<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Three Months Ended March 31, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________to____________
Commission File Number 0-7974
CHITTENDEN CORPORATION
(Exact Name of Registrant as Specified in its Charter)
VERMONT 03-0228404
(State of Incorporation) (IRS Employer Identification No.)
TWO BURLINGTON SQUARE
BURLINGTON, VERMONT 05401
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number: (802) 658-4000
NOT APPLICABLE
Former Name, Former Address and Formal Fiscal Year
If Changed Since Last Report
Indicate by checkmark 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
-
At March 31, 1999, there were 15,929,661 shares of the Corporation's $1.00 par
value common stock issued, with 14,231,798 shares outstanding.
1
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
2
<PAGE>
Chittenden Corporation
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------------------------
<S> <C> <C>
(in thousands)
Assets
Cash and cash equivalents $ 156,294 $ 134,678
Securities available for sale 439,406 503,699
Federal Home Loan Bank stock 5,591 5,591
Mortgage loans held for sale 9,057 25,974
Loans:
Commercial 329,396 304,703
Municipal 68,896 69,436
Real Estate:
Residential 364,107 374,957
Commercial 341,656 332,018
Construction 24,284 24,340
---------------------------
Total Real Estate 730,047 731,315
Consumer 299,542 294,649
---------------------------
Total Loans 1,427,881 1,400,103
Less: Allowance for loan losses (25,019) (24,510)
---------------------------
Net loans 1,402,862 1,375,593
Accrued interest receivable 13,348 14,374
Other real estate owned 316 695
Other assets 22,613 19,480
Premises and equipment, net 29,302 29,441
Intangible assets 12,160 12,494
---------------------------
Total assets $2,090,949 $2,122,019
===========================
Liabilities:
Deposits:
Demand $ 311,072 $ 321,179
Savings 1,044,376 1,056,550
Certificates of deposit less than $100,000 and other time deposits 383,812 394,310
Certificates of deposit $100,000 and over 118,065 118,715
---------------------------
Total deposits 1,857,325 1,890,754
Short-term borrowings 25,872 23,369
Accrued expenses and other liabilities 28,954 32,749
---------------------------
Total liabilities 1,912,151 1,946,872
Commitments and contingencies
Stockholders' Equity:
Preferred stock - $100 par value - -
authorized - 200,000 shares; issued and outstanding - none
Common stock - $1 par value authorized - 30,000,000 shares; 15,930 15,930
issued -15,929,661 in 1999 and 1998
Surplus 72,384 72,468
Retained earnings 126,709 122,056
Treasury stock, at cost - 1,697,863 shares in 1999 and 1,747,354 shares in 1998 (37,757) (38,852)
Accumulated other comprehensive income 1,778 3,811
Unearned portion of employee restricted stock (246) (266)
---------------------------
Total stockholders' equity 178,798 175,147
---------------------------
Total liabilities and stockholders' equity $2,090,949 $2,122,019
===========================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
Chittenden Corporation
Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
1999 1998
----------------------------------------
<S> <C> <C>
(in thousands)
Interest income:
Interest on loans $28,566 $30,595
Investment securities:
Taxable 6,977 6,031
Tax-favored 531 421
Short-term investments 272 462
----------------------------------------
Total interest income 36,346 37,509
----------------------------------------
Interest expense:
Deposits:
Savings 7,568 7,662
Time 6,005 6,884
----------------------------------------
Total interest on deposits 13,573 14,546
Short-term borrowings 395 524
----------------------------------------
Total interest expense 13,968 15,070
----------------------------------------
Net interest income 22,378 22,439
Provision for loan losses 1,350 1,275
----------------------------------------
Net interest income after provision for loan losses 21,028 21,164
----------------------------------------
Noninterest income:
Investment management and trust income 1,802 1,466
Service charges on deposit accounts 1,685 1,747
Mortgage servicing income 384 477
Gains on sales of mortgage loans, net 1,378 1,079
Credit card income, net 893 876
Insurance commissions, net 641 966
Other 1,512 1,230
----------------------------------------
Total noninterest income 8,295 7,841
----------------------------------------
Noninterest expense:
Salaries 7,738 7,243
Employee benefits 2,431 2,592
Net occupancy expense 2,454 2,419
Other real estate owned, income and expense, net 3 39
Other 5,625 5,456
----------------------------------------
Total noninterest expense 18,251 17,749
----------------------------------------
Income before income taxes 11,072 11,256
Provision for income taxes 3,577 3,920
----------------------------------------
Net income $ 7,495 $ 7,336
========================================
Basic earnings per share $0.53 $0.51
Diluted earnings per share 0.52 0.50
Dividends per share $0.20 $0.18
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
4
<PAGE>
Chittenden Corporation
Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
1999 1998
-----------------------
<S> <C> <C>
(in thousands)
Cash flows from operating activities:
Net income $ 7,495 $ 7,336
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 1,350 1,275
Depreciation and amortization 896 913
Amortization of intangible assets 335 355
Amortization of premiums, fees, and discounts, net 132 (154)
Investment securities losses (gains) - (3)
Deferred income taxes 873 1,255
Loans originated and purchased for sale (92,760) (100,000)
Proceeds from sales of loans 111,055 92,292
Gains on sales of loans (1,378) (1,079)
Changes in assets and liabilities:
Accrued interest receivable 1,026 416
Other assets (2,467) 1,694
Accrued expenses and other liabilities (3,521) (5,751)
-----------------------
Net cash provided by (used in) operating activities 23,036 (1,451)
-----------------------
Cash flows from investing activities:
Proceeds from sales of securities available for sale - 16,672
Proceeds from maturing securities and principal payments 232,914 56,640
on securities available for sale
Purchases of securities available for sale (171,395) (107,467)
Loans originated, net of principal repayments (29,323) 20,152
Purchases of premises and equipment (757) (1,453)
-----------------------
Net cash provided by (used in) investing activities 31,439 (15,456)
-----------------------
Cash flows from financing activities:
Net increase (decrease) in deposits (33,429) 11,013
Net increase in short-term borrowings 2,503 8,219
Proceeds from issuance of treasury and common stock 687 233
Dividends on common stock (2,620) (2,598)
Cash paid to list on New York Stock Exchange, net of taxes - (93)
Repurchase of common stock - (1,737)
-----------------------
Net cash provided by (used in) financing activities (32,859) 15,037
-----------------------
Net increase (decrease) in cash and cash equivalents 21,616 (1,870)
Cash and cash equivalents at beginning of period 134,678 143,394
-----------------------
Cash and cash equivalents at end of period $ 156,294 $ 141,524
=======================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 14,088 $ 14,983
Income taxes 2,194 237
Non-cash investing and financing activities:
Loans transferred to other real estate owned 287 220
Issuance of treasury and restricted stock 104 39
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
Chittenden Corporation
Notes to Consolidated Financial Statements
NOTE 1 - ACCOUNTING POLICIES
The Company's significant accounting policies, other than those described in
Note 2 below, are described in Note 1 of the Notes to Consolidated Financial
Statements included in its 1998 Annual Report on Form 10-K filed with the
Securities and Exchange Commission. For interim reporting purposes, the Company
follows the same basic accounting policies and considers each interim period as
an integral part of an annual period. Certain amounts for 1998 have been
reclassified to conform to 1999 classifications.
The financial information included herein is unaudited; however, such
information reflects all adjustments (consisting of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
statement of results for the interim periods. Results for interim periods are
not necessarily indicative of the results of operations for the full year or any
other interim period.
NOTE 2 - RECENTLY ADOPTED ACCOUNTING POLICIES
Effective January 1, 1999, the Company adopted Statement of Position (SOP)
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP 98-1 requires computer software costs associated with
internal-use software to be expensed as incurred until certain capitalization
criteria are met. The adoption of SOP 98-1 did not have a material effect on
the Company's financial position or its results of operations.
As of January 1, 1999, the Company adopted Statement of Position (SOP) 98-5,
Reporting on the Costs of Start-Up Activities. SOP 98-5 requires all costs
associated with pre-opening, pre-operating and organization activities to be
expensed as incurred. The adoption of SOP 98-5 did not have a material impact
on the Company's financial position or results of operations.
Effective January 1, 1999, the Company adopted SFAS No. 134, Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise. This statement requires 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. SFAS No. 134 did not have a material impact on the Company's
financial condition or results of operations.
NOTE 3 - COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130
establishes standards for the reporting and display of comprehensive income and
its components (revenues, expenses, gains, and losses) in a full set of general-
purpose financial statements. Comprehensive income is the total of net income
and all other nonowner changes in equity. SFAS 130 requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements in year end financial
statements. Interim period disclosure may be shown in the footnotes to the
consolidated financial statements. The Company's comprehensive income for the
three-month periods ended March 31, 1999 and 1998 is presented below:
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
1999 1998
----------------------------------------
<S> <C> <C>
(in thousands)
Net Income $ 7,495 $7,336
Unrealized gains on investment securities:
Unrealized holding gains (losses) on securities available for sale, net of tax (2,033) 251
Reclassification adjustments for (gains) losses arising during period, net of tax - (2)
----------------------------------------
Total Comprehensive income $ 5,462 $7,585
========================================
</TABLE>
6
<PAGE>
NOTE 4 - BUSINESS SEGMENTS
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and
Related Information, which establishes standards for reporting operating
segments of a business enterprise. Under SFAS 131, operating segments are
defined as components of an enterprise which are evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company's chief operating decision maker is the
President and Chief Executive Officer of the Company. The adoption of SFAS 131
did not have a material effect on the Company's primary financial statements,
but did result in the disclosure of segment information contained herein.
The Company has identified Commercial Banking as its reportable operating
business segment based on the fact that the results of operations are viewed as
a single strategic unit by the chief operating decision maker. The Commercial
Banking segment is comprised of Chittenden Bank, Bank of Western Massachusetts,
Flagship Bank and Trust, and Chittenden Connecticut Corporation, which provide
similar products and services, have similar distribution methods, types of
customers and regulatory responsibilities. Commercial Banking derives its
revenue from a wide range of banking services, including lending activities,
acceptance of demand, savings and time deposits, safe deposit facilities,
merchant credit card services, trust and investment management, data processing,
brokerage services, mortgage banking, and loan servicing for investor
portfolios.
Immaterial operating segments of the Company's operations, which do not have
similar characteristics to the commercial banking operations and do not meet the
quantitative thresholds requiring disclosure, are included in the Other category
in the disclosure of business segments below.
The accounting policies used in the disclosure of business segments are the
same as those described in the summary of significant accounting policies
included in Note 1 of the Company's 1998 Annual Report on Form 10-K. The
consolidation adjustment reflects certain eliminations of inter-segment revenue,
cash and parent company investments in subsidiaries.
<TABLE>
<CAPTION>
For Three Months Ended Commercial Other (2) Consolidation Consolidated
Banking Adjustments
--------------------------------------------------------------
March 31, 1999
<S> <C> <C> <C> <C>
Net interest revenue (1) $ 22,304 $ 74 $ - $ 22,378
Noninterest income 7,653 642 - 8,295
Provision for Loan Losses 1,350 - - 1,350
Noninterest expense 17,471 780 - 18,251
--------------------------------------------------------------
Net income before tax 11,136 (64) - 11,072
Income tax expense/(benefit) 3,588 (11) - 3,577
Total Net Income $ 7,548 $ (53) $ - $ 7,495
==============================================================
End of Period Assets $2,126,430 $178,122 $(213,603) $2,090,949
</TABLE>
<TABLE>
<CAPTION>
Commercial Other (2) Consolidation Consolidated
Banking Adjustments
--------------------------------------------------------------
March 31, 1998
<S> <C> <C> <C> <C>
Net interest revenue (1) $ 22,401 $ 38 $ - $ 22,439
Noninterest income 6,875 972 (6) 7,841
Provision for Loan Losses 1,275 - - 1,275
Noninterest expense 16,885 864 - 17,749
--------------------------------------------------------------
Net income before tax 11,116 146 (6) 11,256
Income tax expense/(benefit) 3,842 78 - 3,920
Total Net Income $ 7,274 $ 68 $ (6) $ 7,336
==============================================================
End of Period Assets $2,020,865 $167,292 $(198,852) $1,994,305
</TABLE>
7
<PAGE>
(1) The Commercial Banking segment derives a majority of its revenue from
interest. In addition, management primarily relies on net interest
revenue, not the gross revenue and expense amounts, in managing that
segment. Therefore, only the net amount has been disclosed.
(2) Revenue derived from these non-reportable segments includes insurance
commissions from various insurance related products and services.
NOTE 5 - ACQUISITIONS
On December 16, 1998, the Company announced the signing of a definitive
merger agreement whereby Chittenden Corporation would acquire Vermont Financial
Services Corporation (VSFC), a $2.1 billion bank holding company headquartered
in Brattleboro, Vermont in a stock-for-stock merger. Under the terms of the
agreement, each share of VFSC stock would be exchanged for 1.07 shares of
Chittenden stock. The transaction will be accounted for as a pooling of
interests and is expected to be completed in the second quarter of 1999,
following the receipt of all regulatory approvals, as well as approval of the
shareholders of each company. In connection with the transaction, the Company
expects to incur a one-time charge of between $25 million to $35 million ($35 to
$45 million pre-tax) in acquisition related costs including severance payments
and integration of duplicative systems.
NOTE 6 - SUBSEQUENT EVENTS
On April 21, 1999, the Company declared regular dividends of approximately
$3.1 million, or $0.22 per share, to be paid on May 21, 1999 to shareholders of
record on May 7, 1999. On May 4, 1999, the Company announced the signing of a
definitive agreement to sell fourteen banking office locations owned by VFSC to
Charter One Financial, Inc., with approximately $400 million in deposits and
$120 million in commercial loans. The deposits will be assumed for a deposit
premium of approximately 10.5%. The sale is related to the branch divestiture
required by federal regulators relative to the Company's pending acquisition of
VFSC. The cash transaction is subject to review by federal and state
regulators, and is expected to be completed during the fourth quarter of 1999.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Chittenden Corporation posted first quarter 1999 net income of $0.52 per
diluted share, an increase of 4% over the $0.50 per diluted share posted in the
first quarter of last year. Net income for the first quarter of 1999 was $7.5
million, an increase of 2% over the $7.3 million recorded in the same quarter a
year ago. Return on average equity was 17.24% for the quarter ended March 31,
1999 compared with 18.14% for the same period in 1998. Return on average assets
was 1.46% for the first quarter of 1999, compared with 1.52% for the first
quarter of last year. The decline in return on average equity was primarily
attributed to increased levels of average stockholders equity caused by the
Company's rescission of its share repurchase program prior to the announcement
of the agreement to acquire VFSC, which will be accounted for as a pooling of
interests.
Net interest income on a tax equivalent basis for the first three months
ended March 31, 1999 was $22.9 million, down slightly from $23.0 million for the
same period a year ago. The yield on earning assets declined from 5.06% in the
first quarter of 1998 to 4.76% for the same period in 1999. This decrease was
attributable to increased liquidity in the Company's mix of investments and
loans, which was caused by deposit growth outpacing loan growth. Also
contributing to the decline in the net interest margin were declining yields in
the Company's loan portfolio reflecting reductions in market interest rates,
which resulted from three rate reductions by the Federal Reserve occurring in
the third and fourth quarters of 1998.
8
<PAGE>
The following table presents an analysis of average rates and yields on a fully
taxable equivalent basis for the three months ended March 31,
<TABLE>
<CAPTION>
1999 1998
-----------------------------------------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense (1) Rate (1) Balance Expense (1) Rate (1)
-----------------------------------------------------------------------
Assets (in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $1,414,621 $28,896 8.27% $1,401,343 $31,047 8.99%
Investments:
Taxable 464,899 7,066 6.16 377,006 6,097 6.56
Tax-favored securities 46,843 610 5.28 32,067 481 6.08
Interest-bearing deposits in banks 1,822 23 5.04 100 1 3.25
Federal funds sold 21,178 249 4.77 33,536 461 5.57
------------------------- --------------------------
Total interest-earning assets 1,949,363 36,845 7.67 1,844,052 38,087 8.38
------------- -------------
Noninterest-earning assets 149,849 145,268
Allowance for loan losses (24,999) (27,114)
------------ -------------
Total assets $2,074,213 $1,962,206
============ =============
Liabilities and stockholders' equity
Interest-bearing liabilities:
Savings and interest-bearing transactional accounts $1,029,398 $ 7,568 2.98 $ 922,119 $ 7,662 3.37
Certificates of deposit under $100,000 and other 389,164 4,699 4.90 409,005 5,264 5.22
time deposits
Certificates of deposit $100,000 and over 115,176 1,305 4.60 123,699 1,621 5.31
------------------------- --------------------------
Total interest-bearing deposits 1,533,738 13,572 3.59 1,454,823 14,547 4.06
Short-term borrowings 24,680 395 6.50 30,781 524 6.90
------------------------- --------------------------
Total interest-bearing liabilities 1,558,417 13,967 3.63 1,485,604 15,071 4.11
------------- -------------
Noninterest-bearing liabilities:
Demand deposits 307,275 283,969
Other liabilities 32,431 28,618
------------ -------------
Total liabilities 1,898,123 1,798,191
Stockholders' equity 176,089 164,015
------------ -------------
Total liabilities and stockholders' equity $2,074,213 $1,962,206
============ =============
Net interest income $22,878 $23,016
============= =============
Interest rate spread (2) 4.04% 4.27%
Net yield on earning assets (3) 4.76% 5.06%
</TABLE>
(1) On a fully taxable equivalent basis. Calculated using a Federal income tax
rate of 35%. Loan income includes fees.
(2) Interest rate spread is the average rate earned on total interest-earning
assets less the average rate paid on interest-bearing liabilities.
(3) Net yield on earning assets is net interest income divided by total
interest-earning assets.
Noninterest income amounted to $8.3 million for the first quarter of 1999, up
from $7.8 million for the first quarter of 1998. Investment management revenue
of $1.8 million increased 23% compared to $1.5 million in the first quarter of
1998, due to increased assets under management. Gains on sales of mortgages of
$1.4 million increased $299,000 or 28% from $1.1 million for the first quarter
of 1998 resulting from increased market activity. Commissions from insurance
sales declined $325,000 from the comparable period in 1998, to $641,000 for the
first quarter of 1999 due to lower levels of contingent commissions received
from insurance companies. The decline in contingent commissions, which are
based on loss experience associated with policies sold and the insurance
agency's ability to attain sales goals, was related to a less favorable loss
experience on policies sold by the agency and increased competition for
insurance sales in that industry.
Noninterest expenses were $18.3 million for the first quarter, an increase of
$502,000 or 3% over the first quarter of 1998. Salaries and employee benefits
amounted to $10.2 million for the first quarter of 1999, which was $334,000 or
3% higher than the first quarter of 1998. This increase was primarily
attributed to an increase in mortgage commissions related to increased market
activity, offset by a decrease in anticipated levels of incentive compensation
payments caused by actual profitability levels as compared to plan.
Income Taxes
The Company and its subsidiaries are taxed on income by the IRS at the Federal
level and by various states in which they do business. The majority of the
Company's income is generated in the State of Vermont, which levies
9
<PAGE>
franchise taxes on banks based upon average deposit levels in lieu of taxing
income. Franchise taxes are included in income tax expense in the consolidated
statements of income.
For the three months ended March 31, 1999 and 1998, Federal and state
income tax provisions amounted to $3.6 million and $3.9 million, respectively.
The effective tax rates for the respective periods were 32.3% and 34.8%. During
all periods, the Company's statutory Federal corporate tax rate was 35%. The
Company's effective tax rates differed from the statutory rates primarily
because of 1) the proportion of interest income from state and municipal
securities and corporate dividend income, which are partially exempt from
Federal taxation and 2) tax credits on investments in qualified low income
housing projects.
Financial Position
Total assets decreased slightly from $2.122 billion at December 31, 1998 to
$2.091 billion at March 31, 1999. The Company invests the majority of its
assets in loans and investments. During the first three months of 1999, total
loans increased $27.8 million, to $1.428 billion at March 31, 1999. This
increase was primarily attributable to growth in the commercial and consumer
portfolios, which offset reduced balances in the residential portfolios.
Consistent with the Company's past practice, all conforming fixed-rate loan
production is sold on the secondary market. Total deposits at March 31, 1999
were $1.857 million, a $33.4 million decrease from December 31, 1998 due to a
decline in seasonally high deposit balances at year end 1998. Securities
available for sale decreased $64 million to $439.4 million at March 31, 1999.
The decline was primarily due to a decrease in short-term investments, which
matured during the first quarter of 1999 providing available funds to support
the increase in loans and decline in deposits.
Credit Quality
Nonperforming assets include nonaccrual loans, restructured debt, and
foreclosed real estate (Other Real Estate Owned). As of March 31, 1999,
nonperforming assets totaled $8.2 million, compared to $10.7 million and $8.1
million at December 31, 1998 and March 31, 1998, respectively. The allowance
for loan losses was $25.0 million at March 31, 1999, up slightly from the
December 31, 1998 level of $24.5 million. The provision for loan losses that
was charged against earnings in the first quarter of 1999 was $1.4 million
compared to $1.3 million a year ago.
A summary of credit quality follows:
<TABLE>
<S> <C> <C> <C> <C>
3/31/99 12/31/98 9/30/98 6/30/98
---------------------------------------------------------------------------
(In thousands)
Nonaccrual loans $ 7,850 $ 10,011 $ 10,792 $ 8,007
Restructured debt - - 36 -
Other real estate owned (OREO) 316 695 761 661
---------------------------------------------------------------------------
Total nonperforming assets (NPA) $ 8,166 $ 10,706 $ 11,589 $ 8,668
===========================================================================
Loans past due 90 days or more
and still accruing interest $ 2,141 $ 2,267 $ 1,314 $ 1,419
Allowance for loan losses 25,019 24,510 24,576 27,118
NPA as % of loans plus OREO 0.57% 0.75% 0.80% 0.62%
Allowance as % of loans 1.74% 1.72% 1.70% 1.94%
Allowance as % of nonperforming loans 318.71% 244.83% 226.99% 338.68%
Allowance as % of NPA 306.38% 228.93% 212.06% 312.85%
</TABLE>
10
<PAGE>
Provisions for and activity in the allowance for loan losses are summarized as
follows:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
1999 1998
---------------------------------
<S> <C> <C>
(In thousands)
Beginning Balance $24,510 $26,721
Provision for Loan Losses 1,350 1,275
Loans Charged Off (1,839) (1,650)
Loan Recoveries 998 379
---------------------------------
Ending Balance $25,019 $26,725
=================================
</TABLE>
The provision for loan losses represents the charge to expense that is
required to fund the allowance for loan losses. The level of the allowance for
loan losses is determined by management based upon known and anticipated
circumstances and conditions. An analysis of individual loans and the overall
risk characteristics and size, and mix of the different loan portfolios is
conducted on an ongoing basis. In addition, management considers the Company's
historical loss experience, industry trends, the impact of regional and national
economic conditions on the Company's borrowers, and past estimates of loan
losses as compared to actual losses. Management assesses the adequacy of the
allowance for loan losses and reviews that assessment quarterly with the Board
of Directors.
Capital
Stockholders' equity totaled $178.8 million at March 31, 1999, compared to
$175.1 million at year-end 1998. The current level reflects year-to-date net
income of $7.5 million, net of dividends paid to shareholders totaling $2.6
million, and a decrease in accumulated other comprehensive income of $2.0
million. The decrease in other comprehensive income resulted from decreases in
the unrealized gains on available for sale securities caused by an increase in
yields in the Treasury bond market during the first quarter of 1999.
"Tier One" capital, consisting entirely of common equity, measured 10.19% of
risk-weighted assets at March 31, 1999. Total capital, including the "Tier Two"
allowance for loan losses, was 11.48% of risk-weighted assets. The leverage
capital ratio was 7.68%. These ratios placed Chittenden in the "well-
capitalized" category according to regulatory standards.
Liquidity
The Company's liquidity and rate sensitivity are monitored by the asset and
liability committee, based upon policies approved by the Board of Directors.
Strategies are implemented by the Company's asset and liability committee. This
committee meets periodically to review and direct the Banks' lending and
deposit-gathering functions. Investment and borrowing activities are managed by
the Company's Treasury function.
The measure of an institution'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 March 31, 1999, the Company maintained cash
balances and short-term investments of approximately $156.3 million, compared
with $134.7 million at December 31, 1998. During this three month period the
Company continued to be an average daily net seller of Federal Funds.
Interest-rate risk is the sensitivity of income to variations in interest
rates over both short-term and long-term horizons. The primary goal of
interest-rate management is to control this risk within limits approved by the
Board of Directors. These limits and guidelines reflect the Company's tolerance
for interest-rate risk. The Company attempts to control interest-rate risk by
identifying exposures, quantifying them and taking appropriate actions. The
Company quantifies its interest-rate risk exposure using sophisticated
simulation and valuation models, as well as simpler gap analyses. For a full
discussion of interest-rate risk see "Liquidity and Rate Sensitivity" in the
Company's 1998 annual report on Form 10-K. There has not been a material change
in the Company's interest-rate exposure or its anticipated market risk during
the current period.
Year 2000
11
<PAGE>
The Year 2000 problem, which is common to most corporations, concerns the
inability of information systems, primarily computer software programs, to
properly recognize and process date sensitive information as the year 2000
approaches. In April 1997, the Company formed a task force to manage the
completion of the five phases of the Year 2000 (Y2K) readiness process which had
informally started in November 1996. These phases include awareness of the Y2K
problem; the assessment of its impact on the Company; the subsequent renovation
of affected systems; the validation of designed Y2K renovations; and the
implementation of the validated renovations.
The Company's information systems include larger programs that run on
mainframe systems and smaller programs that reside on individual or networked
personal computers. The vast majority of the systems considered by the Company
to be mission-critical (vital to the successful continuance of the Company's
core business activities) are mainframe-based systems. The assessment of all
mission-critical mainframe systems has been completed. In addition, the
renovation, testing, and implementation of the renovations to all but one
mission-critical mainframe system (the trust accounting system) are also
complete. The Company's trust accounting system, which is used to maintain
detailed accounting records for the Company's trust customers, has been
represented by the vendor to be Y2K compliant but management has chosen to
replace that system rather than renovate it. The new system has been installed
and has been placed into production. Validation testing for Y2K compliance is
expected to be completed by the end of the second quarter of 1999. The vendor
of the new system has certified to the Company that the system is Y2K compliant.
The Company has developed an internal reporting system to track its deadlines
relating to the renovation, testing, and implementation of Y2K related tasks to
ensure that they are completed on schedule.
The personal computer (PC) based systems considered to be mission-critical by
management are smaller in scope than the mainframe-based systems. The Company's
assessment of its mission-critical PC-based systems is complete. Renovation,
testing, and implementation of all systems are also complete.
The Company's Y2K readiness is also affected by the readiness of its vendors.
The Company's most significant vendors are those that provide the mainframe
software that the Company uses to process its mission-critical systems. The
Company has two major vendors that provide the majority of the mainframe based
computer programs used in mission-critical systems. The Company has confirmed
with each of these vendors that they expect to be ready for the Year 2000 within
mandated timeframes. The vendor who will provide the new trust accounting
system has also confirmed that it is Y2K compliant. The Company has also
contacted the remainder of its vendors to determine their compliance and has
developed a tracking mechanism that will provide immediate notification if a
vendor does not meet a promised deadline.
The Company also performs ongoing evaluations of the Y2K readiness of its
significant customers. The results of this evaluation to date include responses
from approximately 97% of the Company's significant customers. These customers
responded to a questionnaire which asked them detailed questions regarding their
Year 2000 readiness, including:
. whether or not they had developed a comprehensive plan for Year 2000
compliance;
. whether or not a specific individual had been assigned responsibility for
managing Y2K compliance;
. whether or not senior management had reviewed and approved the plan;
. whether or not the customer had inventoried its hardware, software,
telecommunications, and facilities for Y2K compliance;
. whether or not the customer had budgeted sufficient resources to accomplish
its Y2K mission;
. whether or not the plan had been reviewed by outside auditors;
. the timing for the completion of testing of critical systems and the
preparation of contingency plans for those systems;
. whether or not the customers had discussed Y2K related issues with their
attorneys and insurers.
The responses were directed to the customer's primary customer service
contact, who reviewed their responses and then forwarded them to a specific
individual responsible for coordinating all responses and assessing their impact
on the Company. Responses were rated from 1 to 6, with 1 representing the most
progress and 6 representing the least. Of the customers who are being
evaluated, 90% have been rated as either 1 or 2. None of the responses have
indicated the existence of any Y2K related issues which might have a material
impact on the Company. Alternative assessments have been performed on a case-
by-case basis for the two significant customers
12
<PAGE>
who have not yet responded to the questionnaire. These assessments included any
procedures considered necessary to satisfy the Company that there are no Y2K
related issues associated with these two significant customers.
The monitoring of the Y2K readiness of these customers will continue until
after January 1, 2000 and could result in future increased credit risk to the
Company in the event that these customers do not successfully remediate any Y2K
issues that they might have.
The Company expects that it will incur costs to replace existing hardware and
software which will be capitalized and depreciated in accordance with the
Company's existing accounting policy as well as maintenance and software
modification costs which will be expensed as incurred. The Company's current
estimate of the total costs expected to be incurred, and those already incurred,
relative to Y2K follows:
<TABLE>
<CAPTION>
Costs incurred through Costs expected to be incurred
March 31, 1999 after March 31, 1999
------------------------------------------------------------------------
<S> <C> <C>
Software Modification $ 28,000 $ 269,000
Replacement of non-compliant software 109,000 500,000
Replacement of non-compliant hardware 119,000 575,000
------------------------------------------------------------------------
Total $256,000 $1,344,000
========================================================================
</TABLE>
Of the $1.35 million in estimated future costs of Y2K compliance, it is
expected that approximately 80% will consist of hardware and software purchases
that will have future utility and expanded functionality and therefore will be
capitalized and depreciated in accordance with the Company's existing accounting
policy. The above costs do not include salaries and benefits of Company
personnel or allocated costs of the Company's two major mainframe contracts as
these costs would have been incurred regardless of the Y2K problem. The Company
has not deferred any significant information technology (IT) projects that would
have a material adverse effect on its future operations if not performed in a
timely manner. Funds allocated for remediation of Year 2000 issues have not
been appropriated from the Company's ongoing IT budget.
Based upon the Company's progress in its Y2K readiness process, management
considers its most reasonably likely worst case Year 2000 mainframe-based
scenario to be that the Y2K patch to be delivered by the vendor who provides the
Company's credit card transaction processing software does not arrive prior to
the Company's drop dead date when it must switch to software with an available
patch. The original deadline for delivery of the patch by the vendor was May 1,
1999. The deadline has been extended to July 31, 1999. In the event that the
patch were not delivered by July 31, 1999, the Company would convert its
processing operations to software utilized by Vermont National Bank (VNB).
Vermont National Bank is a subsidiary of Vermont Financial Services Corp., which
is being acquired by the Company in a stock-for-stock transaction expected to
close in the second quarter of 1999. The software utilized by VNB is Y2K
compliant and testing has been completed. Management considers its most
reasonably likely worst case PC-based scenario to be that certain vendors will
not provide software renovations or upgrades for non-mission critical
applications on a timely basis and that the Company will need to convert to
other software providers or to temporarily adopt manual procedures to replace
these systems. The Company has identified those instances in which alternate
software providers are available, as well as those for which the only
alternative is manual processing.
The Company has been notified by IBM that after December 31, 1999, it will no
longer support the compiler that the Company currently employs to convert source
programming code to machine language. Management has chosen to replace this
compiler and expects to complete this replacement by the end of the third
quarter of 1999. The compiler will not have any impact on the Company's Year
2000 readiness other than that the renovated systems will be running on a
compiler supported by IBM through and beyond the Year 2000. As part of the
replacement, all mainframe-based systems will be re-validated on the new
compiler.
The agencies that regulate the Company (the Federal Reserve Board) and its
subsidiary banks (the Federal Deposit Insurance Corporation, the State of
Vermont and the Commonwealth of Massachusetts) have issued guidance as to the
standards they will use in assessing Year 2000 readiness. If, in the judgment
of these
13
<PAGE>
regulatory agencies, a regulated institution, such as the Company and its
subsidiaries, fails to take appropriate action to address its Y2K issues, the
regulatory agencies could impose enforcement actions which could have a material
adverse impact on such an institution, including the imposition of civil money
penalties, or the delay of applications seeking to complete acquisitions.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
A report was filed by the Company on Form 8-K/A on January 6, 1999 as an
amendment to Form 8-K filed by the Company on December 17, 1998. The Form
8-K/A was filed in connection with the signing of a definitive merger
agreement between Chittenden Corporation, Chittenden Subsidiary Inc. and
Vermont Financial Services Corp.
14
<PAGE>
CHITTENDEN CORPORATION
SIGNATURES
Pursuant to the requirement 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.
CHITTENDEN CORPORATION
Registrant
May 12, 1999 S/PAUL A. PERRAULT
- ------------ -------------------------------------
Date Paul A. Perrault,
Chairman, President and
Chief Executive Officer
May 12, 1999 S/KIRK W. WALTERS
- ------------ -------------------------------------
Date Kirk W. Walters
Executive Vice President,
Treasurer, and Chief Financial Officer
15
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