,178 33,469
Surplus........................................ 112,572 98,141 84,917 74,604 65,192
Net unrealized gain (loss) on securities
available for sale, net of taxes,
included in surplus....................... 2,552 1,614 174 16 (1,910)
Non-performing loans........................... 4,425 10,925 10,326 8,506 15,171
Non-performing assets.......................... 5,436 12,632 12,924 12,424 20,969
Year ended October 31,
----------------------------------------------------------------
Selected Operating Data:
Interest income................................ $ 87,167 $ 80,032 $ 74,126 $ 66,472 $ 50,682
Interest expense............................... 43,498 39,831 37,245 34,539 23,280
----------- ----------- ---------- ---------- ----------
Net interest income....................... 43,669 40,201 36,881 31,933 27,402
Provision (credit) for loan losses............. 1,402 1,865 1,166 (351) 2,524
----------- ----------- ---------- ---------- ----------
Net interest income after provision.......
(credit) for loan losses.................. 42,267 38,336 35,715 32,284 24,878
Gains (losses) on sales of securities, net 7 37 60 (84) 663
Other non-interest income...................... 7,037 5,906 5,086 4,487 3,475
Other real estate owned expense, net........... 215 519 644 1,072 1,026
Other non-interest expense..................... 27,296 24,291 23,514 23,618 19,342
----------- ----------- ---------- ---------- ----------
Income before income taxes..................... 21,800 19,469 16,703 11,997 8,648
Provision for income taxes..................... 8,307 7,685 6,548 4,511 3,292
----------- ----------- ---------- ---------- ----------
Net income..................................... $ 13,493 $ 11,784 $ 10,155 $ 7,486 $ 5,356
=========== =========== ========== ========== ==========
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Year ended October 31,
----------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data (3):
Performance Ratios:
Return on average assets.......................... 1.15% 1.11% 1.02% 0.82% 0.71%
Return on average surplus......................... 12.46 12.73 12.63 10.57 8.42
Surplus to total assets at end of period.......... 8.91 8.87 8.26 7.58 8.23
Net interest rate spread (4)...................... 3.42 3.48 3.47 3.33 3.50
Net interest margin (5)........................... 3.91 3.95 3.90 3.69 3.81
Average interest-earning assets to average
interest-bearing liabilities................... 112.51 112.01 110.71 108.94 109.25
Total non-interest expense to average assets...... 2.35 2.33 2.42 2.70 2.66
Efficiency ratio (6).............................. 54.25 53.77 57.48 67.95 64.58
Regulatory Capital Ratios (3):
Tier 1 leverage capital........................... 8.68 8.60 8.13 7.35 8.14
Tier 1 risk-based-capital......................... 11.83 12.67 12.47 11.07 12.35
Total risk-based capital.......................... 13.15 13.92 13.73 12.31 13.69
Asset Quality Ratios (3):
Non-performing loans as a percent of
loans (7)...................................... 0.46 1.33 1.38 1.26 2.98
Non-performing assets as a percent of
total assets................................... 0.43 1.14 1.26 1.26 2.65
Allowance for loan losses as a percent
of loans....................................... 1.15 1.30 1.38 1.46 1.37
Allowance for loan losses as a percent
total non-performing loans..................... 248.72 97.41 100.08 115.80 46.15
Number of Full Service Customer Facilities............. 23 22 22 22 17
</TABLE>
(1) Loans are comprised of gross loan balances, less loans held for sale, net
unadvanced funds on loans, net deferred loan origination fees and unearned
discounts.
(2) In November 1995, Compass reclassified securities having a market value of
$138.7 million from its held-to-maturity portfolio to its
available-for-sale portfolio pursuant to a Financial Accounting Standards
Board (the "FASB") interpretation of SFAS No. 115.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end-of-period
ratios. With the exception of end-of-period ratios, all ratios are based on
average daily balances during the periods indicated.
(4) The net interest rate spread represents the difference between the weighted
average yield on average interest-earning assets and the weighted average
cost of average interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percentage of
average interest-earning assets.
(6) The efficiency ratio represents the ratio of non-interest expenses to the
sum of net interest income and non-interest income.
(7) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by Compass as presenting uncertainty
with respect to the collectibility of interest or principal. It is
Compass's policy to cease accruing interest on all such loans, except
indirect auto loans and other consumer loans.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-K contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual events could differ materially from
those anticipated in the forward-looking statements. Important factors that
might cause such a difference include, among other things, general economic
conditions, particularly the real estate market, in the Company's primary market
area, potential increases in the Company's non-performing assets (as well as
increases in the allowance for loan losses that might be
33
<PAGE>
necessary), concentrations of loans in a particular geographic area or with
certain large borrowers, changes in government regulation and supervision,
including increased deposit insurance premiums or capital or reserve
requirements, the so-called Year 2000 issue, changes in interest rates, and
increased competition and bank consolidations in the Company's market area.
These and other factors that might cause differences between actual and
anticipated results, performance and achievements are discussed in greater
detail in this Form 10-K under "Management's Dicussion and Analysis of Financial
Condition and Results of Operations" and "Business".
Seacoast Financial's results of operations depend primarily on its net
interest income, which is the difference between the income earned on its loan
and securities portfolios and its cost of funds, consisting of the interest paid
on deposits and borrowings. Results of operations are also affected by Seacoast
Financial's provision for loan losses, as well as noninterest income and
expenses. Seacoast Financial's noninterest income consists principally of gains
and losses from sales of loans and securities, deposit and other banking fees.
Seacoast Financial's non-interest expenses consist principally of compensation
and employee benefits, occupancy, data processing, marketing and professional
services costs and other operating expenses. Results of operations are also
significantly affected by general economic and competitive conditions and
changes in interest rates as well as government policies and actions of
regulatory authorities. Future changes in applicable law, regulations or
government policies may materially affect Seacoast Financial and Compass.
Comparison of Financial Condition at October 31, 1998 and October 31, 1997
Total assets increased by $157.5 million, or 14.2%, from $1,106.6 million
at October 31, 1997 to $1,264.1 million at October 31, 1998. This growth was due
primarily to a $27.9 million, or 109.1%, increase in cash and due from banks and
a $140.3 million, or 17.3% increase in net loans, partially offset by a $30.4
million, or 13.4%, decrease in investment securities. Asset growth was funded
primarily by a $126.5 million, or 13.5%, increase in deposits and a $14.8
million, or 24.4%, increase in borrowed funds.
The increase in cash and due from banks at October 31, 1998 was
attributable to three factors, namely, a change in the Bank's processing of its
daily cash letter, the receipt of significant funds being held in escrow in
connection with the Company's subscription offering of stock and the net
deposits of Saturday, October 31.
The increase in loans occurred primarily in Compass's indirect auto and
residential mortgage loan portfolios. From October 31, 1997 to October 31, 1998,
indirect auto loans (net of unearned discounts) increased by $97.0 million, or
46.6%. This growth is primarily attributable to the favorable interest rate
environment and economic conditions which prevailed during the period and
Compass's continued emphasis of this area of lending. Residential mortgage loans
increase by $22.2 million, or 6.1%, during 1998. Due to the favorable interest
rate environment which prevailed, Compass originated $201.3 million of
residential mortgage loans in 1998, a 112.5% increase over 1997. As the Bank
continued to sell such fixed rate loans with terms of 15 years or longer during
1998 and due to the high volume of loan refinancing attributable to lower
interest rates, the net growth in this portion of the loan portfolio was
constrained.
Total deposits at October 31, 1998 were $1,064.5 million, an increase of
$126.6 million, or 13.5%, compared to $937.9 million at October 31, 1997. The
increase in deposits was primarily due to favorable economic conditions and the
impact of escrowed deposits of $21.9 million received in the subscription
offering portion of the Company's initial public offering of stock, partially
offset by a continuing low interest rate environment wherein Compass competes
against other instruments available to the public such as mutual funds and
annuities. Total borrowed funds were $75.5 million at October 31, 1998 compared
to $60.7 million at October 31, 1997, an increase of $14.8 million, or 24.4%.
During the year ended October 31, 1998, Compass's net borrowings from the FHLB
increased by $8.4 million and its retail repurchase agreements increased by $5.3
million.
The increase in surplus of $14.4 million to $112.6 million at October 31,
1998 resulted from net income of $13.5 million for the year ended October 31,
1998 and a $938,000 increase in unrealized gains (net of taxes) on securities
available for sale, most of which pertained to the marketable equity securities
portfolio.
34
<PAGE>
Comparison of Financial Condition at October 31, 1997 and October 31, 1996
Total assets were $1,106.6 million at October 31, 1997 compared to $1,027.8
million at October 31, 1996, an increase of $78.8 million, or 7.7%.
Substantially all of the growth was due to a $71.8 million, or 9.7%, increase in
net loans. Asset growth was funded primarily from increased deposits ($55.3
million), increased borrowings from the FHLB ($5.6 million), increased
borrowings through repurchase agreements ($7.6 million) and increased surplus
($13.2 million). Total net loans increased from $737.8 million at October 31,
1996 to $809.6 million at October 31, 1997. Between those dates, total real
estate loans increased by $21.9 million, or 4.3%, to $536.1 million, and total
commercial loans increased by $5.2 million, or 11.2%, to $51.4 million. The most
significant area of real estate loan growth was in residential real estate loans
which increased by $19.8 million, or 5.8%, to $363.0 million. While the
residential real estate loan market was strong throughout the year due to a
favorable interest rate environment, so too was the competition for such
business. Many borrowers took advantage of the increased competition to
refinance their loans. This factor, along with an increase in the sales of
fixed-rate mortgage loans, caused Seacoast Financial's net growth in real estate
loans in 1997 ($21.9 million) to be less than that achieved in 1996 ($39.9
million) despite approximately the same level of loan originations in each year.
The most significant area of overall loan growth in 1997 and 1996 was in
the area of indirect auto loans. During 1997, such loans increased, before
unearned discount, $48.2 million, or 25.4%, to $238.1 million at October 31,
1997. During 1996 such loans increased $30.4 million, or 19.1%, to $189.9
million at October 31, 1996. This growth is primarily attributable to the
expansion of the network of auto dealerships offering Compass's auto financing
program. This expansion resulted in an increase in the number of new loan
originations from 8,181 in 1996 to 9,817 in 1997, an increase of 20%.
Total investments increased modestly from $216.7 million at October 31,
1996 to $227.1 million at October 31, 1997. Among debt securities, Seacoast
Financial increased its holdings of U.S. Government and Agency obligations by
$2.8 million and corporate bonds by $22.4 million while decreasing its holdings
of mortgage-backed securities by $18.5 million. These shifts were caused by a
change in tax regulations and an opportunity to increase portfolio yield without
extending portfolio duration.
Total deposits increased 6.3% from $882.6 million at October 31, 1996 to
$937.9 million at October 31, 1997. The overall growth in deposits in 1997 was
favorably affected by Compass's introduction and promotion of relationship-
based retail checking account products offering a package of benefits, including
enhanced pricing on certificates of deposits. The acquisition of competing local
financial institutions by larger regional banks also contributed to Compass's
deposit growth in 1997 as customers who prefer to bank with a locally-based
community institution shifted their deposits to Compass.
Of the $55.3 million increase in deposits in 1997, $37.4 million occurred
in certificates of deposit, continuing a gradual shift of deposits to
higher-yielding accounts. The remaining deposit growth of $17.9 million, or
4.1%, resulted from an increase in retail and business checking accounts.
Compass also offers customers with checking accounts the opportunity to "sweep"
funds into a higher-yielding, non-insured, investments under a repurchase
agreement. The balance in these accounts increased by $7.6 million from October
31, 1996 to October 31, 1997. Funds invested under repurchase agreements are
classified as short-term borrowings rather than as deposits.
Customers also moderated inflows of deposits by opting to invest their
funds in alternative investments, such as mutual funds and annuities, that
Compass does not offer directly (other than through its affiliation with Invest
Financial Corporation), rather than in deposit products perceived to have less
attractive returns.
Compass increased its borrowings from the FHLB from $45.4 million at
October 31, 1996 to $51.0 million at October 31, 1997 as part of its Affordable
Home Loan Program. Under that program, Compass borrows funds under a special
fixed-rate, amortizing program to provide low cost financing for first time home
buyers in the low-to-moderate income categories.
The increase in surplus of $13.2 million to $98.1 million at October 31,
1997 resulted from net earnings of $11.8 million and a $1.4 million increase in
unrealized gains (net of taxes) on securities available for sale.
35
<PAGE>
Results of Operations
Net Interest Income
The Company's performance is primarily attributable to its level of net
interest income. General economic conditions, corporate strategies,
asset/liability management and the policies of regulatory authorities all have a
significant impact on the level of net interest income achieved.
During the period 1996 to 1998, the Company's net interest income has
increased from $36.9 million for the year ended October 31, 1996 to $43.7 for
the year ended October 31, 1998, an increase of $6.8 million, or 18.4%. This
achievement has been entirely attributable to the Company's growth in average
interest-earning assets over that same period.
During the period 1996 to 1998, the Company's interest rate spread (the
difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities) has declined slightly from 3.47% in 1996 to 3.42%
in 1998. The strategy to emphasize indirect auto lending has been a significant
factor in the Company's maintenance of its interest rate spread during a period
when many community banks have experienced a decline in this key measure of
performance.
36
<PAGE>
The following table presents average balances, interest income and expense
and yields earned or rates paid on the major categories of assets and
liabilities for the years indicated.
<TABLE>
<CAPTION>
Year ended October 31,
------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ----------------------------- ------------------------------
Average Average Average
Average yield/ Average yield/ Average yield/
balance Interest cost balance Interest cost balance Interest cost
----------- -------- --------- ---------- -------- --------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Short-term investments..... $ 22,539 $ 1,363 6.05% $ 21,516 $ 1,235 5.74% $ 15,969 $ 947 5.93%
Debt securities (1)........ 194,848 11,958 6.14 211,304 12,910 6.11 208,665 12,370 5.93
Equity securities (1)...... 13,510 546 4.04 7,290 388 5.32 7,296 386 5.29
Mortgage loans (2)......... 558,862 46,107 8.25 523,376 43,977 8.40 498,185 42,162 8.46
Commercial loans (2)....... 55,432 5,416 9.77 50,361 4,972 9.87 45,283 4,456 9.84
Indirect auto loans (2).... 245,679 19,423 7.91 180,600 14,497 8.03 150,070 11,927 7.95
Other consumer loans (2)... 26,316 2,354 8.95 23,195 2,053 8.85 20,795 1,878 9.03
---------- -------- ---------- -------- --------- --------
Total interest-earning
assets................. 1,117,186 87,167 7.80 1,017,642 80,032 7.86 946,263 74,126 7.83
-------- ------- -------- ------- -------- -------
Allowance for loan losses.. (10,588) (10,570) (10,109)
Non-interest earning assets 65,306 59,094 61,480
---------- ---------- ---------
Total assets............. $1,171,904 $1,066,166 $997,634
========== ========== =========
Liabilities and Surplus:
Interest-bearing liabilities:
Deposits:
NOW accounts............. $ 84,807 $ 1,192 1.42% $ 72,837 $ 1,065 1.46% $ 68,156 $ 1,008 1.48%
Savings accounts......... 175,036 4,529 2.59 171,157 4,434 2.59 176,311 4,660 2.64
Money market savings
accounts............... 150,635 4,153 2.76 140,413 3,959 2.82 136,322 3,888 2.85
Certificate of deposit
accounts............... 509,114 28,976 5.69 466,942 26,651 5.71 434,930 25,065 5.76
---------- -------- ---------- -------- --------- --------
Total deposits......... 918,872 38,850 4.23 851,349 36,109 4.24 815,719 34,621 4.24
Borrowed funds:
Short-term borrowings (3) 12,303 599 4.87 5,666 283 4.99 1,727 100 5.79
FHLB advances............ 61,815 4,049 6.55 51,490 3,439 6.68 37,288 2,524 6.77
---------- -------- ---------- -------- --------- --------
Total borrowings....... 74,118 4,648 6.27 57,156 3,722 6.51 39,015 2,624 6.73
---------- -------- ---------- -------- --------- --------
Total interest-bearing
liabilities..... 992,990 43,498 4.38 908,505 39,831 4.38 854,734 37,245 4.36
Non-interest bearing demand
checking accounts........ 60,457 56,284 53,684
Other liabilities.......... 10,135 8,807 8,807
---------- ---------- ---------
Total liabilities........ 1,063,582 973,596 917,225
Surplus.................... 108,322 92,570 80,409
---------- ---------- ---------
Total liabilities and
surplus................ $1,171,904 $1,066,166 $997,634
========== ========== =========
Net interest income/interest
rate spread (4)........... $ 43,669 3.42% $ 40,201 3.48% $ 36,881 3.47%
======== ======= ======== ======= ======== =======
Net interest margin (5).... 3.91% 3.95% 3.90%
======= ======= =======
Ratio of interest-earning assets to
interest-bearing liabilities 112.51% 112.01% 110.71%
======= ======= =======
</TABLE>
- ---------------------------
(1) Average balances include unrealized gains on securities available for sale.
Equity securities include marketable equity securities and restricted
equity securities.
(2) Loans on non-accrual status are includes in the average balances.
(3) Short-term borrowings include immaterial balances of other borrowings.
(4) Interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
37
<PAGE>
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities have affected Seacoast Financial's interest income
and interest expense during the periods indicated. Information is provided in
each category with respect to: (i) changes attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) changes attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) the net
change. The changes attributable to the combined impact of volume and rate have
been allocated proportionately to the changes due to volume and the changes due
to rate.
<TABLE>
<CAPTION>
Year ended Year ended
October 31, 1998 October 31, 1997
compared to compared to
year ended year ended
October 31, 1997 October 31, 1996
------------------------ ------------------------
Increase (decrease) due to Increase (decrease) due to
------------------------ ------------------------
Volume Rate Net Volume Rate Net
------- ------- ------ -------- ----- ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Short-term investments........................ $ 60 $ 68 $ 128 $ 319 $ (31) $ 288
Debt securities............................... (1,010) 58 (952) 158 382 540
Equity securities............................. 269 (111) 158 -- 2 2
Mortgage loans................................ 2,939 (809) 2,130 2,119 (304) 1,815
Commercial loans.............................. 496 (52) 444 501 15 516
Indirect auto loans........................... 5,148 (222) 4,926 2,450 120 2,570
Other consumer loans.......................... 279 22 301 213 (38) 175
------- ------- ------ -------- ----- ------
Total interest-earning assets.............. $ 8,182 $(1,047) $7,135 $ 5,760 $ 146 $5,906
------- ------- ------ -------- ----- ------
Interest-bearing liabilities:
Deposits:
NOW accounts............................... $ 160 $ (33) $ 127 $ 69 $ (12) $ 57
Savings accounts........................... 100 (5) 95 (135) (91) (226)
Money market savings accounts.............. 283 (89) 194 116 (45) 71
Certificate of deposit accounts............ 2,400 (75) 2,325 1,829 (243) 1,586
------ ------- ------ -------- ----- ------
Total deposits........................... 2,944 (203) 2,741 1,879 (391) 1,488
------ ------- ------ -------- ----- ------
Borrowed funds:
Short-term borrowings...................... 323 (7) 316 199 (16) 183
FHLB advances.............................. 677 (67) 610 950 (35) 915
------ ------- ------ -------- ----- ------
Total borrowings......................... 1,000 (74) 926 1,149 (51) 1,098
------ ------- ------ -------- ----- ------
Total interest-bearing liabilities....... 3,944 (277) 3,667 3,028 (442) 2,586
------ ------- ------ -------- ----- ------
Net change in net interest income............. $ 4,238 $ (770) $3,468 $ 2,732 $ 588 $3,320
======= ======= ====== ======== ===== ======
</TABLE>
Comparison of Operating Results for the Years Ended October 31, 1998 and
October 31, 1997
General. Net income increased by $1.7 million or 14.4%, from $11.8 million
for the year ended October 31, 1997 to $13.5 million for the year ended October
31, 1998. The improvement was attributable to higher net interest income of $3.5
million, a $463,000 decrease in the provision for loan losses due to a
continuation of the favorable trends in the various factors considered by
management in evaluating the adequacy of the allowance for loan losses and an
increase in net gains on sales of loans of $734,000. The improvement was
partially offset by an increase of $2.7 million in non-interest expense due to
higher salaries, occupancy and equipment expenses, data processing expenses and
marketing costs. The increase in net interest income was due to growth in
average interest-earning assets.
Interest Income. Interest income for the year ended October 31, 1998 was
$87.2 million, compared to $80.0 million for the year ended October 31, 1997, an
increase of $7.2 million, or 9.0%. Substantially all of the increase in interest
income resulted from growth in average interest-earning assets of $99.5 million,
or 9.8%. The principal areas of growth related to real estate loans (up $35.5
million, or 6.8%) and indirect auto loans (up $65.1 million, or 36.1%). Most of
38
<PAGE>
the real estate loan growth resulted from increased originations of one- to
four-family real estate loans. The increase in indirect auto loans resulted from
an improved economic environment within Compass's local markets, the expansion
of such lending into Rhode Island and the continued emphasis of this area of
lending.
Interest Expense. Interest expense for the year ended October 31, 1998 was
$43.5 million, compared to $39.8 million for the year ended October 31, 1997, an
increase of $3.7 million, or 9.3%. This increase resulted from a higher average
balance of interest-bearing liabilities ($84.5 million, or 9.3%). Average
interest-bearing deposit balances increased $67.5 million, or 7.9%, primarily as
a result of the introduction and promotion of relationship-based retail checking
account products in 1996 and 1997.
Compass increased its borrowings from both the FHLB and customers under
retail repurchase agreements during the year ended October 31, 1998. Interest
expense on borrowed funds increased $926,000, or 24.9%, in the year ended
October 31, 1998 due to a $17.0 million, or 29.7%, increase in the average
balance of such funds to $74.1 million, which was partially offset by a 24 basis
point reduction in the average rate paid on borrowed funds to 6.27% in 1998
compared to 1997.
Provision for Loan Losses. Compass establishes provisions for loan losses,
which are charged to operations, in order to maintain the allowance for loan
losses at a level that management estimates is appropriate to absorb future
charge-offs of loans deemed uncollectible. In determining the appropriate level
of the allowance for loan losses, management considers past and anticipated loss
experience, evaluations of real estate collateral, current and anticipated
economic conditions, volume and type of lending and the levels of nonperforming
and other classified loans. The amount of the allowance is based on estimates
and the ultimate losses may vary from such estimates. Management assesses the
allowance for loan losses on a quarterly basis and makes provisions for loan
losses monthly in order to maintain the adequacy of the allowance.
Compass provided $1.4 million for loan losses in the year ended October 31,
1998 compared to $1.9 million in the year ended October 31, 1997, a decrease of
$463,000, or 24.8%. The total allowance of $11.0 million at October 31, 1998
represented 1.15% of total loans, a decrease from 1.30% at October 31, 1997.
These decreases were primarily influenced by a reduction in the balance of
adversely classified loans and fewer delinquencies.
Non-Interest Income. Non-interest income is comprised of fees and charges
for bank services, net interchange fees on the processing of merchant credit
card receipts, gains or losses from sales of assets, loan servicing fees and
other income resulting from miscellaneous transactions. Total non-interest
income was $7.0 million for the year ended October 31, 1998 compared to $5.9
million for the year ended October 31, 1997, an increase of $1.1 million, or
18.6%. The increase resulted primarily from an increase of $734,000 in the gain
on sale of mortgage loans, from $542,000 in the year ended October 31, 1997 to
$1.3 million in the year ended October 31, 1998. Compass has generally sold in
the secondary mortgage market fixed rate residential mortgage loans with terms
of 15 years or longer. With the reduction in interest rates on 15- and 30-year
fixed rate mortgages which occurred in 1997 and 1998, the volume of fixed-rate
mortgage loan originations increased which contributed to this increase. Also,
Compass earned $270,000 of fees in 1998 under a new relationship with an outside
vendor which processes its official checks. This fee is determined based on the
average length of time such checks, which are drawn on the account of the
outside vendor, remain outstanding. Prior to 1998, income on such float was
classified as interest income.
Non-Interest Expense. Non-interest expense increased by $2.7 million, or
10.9%, from $24.8 million for the year ended October 31, 1997 to $27.5 million
for the year ended October 31, 1998. Of this increase, $1.4 million related to
compensation and employee benefits, which rose 10.3% to $15.0 million for the
year ended October 31, 1998. The higher level of compensation and employee
benefits was caused by overall salary increases averaging 4%, increased
commissions related to higher mortgage loan originations, an increase of
$125,000 in incentive compensation, employee benefit increases of $225,000 and
staffing increases in the lending area and in a new branch opened in May 1998.
Seacoast Financial expects compensation and employee benefits expenses to
increase primarily as a result of the adoption of an ESOP in connection with the
stock offering completed on November 20, 1998. The ESOP purchased 1,120,000
shares in connection with the stock offering, which will result in increased
compensation and employee benefits expenses as the ESOP shares are allocated.
The Company intends to allocate these shares over 20 years which will result in
annual expense, assuming an average stock price of $10 per share, of $556,000. A
higher average stock
39
<PAGE>
price will result in a higher level of expense.
Occupancy and equipment expenses increased $289,000, or 8.6%, to $3.6
million for the year ended October 31, 1998. This increase was due to increases
in depreciation expense of $98,000 and rent expense of $207,000. The increase in
rent expense is attributable to the relocation of the Bank's operations
department, the opening of a new branch, an upgraded branch and a one-time
reduction in rent expense in 1997 of $36,000 attributable to a leased facility
no longer utilized.
Marketing expenses increased $306,000, or 25.0%, to $1.5 million for the
year ended October 31, 1998. This increase was primarily attributable to
advertising campaigns related to the new ROTH IRA accounts allowed by changes in
the tax law, the advertising of Compass's Preferred Checking account and
Flagship Money Market programs, promotion of the new Plymouth branch and on-line
banking capabilities through the Internet.
Data processing expenses increased $389,000, or 17.7%, to $2.6 million for
the year ended October 31, 1998. This increase was due to new services,
including laser printing and Internet services, and volume-related increases in
loans and deposits.
Other real estate owned (OREO) expenses decreased $304,000, or 58.6%, to
$215,000 for the year ended October 31, 1998 due to the continuation of the
decline in the number of properties held as OREO and stable real estate market
values.
Other non-interest expenses increased $559,000, or 20.5%, for the year
ended October 31, 1998. Included in other non-interest expense in 1997 and 1998
were recoveries of life insurance premiums from an insurance company which
emerged from receivership in 1997. The net impact of the resolution of this
matter resulted in an increase in non-interest expense in 1998 compared to 1997
of $273,000. In addition, increases in office supplies ($92,000), charitable
contributions ($69,000) and telephone expenses ($63,000) also caused the overall
increase in non-interest expenses in the year ended October 31, 1998.
Income Taxes. Income tax expense was $8.3 million for the year ended
October 31, 1998, an increase of $622,000, or 8.1%, compared to the 1997 period.
The effective tax rate was 38.1% in 1998 compared to 39.5% in 1997 which
decrease was caused by Compass's greater utilization of non-bank subsidiaries
that were taxed at a lower rate for state tax purposes.
Comparison of Operating Results for the Years Ended October 31, 1997 and
October 31, 1996
General. Net income was $11.8 million in 1997 compared to $10.2 million in
1996, an increase of $1.6 million or 15.7%. Due primarily to an increase in
average interest-earning assets of $71.4 million, or 7.5%, net interest income
increased by $3.3 million, or 9.0%, from $36.9 million in 1996 to $40.2 million
in 1997. The other significant factors affecting the change in net income was an
increase of $797,000 in non-interest income offset by an increase of $699,000 in
the provision for loan losses and an increase of $652,000 in non-interest
expense.
Interest Income. Interest income was $80.0 million in 1997, compared to
$74.1 million in 1996, an increase of $5.9 million, or 8.0%. This increase in
interest income resulted almost exclusively from interest-earning asset growth.
The yield on interest-earning assets increased three basis points in 1997 from
7.83% in 1996 to 7.86% in 1997. A significant portion of the increase in
interest-earning assets was attributable to the indirect auto loan portfolio,
which increased from $165.6 million at October 31, 1996 to $208.0 million at
October 31, 1997, and the real estate portfolio, which increased from $514.2
million to $536.1 million, at those dates, respectively.
Interest Expense. Interest expense increased by $2.6 million, or 6.9%, from
$37.2 million in 1996 to $39.8 million in 1997. The increase resulted from a
$53.8 million, or 6.3%, increase in average interest-bearing liabilities and a
two basis point increase in the average rate paid on such liabilities. Total
average interest-bearing deposits increased by $35.6 million, or 4.4%, with most
of the increase occurring in certificates of deposit because of the higher rates
offered
40
<PAGE>
on such deposits in comparison to those offered on other types of deposits.
Because of the level of loan growth, Compass increased its borrowings from the
FHLB with the average amount of such borrowings outstanding increasing by $14.2
million, or 38.1%, from $37.3 million in 1996 to $51.5 million in 1997.
Provision for Loan Losses. The provision for loan losses increased by
$699,000, or 60.0%, from $1.2 million in 1996 to $1.9 million in 1997. With net
loan charge-offs of $1.6 million in 1997 (as compared to $682,000 in 1996), the
allowance for loan losses increased by $308,000 in 1997. The total allowance of
$10.6 million at October 31, 1997 represented 1.30% of total loans, a slight
decrease from 1.38% at October 31, 1996.
The increase of $875,000 in net charge-offs in 1997 resulted from the
resolution of certain commercial and commercial real estate loans as well as the
impact of the increasing indirect auto loan portfolio.
Non-Interest Income. Total non-interest income was $5.9 million in 1997, an
increase of $797,000, or 15.5%, from $5.1 million in 1996. The increase in
deposit and other banking fees from $2.7 million in 1996 to $3.2 million in 1997
was primarily attributable to a $141,000 increase in monthly checking account
fees and $182,000 in additional returned check fees. An increase in the monthly
maintenance fee on basic checking accounts instituted in 1996 caused higher
monthly checking account fees in 1997. Returned check fees increased in 1997
because of price increases on check returns put into effect in July 1996.
The remaining growth in non-interest income resulted from gains on sales of
loans, which increased by $361,000, or 200%, from $181,000 in 1996 to $542,000
in 1997. Of this increase, $255,000 was attributable to the initial application
of SFAS No.125. As more fully disclosed in Note 1 to the accompanying
consolidated financial statements, SFAS No. 125 required that Compass
capitalize, for the first time, the value of servicing rights on loans
originated and sold to others with servicing retained by Compass. The remaining
increase of $106,000 in gains on sales of loans was attributable to an increase
in the volume of loan sales from $15.5 million in 1996 to $30.1 million in 1997.
Non-Interest Expense. Total non-interest expense was $24.8 million in 1997,
compared to $24.2 million in 1996, an increase of $652,000, or 2.7%. This
increase was primarily attributable to an increase of $743,000, or 5.8%, in
salaries and employee benefits and an increase of $482,000, or 64.9%, in
marketing expenses, which increases were partially offset by a decrease of
$271,000 in deposit insurance premiums, $125,000 in other real estate owned
expenses, and a $416,000 recovery of life insurance premiums recognized when an
insurance company emerged from receivership in 1997.
The increase in salaries and employee benefits in 1997 was caused by an
increase of $415,000, or 3.4%, in salaries and employee benefits and a $328,000,
or 47.1%, increase in bonuses paid in accordance with Compass's bonus plan.
These increases were primarily driven both by individual and institutional
performance in 1997 as the average number of full-time equivalent employees in
1997 remained almost flat at 336 compared to 334 in 1996.
The increase in marketing expense in 1997 was due to significant
promotional activities associated with the introduction of the Preferred
Checking and Prime for Life equity loan programs. In addition, Compass
introduced its website on the Internet.
FDIC insurance expense decreased by $271,000 in 1997 because of a reduction
in the annual premiums charged by the FDIC on insurable deposits.
OREO expenses declined by $125,000 in 1997 primarily due to a reduction in
the number of properties held as OREO and stable real estate market values.
Income Taxes. Total income tax expense was $7.7 million in 1997 compared to
$6.5 million in 1996. The effective tax rate was slightly higher in 1997 (39.5%)
than in 1996 (39.2%) primarily because Compass's effective Federal statutory tax
rate increased by 1% with the growth in taxable income partially offset by a
reduction in the effective state tax rate caused by Compass's greater
utilization of non-bank subsidiaries that were taxed at a lower rate.
Liquidity and Capital Resources
Compass's liquidity, represented by cash and cash equivalents and debt
securities is a product of its operating,
41
<PAGE>
investing, and financing activities. The Bank's primary sources of funds are
deposits, borrowings, principal and interest payments on outstanding loans and
mortgage-backed securities, maturities of investment securities and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage related securities and maturing investment securities are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by general interest rates. Compass invests excess funds in
federal funds sold which provides liquidity to meet lending requirements.
Liquidity management is both a daily and long term function of business
management. The measure of a bank's liquidity is its ability to meet its cash
commitments at all times with available cash or by conversion of other assets to
cash at a reasonable price. At October 31, 1998, the Company maintained cash and
due from banks, short-term investments and debt securities maturing within one
year of $99.0 million, or 7.8% of total assets. During 1998, Compass continued
to be an average daily net seller of Federal Funds.
The Company's "Tier One" capital, consisting entirely of its surplus
account, measured 11.83% of risk-weighted assets at October 31, 1998. Total
capital, including the "Tier Two" allowance for loan losses, was 13.15% of risk-
weighted assets. The leverage ratio was 8.68%. These ratios placed the Company
in the "well-capitalized" category according to regulatory standards.
At October 31, 1998, Compass had commitments to originate loans, unused
outstanding lines of credit, standby letters of credit and undisbursed proceeds
of loans totaling $110.1 million. Compass anticipates that it will have
sufficient funds available to meet its current loan commitments. Certificates of
deposit maturing within one year from October 31, 1998 amounted to $437.0
million. Compass expects that substantially all maturing certificate accounts
will be retained by Compass at maturity.
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented herein
have been prepared in accordance with GAAP, which requires the measurement of
financial position and operating results in terms of historical dollar amounts
without considering changes in the relative purchasing power of money over time
due to inflation. The impact of inflation is reflected in the increased cost of
the Company's operations. Unlike industrial companies, nearly all of the
Company's assets and liabilities are monetary in nature. As a result, interest
rates have a greater impact on its performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
Impact of New Accounting Standards
Earnings Per Share. In February 1997, the FASB issued SFAS No. 128,
"Earnings Per Share." This statement, which supersedes APB Opinion 15,
simplifies the reporting of earnings per share by eliminating the presentation
of primary earnings per share and requiring the presentation of basic earnings
per share. The calculation of basic earnings per share excludes the effect of
potential common shares to be issued, thus resulting in no dilution. The
statement requires entities with complex capital structures to present basic and
diluted earnings per share on the face of the income statement and eliminates
the modified treasury stock method of computing potential common shares. The
statement is effective for financial statements issued for fiscal years ending
after December 15, 1997. Seacoast Financial will follow the guidance of SFAS No.
128 beginning in fiscal 1999.
Reporting Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income." The statement requires entities presenting a
complete set of financial statements to include details of comprehensive income
that arise in the reporting period. Comprehensive income consists of net income
or loss for the current period and other comprehensive income consisting of
revenue, expenses, gains and losses that bypass the income statement and are
reported directly in a separate component of equity. Other comprehensive income
includes, for example, unrealized gains and losses on certain investment
securities, minimum pension liability adjustments and foreign currency items.
SFAS No. 130 requires that components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. At October 31, 1998, Seacoast Financial's other
comprehensive income consisted of unrealized gains on securities classified as
available for sale, net of taxes. The statement is effective for fiscal years
beginning after December 15, 1997 and requires restatement of prior period
financial statements presented for comparative purposes.
42
<PAGE>
Disclosures about Segments of an Enterprise and Related Information. In
June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The statement changes the current practice
for reporting segment information under SFAS No. 14, "Financial Reporting for
Segments of an Enterprise." Public entities are required to report financial and
descriptive information about their reportable operating segments. An operating
segment is a component of an entity for which financial information is developed
and evaluated by the entity's chief operating decision maker to assess
performance and to make decisions about resource allocation. Disclosures about
operating segments should generally be based on the information used internally.
The statement is effective for financial statements for periods beginning after
December 15, 1997. On adoption, comparative information for earlier years is to
be restated. As the Company believes it consists of a single reportable
operating segment, this statement should have no significant impact on its
financial reporting.
Employers' Disclosures About Pensions and Other Postretirement Benefits. In
February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and other Postretirement Benefits," which is to become effective for
fiscal years beginning after December 15, 1997. This statement revises
employers' disclosures about pension and other postretirement benefit plans. It
does not change the measurement or recognition of those plans. Restatement of
disclosures for earlier periods provided for comparative purposes is required
unless the information is not readily available.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which is effective for fiscal years
beginning after June 15, 1999. The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting. Management does not anticipate
that the adoption of this statement will have a material impact on the financial
position or operating results of the Company.
In October 1998, the FASB issued SFAS No. 134 "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise" which is to become effective for
the first fiscal quarter beginning after December 15, 1998. This Statement
further amends SFAS No. 65 to require that after the securitization of mortgage
loans held for sale, an entity engaged in mortgage banking activities classify
the resulting mortgage-backed securities or other retained interests based on
its ability and intent to sell or hold those investments.
Year 2000 Issue
The Year 2000 Issue (commonly referred to as "Y2K") is the result of
computer programs being written using two digits, rather than four digits, to
define the applicable year. The Y2K issue, which is common to most corporations,
including banks, concerns the inability of information systems, primarily (but
not exclusively) computer software programs, to properly recognize and process
date-sensitive information as the Year 2000 approaches. The following
constitutes the Company's Y2K readiness disclosure under the Year 2000
Information and Readiness Disclosure Act.
Since Compass's information systems functions are either outsourced to
service bureaus or processed in-house using programs developed by third-party
vendors, the direct effort to correct Y2K issues will be undertaken largely by
third parties and will therefore not be within Compass's direct control. Compass
expects to bring its mission critical operating systems into compliance with Y2K
requirements through the installation of updated or replacement programs
developed by third parties.
Compass began addressing the Y2K issue in the Fall of 1996 when if formed a
Y2K Project Team comprised of financial, operations, information systems,
internal audit, compliance, lending, corporate services, loan servicing and
retail personnel. A formal Y2K Action Plan was developed by the Y2K Project Team
and approved by the Board of Directors in 1997. During 1998, Compass engaged an
outside consultant to assist in providing limited Y2K assurance. Notwithstanding
this engagement, Compass retains responsibility for Y2K issues, plans and
compliance efforts.
43
<PAGE>
The Y2K Project Team has completed an assessment, identified mission
critical systems, and created a formal tracking system identifying all third
party vendors and their Y2K compliant version of all bank installed systems.
Mission critical systems include hardware, software, program interfaces,
operating systems as well as other mechanical or computer-generated requirements
that are beyond Compass's main central processing system and network. Based upon
the results of the assessment, Compass has established internal time frames to
upgrade or replace its existing hardware and software systems. During the third
and fourth quarters of 1998, Compass began to upgrade its retail branches with
new Y2K compliant hardware and branch teller platform software. All branch
upgrades are expected to be substantially completed by the end of the first
quarter 1999. Additionally, Compass has replaced specific hardware and software
that had been identified as non-compliant according to schedule.
Compass's plan to resolve the Y2K issue was developed along the five phase
project management process outlined in the Federal Financial Institutions
Examination Council (FFIEC) Year 2000 statement of May 5, 1997 which consisted
of (i) awareness; (ii) assessment; (iii) renovation; (iv) validation; and (v)
implementation. The awareness phase has been completed. The Y2K assessment was
completed and monitoring of service bureau and vendor progress is ongoing.
Renovation of third party systems that were identified as non-compliant have
either been upgraded or replaced to the compliant version or scheduled to be
upgraded by March 31, 1999. All non critical software applications effected by
the millennium have been identified. It is expected that these applications will
be upgraded and Y2K compliant by June 30, 1999. The Y2K Project Team has
developed and implemented test plans of all mission critical systems. Compass
conducted a successful test of its key transaction processing system with its
service bureau in the fourth quarter of 1998. In addition, Compass is scheduled
to review documentation of its service bureaus' test results during the first
quarter of 1999. Compass is in the process of developing its Y2K contingency
plan incorporating certain elements of its bankwide Disaster Recovery Plan.
Also, Compass is working with its service bureau to create a remote branch
Mobile Recovery Unit, located in Framingham, Massachusetts or possibly develop a
paper-based, batch entry system to be used in the event of a catastrophic
telecommunications or power failure. The remote branch Mobile Recovery Unit or
paper-based, batch entry system would be created at an off premises bank site
that is capable of creating its own emergency power for extended periods of
time. Key documents would then be delivered to the remote branch which is
capable of transmitting data to Compass's service bureau which also has
emergency power to continue processing customer account activity. The Compass's
contingency plan is scheduled to be completed by June 30, 1999 in accordance
with the recently issued Interagency Regulatory Statement on Contingency
Planning. Contingency plans will be initiated if a vendor misses its target date
or is not considered Y2K compliant by June 30, 1999.
The chief components of Compass's expense related to the Y2K issue are
currently believed to be the replacement of personal computer equipment and the
purchase or upgrade of third-party software. External maintenance and internal
modification costs will be expensed as incurred. Costs of new hardware and
software will be capitalized and depreciated in accordance with Compass
policies. Management expects to incur cost in the range of $750,000 to $1.0
million on its Year 2000 readiness efforts. Through October 31, 1998, Compass
has expended approximately $223,000. Costs of the Y2K project are based on
current estimates and actual results could vary significantly from such
estimates once detailed testing is completed. If the resolution plan is
unsuccessful, it may have a material, adverse effect on Compass's future
operating results and financial condition.
Recognizing the importance of customer awareness, Compass has completed two
mailings of Y2K information to all customers with statement accounts. Also,
letters have been sent to major commercial loan customers and automobile
dealerships informing them of the Year 2000 Issue and how it can impact
businesses. An overall assessment of the Y2K readiness of the Compass's
commercial loan customers was completed in October 1998, with an overall
assessment of low to medium risk. The Bank will continue to monitor its large
commercial loan relationships through account officers contact programs. Also,
new and renewed credits greater than $100,000 include a Y2K analysis as part of
the underwriting decision process.
To date, Compass has not identified any system which presents a material
risk of not being Year 2000 ready in a timely fashion or for which a suitable
alternative cannot be implemented. However, as Compass progresses with its Year
2000 project, it may identify systems which do present a material risk of Year
2000 disruption. Such disruption could include, among other things, the
inability to process and underwrite loan applications, to credit deposits and
withdrawals from customer accounts, to credit loan payments or track
delinquencies, to properly reconcile and record daily activity or to engage in
normal banking activities. Additionally, if Compass's commercial customers are
not Year 2000 compliant and suffer adverse effects on their operations, their
ability to meet their obligations to the Bank could
44
<PAGE>
be adversely affected. The failure of Compass to identify systems which require
Year 2000 hardware and software upgrades that are critical to the Bank's
operations or the failure of the Bank or others with which the Bank does
business to become Year 2000 ready in a timely manner could have a material
adverse impact on the Bank's financial condition and results of operations.
Moreover, to the extent that the risks posed by the Year 2000 problem are
pervasive in data processing and transmission and communications services
worldwide, the Bank cannot predict with any certainty that its operations will
remain materially unaffected after January 1, 2000 or on dates preceding this
date at which time post-January 1, 2000 dates become significant within the
Bank's systems.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General. The chief market risk factor affecting the financial condition and
operating results of Seacoast Financial is interest rate risk. This risk is
managed by periodic evaluation of the interest rate risk inherent in certain
balance sheet accounts, determination of the level of risk considered
appropriate given Compass's capital and liquidity requirements, business
strategy, performance objectives and operating environment and maintenance of
such risks withing guidelines approved by the Board. Through such management,
Compass seeks to reduce the vulnerability of its net earnings to changes in
interest rates. Compass's Asset/Liability Committee, comprised of senior
management, is responsible for managing interest rate risk and reviewing with
the Board of Directors on a quarterly basis its activities and strategies, the
effect of those strategies on Compass's and Seacoast Financial's operating
results, Compass's interest rate risk position and the effect changes in
interest rates would have Compass's net interest income. The extent of movement
of interest rates is an uncertainty that could have negative impact on the
earnings of Seacoast Financial.
The principal strategies Seacoast Financial and Compass use to manage
interest rate risk include (i) emphasizing the origination and retention of
adjustable-rate loans, origination of indirect auto loans which have relatively
short maturities and origination of loans with maturities at least partly
matched with those of the deposits and borrowings funding the loans, (ii)
investing in debt securities with relatively short maturities and (iii)
classifying a significant portion of its investment portfolio as available for
sale so as to provide sufficient flexibility in liquidity management.
Seacoast Financial quantifies its interest-rate risk exposures using a
sophisticated simulation model. Simulation analysis is used to measure the
exposure of net interest income to changes in interest rates over a specified
time horizon. Simulation analysis involves projecting future interest income and
expense under various rate scenarios. Compass's internal guidelines on interest
rate risk specify that for every 100 basis points immediate shift in interest
rates, its estimated net interest income over the next 12 months should decline
by less than 5%.
In utilizing a 300 basis point increase in rates in its simulation model,
the full impact of annual rate caps of 200 basis points common to most
adjustable rate mortgage loan products is considered. The rate shocks used
assume an instantaneous and parallel change in interest rates. Prepayment speeds
for loans are based on published median dealer forecasts for each interest rate
scenario.
As of September 30, 1998, the date of the most recent analysis, Seacoast
Financial's estimated exposure as a percentage of estimated net interest income
for the next twelve and twenty-four month periods is as follows:
<TABLE>
<CAPTION>
Percentage Change in Estimated
Net Interest Income Over:
------------------------------------------
12 months 24 months
---------------------- -------------------
<S> <C> <C>
300 basis point increase in rates (9.62%) (5.97%)
200 basis point decrease in rates (4.00%) (8.51%)
</TABLE>
Based on the scenario above, net income would be adversely affected (within
Compass's internal guidelines) in both the twelve and twenty-four month periods.
For each one percentage point change in net interest income, the affect on net
income would be $293,000, assuming a 40% tax rate.
45
<PAGE>
Item 8. Financial Statements and Supplementary Data
<TABLE>
Historical Financial Statements: Page
----
<S> <C>
Report of Independent Public Accountants.................................................................. 47
Consolidated Balance Sheets as of October 31, 1998 and 1997............................................... 48
Consolidated Statements of Income for the Years Ended October 31, 1998, 1997 and 1996..................... 49
Consolidated Statements of Changes in Surplus for the Years Ended October 31, 1998, 1997 and 1996......... 50
Consolidated Statements of Cash Flows for the Years Ended October 31, 1998, 1997 and 1996................. 51
Notes to Consolidated Financial Statements................................................................ 53-78
All schedules are omitted because they are not required or applicable, or the
required information is shown in the financial statements or notes thereto.
</TABLE>
46
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Audit Committee of
Seacoast Financial Services Corporation:
We have audited the accompanying consolidated balance sheets of Seacoast
Financial Services Corporation and subsidiary (the Bank) as of October 31, 1998
and 1997, and the related consolidated statements of income, changes in surplus
and cash flows for each of the three years in the period ended October 31, 1998.
These consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
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
Seacoast Financial Services Corporation and subsidiary as of October 31, 1998
and 1997, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended October 31, 1998, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts,
December 10, 1998
47
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
October 31
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS:
Cash and due from banks................................................... $ 53,553 $ 25,611
Federal funds sold........................................................ 12,080 7,150
---------- ----------
Total cash and cash equivalents....................................... 65,633 32,761
Investment securities (Note 2) --
Available-for-sale, at fair value..................................... 177,689 209,316
Held-to-maturity, at amortized cost................................... 13,694 12,633
Restricted equity securities.......................................... 5,286 5,156
Loans held-for-sale (Note 1).............................................. 13,495 4,277
Loans, net (Notes 3 and 13)............................................... 949,844 809,555
Accrued interest receivable............................................... 5,779 5,805
Banking premises and equipment, net (Note 5).............................. 15,020 12,254
Other real estate owned (Note 4).......................................... 1,011 1,707
Net deferred tax asset (Note 9)........................................... 6,224 6,988
Other assets (Notes 1, 12, 16 and 17)..................................... 10,428 6,138
---------- ----------
Total assets.......................................................... $1,264,103 $1,106,590
========== ==========
LIABILITIES AND SURPLUS:
Deposits (Note 6)......................................................... $1,064,483 $ 937,948
Short-term borrowings (Notes 2 and 7)..................................... 15,801 9,697
Federal Home Loan Bank advances (Note 8).................................. 59,420 51,006
Other borrowings ......................................................... 284 --
Mortgagors' escrow payments............................................... 1,417 1,002
Accrued expenses and other liabilities (Note 12).......................... 10,126 8,796
---------- ----------
Total liabilities..................................................... 1,151,531 1,008,449
---------- ----------
COMMITMENTS AND CONTINGENCIES
(Notes 9, 10 and 13)
SURPLUS (Note 11)............................................................... 110,020 96,527
NET UNREALIZED GAIN ON INVESTMENT SECURITIES
AVAILABLE-FOR SALE, NET OF INCOME TAXES................................... 2,552 1,614
---------- ----------
Total surplus......................................................... 112,572 98,141
---------- ----------
Total liabilities and surplus......................................... $1,264,103 $1,106,590
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
48
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands)
<TABLE>
<CAPTION>
Years Ended October 31,
-------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
INTEREST AND DIVIDEND INCOME:
Interest on loans (Note 3)................................................... $ 73,300 $ 65,499 $ 60,423
Interest and dividends on investments securities............................. 12,504 13,298 12,756
Interest on federal funds sold............................................... 1,363 1,235 947
-------- -------- --------
Total interest and dividend income....................................... 87,167 80,032 74,126
-------- -------- --------
INTEREST EXPENSE:
Interest on deposits......................................................... 38,850 36,109 34,621
Interest on borrowed funds................................................... 4,648 3,722 2,624
-------- -------- --------
Total interest expense................................................... 43,498 39,831 37,245
-------- -------- --------
Net interest income...................................................... 43,669 40,201 36,881
PROVISION FOR LOAN LOSSES (Note 3).............................................. 1,402 1,865 1,166
-------- -------- --------
Net interest income after provision
for loan losses........................................................ 42,267 38,336 35,715
-------- -------- --------
NONINTEREST INCOME:
Deposit and other banking fees............................................... 3,289 3,213 2,733
Loan servicing fees, net (Note 3)............................................ 491 571 607
Card fee income, net......................................................... 438 398 354
Other loan fees.............................................................. 453 449 412
Gain on sales of investment securities, net.................................. 7 37 60
Gain on sales of loans, net.................................................. 1,276 542 181
Other income................................................................. 1,090 733 799
-------- -------- --------
Total noninterest income................................................. 7,044 5,943 5,146
-------- -------- --------
NONINTEREST EXPENSE:
Salaries and employee benefits (Note 12)..................................... 15,027 13,633 12,890
Occupancy and equipment expenses (Notes 5 and 10)............................ 3,633 3,344 3,276
Data processing expenses..................................................... 2,581 2,192 2,049
Marketing expenses........................................................... 1,531 1,225 743
Professional services expenses............................................... 1,078 1,044 975
Deposit insurance premiums................................................... 155 121 392
Other real estate owned expenses, net (Note 1)............................... 215 519 644
Other operating expenses..................................................... 3,291 2,732 3,189
-------- -------- --------
Total noninterest expense................................................ 27,511 24,810 24,158
-------- -------- --------
Income before provision for income taxes................................. 21,800 19,469 16,703
PROVISION FOR INCOME TAXES (Note 9)............................................. 8,307 7,685 6,548
-------- -------- --------
Net income............................................................... $ 13,493 $ 11,784 $ 10,155
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
49
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SURPLUS
FOR THE YEARS ENDED OCTOBER 31, 1998, 1997 AND 1996
(In Thousands)
<TABLE>
<CAPTION>
Net Unrealized Gain
on Securities
Available-for-Sale,
Surplus Net of Income Taxes Total Surplus
-------- ------------------- -------------
<S> <C> <C> <C>
BALANCE, OCTOBER 31, 1995................................. $ 74,588 $ 16 $ 74,604
Net income........................................... 10,155 -- 10,155
Change in unrealized gain on securities
available-for-sale................................. -- 158 158
-------- ------ --------
BALANCE, OCTOBER 31, 1996................................. 84,743 174 84,917
Net income........................................... 11,784 -- 11,784
Change in unrealized gain on securities
available-for-sale................................. -- 1,440 1,440
-------- ------ --------
BALANCE, OCTOBER 31, 1997................................. 96,527 1,614 98,141
Net income........................................... 13,493 -- 13,493
Change in unrealized gain on securities
available-for-sale................................. -- 938 938
-------- ------ --------
BALANCE, OCTOBER 31, 1998................................. $110,020 $2,552 $112,572
======== ====== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
50
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
Years Ended October 31,
-------------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................... $ 13,493 $ 11,784 $ 10,155
Adjustments to reconcile net income to net cash
provided by operating activities--
Depreciation of premises and equipment....................... 1,518 1,420 1,301
Amortization and accretion, net.............................. 699 906 337
Provision for loan losses.................................... 1,402 1,865 1,166
Gain on sale of investment securities, net................... (7) (37) (60)
Provision for other real estate losses....................... 62 202 390
Gain on sale of other real estate owned...................... (24) (4) (5)
Provision for deferred (prepaid) taxes....................... 177 453 (757)
Originations of loans held-for-sale.......................... (108,367) (30,014) (19,006)
Proceeds from sales of loans originated for resale........... 100,425 34,268 35,441
Gain on sales of loans, net.................................. (1,276) (542) (181)
Loss on sale of premises and equipment....................... 42 -- 5
Net (increase) decrease in accrued interest receivable....... 26 (383) --
Net (increase) decrease in other assets...................... (939) (714) 3,770
Net increase (decrease) in accrued expenses
and other liabilities..................................... (70) (605) 1,932
---------- ---------- ----------
Net cash provided by operating activities.......... 7,161 18,599 34,488
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities classified as available-for-sale....... (65,577) (104,748) (77,055)
Purchase of securities classified as held-to-maturity......... (7,480) (5,971) (6,924)
Proceeds from sales, calls, paydowns and maturities of
securities classified as available-for-sale.................. 98,403 100,553 114,820
Proceeds from paydowns, maturities and calls of securities
classified as held-to-maturity............................... 6,300 5,069 10,276
Purchase of premises and equipment............................ (4,326) (1,123) (1,670)
Purchase of loans............................................. (11,911) (4,461) (8,859)
Net increase in loans......................................... (130,517) (78,620) (106,726)
Recoveries of loans previously charged off.................... 375 377 389
Proceeds from sales of other real estate owned................ 1,020 2,315 2,722
Proceeds from sales of premises and equipment................. -- -- 4
Net cash used in investing activities.............. (113,713) (86,609) (73,023)
---------- ---------- ----------
</TABLE>
51
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In Thousands)
<TABLE>
<CAPTION>
Years Ended October 31,
----------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in NOW, money market deposit and
demand deposit accounts...................................... $ 48,249 $(11,072) $ 15,441
Increase (decrease) in passbook and other
savings accounts............................................. 35,404 29,014 (7,743)
Increase in term certificates................................. 42,882 37,398 15,187
Advances from Federal Home Loan Bank.......................... 21,787 17,007 16,992
Repayments of Federal Home Loan Bank advances................. (13,373) (11,376) (10,981)
Payment of stock offering and merger costs.................... (2,328) -- --
Increase in short-term and other borrowings................... 6,388 5,124 2,759
Increase (decrease) in mortgagors' escrow payments............ 415 112 (111)
-------- -------- --------
Net cash provided by financing activities.......... 139,424 66,207 31,544
-------- -------- --------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS.......................................... 32,872 (1,803) (6,991)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR............................................. 32,761 34,564 41,555
-------- -------- --------
CASH AND CASH EQUIVALENTS,
END OF YEAR................................................... $ 65,633 $ 32,761 $ 34,564
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid on deposits and borrowed funds................. $ 43,472 $ 39,734 $ 37,244
Income taxes paid............................................ 7,482 8,434 6,264
SUPPLEMENTAL DISCLOSURE OF NONCASH
TRANSACTIONS:
Transfers from loans to other real estate owned.............. 1,474 3,333 2,430
Financed other real estate and owned sales................... 1,112 1,460 638
Loans securitized into mortgage-backed
investments............................................... -- 3,595 20,837
Transfer of investments from held-to-maturity
to available-for-sale..................................... -- -- 138,701
</TABLE>
The accompanying notes are part of these consolidated financial statements.
52
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Compass Bank for Savings was reorganized into a mutual bank holding company
operating under the name of The 1855 Bancorp, now known as Seacoast Financial
Services Corporation (the Company), on October 1, 1994 under the provisions of
Massachusetts general law. A new Massachusetts savings bank in stock form, known
as Compass Bank for Savings (the Bank), was chartered as a wholly owned
subsidiary of the Company. All deposits of the Bank are insured by the Federal
Deposit Insurance Corporation (FDIC) or the Depositors Insurance Fund.
On November 20, 1998, the Company completed its conversion from a mutual
bank holding company to a stock holding company with the issuance of 14,000,000
shares of common stock in an initial public offering (see Note 16). On December
4, 1998, the Company completed its acquisition of Sandwich Bancorp, Inc.
(Sandwich) in a stock-for-stock exchange to be accounted for as a pooling of
interests (see Note 17). Neither the issuance of stock in connection with the
Company's conversion nor the acquisition of Sandwich are reflected in the
accompanying consolidated financial statements as they occurred subsequent to
year end. In the future, financial statements of the Company presenting
financial information prior to the acquisition of Sandwich, will be restated to
combine the assets, liabilities, equity and results of operations of Sandwich as
required by the pooling of interests method of accounting.
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, Compass Bank for Savings,
(collectively referred to as the Bank). The Bank has four wholly owned
subsidiaries--Compass Credit Corp. which engages in buying, selling and
originating automobile loans and other extensions of credit; The 1855
Corporation which engages in leasing of property primarily for Bank use; CB
Securities Corporation which engages in the investment of securities; and
Buffinton-Brook Realty Corporation which is the owner of Compass Preferred
Capital Corporation which is involved in real estate activities which enables it
to be taxed as a real estate investment trust. The 1855 Corporation has two
wholly owned subsidiaries-Purchase Corporation and North Front Street, Inc.,
which engage in the management of real estate acquired from the Bank through
foreclosure. All significant intercompany balances and transactions have been
eliminated in consolidation.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. In preparing the
financial statements, management is required 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 sheets and
income and expenses during the reporting periods. Actual results could differ
from those estimates. Material estimates that are particularly susceptible to
change relate to the determination of the allowance for possible loan losses and
the valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash, amounts due from banks and federal funds sold. Federal funds are sold with
maturities of one day.
Investment Securities
Debt securities that the Bank has the positive intent and ability to hold
to maturity are classified as held-to-maturity and reported at cost, adjusted
for amortization of premiums and accretion of discounts, both computed by a
method that approximates the effective yield method; debt and equity securities
that are bought and held principally for the purpose of selling them in the near
term are classified as trading and reported at fair value, with unrealized gains
and losses included in earnings. Debt and equity securities not classified as
either held-to-maturity or trading are classified as
53
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of surplus, net of
taxes. The Bank classifies its securities based on the Bank's intention at the
time of purchase.
Restricted equity securities are reported at cost.
Unrealized losses deemed to be other than temporary declines in value are
charged to operations. When securities are sold, the adjusted cost of the
specific securities sold is use to compute gains or losses on the sale.
Loans, Deferred Fees and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by amounts due
to borrowers on unadvanced loans, net deferred loan fees, unearned discount and
the allowance for loan losses.
Unearned discount is recognized on the level-yield method for discounted
installment loans. All other interest on loans is recognized on a simple
interest basis.
Deferred loan origination fees and certain deferred loan origination costs
are amortized over the contractual life of the related loan using the
level-yield method. At October 31, 1998 and October 31, 1997, the Bank had net
deferred loan fees of $721,000, and $706,000 respectively.
It is the policy of the Bank to discontinue the accrual of interest on
loans delinquent in excess of 90 days or sooner if, in the judgement of
management, the ultimate collectibility of principal or interest becomes
doubtful and to reverse all interest previously accrued. Interest income is
subsequently recognized only to the extent cash payments are received.
Loans are considered impaired when it is probable that the Bank will not be
able to collect principal, interest and fees according to the contractual terms
of the loan agreement. Management considers the paying status, net worth and
earnings potential of a borrower, and the value and cash flow of the collateral
as factors to determine whether a loan will be paid in accordance with its
contractual terms. The amount judged to be impaired is the difference between
the present value of the expected cash flows using as a discount rate the
original contractual effective interest rate and the recorded investment of the
loan. If foreclosure on a collateralized loan is probable, impairment is
measured based on the fair value of the collateral compared to the recorded
investment. If appropriate, a valuation reserve is established to recognize the
difference between the recorded investment and the present value. Impaired loans
are charged off when management believes that the collectibility of the loan is
remote. The Bank considers nonaccrual loans, except for smaller balance
homogeneous residential mortgage and consumer loans, and troubled debt
restructures to be impaired. All impaired loans are classified as nonaccrual.
The allowance for loan losses is maintained at a level considered adequate
to provide for potential loan losses. The allowance is increased by provisions
charged to operations, and realized losses, net of recoveries, are charged
directly to the allowance. The provision and the level of the allowance are
based on management's periodic review of the loan portfolio in light of
historical experience and prevailing economic conditions. The allowance is an
estimate, and ultimate losses may vary from current estimates. As adjustments
become necessary, they are reported in the results of operations of the period
in which they become known.
Loan Sales
Loans held for sale are valued at the lower of the recorded loan balance or
market value. The Bank periodically enters
54
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
into forward commitments to sell loans for the purpose of reducing interest rate
risk associated with the origination of loans for sale. Unrealized losses on
contracts used to hedge the Bank's closed loans and pipeline of loans expected
to close are considered in adjusting the carrying value of loans held for sale.
No adjustments for unrealized losses were required at October 31, 1998, 1997 and
1996.
Prior to November 1, 1996, gains and losses on sales of loans were
recognized based on the difference between the selling price and the carrying
value of the related loans sold. When the servicing of such loans was retained
by the Bank, gains and losses were adjusted by the present value of the
difference, if any, between the weighted average interest rate on the loans
sold, adjusted for a normal servicing fee, and the agreed yield to the buyer.
Effective November 1, 1996, the Bank adopted Statement of Financial
Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights."
SFAS No. 122, required entities that engage in mortgage banking activities to
recognize, as separate assets, rights to service mortgage loans for others
acquired through either the purchase or origination of mortgage loans and sale
or securitization of those loans with servicing retained. The amount capitalized
is based on an allocation of the total cost of the mortgage loans to the
mortgage servicing rights and the loans without the mortgage servicing rights
based on their relative fair values. In addition, capitalized mortgage servicing
rights are required to be assessed for impairment based on the fair value of
those rights. For purposes of measuring impairment, the rights are stratified
based on certain predominant risk characteristics of the underlying loans,
namely, interest rates, frequency of interest rate adjustment and loan maturity
dates. Effective January 1, 1997, SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities," superseded
SFAS No. 122. For servicing contracts in existence before January 1, 1997,
previously recognized servicing rights and excess servicing receivables that do
not exceed contractually specified servicing fees were combined.
For the years ended October 31, 1998 and 1997, the Bank capitalized
$725,000 and $255,000, respectively, in mortgage servicing rights. The mortgage
servicing rights are amortized in proportion to, and over the period of,
estimated net servicing income on loans. Amortization of mortgage servicing
rights for the years ended October 31, 1998 and 1997 was $167,000 and $33,000,
respectively. No impairment loss was recognized in 1998 and 1997.
Banking Premises and Equipment
Land is stated at cost. Buildings, leasehold improvements and equipment are
stated at cost, less accumulated depreciation and amortization, which are
computed on the straight-line method over the estimated useful lives of the
assets or the terms of the leases, if shorter. Maintenance and repairs are
expensed when incurred; major expenditures for betterments are capitalized and
depreciated.
Other Real Estate Owned
Other real estate owned (OREO) is composed of properties acquired through
foreclosure or deed in lieu of foreclosure. After foreclosure, foreclosed assets
are presumed to be held-for-sale and are recorded at the lower of the carrying
value of the related loan or the fair value of property, less estimated costs to
sell. The excess, if any, of the loan balance over the fair value of the
property at the time of transfer from loans to OREO is charged to the allowance
for loan losses. Subsequent write-downs of the carrying value of the foreclosed
assets are charged to expense. Costs relating to the development and improvement
of the property are capitalized. Costs relating to holding the property are
charged to expense. Included in other real estate owned expenses are net gains
on sale and provisions for losses amounting to $38,000, $210,000 and $385,000
and net operating expenses of $177,000, $309,000 and $259,000 in 1998, 1997 and
1996, respectively.
55
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
The Bank utilizes the asset and liability method of accounting for income
taxes. Under this method, deferred tax assets and liabilities 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 effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Core Deposit Intangible Asset
The core deposit intangible asset is being amortized over periods ranging
from six to ten years using the straight-line method. Amortization expense was
$273,000, $280,000 and $306,000 in 1998, 1997, and 1996, respectively. The core
deposit intangible asset is reported net of accumulated amortization and
amounted to $1,412,000 and $1,685,000 at October 31, 1998 and 1997,
respectively.
Reclassifications
Certain reclassifications have been made to the 1996 and 1997 financial
statements to conform to the 1998 presentation. Such reclassifications have no
effect on previously reported net income.
(2) INVESTMENT SECURITIES
The amortized cost and fair value of securities available-for-sale at October
31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
October 31, 1998
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
U.S. government and agency obligations........................... $ 81,638 $1,282 $ 2 $ 82,918
Other bonds and obligations...................................... 47,771 683 29 48,425
Mortgage-backed investments...................................... 32,840 469 21 33,288
-------- ------ ---- --------
Total debt securities....................................... 162,249 2,434 52 164,631
-------- ------ ---- --------
Marketable equity securities and mutual funds.................... 11,338 1,758 38 13,058
-------- ------ ---- --------
Total securities available for sale......................... $173,587 $4,192 $ 90 $177,689
======== ====== ==== ========
</TABLE>
56
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(2) INVESTMENT SECURITIES (Continued)
<TABLE>
<CAPTION>
October 31, 1997
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
U.S. government and agency obligations.......................... $ 113,231 $ 392 $ 127 $ 113,496
Other bonds and obligations..................................... 45,774 239 46 45,967
Mortgage-backed investments..................................... 45,652 555 50 46,157
---------- -------- ------ ----------
Total debt securities.................................... 204,657 1,186 223 205,620
Marketable equity securities and mutual funds................... 2,164 1,532 --- 3,696
---------- -------- ------ ----------
Total securities available for sale $ 206,821 $ 2,718 $ 223 $ 209,316
========== ======== ====== ==========
</TABLE>
A schedule of the maturity distribution of debt securities
available-for-sale at October 31, 1998 is as follows:
<TABLE>
<CAPTION>
Carrying Percent of Amortized
Value Total Cost
--------- ----- --------
(Dollars in thousands)
<S> <C> <C> <C>
One year or less................................................ $ 31,017 18.8% $ 30,826
Over 1 year to 5 years.......................................... 88,710 53.9 87,303
Over 5 years to 10 years........................................ 22,451 13.6 22,021
Over 10 years................................................... 22,453 13.7 22,099
--------- ----- --------
$ 164,631 100.0% $162,249
========= ===== ========
</TABLE>
Mortgage-backed investments are shown at their contractual maturity dates,
but actual maturities may differ as borrowers have the right to prepay
obligations without incurring prepayment penalties.
The amortized cost and fair value of securities held-to-maturity at October
31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
October 31, 1998
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------ ------------ -------
(In thousands)
<S> <C> <C> <C> <C>
U.S. government and agency obligations.................. $ 13,694 $ 286 $ -- $13,980
-------- ----- ----- -------
Total securities held to maturity................ $ 13,694 $ 286 $ -- $13,980
======== ===== ===== =======
</TABLE>
57
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(2) INVESTMENT SECURITIES (Continued)
<TABLE>
<CAPTION>
October 31, 1997
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ---------- ---------- -------
(In thousands)
<S> <C> <C> <C> <C>
U.S. government and agency obligations.................. $ 12,633 $ 68 $ 7 $12,694
-------- ---- --- -------
Total securities held to maturity................ $ 12,633 $ 68 $ 7 $12,694
======== ==== === =======
</TABLE>
A schedule of the maturity distribution of debt securities held-to-maturity at
October 31, 1998 is as follows:
<TABLE>
<CAPTION>
Carrying Percent of
Value Total Fair Value
---------- ----- -------
(Dollars in thousands)
<S> <C> <C> <C>
One year or less................................................ $ 2,329 17.0% $ 2,344
Over 1 year to 5 years.......................................... 11,365 83.0 11,636
--------- ----- -------
$ 13,694 100.0% $13,980
========= ===== =======
</TABLE>
Included in restricted equity securities at October 31, 1998 and 1997 are
Federal Home Loan Bank (FHLB) stock, Savings Bank Life Insurance Company of
Massachusetts stock and the Depositors Insurance Fund.
Proceeds from the sales of investment securities and related gains and
losses for the years ended October 31, 1998, 1997 and 1996 (all classified as
available-for-sale) were as follows:
<TABLE>
<CAPTION>
Years Ended October 31,
----------------------------------------
1998 1997 1996
-------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Proceeds from sales.................................................... $ 6,105 $ 22,017 $ 26,051
Gross gains............................................................ 24 58 101
Gross losses........................................................... 17 21 41
</TABLE>
At October 31, 1998, investment securities carried at $4,000,000 were
pledged to secure public deposits under the Treasury, Tax and Loan program, as
required by law, securities carried at $5,230,000 were pledged to secure
deposits held by various municipalities and securities, which are under the
Bank's control, carried at $18,000,000 were pledged against various repurchase
agreements.
58
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(3) LOANS
The Bank's loan portfolio consisted of the following:
<TABLE>
<CAPTION>
October 31,
-----------------------------------
1998 1997
---------- ----------
(In thousands)
<S> <C> <C>
Real estate loans:
Residential (one-to-four family)................... $ 385,233 $ 363,030
Commercial......................................... 125,870 124,059
Home equity lines of credit........................ 16,106 15,133
Construction....................................... 41,042 33,894
---------- ----------
Total real estate loans...................... 568,251 536,116
---------- ----------
Commercial loans........................................ 59,916 51,371
---------- ----------
Consumer loans:
Indirect auto loans................................ 342,266 238,114
Other.............................................. 27,618 24,662
---------- ----------
Total consumer loans......................... 369,884 262,776
Less---Unearned discount................................ 37,201 30,066
---------- ----------
Total consumer loans, net.................... 332,683 232,710
---------- ----------
Total loans.................................. 960,850 820,197
Less--Allowance for loan losses.......................... 11,006 10,642
Total loans, net............................. $ 949,844 $ 809,555
========== ==========
</TABLE>
Nonaccrual loans consisted of the following:
<TABLE>
<CAPTION>
October 31,
----------------------------
1998 1997
-------- ---------
(In Thousands)
<S> <C> <C>
Real estate........................................ $ 4,116 $ 10,180
Commercial......................................... 309 745
-------- ---------
$ 4,425 $ 10,925
======== =========
</TABLE>
At October 31, 1998 and 1997, troubled debt restructurings totaled
$1,681,000 and $4,619,000 respectively. There are no commitments to extend
additional credit on these loans.
During 1998, the average recorded investment in impaired loans was
$7,747,000 and the income recognized related to impaired loans while impaired
was $437,000. At October 31, 1998, the Bank classified $4,425,000 of its loans
as impaired of which $1,007,000 had a related valuation reserve of $110,000.
Impaired loans of $3,418,000 did not require a valuation reserve.
During 1997, the average recorded investment in impaired loans was
$10,844,000 and the income recognized related to impaired loans while impaired
was $778,000. At October 31, 1997, the Bank classified $10,560,000 of its loans
as impaired of which $7,912,000, had a related valuation reserve of $1,114,000.
Impaired loans of $2,648,000 did not require a valuation reserve.
59
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(3) LOANS (Continued)
During 1996, the average recorded investment in impaired loans was
$9,174,000, and the income recognized related to impaired loans while impaired
was $671,000.
In the ordinary course of business, the Bank makes loans to its executive
officers, directors and related parties at substantially the same terms as loans
made to unrelated borrowers. The Bank rarely extends credit to its officers. An
analysis of related party loans for the years ended October 31, 1998 and 1997 is
as follows:
<TABLE>
<CAPTION>
October 31,
-----------------------
1998 1997
-------- -------
(In thousands)
<S> <C> <C>
Balance, beginning of year...................................................... $ 5,116 $ 5,807
New loans.................................................................. 40 442
Payments................................................................... (122) (1,133)
Other (due to director resignations)....................................... (3,514) --
-------- -------
Balance, end of year............................................................ $ 1,520 $ 5,116
======== =======
</TABLE>
Loans serviced for others at October 31, 1998 and 1997 amounted to
$263,163,000 and $204,162,000, respectively. At October 31, 1998 there were no
serviced loans outstanding subject to formal recourse provisions.
An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
Years Ended October 31,
---------------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Balance, beginning of year.................................. $ 10,642 $ 10,334 $ 9,850
Provision for possible loan losses.......................... 1,402 1,865 1,166
Charge-offs---
Real estate.............................................. (571) (898) (501)
Commercial............................................... (142) (442) (134)
Consumer................................................. (700) (594) (436)
-------- -------- -------
(1,413) (1,934) (1,071)
-------- -------- -------
Recoveries---
Real estate.............................................. 58 147 191
Commercial............................................... 164 57 96
Consumer................................................. 153 173 102
-------- -------- -------
375 377 389
-------- -------- -------
Net charge-offs................................. (1,038) (1,557) (682)
-------- -------- -------
Balance, end of year........................................ $ 11,006 $ 10,642 $10,334
======== ======== =======
</TABLE>
60
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(4) OTHER REAL ESTATE OWNED
Other real estate owned acquired through foreclosure consisted of the
following:
<TABLE>
<CAPTION>
October 31,
------------------------
1998 1997
------- --------
(In thousands)
<S> <C> <C>
Residential real estate............................. $ 709 $ 1,227
Commercial real estate.............................. 302 480
------- --------
$ 1,011 $ 1,707
======= ========
</TABLE>
(5) BANKING PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of
banking premises and equipment and their estimated useful lives is as follows:
<TABLE>
<CAPTION>
October 31,
--------------------------- Estimated
1998 1997 Useful Lives
---------- ---------- -----------------
(In thousands)
<S> <C> <C> <C>
Land.......................................................... $ 3,002 $ 2,503
Buildings..................................................... 11,089 9,378 30 to 50 years
Leasehold improvements........................................ 1,989 2,143 8 to 10 years
Furniture and equipment....................................... 8,263 7,026 3 to 20 years
Construction-in-progress...................................... 403 156
-------- -------
24,746 21,206
Less--Accumulated depreciation and
amortization............................................. 9,726 8,952
-------- -------
$ 15,020 $12,254
======== =======
</TABLE>
Total depreciation and amortization expense of banking premises and
equipment for the years ended October 31, 1998, 1997 and 1996 amounted to
$1,518,000, $1,420,000, and $1,301,000 respectively, and is included in
occupancy and equipment expenses in the accompanying consolidated statements of
income.
61
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(6) DEPOSITS
A summary of deposit balances is as follows:
<TABLE>
<CAPTION>
October 31,
--------------------------
1998 1997
---------- --------
(In thousands)
<S> <C> <C>
Demand deposit account........................................................ $ 70,817 $ 58,840
NOW and money market deposit accounts......................................... 259,852 223,580
Passbook and other savings accounts........................................... 206,476 171,072
---------- --------
Total noncertificate accounts......................................... 537,145 453,492
---------- --------
Term certificates-
Term certificates of $100,000 and over................................... 103,168 82,647
Term certificates less than $100,000..................................... 424,170 401,809
---------- --------
Total term certificate accounts....................................... 527,338 484,456
---------- --------
$1,064,483 $937,948
========== ========
</TABLE>
A schedule of the maturity distribution of term certificates with weighted
average interest rates is as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
--------- -------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Within 1 year...................................... $ 437,008 5.42% $ 408,291 5.69%
Over 1 to 2 years.................................. 47,762 5.75 46,405 6.17
Over 2 to 3 years.................................. 31,633 5.94 18,129 5.90
Over 3 to 5 years.................................. 10,935 5.85 11,631 6.05
--------- ----------
$ 527,338 5.49% $ 484,456 5.75%
========= ==========
</TABLE>
(7) SHORT-TERM BORROWINGS
Short-term borrowings consisted of the following:
<TABLE>
<CAPTION>
October 31,
--------------------------
1998 1997
--------- -------
(In thousands)
<S> <C> <C>
Securities sold under agreements to repurchase............ $ 14,830 $ 9,533
Treasury tax and loan note account........................ 971 164
--------- -------
$ 15,801 $ 9,697
========= =======
</TABLE>
The weighted average interest rates on short-term borrowings during 1998,
1997 and 1996 were 4.78%, 4.77% and 4.82%, respectively.
62
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(8) FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank (FHLB) advances are collateralized by a blanket-type
pledge agreement on the Bank's FHLB stock, certain qualified investment
securities, deposits at the FHLB and first mortgages on residential property. As
a member of the FHLB, the Bank is required to invest in stock of the FHLB at an
amount equal to the greater of 1% of its outstanding first mortgage residential
loans, .3% of total assets or 5% of its outstanding advances from the FHLB
divided by a leverage factor of 20. When such stock is redeemed, the Bank will
receive from the FHLB an amount equal to the par value of the stock. The Bank
also has access to a preapproved line of credit of $20,000,000. No funds were
advanced under this line of credit during 1998 and 1997.
A schedule of the maturity distribution of FHLB advances with weighted
average interest rates is as follows:
<TABLE>
<CAPTION>
October 31,
---------------------------------------------------------
1998 1997
--------------------------- ---------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
----------- ----------- ----------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Within 1 year.......................................... $ 2,296 5.85% $ 6,087 6.40%
Over 1 to 5 years...................................... 33,731 6.14 16,528 6.02
Over 5 to 10 years..................................... 4,612 6.45 10,741 6.61
Over 10 years.......................................... 18,781 7.16 17,650 7.29
-------- ---------
$ 59,420 6.47% $ 51,006 6.63%
======== =========
</TABLE>
The Bank may be subject to a substantial penalty upon prepayment of FHLB
advances.
63
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(9) INCOME TAXES
The components of the provision for income taxes for the years ended
October 31 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Current--
Federal........................................................ $ 7,083 $ 5,762 $5,448
State.......................................................... 1,047 1,470 1,857
-------- -------- -------
Total current............................................. 8,130 7,232 7,305
-------- -------- -------
Deferred (prepaid)--
Federal........................................................ 130 231 (560)
State.......................................................... 47 222 (197)
-------- -------- -------
Total deferred (prepaid).................................. 177 453 (757)
-------- -------- -------
$ 8,307 $ 7,685 $6,548
======== ======== =======
</TABLE>
The difference between the income tax rate computed by applying the statutory
federal income tax rate to income before income taxes and the actual effective
income tax rate is summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Statutory rate....................................................... 35.00% 35.00% 34.00%
State taxes, net of federal benefit.................................. 3.26 5.68 6.56
Other, net........................................................... (0.15) (1.21) (1.36)
----- ----- -----
Effective tax rate........................................... 38.11% 39.47% 39.20%
===== ===== =====
</TABLE>
The Bank's net deferred tax asset, as presented in the accompanying
consolidated balance sheets, consisted of the following components:
<TABLE>
<CAPTION>
October 31,
---------------------
1998 1997
------- ------
(In thousands)
<S> <C> <C>
Allowance for loan losses............................ $ 4,314 $4,114
Deferred compensation................................ 2,210 2,239
Acquired net operating loss carryforward............. 712 946
Accrued liabilities.................................. 265 547
Unrealized gain on available-for-sale securities..... (1,407) (898)
Other................................................ 130 40
------- ------
$ 6,224 $6,988
======= =======
</TABLE>
In August 1996, Congress passed the Small Business Job Protection Act of
1996. Included in this bill was the repeal of IRC Section 593, which allowed
thrift institutions special provisions in calculating bad debt deductions for
income tax purposes. Thrift institutions are now viewed as commercial banks for
income tax purposes. The repeal is effective for tax years which began after
December 31, 1995.
64
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(9) COMMITMENTS AND CONTINGENCIES (Continued)
One effect of this legislative change is to suspend the Bank's bad debt
reserve for income tax purposes as of its base year (October 31, 1988). Any bad
debt reserve in excess of the base year amount is subject to recapture over a
six-year time period. The suspended (i.e., base year) amount is subject to
recapture upon the occurrence of certain events, such as complete or partial
redemption of the Bank's stock or if the Bank ceases to qualify as a bank for
income tax purposes.
At October 31, 1998, the Bank's surplus includes $9,085,000 of bad debt
reserves, representing the base year amount, for which income taxes have not
been provided. Since the Bank does not intend to use the suspended bad debt
reserve for purposes other than to absorb the losses for which it was
established, deferred taxes in the amount of $3,800,000 have not been recorded
with respect to such reserve.
(10) COMMITMENTS AND CONTINGENCIES
In the normal course of business, there are outstanding commitments and
contingencies that are not reflected in the accompanying consolidated financial
statements.
Pursuant to the terms of noncancellable lease agreements pertaining to
banking premises and equipment, future minimum lease payment commitments are as
follows:
<TABLE>
<CAPTION>
Years Ending Future Minimum
October 31, Lease Payments
- ------------------ ------------------
(In thousands)
<S> <C>
1999.......................... $645
2000.......................... 542
2001.......................... 414
2002.......................... 313
2003.......................... 277
Thereafter.................... 651
</TABLE>
The leases contain renewal options for periods ranging from 8 to 85 years,
the cost of which is not included above. Rent expense for the years ended
October 31, 1998, 1997 and 1996 amounted to $577,000, $370,000 and $403,000
respectively, and is included in occupancy and equipment expenses in the
accompanying consolidated statements of income.
Aggregate reserves (in the form of deposits with the Federal Reserve Bank
and vault cash) of $8,567,000 and $6,754,000 were maintained to satisfy
regulatory requirements at October 31, 1998 and 1997, respectively.
In the ordinary course of business, the Bank is involved in litigation.
Based on its review of current litigation and discussion with legal counsel,
management does not expect any material adverse impact on the consolidated
financial position or results of operations resulting from the resolution of
pending litigation.
65
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(11) REGULATORY CAPITAL REQUIREMENTS
The Company and 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
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgements by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of October 31,
1998, that the Company and the Bank met all capital adequacy requirements to
which they are subject.
As of October 31, 1998, the most recent notification from the Federal
Reserve Bank of Boston classified the Company's capital as satisfactory, and the
most recent notification from the FDIC relating to the Bank categorized the Bank
as well capitalized under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, an insured depository institution must
maintain minimum total risk-based, Tier I-based and Tier I leverage ratios as
set forth in the table. There are no conditions or events since that
notification that management believes would have changed these classifications.
66
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(11) REGULATORY CAPITAL REQUIREMENTS (Continued)
The Company's and the Bank's actual capital amounts and ratios are as
follows:
<TABLE>
<CAPTION>
For Capital
Adequacy
Actual Purposes
---------------- ------------------------------------------------------------
Amount Ratio Amount Ratio
-------- ----- ------------------------------- ---------------------------
(Dollars in thousands)
As of October 31, 1998:
Company (consolidated) --
<S> <C> <C> <C> <C>
Total capital (to risk weighted assets) .. $117,934 13.15% greater than/equal to $ 71,767 greater than/equal to 8.0%
Tier I capital (to risk weighted assets .. $106,153 11.83% greater than/equal to $ 35,883 greater than/equal to 4.0%
Tier I capital (to average assets) ....... $106,153 8.68% greater than/equal to $ 48,918 greater than/equal to 4.0%
Bank --
Total capital (to risk weighted asseets) . $113,608 12.69% greater than/equal to $ 71,642 greater than/equal to 8.0%
Tier I capital (to risk weighted assets) . $102,602 11.46% greater than/equal to $ 35,821 greater than/equal to 4.0%
Tier I capital (to average assets) ....... $102,602 8.38% greater than/equal to $ 48,974 greater than/equal to 4.0%
As of October 31, 1997:
Company (consolidated) --
Total capital (to risk weighted assets ... $104,158 13.92% greater than/equal to $ 59,867 greater than/equal to 8.0%
Tier I capital (to risk weighted assets .. $ 94,788 12.67% greater than/equal to $ 29,933 greater than/equal to 4.0%
Tier I capital (to average assets) ....... $ 94,788 8.60% greater than/equal to $ 44,092 greater than/equal to 4.0%
Bank --
Total capital (to risk weighted assets ... $100,637 13.47% greater than/equal to $ 59,766 greater than/equal to 8.0%
Tier I capital (to risk weighted assets .. $ 91,283 12.22% greater than/equal to $ 29,883 greater than/equal to 4.0%
Tier I capital (to average assets) ....... $ 91,283 8.29% greater than/equal to $ 44,045 greater than/equal to 4.0%
<CAPTION>
To Be Well
Capitalized
Under Prompt
Corrective
Action Provisions
-------------------------------------
Amount Ratio
------------------------------ -----
As of October 31, 1998:
Company (consolidated) --
<S> <C> <C>
Total capital (to risk weighted assets) .. N/A N/A
Tier I capital (to risk weighted assets .. N/A N/A
Tier I capital (to average assets) ....... N/A N/A
Bank --
Total capital (to risk weighted asseets) . greater than/equal to $89,552 10.0%
Tier I capital (to risk weighted assets) . greater than/equal to $53,731 6.0%
Tier I capital (to average assets) ....... greater than/equal to $61,218 5.0%
As of October 31, 1997:
Company (consolidated) --
Total capital (to risk weighted assets ... N/A N/A
Tier I capital (to risk weighted assets .. N/A N/A
Tier I capital (to average assets) ....... N/A N/A
Bank --
Total capital (to risk weighted assets ... greater than/equal to $74,796 10.0%
Tier I capital (to risk weighted assets .. greater than/equal to $44,877 6.0%
Tier I capital (to average assets) ....... greater than/equal to $55,056 5.0%
</TABLE>
(12) EMPLOYEE BENEFITS
The Bank provides basic and supplemental pension benefits for eligible
employees through the Savings Bank's Employees Retirement Association Pension
Plan (the Plan). Each employee having reached the age of 21 and having completed
at least 1,000 hours of service in two consecutive 12-month periods beginning
with such employee's date of employment automatically becomes a participant in
the Plan. Benefits are based on employee's years of service and annual
compensation, as defined in the Plan. The Bank's funding policy is to contribute
annually the maximum amount that can be deducted for federal income tax
purposes. Contributions made under the Plan totaled $947,000, $609,000 and
$425,000 for 1998, 1997 and 1996, respectively.
67
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(12) EMPLOYEE BENEFITS (Continued)
Net pension cost under the Plan for the years ended October 31 included the
following components:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- ----
(In thousands)
<S> <C> <C> <C>
Service cost during year........................................................ $ 651 $ 517 $500
Interest cost on projected benefit obligation................................... 745 656 618
Return on plan assets........................................................... (670) (544) (439)
Net amortization and deferral................................................... (59) (57) (28)
Net pension cost........................................................... $ 667 $ 534 $651
===== ===== ====
</TABLE>
According to the Plan's actuary, the funded status of the Plan was as
follows at October 31:
<TABLE>
<CAPTION>
1998 1997
------- -------
(In Thousands)
<S> <C> <C>
Plan assets at fair value............................................................ $ 9,779 $ 8,369
Actuarial present value of projected benefit obligation
(substantially all vested)........................................................ 11,339 9,884
-------- --------
Excess of projected benefit obligation over assets................................... (1,560) (1,515)
Unrecognized net asset existing at transition........................................ (372) (398)
Unrecognized net gain................................................................ (874) (1,172)
-------- --------
Accrued pension liability included on balance sheet.................................. $(2,806) $(3,085)
======== ========
</TABLE>
The accumulated benefit obligation (all vested) at October 31, 1998 and
1997 amounted to $6,067,489 and $5,258,499, respectively. Plan assets consist
primarily of common stock, U.S. government and agency obligations and a
guaranteed investment contract.
Actuarial assumptions used in determining plan obligations and net pension
expense are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Discount rate used to calculate projected benefit obligation........... 7.25% 7.50% 7.50%
Expected long-term rate of return on plan assets....................... 8.00 8.00 7.50
Annual salary increases................................................ 5.00 5.00 5.00
</TABLE>
68
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(12) EMPLOYEE BENEFITS (Continued)
In addition to the Bank's defined benefit pension plan, the Bank sponsors a
noncontributory benefit postretirement life insurance plan (the Life Insurance
Plan) that covers all pre-1996 retirees and active employees designated by the
Bank for coverage. The Life Insurance Plan generally provides lifetime coverage
to retired employees equal to retiring employee's final rate of pay, but not
more than $50,000, and to active employees equal to three times the employee's
annual salary, but not more than $350,000. The Bank funds the Life Insurance
Plan in combination with its active employee coverage. The status of this Life
Insurance Plan is as follows:
<TABLE>
<CAPTION>
October 31,
-----------------
1998 1997
------ ------
(In thousands)
<S> <C> <C>
Accumulated postretirement benefit obligation--
Retirees...................................................................... $(289) $(288)
Eligible plan participants.................................................... (27) (26)
------ ------
Total............................................................ $(316) $(314)
====== ======
Plan assets................................................................... $ -- $ --
------ ------
Accumulated postretirement benefit obligation in excess of plan assets........ (316) (314)
Unrecognized transition obligation............................................ 23 25
Unrecognized prior service cost............................................... 59 62
Unrecognized net gain......................................................... (51) (31)
------ ------
Accrued postretirement benefit cost........................................... $(285) $(258)
====== =====
</TABLE>
Net periodic postretirement benefit cost included the following components:
<TABLE>
<CAPTION>
Years Ended October 31,
---------------------------
1998 1997 1996
-------- ------- -------
(In thousands)
<S> <C> <C> <C>
Service cost--benefits attributed to service during the period....................... $-- $-- $--
Interest cost on accumulated postretirement benefit obligation...................... 22 22 21
Amortization on transition obligation over 20 years................................. 2 2 2
Amortization of unrecognized prior service cost..................................... 3 2 2
--- --- ---
Net periodic postretirement benefit cost............................................ $27 $26 $25
=== === ===
</TABLE>
The discount rate used in determining the accumulated postretirement
benefit obligation was 7% in all years presented.
The Bank has entered into agreements with certain officers to provide
supplemental retirement benefits based on 25% of average compensation computed
over a three-year period. The present value of these future payments is being
accrued over the estimated remaining terms of employment. The accrued
supplemental retirement liability is $1,366,000 and $1,332,000 at October 31,
1998 and 1997, respectively. The agreements are being funded through a life
insurance program with policy benefits accruing to the Bank. The cash surrender
value of the policies is $1,746,000 and $1,567,000 at October 31, 1998 and 1997,
respectively, and is included in other assets in the accompanying consolidated
balance sheets. Net expense for these supplemental retirement benefits for the
years ended October 31, 1998, 1997 and 1996 amounted to $128,000, $70,000 and
$222,000, respectively, and is included in salaries and employee benefits in
69
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(12) EMPLOYEE BENEFITS (Continued)
the accompanying consolidated statements of income.
The Bank has an Employee Bonus and Management Incentive Compensation Plan
(the Bonus Plan) in which employees are eligible to participate. The Bonus Plan
provides for awards based on a combination of Bank and individual performance
objectives being met, subject to the approval of the Board of Directors. Amounts
charged to operations under the Bonus Plan amounted to $1,150,000, $1,024,000
and $696,000 for the years ended October 31, 1998, 1997 and 1996, respectively.
The Bank offers a 401(k) Retirement Savings Plan for employees.
Participating employees are able to contribute up to 15% of their salary, and
the Bank matches 50% of a participant's deferral contribution on the first 6% of
the deferral amount subject to the maximum allowable under federal regulations.
The Bank's matching contribution expense was $248,000, $218,000 and $193,000 for
the years ended October 31, 1998, 1997 and 1996, respectively, and is included
in salaries and employee benefits in the accompanying consolidated statements of
income.
(13) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATION OF
CREDIT RISK
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments may involve, to varying degrees, elements
of credit and interest rate risk in excess of the amounts recognized in the
accompanying consolidated balance sheets. The contract amounts of those
instruments reflect the extent of involvement the Bank has in particular classes
of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
Off-balance-sheet financial instruments whose contract amount present
credit risk included the following:
<TABLE>
<CAPTION>
October 31,
-------------------------
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Unused portion of existing lines of credit................. $49,458 $37,744
Standby letters of credit.................................. 1,742 1,110
Unadvanced construction loans.............................. 19,349 16,327
Firm commitments to extend credit:
Residential mortgage loans--
Fixed rate.......................................... 24,269 12,245
Adjustable rate..................................... 5,946 5,447
Commercial and commercial real estate loans........... 9,367 11,207
</TABLE>
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
70
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(13) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATION OF
CREDIT RISK(Continued)
require payment of a fee. Since some of the commitments may expire without being
drawn upon, the total commitment amounts do not necessarily require future cash
requirements. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained upon extension of the
credit is based on management's credit evaluation of the customer. Collateral
held varies but may include accounts receivable, inventory, property, plant and
equipment and income-producing commercial real estate.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. Most
guarantees extend for one year. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to
customers. The collateral supporting those commitments varies and may include
real property, accounts receivable or inventory.
The Bank originates primarily residential and commercial real estate loans
as well as auto loans to customers primarily located in southeastern
Massachusetts and, to a lesser extent, Rhode Island. The Bank estimates that
approximately 90% of its loan portfolio is based in Massachusetts, the majority
of which is located in southeastern Massachusetts.
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The reported fair values of financial instruments are based on a variety of
valuation techniques. In some cases, fair values represent quoted market prices
for identical or comparable instruments. In other cases, fair values have been
estimated based on assumptions concerning the amount and timing of estimated
future cash flows, assumed discount rates reflecting varying degrees of risk and
future expected loss assumptions. These estimates involve a high degree of
judgement. The estimates do not reflect any premium or discount that could
result from offering significant holdings of financial instruments at bulk sale.
Tax implications of unrealized gains and losses can also have a significant
effect on fair value of the financial instruments that could have been realized
as of October 31, 1998 and 1997 or that will be realized in the future. Changes
in economic conditions may dramatically affect the fair value of financial
instruments.
The following methods and assumptions were used to estimate the fair value
of the Bank's financial instruments:
For cash and due from banks and federal funds sold, the carrying amount
approximates fair value due to the short maturity of those instruments.
The fair values of investment securities are based on published market
prices or quotations received from securities dealers.
The fair values of loans are estimated for loan portfolios with similar
financial characteristics. Loans are segregated by type, fixed- and
adjustable-rate interest terms and by performing and nonperforming status. The
fair values of performing residential real estate loans are estimated by
discounting the anticipated future cash flows at rates currently required by the
secondary mortgage market for the purchase of similar loans. For performing
commercial real estate loans and performing business loans, fair values are
estimated by discounting the anticipated future cash flows using estimated
market discount rates that reflect the credit and interest rate risk inherent in
the loan as determined by the loan's terms and credit rating. For home equity
loans and certain consumer loans, the recorded book values approximate
71
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
fair value because the majority of these loans reprice with changes in market
rates.
The fair value of noncertificate deposits does not include the value of
the Bank's long-term relationships with its depositors and does not reflect the
value associated with possessing this relatively inexpensive source of funds
that may be available for a considerable length of time. The fair value of
noncertificate deposits is equal to the amount payable on demand at the
reporting date. The fair values of fixed-maturity certificates of deposit are
estimated by discounting the contractual future cash flows at rates currently
offered for certificates of deposit with similar remaining maturities.
The fair values of FHLB advances are determined by discounting the
anticipated future cash payments by using the rates currently available to the
Bank for advances with similar terms and remaining maturities. For other
borrowings, the carrying amount approximates fair value due to the short
maturity of those instruments.
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparties. For fixed rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed rates. The
fair value of financial standby letters of credit is based on fees currently
charged for similar agreements or on the estimated cost to terminate them or
otherwise settle the obligations with the counter parties. While these
commitment fees have value, the Bank has not estimated their value due to the
short-term nature of the underlying commitments and their immateriality.
Certain assets are excluded from disclosure requirements, including banking
premises and equipment, the value of the Bank's portfolio of loans serviced for
others and the intangible value inherent in the Bank's deposit relationship
(i.e., core deposits) among others. Accordingly, the aggregate fair value
amounts presented below do not represent the underlying value of the Company.
72
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The estimated fair values of the Bank's financial instruments at October
31 are as follows (the amounts in the book value column represent the amounts at
which such instruments are carried in the accompanying consolidated balance
sheets):
<TABLE>
<CAPTION>
1998 1997
-------------------------- ---------------------------
Estimated Estimated
Book Value Fair Value Book Value Fair Value
---------- --------- ----------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks....................... $ 53,553 $ 53,553 $ 25,611 $ 25,611
Federal funds sold............................ 12,080 12,080 7,150 7,150
Investment securities......................... 196,669 196,955 227,105 227,166
Loans held-for-sale........................... 13,495 13,567 4,277 4,305
Loans......................................... 960,850 820,197
Less: Allowance for possible loan losses...... (11,006) (10,642)
---------- -----------
Total loans, net.............................. 949,844 959,195 809,555 817,599
========== ===========
Financial liabilities:
Noncertificate deposits....................... 537,145 537,145 453,492 453,492
Term certificates............................. 527,338 529,586 484,456 485,202
Borrowings.................................... 16,085 16,085 9,697 9,697
FHLB advances................................. 59,420 62,687 51,006 51,941
</TABLE>
(15) CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The balance sheets of the Company are as follows:
<TABLE>
<CAPTION>
October 31,
---------------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
ASSETS:
Cash and due from banks..................................... $ 2,175 $ 142
Investment securities available-for-sale.................... 2,858 4,856
Accrued interest receivable................................. -- 62
Investment in subsidiary.................................... 108,023 93,603
Other assets................................................ 57 41
-------- -------
Total assets..................................... $113,113 $98,704
======== =======
LIABILITIES AND SURPLUS:
Accrued expenses and other liabilities...................... $ 541 $ 563
Surplus..................................................... 112,572 98,141
-------- -------
Total liabilities and surplus.................... $113,113 $98,704
======== =======
</TABLE>
73
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(15) CONDENSED PARENT COMPANY FINANCIAL STATEMENTS (Continued)
The income statements of the Company are as follows:
<TABLE>
<CAPTION>
Years Ended October 31,
------------------------------------------
1998 1997 1996
------- -------- -------
(In thousands)
<S> <C> <C> <C>
INTEREST AND DIVIDEND INCOME:
Interest and dividends on investment securities.. $ 191 $ 217 $ 195
NONINTEREST INCOME:
Gain on sales of investment securities........... 2 -- --
NONINTEREST EXPENSE:
Salaries and employee benefits................... 98 58 62
Amortization of organization costs............... 14 21 43
Other operating expenses......................... 31 14 23
-------- ------- -------
Total noninterest expense 143 93 128
-------- ------- -------
Income before income taxes and equity in
undistributed net income of subsidiary........ 50 124 67
PROVISION (BENEFIT) FOR INCOME TAXES.................... (32) 18 23
-------- ------- -------
Income before equity in undistributed net
income of subsidiary.......................... 82 106 44
EQUITY IN UNDISTRIBUTED NET INCOME
OF SUBSIDIARY........................................ 13,411 11,678 10,111
-------- ------- -------
Net income....................................... $13,493 $11,784 $10,155
======== ======= =======
</TABLE>
74
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(15) CONDENSED PARENT COMPANY FINANCIAL STATEMENTS (Continued)
The cash flow statements of the Company are as follows:
<TABLE>
<CAPTION>
Years Ended October 31,
-------------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................... $ 13,493 $ 11,784 $ 10,155
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sales of investments.............................. (2) -- --
Net (accretion) amortization of
investment securities.................................. 4 (2) (17)
Equity in undistributed earnings of subsidiary............ (13,411) (11,678) (10,111)
Net increase in other liabilities......................... (6) 3 (12)
Net decrease in other assets.............................. 47 20 4
-------- -------- --------
Net cash provided by operating activities............... 125 127 19
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales and maturities of
held-to-maturity and available-for-sale
securities................................................ 2,494 -- 2,017
Purchase of securities classified as held-to-maturity......... -- (96) --
Purchase of securities classified as available-for-sale....... (586) -- (2,071)
-------- -------- --------
Net cash provided by (used in) investing activities..... 1,908 (96) (54)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents.... 2,033 31 (35)
CASH AND DUE FROM BANKS,
BEGINNING OF YEAR............................................. 142 111 146
-------- -------- --------
CASH AND DUE FROM BANKS,
END OF YEAR................................................... $ 2,175 $ 142 $ 111
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Income taxes paid......................................... $ 2 $ 27 $ 43
======== ======== ========
Transfer of investments from held-to-
maturity to available-for-sale......................... -- -- $ 496
======== ======== ========
</TABLE>
75
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(16) STOCK CONVERSION
On April 23, 1998, the Board of Trustees of the Company adopted a Plan of
Conversion (the Conversion) pursuant to which the Company would convert to a
stock form of ownership and offer for sale 100% of its common stock in a
subscription offering initially to Bank depositors, employee benefit plans of
the Bank and certain other eligible subscribers. Any shares of stock not sold in
the subscription offering were to be sold to the public by underwriters.
The Company completed its mutual-to-stock conversion and the initial public
offering of common stock on November 20, 1998, whereby a total of 14,000,000
shares were sold at a purchase price of $10 per share. An Employee Stock
Ownership Plan (ESOP) set up by the Company acquired 8%, or 1,120,000, of the
shares issued which was funded by a loan from the Company. Net proceeds of the
Conversion were approximately $121,600,000 which excludes the sale of ESOP
shares which were internally funded. At October 31, 1998, the Company had
deferred offering costs of $2,280,000, included in other assets in the
accompanying consolidated balance sheet, that were subsequently recorded as a
reduction of the proceeds received.
As part of the Conversion, the Bank established a liquidation account in
an amount equal to the net worth of the Bank as of May 31, 1998, the date of the
latest consolidated balance sheet which appeared in the prospectus. The
liquidation account will be maintained for the benefit of eligible account
holders and supplemental eligible account holders who maintain their accounts at
the Bank after the Conversion. The liquidation account will be reduced annually
to the extend that such account holders have reduced their qualifying deposits
as of each anniversary date. Subsequent increases will not restore an account
holder's interest in the liquidation account. In the event of a complete
liquidation, each eligible account holder will be entitled to receive balances
for accounts then held.
(17) ACQUISITION OF SANDWICH
On February 2, 1998 the Company and the Bank entered into a definitive
agreement under which the Bank agreed to acquire Sandwich, a one-bank holding
company with approximately $519,000,000 in total assets at December 31, 1997. On
February 24, 1998, Sandwich announced that its Board of Directors determined
that it was appropriate to request additional information and a clarification of
renewed expressions of interest that it had received from other parties
subsequent to February 2, 1998.
Following a review of the other expressions of interests for Sandwich, the
Company and Sandwich jointly announced on March 23, 1998 that they had signed an
amendment to their previously announced agreement of February 2, 1998 (the
Amended Agreement) by which the Company would acquire Sandwich. Under the terms
of the Amended Agreement, the Company would convert to a 100% publicly owned
stock holding company and, thereafter, issue stock having a value of $64.00 per
share to Sandwich shareholders in a tax-free exchange of common stock. The value
to be received by Sandwich shareholders was subject to adjustment pursuant to a
formula based on the value of the Company's stock near the transaction date.
On December 4, 1998, the Company completed its acquisition of Sandwich.
Pursuant to the Amended Agreement, each share of common stock of Sandwich (other
than 90,000 shares held by the Company and the Bank and other than fractional
shares) was converted into and became exchangeable for 6.385 shares of the
Company's common stock. As set forth in the preceding paragraph, the exchange
ratio was adjusted using a formula based on the Company's stock trading price
between the date of the Conversion and the closing of the acquisition. A total
of 12,758,471 shares were issued in connection with the acquisition.
This transaction is being accounted for in accordance with the pooling of
interests method. As the acquisition had not been completed as of October 31,
1998, the accompanying financial statements do not reflect the transaction.
76
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(17) ACQUISITION OF SANDWICH (Continued)
The following unaudited summarized information presents certain financial
data as if the Company's acquisition of Sandwich had been completed as of
October 31, 1998. This information does not include the effect of the Company's
stock conversion discussed in Note 16.
<TABLE>
<CAPTION>
At October 31,
----------------------------
1998 1997
------------ ------------
(In thousands)
<S> <C> <C>
Total loans, net............... $1,304,443 $1,176,197
Total deposits................. 1,531,074 1,360,962
Total assets................... 1,807,047 1,625,260
Total equity................... 153,911 140,128
</TABLE>
<TABLE>
<CAPTION>
For the years ended October 31,
-----------------------------------
1998 1997 1996
---------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Net interest income............ $60,784 $57,796 $53,398
Non-interest income............ 10,024 8,664 7,985
Non-interest expense........... 39,807 37,036 36,491
Net income..................... 18,431 16,644 14,292
</TABLE>
Included in total assets in the table above at October 31, 1998, are
deferred merger related costs of $1,824,000 which, along with other
merger-related costs incurred thereafter, will be expensed by the Company in the
reporting period in which the acquisition occurs.
The Company is currently in the process of identifying and measuring all
merger related costs. These costs encompass both costs directly identifiable to
the merger, such as professional fees for investment bankers, attorneys and
accountants, and contractual severance pay as well as costs incurred by Sandwich
and the Bank that result from the merger and do not generally benefit the
on-going activities of the banks. The Company currently estimates that the
aggregate of merger-related costs will be $6,813,000 consisting of the
following items (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Professional fees....................................................... $2,692
Severance pay........................................................... 2,555
Asset write-offs ....................................................... 143
Contractual obligations................................................. 406
Shareholder meeting (including printing costs).......................... 283
Customer service (including checkbook replacements)..................... 662
Other................................................................... 72
-------
$6,813
=======
</TABLE>
These costs will be expensed by the Company in the reporting period in
which the acquisition occurs.
77
<PAGE>
SEACOAST FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998, 1997 AND 1996
(18) NEW CORPORATE HEADQUARTERS
On December 1, 1998, the Bank closed on its acquisition of several parcels
of land in downtown New Bedford, Massachusetts to be used for the development of
the Company's and the Bank's corporate headquarters and main banking office. The
Bank purchased the land from the New Bedford Redevelopment Authority and an
optionholder for $550,000. The land is currently occupied by two municipal
buildings which will be demolished. In connection with this transaction, the
Bank has agreed to donate one of its downtown New Bedford buildings to the City
at the time it takes occupancy of its proposed new corporate headquarters. The
Bank has not selected a general contractor for construction, however, based on
preliminary estimates by its architectural consultants, it expects to expend
approximately $20 million in the construction of the building and the purchase
of land, furniture, fixtures and equipment. At the completion of the project,
which is estimated to be in 2000, all Bank personnel, except retail branch
personnel, are expected to be located in this building.
As part of this transaction, the Bank entered into a Tax Increment
Financing Agreement with the City of New Bedford. This agreement provides a
reduction in future property taxes to the Bank in return for its investment,
through this project, in downtown New Bedford. The tax incentives extend over a
twenty year period and are scheduled to produce an estimated $1.2 million in
property tax reductions. This agreement is conditional and requires the Bank to
retain and create permanent jobs in the City.
The Bank's plan to construct a new corporate headquarters will result in
the ultimate disposal of its existing corporate offices. One location is
currently being marketed for sale. Two other buildings will continue to be
utilized until the Bank relocates to its new corporate headquarters (one of
which will be donated to the City of New Bedford at that time). Based on
estimates of the fair value of these buildings and the benefits associated with
their continuing utilization through the estimated date of relocation, the Bank
recorded a write-down of $1.9 million in December 1998.
78
<PAGE>
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Part III
Item 10. Directors and Executive Officers of the Registrant
Directors of Seacoast Financial
The following table sets forth certain information about each of the
Directors of the Company as of January 29, 1999.
<TABLE>
<CAPTION>
Term Date
Name (1) Age Expires Elected (1)
- ---------------------------------------------- --- ------------- --- ------------- ---- ----------------
<S> <C> <C> <C>
Manuel G. Camacho 73 1999 1979
David P. Cameron 73 2000 1976
Kevin G. Champagne 48 1999 1993
Howard C. Dyer, Jr. 70 2000 1963
Mary F. Hebditch 67 1999 1998
Glen F. Johnson 74 2001 1972
Thornton P. Klaren, Jr. 62 2000 1968
J. Louis LeBlanc 59 2001 1982
Frederic D. Legate 56 2001 1998
Reale J. Lemieux 59 2000 1998
A. William Munro 65 2001 1986
Carl Ribeiro 52 1999 1991
Joseph H. Silverstein 71 2000 1980
Gerald H. Silvia 64 1999 1990
</TABLE>
- ---------------
(1) Includes service as a trustee of the Bank prior to its reorganization into
the mutual holding company form of organization (the "Reorganization") and
as a trustee of the Company from the date of Reorganization until the
conversion of the Company from a mutual to a stock holding company.
The principal occupation and business experience during at least the last
five years for each Director of the Company is set forth below.
Manuel G. Camacho is a dentist in private practice in New Bedford,
Massachusetts. He is semi-retired.
David P. Cameron was President of Morse Cutting Tools in New Bedford,
Massachusetts until his retirement in 1982.
Kevin G. Champagne. See "Executive Officers," below.
Howard C. Dyer, Jr. was General Manager, New Bedford Storage Warehouse, New
Bedford, Massachusetts, until his retirement in 1996.
Mary F. Hebditch has been a self-employed public accountant and auditor in
Sandwich, Massachusetts since 1983.
Glen F. Johnson was a General Manager, Goodyear Tire and Rubber, New
Bedford, Massachusetts, until his retirement in 1985.
79
<PAGE>
Thornton P. Klaren, Jr. is retired.
J. Louis LeBlanc is an attorney in private practice in New Bedford,
Massachusetts.
Frederic D. Legate joined Sandwich Co-operative Bank in 1977. He was
appointed President and Chief Executive Officer of Sandwich Co-operative Bank in
1981 and of Sandwich Bancorp, Inc. in 1997, positions he held until Sandwich
Bancorp, Inc. was merged into the Company and Sandwich Co-operative Bank was
merged into the Bank in December 1998.
Reale J. Lemieux has owned and operated Bay Beach, a bed and breakfast
establishment in Sandwich, Massachusetts since 1988.
A. William Munro is President of Munro Distributing, Inc., Fall River,
Massachusetts.
Carl Ribeiro is President, Luzo Foodservice Corp., New Bedford,
Massachusetts.
Joseph H. Silverstein was the President of Silverstein's Family Store, a
retail clothing store located in New Bedford, Massachusetts, until his
retirement in 1992.
Gerald H. Silvia is the owner of Americana Travel, a travel agency located
in Fall River, Massachusetts.
Executive Officers
The names and ages of each of the executive officers of the Company and the
Bank and the principal occupation and business experience during at least the
last five years for each is set forth below. Each of Messrs. Short, Kelleher,
Lambert, Rigby, Taber, Camara and Rice and Ms. Belanger serve as a Vice
President of the Company, a position each (except Messrs. Short and Rice) has
held since the formation of the Company in 1994. Mr. Short has served as Vice
President of the Company since 1997 and Mr. Rice has served as Vice President of
the Company since October 1998.
Kevin G. Champagne has served as President and Chief Executive Officer of
the Company since its formation in 1994 and as President and Chief Executive
Officer of the Bank since 1994. Prior to 1994, Mr. Champagne was Executive Vice
President/Retail Banking of the Bank. He joined the Bank's Management Training
Program in 1971. Mr. Champagne is 48 years old.
Arthur W. Short served as Treasurer of the Company since its formation in
1994 until 1997. He currently serves as Executive Vice President of the Bank, a
position he has held since 1993, and as Chief Operating Officer of the Bank, a
position he has held since 1997. Prior to 1997, Mr. Short served as Treasurer
and Chief Financial Officer of the Bank. He joined the Bank in 1981. Mr. Short
is 57 years old.
John D. Kelleher has served as Executive Vice President of the Bank since
1993 and has headed the Bank's Lending Division since 1984. Mr. Kelleher joined
the Bank's Management Training Program in 1971. Mr. Kelleher is 53 years old.
James E. Lambert has served as Executive Vice President of the Bank since
1994. Prior to joining the Bank, Mr. Lambert served as President of Martha's
Vineyard National Bank, which merged with the Bank in 1994. Mr. Lambert is 54
years old.
Francis S. Mascianica, Jr. has served as Senior Vice President/Treasurer
and Chief Financial Officer of the Bank since 1997 and as Treasurer of the
Company since 1997. Mr. Mascianica has held various positions with the Bank
since he joined the Bank in 1981. He is 51 years old.
Carolyn A. Belanger has served as Senior Vice President and head of the
Retail Banking Division of the Bank since 1994. Ms. Belanger has held various
positions with the Bank since she joined the Bank in 1966. She is 50 years old.
William D. Rigby has served as Senior Vice President since 1994 and Manager
of the Consumer Lending
80
<PAGE>
Department of the Bank since 1985, when he joined the Bank. He is 51 years old.
Carl W. Taber has served as Senior Vice President since 1993 and head of
Mortgage Lending of the Bank since 1984. Mr. Taber joined the Bank's Management
Training Program in 1975. He is 45 years old.
Robert J. Camara has served as Senior Vice President and Loan Servicing
Manager of the Bank since 1997. He joined the Bank in 1987 as Assistant Vice
President and Auditor and became Vice President and Loan Servicing Manager in
1990. Mr. Camara is 42 years old.
James R. Rice has served as Senior Vice President of Marketing of the Bank
since December 1998. He joined the Bank in 1997 as Vice President of Marketing.
Prior to joining the Bank, Mr. Rice served as a Senior Marketing Manager for
BankBoston from 1995 to 1997 and as Vice President of Marketing for Medford
Savings Bank from 1988 to 1995. Mr. Rice is 37 years old.
Section 16(a) Beneficial Ownership Reporting Compliance
The Company did not have a class of securities registered pursuant to
Section 12 of the Securities Exchange Act of 1934 (the "Exchange Act") during
the fiscal year ended October 31, 1998. Therefore, no Forms 3, 4 or 5 were
required to be filed for the fiscal year then ended.
Item 11. Executive Compensation
Compensation of Directors
Members of the Company and Bank Boards receive $500 for each Board meeting
that they attend. Prior to his death on September 10, 1998, the Chairman of the
Board of the Bank received an annual retainer of $50,000. The Company's Board
has not elected a new Chairman nor has it determined what the compensation of
any future Chairman would be. Members of the Bank's Executive Committee receive
an annual retainer of $13,000 and members of the Bank's Audit Committee receive
an annual retainer of $5,000. In addition, members of the Audit Committee (other
than the Chairman) are paid $500 for each Company Audit Committee meeting that
they attend and the Chairman of the Audit Committee is paid $600 for each
Company Audit Committee meeting that he attends. The most senior member of the
Board of Directors of the Bank receives an annual retainer of $7,000 for duties
performed in connection with his appointment as a non-operating Vice President
of the Company. Mr. Champagne does not receive any fees for service on the Board
of Directors of the Company or the Bank or for service on any committees of
either Board.
81
<PAGE>
Executive Compensation
Summary Compensation Table. The following table sets forth the cash
compensation paid by the Bank as well as certain other compensation paid or
accrued for services rendered in all capacities during the fiscal years ended
October 31, 1997 and 1998 to the Chief Executive Officer of the Bank and the
four other executive officers of the Company or the Bank who received total
annual compensation in excess of $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation All Other Compensation(4)
Name and Principal --------------------------------------------- -----------------------------
Position with the Company Fiscal
and the Bank Year(1) Salary Bonus(2) Other(3)
- ------------------------------ ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Kevin G. Champagne 1998 $263,849 $ 75,601 $48,506
President and Chief 1997 225,387 59,801 5,794
Executive Officer of
the Company and the
Bank
A. William Short 1998 155,275 34,431 7,700
Vice President of the 1997 143,505 34,750 6,912
Company; Executive Vice
President and Chief
Operating Officer of the
Bank
John D. Kelleher 1998 140,686 31,164 6,649
Vice President of the 1997 133,920 31,568 6,125
Company; Executive Vice
President/Lending of the
Bank
James E. Lambert 1998 125,079 23,940 6,182
Vice President of the 1997 120,002 23,400 5,996
Company; Executive Vice
President/Commercial
Lending of the Bank
Carolyn A. Belanger 1998 109,577 24,276 5,593
Vice President of the 1997 102,561 24,651 4,588
Company; Senior Vice
President/Retail Banking
of the Bank
</TABLE>
- ---------------
(1) Because the Company did not become a public company until November 20,
1998, Summary Compensation information is not provided for 1996 in
accordance with the rules of the SEC.
(2) Represents bonuses paid in December of each year for the preceding fiscal
year ended October 31.
(3) Perquisites and other personal benefits paid to each officer included in
the Summary Compensation Table in each instance aggregated less than 10% of
the total annual salary and bonus set forth in the columns entitled
"Salary" and "Bonus" for each officer, and accordingly, are omitted from
the table in accordance with the rules of the SEC.
(4) For 1998, includes the Bank's matching contributions under its 401(k) plan
of $5,000, $5,000, $4,921, $4,454 and $4,027 for Messrs. Champagne, Short,
Kelleher and Lambert and Ms. Belanger, respectively. Also includes premiums
paid by the Bank for group term life insurance of $1,044, $2,700, $1,728,
$1,728 and $1,566 for Messrs. Champagne, Short, Kelleher and Lambert and
Ms. Belanger, respectively. For Mr. Champagne, includes $42,462 contributed
to his account under the Bank's executive deferred compensation plan as a
supplemental retirement benefit.
82
<PAGE>
Employment and Change in Control Agreements
The Company and the Bank have entered into certain employment agreements
(each such agreement, an "Employment Agreement" and, such agreements
collectively, the "Employment Agreements") and certain change in control
agreements (the "Change in Control Agreements") with Messrs. Champagne, Short,
Kelleher and Mascianica and Ms. Belanger (collectively, the "Officers"). The
Employment Agreements provide that the Officers will receive certain benefits
and a base salary equal to $270,000, $156,500, $141,650, $103,380 and $110,346,
respectively, subject to increases in accordance with the usual practices of the
Company and the Bank with respect to review of compensation of their senior
executives.
Mr. Champagne's Employment Agreement has a three-year term and the
Employment Agreements of the other Officers have two-year terms. The terms all
commenced on November 20, 1998, and each term extends by one day for each day
that an Officer remains employed by the Bank or (in the case of Mr. Champagne)
by the Bank or the Company until either of the officer or the Bank or (in the
case of Mr. Champagne) the Bank or the Company give a notice of non-renewal.
Under each of the Employment Agreements, the Company (in the case of Mr.
Champagne) and the Bank (in the case of the other Officers) may terminate an
Officer's employment at any time for "cause," as such term is defined in such
agreements, without incurring any continuing obligations to the Officer. If the
Company or the Bank terminates an Officer's employment for any reason other than
for cause or if the Officer terminates the Officer's employment for "good
reason," as such term is defined in the Employment Agreements, the Company and
the Bank will become obligated to provide the Officer: (i) an amount equal to
the sum of (a) the Officer's base salary or other compensation earned through
the date of termination, (b) the Officer's pro rata share of the Officer's
highest annual bonus paid during the three fiscal years preceding such
termination and (c) all accrued vacation and deferred compensation; (ii) a lump
sum severance benefit equal to three times (in the case of Mr. Champagne) or two
times (in the case of the other Officers) the sum of (a) the Officer's annual
base salary and (b) the highest annual bonus paid to the Officer in the three
fiscal years preceding the termination; (iii) disability and medical benefits
specified in the Officer's Employment Agreement for the duration of what
otherwise would have been the remaining term of the Employment Agreement (which,
as a result of the daily extension of the term of the Agreements, will always be
three years for Mr. Champagne and two years for the other Officer); and (iv) a
pension adjustment as specified in the Employment Agreement. The Employment
Agreements also provide certain retirement, death and disability benefits. Mr.
Champagne's Employment Agreement includes a provision reimbursing him, on an
after-tax basis, for any "golden parachute" excise taxes.
The Change in Control Agreements provide that an Officer may receive
certain benefits if the Officer is terminated within three years of a "Change in
Control" (as such term is defined in the Change in Control Agreements) of either
the Company or the Bank. An Officer would receive such termination benefits if
the Company or the Bank terminated the Officer for any reason other than death
or "cause," as such term is defined in the Employment Agreements, or if the
Officer terminated the Officer's employment following: (i) a significant change
in the nature or scope of the Officer's responsibilities, authorities, powers,
functions or duties; (ii) a determination by the Officer that, as a result of a
Change in Control, the Officer is unable to exercise the responsibilities,
authorities, powers, functions or duties exercised by the Officer immediately
prior to such Change in Control; (iii) a reduction in the Officer's annual base
salary; (iv) a significant relocation of the offices of the Company or the Bank;
(v) a failure of either the Company or the Bank to pay any portion of
compensation due to the Officer; (vi) the termination of or a material reduction
in the Officer's benefits; or (vii) a failure of the Company or the Bank to
obtain a satisfactory agreement from any successor to assume and agree to
perform the Officer's Change in Control Agreement. The benefits in the case of
both Mr. Champagne and the other Officers are: (i) a lump sum severance payment
equal to three times the "base amount," as such term is defined in Section
280G(b)(3) of the Code, applicable to the Officer minus $1.00 and (ii) for a
period of three years, the Officer's disability and medical benefits existing on
the date of the termination. Alternatively, an Officer could elect to receive
such termination benefits as the Officer would be entitled to under the
Officer's Employment Agreement, but may not receive payments under both
agreements. The Company has also entered into Change in Control Agreements with
three other officers that are substantially similar to the foregoing, except
that the benefit is equal to two (rather than three) times the "base amount" and
is payable only if employment terminates within one year after the Change in
Control.
The Bank also has a severance agreement with James E. Lambert, its
Executive Vice President/Commercial Lending. Mr. Lambert was formerly President
of Martha's Vineyard National Bank, which the Bank acquired in December 1994.
Pursuant to this agreement, which the Bank assumed from Martha's Vineyard
National Bank, the Bank has agreed to pay Mr. Lambert one year's severance for
any termination of his employment by the Bank, other than
83
<PAGE>
termination for "cause," and for any termination by Mr. Lambert for "good
reason," as such terms are defined in the agreement.
Cash and benefits paid to each Officer under the Change in Control
Agreements together with payments under other benefit plans following a change
in control of the Company or the Bank may constitute an "excess parachute"
payment under Section 280G of the Code, resulting in the imposition of a 20%
excise tax on the recipient and the denial of the deduction for such excess
amounts to the Company or the Bank. The Change in Control Agreements place
limitations on the salary and benefits the Officers can receive so that such
payments do not exceed the Section 280G limits. However, such limitations would
not apply if an Officer elects to receive payments under his or her Employment
Agreement instead of his or her Change in Control Agreement.
Compensation of Officers and Directors Through Benefit Plans
Defined Benefit Pension Plan. The Bank maintains the Savings Banks
Employees Retirement Association Pension Plan, which is a qualified, tax-exempt
defined benefit plan (the "Retirement Plan"). All employees age 21 or older who
have worked at the Bank for a period of two years and have been credited with
1,000 or more hours of service with the Bank during the year are eligible to
accrue benefits under the Retirement Plan.Tthe Bank contributes annually an
amount to the Retirement Plan necessary to satisfy the actuarially determined
minimum funding requirements in accordance with ERISA.
The retirement benefit provided is an amount equal to 1.25% of a
participant's average compensation based on the average of the three consecutive
years providing the highest average compensation multiplied by the participant's
years of service (up to a maximum of 25 years) plus 0.6% of such average
compensation in excess of covered compensation multiplied by the participant's
total number of years of service (up to a maximum of 25 years). Normal
retirement age is 65. Retirement benefits are also payable upon disability or
death. A reduced benefit is payable upon early retirement at age 62, at age 55
and the completion of ten years of service with the Bank or at age 50 and the
completion of 15 years of such service. Benefits under the Retirement Plan are
payable in various annuity forms as well as in the form of a single lump sum
payment. As of October 31, 1998, the most recent date for which information is
available, the market value of the Retirement Plan's assets was $9.8 million.
The following table indicates the annual retirement benefit that would be
payable under the Retirement Plan upon retirement by existing employees at age
65 between November 1, 1997 and October 31, 1998, expressed in the form of a
single life annuity for the final average salary and benefit service
classifications specified below:
Projected Annual Pension Benefit
Based on Years of Service
<TABLE>
<CAPTION>
Average 10 15 20 25 Years
Compensation Years Years Years and After
- ---------------------------- --------------------- -------------------- ----------------------- ----------------------
<S> <C> <C> <C> <C> <C>
$ 20,000 $ 2,500 $ 3,750 $ 5,000 $ 6,250
40,000 5,532 8,298 11,065 13,831
60,000 9,232 13,848 18,465 23,081
80,000 12,932 19,398 25,865 32,331
100,000 16,632 24,948 33,265 41,581
120,000 20,332 30,498 40,665 50,831
125,000 21,257 31,886 42,515 53,143
140,000 24,032 36,048 48,065 60,081
150,000 25,882 38,823 51,765 64,706
160,000(1) 27,732 41,598 55,465 69,331
</TABLE>
- ---------------
(1) Beginning November 1, 1997, Federal law does not permit defined benefit
pension plans to recognize compensation in excess of $160,000 for plan
years (for SBERA plans).
84
<PAGE>
At October 31, 1998, the approximate years of credited service for the
executive officers named in the Summary Compensation Table were as follows:
<TABLE>
<CAPTION>
Years of Credited Service at Age
Name 65
- ------------------------------------------ ------------------------------------
<S> <C>
Kevin G. Champagne 25
Arthur W. Short 25
John D. Kelleher 25
James E. Lambert 14.75
Carolyn A. Belanger 25
</TABLE>
Executive Salary Continuation Agreements. The Bank has entered into a
salary continuation agreement with four of its executive officers: Messrs.
Champagne, Short, Kelleher and Mascianica. The agreements provide each officer
with a supplemental retirement benefit in an amount equal to 25% of the average
of the three highest years of compensation (including salary and bonuses) paid
to the officer in the ten years of employment immediately preceding the
officer's retirement. The benefit is payable monthly, for a period of 15 years,
commencing on the first day of the month next following the officer's
retirement. A reduced benefit is payable if the officer retires prior to the age
of 65, but after age 55. If the officer dies while employed by the Bank, a
monthly benefit will be paid to the officer's beneficiary for a period of 15
years in an amount equal to 25% of the officer's salary on the date of his
death. If the officer's employment with the Bank is terminated prior to the age
of 55 other than for cause, the officer is entitled to a benefit equal to 5% of
the benefit he would have received upon retirement at age 65, multiplied by the
number of years of service between the age of 35 and termination of employment.
The agreements provide that the Bank may not merge or consolidate into another
corporation or sell substantially all of its assets to another corporation
unless such corporation agrees to assume and discharge the obligations of the
Bank under the agreements. The agreements are funded by life insurance policies,
of which the Bank is the owner and beneficiary, held in a "rabbi" trust.
The Bank has agreed to calculate each year the additional amount that would
need to be accrued in order to result in the executive receiving 70% of the
average of the three highest years of compensation paid to the officer in the
ten years of employment immediately preceding the officer's retirement from a
combination of the Bank's defined benefit plan, executive salary continuation
agreement, the Bank's contribution to the executive's 401(k) plan, the ESOP,
social security and any supplemental funding. This amount, if any, is added to
the executive's account under the Bank's deferred compensation plan.
Executive Deferred Compensation Plan. The Bank has a deferred compensation
plan for the benefit of certain of its senior management employees, as
designated from time to time by the President of the Bank. At the current time,
17 employees are eligible to participate in the plan. Participants may defer 1%
to 15% of their base salary and 1% to 100% of any bonus to which they are
entitled. Deferred amounts are credited to each participant's account and are
held in a "rabbi" trust. The deferred compensation plan permits employees to
direct the investment of their own accounts into various investment options.
Distributions to a participant are made upon the earliest of the participant's
retirement, death or other termination of employment, in the form requested by
the participant in his or her salary reduction deferral election. The plan
permits, at the Committee's discretion, withdrawals in the event of a financial
hardship caused by an unforeseeable emergency.
401(k) Plan. The Bank maintains a Savings Banks Employees Retirement
Association 401(k) Plan, which is a qualified, tax-exempt plan. All employees
who have attained age 21 and have completed one year of employment during which
they worked at least 1,000 hours are eligible to participate.
Under the 401(k) Plan, participants are permitted to make salary reduction
contributions equal to the lesser of 15% of compensation or $10,000 (as indexed
annually). All employee contributions and earnings thereon are fully and
immediately vested. A participant may withdraw salary reduction contributions in
the event the participant suffers a financial hardship. The 401(k) Plan permits
employees to direct the investment of their own accounts into various investment
options. The Bank matches 50% of the first 6% of compensation that a participant
contributes to the 401(k) Plan.
85
<PAGE>
Plan benefits will be paid to each participant in the form of a life
annuity (or joint and survivor annuity if married) upon retirement or death
unless an alternate form of distribution (lump sum or equal payments over a
fixed period) is selected. If a participant terminates employment prior to
retirement, his vested benefit will be held by the 401(k) Plan until the
participant elects to receive his benefit from the plan. If a participant (and
the participant's spouse, if married) elects to receive benefits after
termination of employment prior to normal or early retirement age, benefits will
be paid in a lump sum. Normal retirement age under the plan is age 65. Early
retirement age is age 59 1/2.
ESOP. The Bank has established an Employee Stock Ownership Plan (the
"ESOP"), effective as of January 1, 1998. Employees with at least one year of
employment with the Bank and who have attained age 21 are eligible to
participate. The ESOP has borrowed funds from the Company to purchase 1,120,000
shares of the Company's stock, which shares serve as collateral for the loan.
The loan will be repaid principally from the Bank's contributions to the ESOP,
over a period of 20 years. Shares purchased by the ESOP will be held in a
suspense account for allocation among participants as the loan is repaid.
Contributions to the ESOP and shares released from the suspense account in
an amount proportional to the repayment of the ESOP loan will be allocated among
ESOP participants on the basis of compensation in the year of allocation.
Participants in the ESOP will receive credit for years of service prior to the
effective date of the ESOP. Benefits generally vest at the rate of 20% per year
beginning in the second year of service until a participant is 100% vested after
six years or upon normal retirement (as such term is defined in the ESOP),
disability or death of the participant or a change in control (as such term is
defined in the ESOP). A participant who terminates employment for reasons other
than death, retirement or disability prior to seven years of credited service
will forfeit the nonvested portion of his benefits under the ESOP. Benefits will
be payable in the form of the Company's common stock and cash upon death,
retirement, early retirement, disability or separation from service. Benefits
payable under the ESOP will depend on a number of factors, including the Bank's
contributions to the ESOP and the market value of the Company's common stock.
The Bank is required to record compensation expense in an amount equal to the
fair market value of the shares released from the suspense account.
The Bank has established a committee of three officers of the Bank to
administer the ESOP, and has appointed its President and Chief Executive Officer
to serve as trustee of the ESOP. The ESOP committee may instruct the trustee
regarding investment of funds contributed to the ESOP. The ESOP trustee, subject
to his fiduciary duty, must vote all allocated shares held in the ESOP in
accordance with the instructions of participating employees. Under the ESOP,
nondirected shares and shares held in the suspense account will be voted in a
manner calculated to most accurately reflect the instructions it has received
from participants regarding the allocated stock so long as such vote is in
accordance with the provisions of ERISA.
86
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of January 1, 1999
regarding each person known by the Company to own beneficially more than 5% of
the Company's common stock, each Director of the Company, each executive officer
named in the Summary Compensation Table and all Directors and executive officers
of the Company as a group.
<TABLE>
<CAPTION>
Amount and Nature of Percent of
Name Beneficial Ownership (1) Class (2)
- ------------------------------------- -------------------------------- -----------------
<S> <C> <C>
Carolyn A. Belanger 5,940 (3) *
Manuel G. Camacho 10,000 (4) *
David P. Cameron 5,000 *
Kevin G. Champagne 24,977 (5) *
Howard C. Dyer, Jr. 5,500 *
Mary F. Hebditch 32,360 (6) *
Glen F. Johnson 15,000 *
John D. Kelleher 15,000 (7) *
Thornton P. Klaren, Jr. 5,740 (8) *
James E. Lambert 5,231 (9) *
J. Louis LeBlanc 47,900 (10) *
Frederic D. Legate 555,929 (11) 2.1
Reale J. Lemieux 17,731 (12) *
A. William Munro 135,000 (13) *
Carl Ribeiro 30,000 (14) *
A. William Short 4,702 (15) *
Joseph H. Silverstein 10,000 *
Gerald H. Silvia 11,500 (16) *
Directors and executive
officers as a group 957,755 3.6
</TABLE>
- ------------------------------
* Less than 1%
(1) Except as otherwise noted, all persons have sole voting and investment
power over their shares.
(2) Calculated based on outstanding shares of Common Stock on January 22, 1999
of 26,758,471.
(3) Shares held by 401(k) plan.
(4) Includes 5,000 shares owned by spouse.
(5) Includes 2,700 shares owned by spouse, 8,939 shares held by executive
deferred compensation plan, 7,388 shares held by 401(k) plan and 50 shares
held as custodian for daughter.
(6) Includes 4,469 shares held in IRA.
(7) Includes 500 shares held as custodian for son and 930 shares owned by
spouse.
(8) Includes 2,800 shares owned by spouse and 240 shares owned by daughter.
(9) Shares held by 401(k) plan.
87
<PAGE>
(10) Includes 35,000 shares held in trust of which Mr. LeBlanc is the sole
trustee and over which he has sole voting and investment power; 7,400
shares held by IRA; 3,000 shares held by spouse; and 1,000 shares held in
spouse's IRA.
(11) Includes 31,925 shares owned by spouse, 3,566 held in IRA, 4,578 held in
spouse's IRA and 10,586 held by Sandwich Co-operative Bank ESOP.
(12) Includes 3,270 held by IRA and 3,095 held in spouse's IRA.
(13) Includes 50,000 shares held by company of which Mr. Munro is the principal
owner.
(14) Includes 6,000 shares held by spouse and 5,000 shares held by company of
which Mr. Ribeiro is the principal owner.
(15) Represents 1,072 shares held by 401(k) plan and 3,630 shares held by
executive deferred compensation plan.
(16) Includes 6,200 shares held by spouse.
Item 13. Certain Relationships and Related Transactions
The Bank makes loans to non-officer directors of the Company and the
Bank. Such loans are made on the same terms and conditions as those of
comparable transactions with the general public and do not present more than the
normal risk of collectibility.
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Contents:
1. Financial Statements: All financial statements are included
in Item 8. of Part II to this report.
2. Financial Statement Schedules: All financial statement
schedules have been omitted because they are either not
required, not applicable or are included in the consolidated
financial statements or related notes.
3. Exhibits
3.1 Articles of Organization of Seacoast Financial Services
Corporation**
3.2 By-Laws of Seacoast Financial Services Corporation**
4 Specimen certificate for the common stock of Seacoast
Financial Services Corporation***
10.1* Form of Employment Agreement by and among Seacoast Financial
Services Corporation, Compass Bank for Savings and Kevin G.
Champagne**
10.2* Form of Employment Agreement by and among Compass Bank for
Savings, Seacoast Financial Services Corporation and certain
Officers of Compass Bank for Savings**
10.3* Form of Change in Control Agreements by and among Seacoast
Financial Services Corporation, Compass Bank for Savings,
Kevin G. Champagne and certain other Officers of Compass
Bank for Savings**
10.4* Form of Change in Control Agreement by and among Seacoast
Financial Services Corporation, Compass Bank for Savings and
certain Officers of Compass Bank for Savings**
88
<PAGE>
10.5* Form of Executive Salary Continuation Agreements made and
entered into by and between Compass Bank for Savings and
Kevin G. Champagne, Arthur W. Short, John D. Kelleher and
Francis S. Mascianica and forms of amendments thereto**
10.6* Trust Agreement, made as of December 18, 1992, by and
between Compass Bank for Savings and Shawmut Bank, N.A.**
10.7* Compass Bank for Savings January 1998 Incentive Compensation
Plan***
10.8 Amended and Restated Affiliation and Merger Agreement dated
as of March 23, 1998 by and among Seacoast Financial
Services Corporation, Compass Bank for Savings, Sandwich
Bancorp, Inc. and the Sandwich Co-operative Bank**
10.12* Compass Bank for Savings Executive Deferred Compensation
Plan**
10.13* Rabbi Trust for Compass Bank for Savings Executive Deferred
Compensation Plan**
10.14(a)* Employment Agreements dated July 18, 1994 by and between
Sandwich Co-operative Bank and Frederic D. Legate, Dana S.
Briggs and George L. Larson***
10.14(b)* 1998 Amendment to Employment Agreements dated July 18, 1994
by and between Sandwich Co-operative Bank and Frederic D.
Legate, Dana S. Briggs and George L. Larson***
10.15(a)* Employment Agreement dated December 17, 1991 by and between
Sandwich Cooperative Bank and David A. Parsons***
10.15(b)* 1998 Amendment to Employment Agreement dated December 17,
1991 by and between Sandwich Co-operative Bank and David A.
Parsons***
10.16* Sandwich Co-operative Bank 1983 Directors Deferred Income
Agreement***
10.17* Sandwich Co-operative Bank 1992 Directors Deferred
Compensation Plan***
10.18* Supplemental Executive Retirement Agreements dated May 5,
1995 by and between Sandwich Co-operative Bank and Frederic
D. Legate, Dana S. Briggs, George L. Larson and David A.
Parsons and amendments thereto***
10.19* Employment Agreement by and among Seacoast Financial
Services Corporation, Compass Bank for Savings and James E.
Lambert***
11 A statement regarding earnings per share is not included in
this Report since the Company had no outstanding shares of
common stock during the periods presented.
27 EDGAR Financial Data Schedule
- -----------------
* Management compensatory plan or arrangement.
** Incorporated by reference to the Company's Registration Statement on Form
S-1 (333-52889), filed with the Securities and Exchange Commission under
the Company's prior name, "The 1855 Bancorp", on May 15, 1998.
*** Incorporated by reference to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (333-52889), filed with the Securities and Exchange
Commission under the Company's prior name, "The 1855 Bancorp", on August
14, 1998.
(b) Reports on Form 8-K: The Company filed a Current Report on Form 8-K with
the SEC on December 17, 1998 in connection with the acquisition of Sandwich
Bancorp, Inc.
89
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Seacoast Financial Services Corporation
DATE: January 25, 1999 By: /s/ Kevin G. Champagne
--------------------------------------
Kevin G. Champagne
President and Chief Executive Officer
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>
<S> <C> <C>
/s/ Kevin G. Champagne
----------------------------------------------
Kevin G. Champagne President, Chief Executive January 25, 1999
Officer and Director
/s/ Francis S. Mascianica, Jr.
----------------------------------------------
Francis S. Mascianica, Jr. Senior Vice President and January 25, 1999
Chief Financial Officer
/s/ Manuel G. Camacho
----------------------------------------------
Manuel G. Camacho, D.D.S. Director January 25, 1999
/s/ David P. Cameron
----------------------------------------------
David P. Cameron Director January 25, 1999
/s/ Howard C. Dyer, Jr.
----------------------------------------------
Howard C. Dyer, Jr. Director January 25, 1999
/s/ Mary F. Hebditch
----------------------------------------------
Mary F. Hebditch Director January 25, 1999
/s/ Glen F. Johnson
----------------------------------------------
Glen F. Johnson Director January 25, 1999
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Thornton P. Klaren, Jr.
----------------------------------------------
Thornton P. Klaren, Jr. Director January 25, 1999
/s/ J. Louis LeBlanc
----------------------------------------------
J. Louis LeBlanc Director January 25, 1999
/s/ Frederic D. Legate
----------------------------------------------
Frederic D. Legate Director January 25, 1999
/s/ Reale J. Lemieux
----------------------------------------------
Reale J. Lemieux Director January 25, 1999
/s/ A. William Munro
----------------------------------------------
A. William Munro Director January 25, 1999
/s/ Carl Ribeiro
----------------------------------------------
Carl Ribeiro Director January 25, 1999
/s/ Joseph H. Silverstein
----------------------------------------------
Joseph H. Silverstein Director January 25, 1999
/s/ Gerald H. Silvia
----------------------------------------------
Gerald H. Silvia Director January 25, 1999
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-END> OCT-31-1998
<CASH> 53,553
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 12,080
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 177,689
<INVESTMENTS-CARRYING> 13,694
<INVESTMENTS-MARKET> 13,980
<LOANS> 960,850
<ALLOWANCE> 11,006
<TOTAL-ASSETS> 1,264,103
<DEPOSITS> 1,064,483
<SHORT-TERM> 15,801
<LIABILITIES-OTHER> 11,543
<LONG-TERM> 59,704
0
0
<COMMON> 0
<OTHER-SE> 112,572
<TOTAL-LIABILITIES-AND-EQUITY> 1,264,103
<INTEREST-LOAN> 73,300
<INTEREST-INVEST> 12,504
<INTEREST-OTHER> 1,363
<INTEREST-TOTAL> 87,167
<INTEREST-DEPOSIT> 38,850
<INTEREST-EXPENSE> 43,498
<INTEREST-INCOME-NET> 43,669
<LOAN-LOSSES> 1,402
<SECURITIES-GAINS> 7
<EXPENSE-OTHER> 27,511
<INCOME-PRETAX> 21,800
<INCOME-PRE-EXTRAORDINARY> 21,800
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,493
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 3.91
<LOANS-NON> 4,425
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 10,642
<CHARGE-OFFS> 1,413
<RECOVERIES> 375
<ALLOWANCE-CLOSE> 11,006
<ALLOWANCE-DOMESTIC> 11,006
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
