<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NO. 0-027878
FIRST FINANCIAL CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
<TABLE>
<S> <C>
RHODE ISLAND 05-0391383
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>
180 WASHINGTON STREET, PROVIDENCE, RHODE ISLAND 02903
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
----------------
(401) 421-3600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE
------------------- ON WHICH REGISTERED
---------------------
NONE NONE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $1.00 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 the 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 the definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
The aggregate market value of Common Stock held by nonaffiliates of the
Registrant as of March 9, 1998 was $20,495,166 based on the closing sale price
of Common Stock as reported on the Nasdaq National Market on such date. At
March 9, 1998, there were 1,328,041 shares of the Company's $1.00 par value
Common Stock issued, with 1,261,241 shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held May 13, 1998 are incorporated herein by reference into
Part III hereof.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
REFERENCE
---------
PART I
<C> <S> <C>
Item 1. Business................................................ 3
Item 2. Properties.............................................. 14
Item 3. Legal Proceedings....................................... 15
Item 4. Submission of Matters to a Vote of Security Holders..... 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.................................... 16
Item 6. Selected Consolidated Financial Data.................... 17
Item 7. Management's Discussion and Analysis of Financial
Condition
and Results of Operations.............................. 18
Item 7A. Quantitative and Qualitative Disclosure About Market
Risk................................................... 32
Item 8. Financial Statements and Supplementary Data............. 33
Item 9. Changes in and Disagreements with Accountants on
Accounting
and Financial Disclosure............................... 55
PART III
Item 10. Directors and Executive Officers of the Registrant...... 55
Item 11. Executive Compensation.................................. 55
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................. 55
Item 13. Certain Relationships and Related Transactions.......... 55
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K............................................... 55
Signatures ........................................................ 57
</TABLE>
2
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
First Financial Corp. (Company) is a bank holding company that was organized
under Rhode Island law in 1980 for the purposes of owning all of the
outstanding capital stock of First Bank and Trust Company (Bank) and providing
greater flexibility in helping the Bank achieve its business objectives. The
Bank is a Rhode Island chartered commercial bank that was originally chartered
and opened for business on February 14, 1972. The Bank provides a broad range
of lending and deposit products primarily to individuals and small businesses
($10 million or less in total revenues). Although the Bank has full commercial
banking and trust powers, it has not exercised its trust powers and does not,
at the current time, provide asset management or trust administration
services. The Bank's deposits are insured by the Federal Deposit Insurance
Corporation (FDIC) up to applicable limits.
The Bank offers a variety of consumer financial products and services
designed to satisfy the deposit and loan needs of its retail customers. The
Bank's retail products include interest-bearing and noninterest-bearing
checking accounts, money market accounts, passbook and statement savings
accounts, club accounts, and short-term and long-term certificates of deposit.
The Bank also offers customary check collection services, wire transfers, safe
deposit box rentals, and automated teller machine (ATM) cards and services.
Loan products include commercial, commercial mortgage, residential mortgage,
construction, home equity and a variety of consumer loans.
The Bank's strategy of managed growth through varied and often challenging
economic cycles has been strategically supplemented by both de novo branch
expansion and acquisition. The Bank's first expansion beyond its main office
occurred in 1981 with the opening of its Cranston, Rhode Island branch. The
Bank was presented with a further growth opportunity in 1991 as a result of
the Rhode Island "credit union crisis," when 45 privately-insured banks and
credit unions were closed by the Rhode Island Governor. In 1992, the Bank
acquired certain assets and assumed certain liabilities of the Chariho-Exeter
Credit Union located in the Wyoming section of Richmond, Rhode Island and
opened the facility as its Richmond branch. In June 1997, the Bank opened its
fourth retail facility with an in-store branch in the Wal-Mart super store
located at Wickford Junction in North Kingstown, Rhode Island. The North
Kingstown facility is a full service branch offering the same retail products
as the Banks's other branch offices.
The core of the Bank's business remains its ability to meet the lending and
deposit needs of customers in its market area. Most recently, the Bank has
experienced growth in business loans to borrowers with favorable cash flow
attributes seeking working capital financing secured by real estate. The Bank
is designated a "certified lender" by the Small Business Administration (SBA).
As a result of this designation, the SBA is contractually obligated to respond
within three business days to SBA loan requests submitted by the Bank.
The Bank's ability to attract these new lending relationships and the
related deposits is dependent on its willingness and ability to provide
service to customers with identified needs. The Company believes that the Bank
is particularly well-situated to serve the banking needs of the metropolitan
Providence area. The Company believes that the local character of the business
environment coupled with the Company's knowledge of the customers and their
needs, together with its comprehensive retail and small business products
create opportunities that will enable the Bank to effectively compete.
Further, the Company believes that the accessibility and responsiveness of the
Bank's personnel allow the Bank to compete effectively for certain segments
within its market, in particular local professionals and businesses, who
demand and receive customized and personalized banking products and services.
1992 ACQUISITION
On May 1, 1992, the Bank acquired certain assets and assumed certain
liabilities of Chariho-Exeter Credit Union. On May 4, 1992, the Bank reopened
the Chariho-Exeter facility as the third branch of the Bank providing
3
<PAGE>
the same service to the local community formerly served by Chariho-Exeter as
those provided at the Bank's other two branches. Although the Acquisition was
accounted for as a purchase, no goodwill or other intangible asset was
recorded because the purchase price did not exceed the fair value of the
assets acquired.
Through the Acquisition, the Bank acquired $33.4 million in assets, which
included $19.5 million in loans and an acquired allowance for possible loan
losses of approximately $3.9 million. Under the Acquisition Agreement, the
Bank may, through May 1, 1999, charge-off uncollected acquired loans to this
acquired allowance for possible loan losses. At May 1, 1999, any remaining
acquired allowance, less an amount equal to 1% of the remaining acquired
loans, must be repaid in the form of cash.
In connection with the Acquisition, the Company issued the Senior Debenture
to assist in financing the Acquisition. The proceeds of the Senior Debenture
were invested as a contribution of capital to the Bank. If, at any time prior
to May 1, 1999, net acquired loan losses exceed the acquired allowance for
possible loan losses, such excess may be deducted from the Company's debt
obligations under the Senior Debenture.
MARKET AREA
Although its main office is located in downtown Providence, the Bank's
Cranston branch is its largest office with deposits of $49.9 million at
December 31, 1997. The Providence, Richmond and North Kingstown branches had
approximately $25.5 million, $22.4 million and $1.5 million, respectively, in
deposits at December 31, 1997. Through its branch locations, the Bank provides
for the lending and deposit needs of its commercial and consumer customers in
its market area and by targeting customers who desire the convenience and
personal service not otherwise available as a result of recent major banking
consolidations.
LENDING ACTIVITIES
General. The Bank lends primarily to individuals and small businesses,
including partnerships, professional corporations and associations, and
limited liability companies. Loans made by the Bank to individuals include
owner-occupied residential mortgage loans, unsecured and secured personal
lines of credit, home equity loans, mortgage loans on investment (generally
non-owner occupied 1-4 family) and vacation properties, installment loans,
student loans, and overdraft line of credit protection. Loans made by the Bank
to businesses include typical secured loans, commercial real estate loans
(loans to individuals secured by residential property of 5 units or more are
considered commercial real estate loans) and lines of credit. Within the
commercial real estate portfolio, a loan may be secured by real estate
although the purpose of the loan is not to finance the purchase or development
of real estate nor is the principal source of repayment the sale or operation
of the real estate collateral. The Bank will often secure commercial loans for
working capital or equipment financing with real estate together with
equipment and other assets. The Bank characterizes such loans as "commercial
real estate," consistent with bank regulatory requirements. Generally, the
Bank lends only to borrowers located in Rhode Island or nearby Southeastern
Massachusetts or Connecticut. Occasionally, the Bank will lend to a borrower
in its market area where collateral securing obligations is vacation property
located outside the market area.
During the past few years, the commercial real estate loan portfolio has
increased and remains the largest part of the Bank's loan portfolio. This
increase is partially attributable to the Bank's positive response to an
increase in those businesses seeking working capital and expansion funds who
are frustrated by the consolidation of the banking industry. The Bank has in
the past and continues to specifically target such businesses through the
hiring of experienced commercial loan officers and by focusing on commercial
lending secured by real estate to borrowers, the purpose of which is to help
finance small business plant purchases, expansion, working capital and other
corporate purposes. The Bank continues to believe that opportunities exist to
satisfy the banking and borrowing needs of the small business community.
The Bank's policy on real estate lending standards establishes certain
maximum loan to value ("LTV") ratios for real estate-related loans depending
on the type of collateral securing such loans. These maximum LTV
4
<PAGE>
ratios range from 50% for those loans secured by undeveloped real estate up to
90% for loans secured by residential real estate. Notwithstanding these
maximum LTV ratios, as a general practice, the Bank imposes higher
collateralization requirements than the maximum ratios established in its
policy on real estate lending standards.
Loan Underwriting, Review and Risk Assessment. When considering loan
applications, the primary factors taken into consideration by the Bank are:
(i) the cash flow and financial condition of the borrower; (ii) the value of
any underlying collateral; and (iii) the character and integrity of the
borrower. These factors are evaluated in a number of ways including an
analysis of financial statements, credit reviews, trade reviews, and visits to
the borrower's place of business. The total indebtedness of the borrower to
the Bank determines the maximum limit which a lending officer has the
authority to approve a particular credit. Total indebtedness means the total
of all borrowings, including the loan being requested, whether funded or
unfunded, to a particular borrower and all related loan accounts. The
authority of individual loan officers is limited to the approval of secured
loans equal to or less than either $200,000 or $50,000, depending on the
individual loan officer, and unsecured loans equal to or less than either
$25,000 or $10,000, depending on the individual loan officer. The authority of
the chief executive officer is limited to the approval of secured loans equal
to or less than $400,000 and unsecured loans equal to or less than $300,000.
All loan requests in excess of an individual loan officer's limit must be
approved by the Bank's Credit Committee for secured loans equal to or less
than $500,000 and for unsecured loans equal to or less than $300,000. Loan
requests in excess of the Credit Committee's limit must be presented to the
Bank's Board of Directors. Generally, the Bank requires personal guarantees
and supporting financial statements from one or more of the principals of any
entity borrowing money from the Bank.
Loan business is generated primarily through referrals and direct-calling
efforts. Referrals of loan business come from the Bank's directors,
stockholders of the Company, existing customers of the Bank and professionals
such as lawyers, accountants, financial intermediaries and brokers.
At December 31, 1997, the Bank's statutory lending limit to any single
borrower approximated $1.9 million, subject to certain exceptions provided
under applicable law. The Bank also has a policy of extending loans, under the
same terms and conditions applicable to any other borrower, to directors and
executive officers of the Company and the Bank limiting the aggregate
principal amount of such loans to 100% of capital and otherwise complying with
applicable regulatory requirements. At December 31, 1997, the aggregate
principal amount of all loans to directors and executive officers and related
entities was $.9 million.
The Bank has an informal loan peer review function and a loan loss review
committee. The loan peer review committee, which meets monthly, is an informal
committee comprised of the Bank's chief executive officer and other loan
officers. Every loan of $150,000 or more is scheduled to be reviewed annually
by the loan peer review committee. All loans that undergo loan peer review
receive a numerical grade ranging from 1 to 6 based on a number of criteria,
including the financial strength of the borrower as determined, in part, by
such borrower's liquidity, debt service coverage and historical performance.
Any loan rated 4 or worse will automatically be placed on a "watchlist."
Certain 3 rated loans for which the committee has identified potential
problems may also be placed on the watchlist. The loans on the watchlist are
reviewed monthly by the Bank's Credit Committee in order to determine what
actions should be taken with respect to such loans, whether any loans should
be added or deleted from the watchlist, and to make recommendations regarding
loan loss reserve levels to the loan loss review committee. The loan loss
review committee, comprised of the Bank's executive officers and all other
loan officers, reviews loans on the watchlist on a quarterly basis in order to
establish loan loss reserve levels.
5
<PAGE>
The following table sets forth the repricing frequency of fixed and variable
rate loans included in the Bank's total loan portfolio at December 31, 1997.
Loans having no stated schedule of repayments or no stated maturity (due on
demand) are reported as due in one year.
<TABLE>
<CAPTION>
COMMERCIAL HOME
AND EQUITY
RESIDENTIAL LINES OF
COMMERCIAL REAL ESTATE CREDIT CONSUMER TOTAL
---------- ----------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
FIXED RATE
Amounts Due:
One year or Less......... $ 146 $ 7,357 $ 49 $ 72 $ 7,624
After one year through
five years.............. 829 41,596 89 406 42,920
Beyond five years........ 270 13,522 -- 132 13,924
------ ------- ------ ---- -------
1,245 62,475 138 610 64,468
------ ------- ------ ---- -------
VARIABLE RATE
Repricing Frequency:
Quarterly................ 4,723 4,966 2,700 373 12,762
Annually................. 450 -- -- -- 450
------ ------- ------ ---- -------
5,173 4,966 2,700 373 13,212
------ ------- ------ ---- -------
Total.................. $6,418 $67,441 $2,838 $983 $77,680
====== ======= ====== ==== =======
</TABLE>
Scheduled contractual principal repayments do not, in many cases, reflect
the actual maturities of loans. The average maturity of loans is substantially
less than their average contractual terms because of prepayments and, in the
case of conventional mortgage loans, due-on-sale clauses, which generally give
the Company the right to declare a loan immediately due and payable in the
event, among other things, that the borrower sells the real property subject
to the mortgage. In addition, because many of the Bank's residential and
commercial real estate loans are fixed rate loans subject to rate review
and/or call option within three to five years, such loans are considered by
the Bank to have a stated maturity equal to the rate review period. Prevailing
interest rates at the time of scheduled rate reviews may cause the Bank to
reset rates on these loans. However, such loans may not actually mature at
that time. The average life of mortgage loans tends to increase when current
mortgage loan rates are substantially higher than rates on existing mortgage
loans and, conversely, decrease when rates on existing mortgages are
substantially lower than current mortgage loan rates (due to refinancing at
lower rates). Under the latter circumstances, the weighted average yield on
loans decreases as higher yielding loans are repaid or refinanced at lower
rates. As of December 31, 1997, approximately $17,000 of loans scheduled to
mature within one year or less, were non-accruing.
Commercial Loans. Subject to federal and state restrictions, the Bank is
authorized to make secured or unsecured commercial business loans for general
corporate purposes. Commercial loans include working capital loans, equipment
financing, standby letters of credit, and secured and unsecured demand, term
and time loans. Commercial loans do not include business loans secured by real
estate.
At December 31, 1997, the Bank had outstanding commercial loans totalling
$6.4 million which represented 8.3% of total loans. Of the Bank's total
commercial loan portfolio, $5.2 million or 80.6% consisted of loans priced on
a floating rate basis at a margin over the Bank's base lending rate or Wall
Street Prime Rate. At December 31, 1997, the Bank's base rate was 10.25% while
the Prime Rate was 8.50%.
Commercial and Residential Real Estate Loans. At December 31, 1997, the
Bank's outstanding residential first and second mortgage loans and home equity
lines of credit of approximately $24.3 million, represented 31.3% of the
Bank's total loan portfolio. Of this amount, $20.3 million represented loans
originated directly by the Bank, while approximately $4.0 million represents
loans acquired in the Acquisition.
6
<PAGE>
Most fixed rate conforming loans originated by the Bank are referred to
correspondents. The Bank does not fund these loans. The Bank does not
originate Adjustable Rate Mortgages ("ARMS") for its own portfolio. The Bank
does, however, originate fixed rate residential first mortgage loans for its
own portfolio with a 15 to 30 year amortization period and a rate review
and/or call option at three or five year intervals. Consequently, as the Bank
attempts to satisfy the needs of its customers, it maintains an element of
interest rate sensitivity embedded in the terms of the loan.
The Bank has and plans to continue to commit substantial resources to the
promotion and development of commercial lending (i.e. small business plant
purchases, expansion and working capital) secured by real estate, which loans
are characterized as "commercial real estate loans." At December 31, 1997,
outstanding commercial real estate loans approximated $46.0 million or 59.2%
of total loans outstanding, including total construction and land development
loans of approximately $2.6 million.
Commercial real estate loans are generally priced at a floating rate indexed
to the Bank's base lending rate or to the Prime Rate. If a loan is priced at a
fixed rate, it is generally structured with a three-year or five-year rate
review and/or call option. At December 31, 1997, 79.9% of all residential and
commercial real estate loans are subject to repricing within five years.
Consumer Loans. At December 31, 1997, the Bank's consumer loan portfolio
approximated $1.0 million or 1.2% of total loans outstanding. The Bank offers
a full range of consumer lending products including new and used automobile
loans, passbook and certificate of deposit loans, and other personal secured
and unsecured loans. Although the Bank makes an effort to price these loans
competitively, it faces substantial competition from consumer finance
companies and, therefore, the Bank does not view this market as possessing
significant growth potential.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The following table, exclusive of the acquired allowance for possible loan
losses, represents the allocation of the Bank's allowance for possible loan
losses for the periods ending as indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1997 1996 1995
------------ ------------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Loan Category:
Commercial......................... $ 75 6.2% $ 90 7.5% $ 35 6.1%
Commercial Real Estate............. 848 70.2 718 59.8 463 54.7
Residential Real Estate............ 266 22.0 317 26.4 312 30.7
Home Equity Lines of Credit........ 7 0.6 55 4.6 37 6.3
Consumer........................... 12 1.0 20 1.7 15 2.2
------ ----- ------ ----- ---- -----
Total............................ $1,208 100.0% $1,200 100.0% $862 100.0%
====== ===== ====== ===== ==== =====
</TABLE>
This allocation of the allowance for possible loan losses reflects
management's judgment of the relative risks of the various categories of the
Bank's loan portfolio. This allocation should not be considered an indication
of the future amounts or types of loan charge-offs. At December 31, 1997, the
Bank classified $1.4 million of loans as substandard based on the rating
system adopted by the Bank. Of these amounts, a majority of which are included
in the commercial real estate loan portfolio, the Bank estimates a potential
loss exposure of $237,000.
INVESTMENT ACTIVITIES
The investment policy of the Bank is an integral part of the overall
asset/liability management of the Bank. The Bank's investment policy is to
establish a portfolio which will provide liquidity necessary to facilitate
funding of loans and to cover deposit fluctuations while at the same time
achieving a satisfactory return on the funds invested. The Bank intends to
maximize earnings from its investment portfolio consistent with the safety and
liquidity of those investment assets.
7
<PAGE>
The following table sets forth the amortized cost and estimated market value
of the Bank's investment portfolio at the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
ESTIMATED ESTIMATED ESTIMATED
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Held-to-Maturity:
U.S. Government and
agency obligations... $11,750 $11,745 $11,400 $11,370 $12,596 $12,551
Collateralized
mortgage
obligations.......... 718 717 2,381 2,378 2,048 2,016
------- ------- ------- ------- ------- -------
$12,468 $12,462 $13,781 $13,748 $14,644 $14,567
======= ======= ======= ======= ======= =======
Available-for-Sale:
U.S. Government and
agency obligations... $17,528 $17,559 $17,669 $17,696 $14,995 $15,088
Mortgage backed
securities .......... 8,580 8,727 10,684 10,712 -- --
Marketable equity
security and other... 295 313 1 3 12 44
------- ------- ------- ------- ------- -------
$26,403 $26,599 $28,354 $28,411 $15,007 $15,132
======= ======= ======= ======= ======= =======
</TABLE>
Included in the Bank's held-to-maturity investment portfolio at December 31,
1997, are $4.5 million in structured notes with an estimated fair value of
$4.5 million.
The following table sets forth certain information regarding maturity
distribution and weighted average yields of the Bank's investment portfolio at
December 31, 1997:
<TABLE>
<CAPTION>
WITHIN ONE YEAR ONE TO FIVE YEARS OVER FIVE YEARS TOTAL SECURITIES
----------------- ----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE RATE VALUE RATE VALUE RATE VALUE RATE
-------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Held-to-Maturity:
U.S. Government and
agency obligations... $ 2,250 5.13% $ 9,500 6.03% $ -- -- % $11,750 5.86%
Collateralized mortgage
obligations(1)......... 718 5.93 -- -- -- -- 718 5.93
------- ---- ------- ---- ------ ---- ------- ----
2,968 5.32 9,500 6.03 -- -- 12,468 5.86
------- ---- ------- ---- ------ ---- ------- ----
Available-for-Sale:
U.S. Government and
agency obligations... 9,841 5.80 7,718 5.99 -- -- 17,559 5.88
Mortgage backed
securities(1).......... 1,570 7.46 3,568 7.72 3,589 7.72 8,727 7.67
Marketable equity
security and other..... 313 -- -- -- -- -- 313 --
------- ---- ------- ---- ------ ---- ------- ----
11,724 5.87 11,286 6.54 3,589 7.72 26,599 6.40
------- ---- ------- ---- ------ ---- ------- ----
Total................ $14,692 5.76% $20,786 6.31% $3,589 7.72% $39,067 6.23%
======= ==== ======= ==== ====== ==== ======= ====
</TABLE>
- --------
(1) Fixed rate collateralized mortgage obligations are presented on a
scheduled cash flow basis. The mortgage backed securities are presented
using an assumed constant prepayment rate.
8
<PAGE>
SOURCES OF FUNDS
Deposits obtained through the Bank's offices and automated teller machines
("ATM") have traditionally been the principal source of the Bank's funds for
use in lending, investing and for other general business purposes. At December
31, 1997, the Bank had a total of approximately 2,756 demand deposit accounts
with an average balance of approximately $4,789 each; 3,631 passbook,
statement savings and NOW accounts with an average balance of approximately
$6,066 each; 59 money market accounts with an average balance of approximately
$23,131 each, and 3,590 certificates of deposit with an average balance of
approximately $17,470 (including 83 certificates of deposit of $100,000 or
more totalling $10.0 million).
The Bank's office and service hours are supplemented by the Bank's ATM card
service which facilitates various deposit and/or withdrawal transactions. The
Bank's ATM card may be used in the "CIRRUS", and "NYCE" ATM networks, and the
"Maestro" point-of-sale ("POS") network. These networks provide the Bank's ATM
cardholders with access to ATMs and POS machines throughout Rhode Island, New
England, the United States and more than 34 foreign countries.
The following table sets forth the average balances and average rates paid
on the Bank's deposits for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Non-interest-bearing deposits . $12,124 $10,965 $12,397
Interest bearing deposits:
NOW and savings accounts..... 21,022 2.52% 21,845 2.58% 24,858 2.56%
Money market accounts ....... 1,499 2.40 1,659 2.41 2,149 2.56
Certificates of deposit under
$100,000.................... 51,006 5.37 49,955 5.60 41,034 6.23
Certificates of deposit over
$100,000.................... 9,145 6.38 6,700 5.50 4,974 3.62
------- ------- -------
Total...................... $94,796 $91,124 $85,412
======= ======= =======
</TABLE>
Time certificates of deposit in denominations of $100,000 or more, at
December 31, 1997, had the following schedule of maturities:
<TABLE>
<CAPTION>
TIME REMAINING
TO MATURITY AMOUNT
-------------- --------------
(IN THOUSANDS)
<S> <C>
Less than 3 months........................................ $2,684
3 to 6 months............................................. 2,415
6 to 12 months............................................ 3,154
More than 12 months....................................... 1,746
------
Total................................................... $9,999
======
</TABLE>
For information regarding Other Borrowings refer to "Notes to Consolidated
Financial Statements."
COMMUNITY REINVESTMENT ACT
The Bank is committed to serving the banking needs of the communities in
which its branches are located and surrounding areas, including low and
moderate income areas consistent with its obligations under the Community
Reinvestment Act. There are several ways in which the Bank attempts to fulfill
this commitment, including working with economic development agencies,
undertaking special projects, and becoming involved with neighborhood outreach
programs. The Bank has undertaken as part of its mission to contribute to the
9
<PAGE>
economic and social development of the communities in which it operates. The
Bank believes that its contribution is to deliver competitive services that
are responsive to the needs of its employees, customers, shareholders, and
local communities. At its last CRA-compliance examination, the Bank was given
a "satisfactory" ranking which is the second highest rating of the four
assigned by the FDIC.
In addition to memberships and directorships in a number of civic,
charitable and not-for-profit organizations, the Bank meets with specific
community-based groups which has provided insight into the credit and housing
needs of the local community. The Bank has had periodic discussions with
officials from the Providence Plan Housing Corporation and the Providence
Community Action Program. These groups are primarily concerned with developing
affordable housing opportunities within the City of Providence. The Bank's
community outreach efforts rely on the calling activities of the Bank's loan
officers and branch managers. These individuals contact the area's under-
served small businesses to promote the Bank's services and to gain a better
understanding of their business needs. To a lesser extent, loan officers have
contacted local realtors to ascertain community credit needs and to inform the
realtors of the Bank's residential mortgage and referral program. Loan
officers are also members of, and routinely contact the Providence and
surrounding area's respective Chambers of Commerce.
The Bank has identified two primary needs within its communities: small
business loans with reduced documentation requirements and unconventional
mortgage products with flexible underwriting guidelines. To address the small
business lending demand, the Bank participates, as a "certified lender", in
the SBA loan programs; specifically, the 7A and 504 programs, as well as the
SBA's Low Doc program.
COMPETITION
In attracting deposits and making loans, the Bank encounters competition
from other institutions, including larger downtown Providence and suburban-
based commercial banking organizations, savings banks, credit unions, other
financial institutions and non-bank financial service companies serving Rhode
Island. The principal methods of competition include the level of loan
interest rates, interest rates paid on deposits, efforts to obtain deposits,
range of services provided and the quality of these services. These
competitors include several major financial companies whose greater resources
may afford them a marketplace advantage by enabling them to maintain numerous
banking locations and mount extensive promotional and advertising campaigns.
Certain of these competitors are not subject to the same regulatory
environment as the Bank.
EMPLOYEES
As of December 31, 1997, the Company had 35 full-time and 11 part-time
employees. The Company's employees are not represented by any collective
bargaining unit, and the Company believes its employee relations are good. The
Company maintains a benefit program which includes health insurance, life
insurance, a defined benefit pension plan, and a matching savings incentive
plan.
REGULATION AND SUPERVISION
Banks and bank holding companies are subject to extensive government
regulation through Federal and state statutes and regulations which are
subject to changes that may have significant impact on the way in which such
entities may conduct business. The likelihood and potential effects of any
such changes cannot be predicted. Legislation enacted in recent years has
substantially increased the level of competition among commercial banks,
thrift institutions and nonbanking institutions, including insurance
companies, brokerage firms, mutual funds, investment banks and major
retailers. In addition, the enactment of recent banking legislation such as
the Federal Deposit Insurance Corporation Improvement Act (FDICIA) and the
Interstate Banking Act have affected the banking industry by, among other
things, broadening the regulatory powers of the federal banking agencies in a
number of areas and enabling banks and bank holding companies to expand the
geographic area in which they may provide banking services. The following
summary is qualified in its entirety by the text of the relevant statutes and
regulations.
10
<PAGE>
The Company
General. The Company, as a bank holding company, is subject to regulation
and supervision by the Board of Governors of the Federal Reserve System
("Federal Reserve Board") and by the Rhode Island Department of Business
Regulation, Division of Banking (the "Banking Division"). The Company is
required to file semiannually and annually a report of its operations with,
and is subject to examination by, the Federal Reserve Board.
BHCA--Activities and Other Limitations. The Bank Holding Company Act
("BHCA") prohibits a bank holding company from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any bank, or,
except where a majority of shares are already owned, increasing such ownership
or control of any bank, without prior approval of the Federal Reserve Board.
No approval under the BHCA is required, however, for a bank holding company
already owning or controlling 50% of the voting shares of a bank to acquire
additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring more than 5% of the voting shares of any company that is not a
bank and from engaging in any business other than banking or managing or
controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve Board has determined to be so closely
related to banking or to managing or controlling banks as to be a proper
incident thereto. In making such determinations, the Federal Reserve Board is
required to weigh the expected benefit to the public, including greater
convenience, increased competition or gains in efficiency, against the
possible adverse effects, including undue concentration of resources,
decreased or unfair competition, conflicts of interest or unsound banking
practices.
Rhode Island Law. Rhode Island law requires the prior approval of the
Banking Division in order for a Rhode Island bank or bank holding company to
acquire 5% or more of the voting stock, or merge or consolidate with an out-
of-state bank or bank holding company. In examining the transaction, the
Banking Division must determine whether the transaction is permitted under the
law of the state of the out-of-state bank or bank holding company under
conditions not substantially more restrictive than those imposed by Rhode
Island law. In determining whether to approve the transaction, the Banking
Division must determine whether the transaction is in the public interest,
will promote the safety and soundness of the Rhode Island institution and
needs of the communities served thereby, and will serve the needs of the state
generally. In addition, a merger requires the prior approval of two-thirds of
the shareholders of the Rhode Island bank and such percentage of the
shareholders of the out-of-state bank as required by the laws of such state.
Under Rhode Island law, subject to the approval of the Banking Division, an
out-of-state bank or bank holding company may acquire direct or indirect
control of more than 5% of the voting stock or merge or consolidate with or
acquire substantially all of the assets and liabilities of a Rhode Island bank
or bank holding company provided that the laws of the state in which the out-
of-state bank is located, or in which operations of the bank subsidiaries of
an out-of-state bank holding company are principally conducted, expressly
authorize, as determined by the Banking Division, under conditions no more
restrictive than those imposed by the laws of Rhode Island, the acquisition by
a Rhode Island bank or bank holding company of 5% of the voting stock or the
merger or consolidation with or acquisition of all of the assets of banks or
bank holding companies located in that state. Additionally, under Rhode Island
law, no "person" may acquire 25% of the voting stock, or such lesser number of
shares as constitutes control, of a Rhode Island depository institution
without the prior approval of the Banking Division.
Dividends. The Company is a legal entity separate and distinct from the
Bank. The revenues of the Company (on a parent company only basis) are derived
primarily from interest on investments and dividends paid to the Company by
the Bank. The right of the Company, and consequently the right of creditors
and stockholders of the Company, to participate in any distribution of the
assets or earnings of any subsidiary through the payment of such dividends or
otherwise is necessarily subject to the prior claims of creditors of the
subsidiary
11
<PAGE>
(including depositors, in the case of banking subsidiaries), except to the
extent that certain claims of the Company in a creditor capacity may be
recognized.
It is the policy of the FDIC and the Federal Reserve Board that banks and
bank holding companies, respectively, should pay dividends only out of current
earnings and only if after paying such dividends, the bank or bank holding
company would remain adequately capitalized. Federal banking regulators also
have authority to prohibit banks and bank holding companies from paying
dividends if they deem such payment to be an unsafe or unsound practice. In
addition, it is the position of the Federal Reserve Board that a bank holding
company is expected to act as a source of financial strength to its subsidiary
banks.
The Subsidiary Bank
General. The Bank is subject to extensive regulation and examination by the
Banking Division and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and to certain requirements established by the
Federal Reserve Board. The federal and state laws and regulations which are
applicable to banks regulate, among other things, the scope of their business,
their investments, their reserves against deposits, the timing of the
availability of deposited funds and the nature and amount of, and collateral
for, certain loans. The prior approval of the FDIC and the Banking Division is
required for the Bank to establish or relocate an additional branch office,
assume deposits, or engage in any merger, consolidation or purchase or sale of
all or substantially all of the assets of any bank or savings association. The
laws and regulations governing the Bank generally have been promulgated to
protect depositors and not for the purpose of protecting stockholders.
Examinations and Supervision. The FDIC and the Banking Division regularly
examine the operations of the Bank, including (but not limited to) their
capital adequacy, reserves, loans, investments, earnings, liquidity,
compliance with laws and regulations, record of performance under the
Community Reinvestment Act (see below) and management practices. In addition,
the Bank is required to furnish quarterly and annual reports of income and
condition to the FDIC and periodic reports to the Banking Division. The
enforcement authority of the FDIC includes the power to impose civil money
penalties, terminate insurance coverage, remove officers and directors and
issue cease-and-desist orders to prevent unsafe or unsound practices or
violations of law or regulations. In addition, under recent federal banking
legislation, the FDIC has authority to impose additional restrictions and
requirements with respect to banks that do not satisfy applicable regulatory
capital requirements.
Dividends and Affiliate Transactions. The Bank is subject to certain
restrictions on loans to the Company, on investments in the stock or
securities thereof, on the taking of stock or securities as collateral for
loans to any borrower, and on the issuance of a guarantee or letter of credit
on behalf of the Company. The Bank also is subject to certain restrictions on
most types of transactions with the Company, requiring that the terms of such
transaction be substantially equivalent to terms of similar transactions with
non-affiliates. In addition, there are various limitations on the distribution
of dividends to the Company by the Bank.
Capital Requirements
The FDIC has established guidelines with respect to the maintenance of
appropriate levels of capital by FDIC-insured banks. At such time, if ever,
that the Company exceeds $150 million in consolidated assets or either: (i)
engages in any non-bank activity involving significant leverage; or (ii) has a
significant amount of outstanding debt that is held by the general public, it
will become subject to various capital adequacy requirements of the Federal
Reserve Board applicable to all such bank holding companies. Until such time,
the Federal Reserve Board applies the following guidelines on a bank only
basis. The Federal Reserve Board has adopted substantially identical capital
adequacy guidelines pursuant to which it assesses the adequacy of capital in
examining and supervising a bank holding company and in analyzing applications
to it under the BHCA. If a banking organization's capital levels fall below
the minimum requirements established by such guidelines, a bank or bank
holding company will be expected to develop and implement a plan acceptable to
the FDIC or the Federal Reserve Board, respectively, to achieve adequate
levels of capital within a reasonable period, and may be denied approval to
acquire or establish additional banks or non-bank businesses, merge with other
institutions
12
<PAGE>
or open branch facilities until such capital levels are achieved. Recently
enacted federal legislation requires federal bank regulators to take "prompt
corrective action" with respect to insured depository institutions that fail
to satisfy minimum capital requirements and imposes significant restrictions
on such institutions.
The guidelines generally require banks and bank holding companies to
maintain at least half of its total capital comprised of common equity,
retained earnings and a limited amount of perpetual preferred stock, less
goodwill ("Tier I Capital"). Additionally, these guidelines require banks and
bank holding companies to maintain a ratio of Tier I Capital to risk-weighted
assets of at least four (4%) percent and a ratio of total capital to risk-
weighted assets of at least eight (8%) percent ("Total Risk-Based Capital
Ratio"). Hybrid capital instruments, perpetual preferred stock which is not
eligible to be included as Tier I Capital, term subordinated debt and
intermediate-term preferred stock and, subject to limitations, general
allowances for loan losses, is known as "Tier 2 Capital." The sum of Tier 1
and Tier 2 Capital is "Total Risk-Based Capital." Assets are adjusted under
the risk-based guidelines to take into account different risk characteristics,
with the categories ranging from 0% (requiring no additional capital), for
assets such as cash, to 100% for the bulk of assets which are typically held
by a bank holding company, including multi-family residential and commercial
real estate loans, commercial business loans and consumer loans. Single-family
residential first mortgage loans which are not either 90 days or more past-due
or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighting system,
as are certain privately issued mortgage-backed securities representing
indirect ownership of such loans. Off-balance sheet items also are adjusted to
take into account certain risk characteristics.
Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
FDICIA, each federal banking agency is required to implement a system of
prompt corrective action for institutions which it regulates. The federal
banking agencies have promulgated substantially similar regulations to
implement the system of prompt corrective action established by Section 38 of
the FDIA, which became effective on December 19, 1992. Under the regulations,
a bank shall be deemed to be (i) "well capitalized" if it has Total Risk-Based
Capital Ratio of 10.0% or more, has a Tier Risk-Based Capital Ratio of 6.0% or
more, has a Tier I 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 I Risk-Based
Capital Ratio of 4.0% or more and a Tier I 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 I Risk-Based Capital Ratio that
is less than 4.0% or a Tier I 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 I Risk-
Based Capital Ratio that is less than 3.0% or a Tier I 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%.
Section 38 of the FDIA and the 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 or an undercapitalized institution to comply with supervisory
actions as if it were in the next lower category (except that the FDIC may not
reclassify a significantly undercapitalized institution as critically
undercapitalized).
A "critically undercapitalized institution" is to be placed in
conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or other appropriate federal banking
regulatory agency makes specific further findings and certifies that the
institution is viable and is not expected to fail, an institution that remains
critically undercapitalized on average during the fourth calendar quarter
after the date it becomes critically undercapitalized must be placed in
receivership.
Immediately upon becoming undercapitalized, an institution shall become
subject to the provisions of Section 38 of the FDIA (i) restricting payment of
capital distributions and management fees, (ii) requiring that the appropriate
federal banking agency monitor the condition of the institution and its
efforts to restore its capital, (iii) requiring submission of a capital
restoration plan, (iv) restricting the growth of the institution's assets and
(v) requiring prior approval of certain expansion proposals. The appropriate
federal banking agency for an
13
<PAGE>
undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject in certain cases to
specified procedures. These discretionary supervisory actions include:
requiring the institution to raise additional capital; restricting
transactions with affiliates; restricting interest rates paid by the
institution on deposits; requiring replacement of senior executive officers
and directors; restricting the activities of the institution and its
affiliates; requiring divestiture of the institution or the sale of the
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly
undercapitalized and critically undercapitalized institutions.
As of December 31, 1997, the Bank was classified as "well capitalized" under
these provisions.
Interstate Banking Legislation
The Riegle-Neal Interstate Banking and Branching Act of 1994 ("Interstate
Banking Act"), enacted in 1995, permits adequately capitalized and managed
bank holding companies to acquire control of banks in any state. Additionally,
as of June 1, 1997, the Interstate Banking Act allows for banks to branch
across state lines, but individual states were given the right, prior to June
1,1997, to elect to "opt out" of interstate banking entirely. In 1996, Rhode
Island adopted legislation pursuant to which Rhode Island "opted in" to
interstate banking. The Rhode Island act allows Rhode Island banks to
establish and maintain branches through a merger or consolidation with or by
the purchase of the whole or any part of the assets or stock of any out-of-
state bank or through de novo branch establishment in any state other than
Rhode Island.
The foregoing references to laws and regulations which are applicable to the
Company and the Bank are brief summaries thereof which do not purport to be
complete and which are qualified in their entirety by reference to such laws
and regulations.
RECENT DEVELOPMENTS
In January 1998, the Company and Wal-mart entered into a termination
agreement with respect to the opening of a Bank branch in the Wal-mart store
in Warwick, Rhode Island. In January 1997, the Company had agreed to open an
in-store branch in the Wal-Mart store. As a result of the termination
agreement, the Company and Wal-Mart each agreed that the Bank would not open
the in-store branch. In entering into the termination agreement, management of
the Company decided to allocate resources elsewhere. The termination agreement
does not in any way effect the Bank's branch opened in the North Kingstown
Wal-Mart store in June 1997.
ITEM 2. PROPERTIES
The Bank delivers its products and services through its four branch network
system. The Bank owns its main office building which is located at 180
Washington Street, Providence, Rhode Island. This location consists of a two-
story masonry and steel frame building containing (with basement storage)
approximately 6,800 square feet of space. The ground floor of this building is
used for retail banking as the Providence branch. Attached to this building is
a two lane drive-up facility, the only drive-up facility located in downtown
Providence. The building also houses a built-in ATM. The second floor of this
location is used predominately for executive, administrative, and support
staff office space. This building is located on two lots which are owned by
the Bank and which have a total area of approximately 10,000 square feet. This
land space is also used for customer parking and access and egress through the
drive-up facility. The Bank also owns an adjacent lot of approximately 3,300
square feet which is used solely as employee parking.
In 1981, the Bank leased and opened a branch office building at the corner
of Park and Reservoir Avenues, Cranston, Rhode Island. This one-story masonry
and steel frame building (including the lower level) has approximately 7,400
square feet space. The ground floor of this location contains the Cranston
branch, the Bank's largest branch as measured by deposits. The building also
has a three lane drive-up facility and a drive-up ATM.
14
<PAGE>
The basement of this building is used predominately by the Operations
Department along with several administrative offices. The building is situated
on approximately 21,000 square feet of leased land. The lease has an original
noncancellable term of 15 years with four successive renewal options, each for
an additional five years ending in the year 2009. The Bank is presently in the
second of the four renewal options which expires in the year 1999. Upon the
expiration of the lease in the year 2009, the Bank will have the right to
renew the lease upon the same terms and conditions, except for the term and
annual rent to be paid thereunder which are to be determined by mutual
agreement or, if not so determined, by arbitration. In late 1994 the Bank
acquired an adjacent parcel of land, which approximates 4,700 square feet, for
use as expanded customer parking and access to the facility from Reservoir
Avenue. The Bank also owns land across the street from this building. This
land, with total area of approximately 3,300 square feet, is used solely for
employee parking.
As part of the Acquisition, the Bank purchased the former credit union's
land and building and reopened the facility as the Bank's Richmond branch at
1168 Main Street, Richmond, Rhode Island. The facility is located in the
Wyoming section in the Town of Richmond. The two story wood frame building has
nearly 6,500 square feet space (exclusive of unfinished basement area) on a
land area of approximately 40,400 square feet. The branch location has a
built-in ATM and a two lane drive-up facility.
In June 1997, the Bank opened an in-store branch located in the Wal-Mart
super store at Wickford Junction in North Kingstown, Rhode Island. The Bank
leases nearly 1,700 square feet under an original lease term of five years
with two successive renewal options, each for an additional five years ending
in the year 2012. The branch is a full service facility, exclusive of safe
deposit boxes, with an ATM.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in routine legal proceedings occurring in the
ordinary course of business. In the opinion of management, final disposition
of these lawsuits based upon the advice of legal counsel as to potential
outcome will not have a material adverse effect on the financial condition or
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 1997, the Company did not submit any
matter to a vote of its security holders, through a solicitation of proxies or
otherwise.
15
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCK LISTING
On May 14, 1996, the Company's common stock began trading on the NASDAQ
National Market tier of the NASDAQ Stock Market under the symbol: FTFN.
High and low sales prices and dividends declared during 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
QUARTERLY DIVIDENDS
SALES PRICES HIGH LOW DECLARED
------------ ------ ------ ---------
<S> <C> <C> <C>
1997
1st Quarter........................................ 13 1/4 11 .05
2nd Quarter........................................ 12 3/4 11 3/8 .05
3rd Quarter........................................ 16 12 5/8 .05
4th Quarter........................................ 16 1/4 15 .05
1996
1st Quarter........................................ -- -- .03
2nd Quarter........................................ 10 1/8 9 1/8 .03
3rd Quarter........................................ 10 9 .03
4th Quarter........................................ 11 1/2 9 1/4 .03
</TABLE>
As of March 9, 1998, there were approximately 180 holders of record of the
Company's common stock and approximately 340 shareholders of beneficial
ownership who hold their stock in nominee or "street" name through various
brokerage firms.
16
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- -------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C> <C>
FINANCIAL CONDITION DATA:
Total assets................. $127,310 $121,413 $100,304 $92,822 $87,594
Investments, securities
purchased under agreements
to resell, federal funds
sold and interest bearing
deposits.................... 42,944 44,568 30,811 30,327 29,634
Total loans.................. 77,680 72,536 64,701 58,569 54,453
Allowance for possible loan
losses...................... 1,597 1,942 1,828 2,257 2,300
Total deposits............... 99,290 93,876 89,591 83,184 78,535
Securities sold under
agreements to repurchase.... 10,105 10,778 -- -- --
Senior debenture............. 2,947 2,894 2,845 2,736 2,557
Total stockholders' equity... 13,713 12,570 7,192 6,559 6,124
STATEMENT OF INCOME DATA:
Interest income.............. 9,969 8,867 7,732 6,794 6,624
Interest expense ............ 4,803 4,214 3,669 2,629 2,803
--------- --------- -------- ------- -------
Net interest income ......... 5,166 4,653 4,063 4,165 3,821
Provision for possible loan
losses...................... 250 455 675 555 545
--------- --------- -------- ------- -------
Net interest income after
provision for possible loan
losses...................... 4,916 4,198 3,388 3,610 3,276
Noninterest income........... 465 536 474 390 409
Noninterest expense.......... 3,341 3,177 3,093 2,989 2,805
Income taxes................. 728 513 251 399 330
--------- --------- -------- ------- -------
Net income................... $ 1,312 $ 1,044 $ 518 $ 612 $ 550
========= ========= ======== ======= =======
PER SHARE DATA:
Net income:
Basic...................... $ 1.04 $ 0.99 $ 0.76 $ 0.90 $ 0.81
Diluted.................... 1.04 0.98 0.71 0.84 0.76
Book value................... 10.87 9.89 10.35 9.60 8.96
Cash dividends declared...... 0.20 0.12 0.11 0.09 0.07
Dividend payout ratio........ 19.23% 12.83% 14.51% 10.05% 8.69%
Weighted average common
shares outstanding.......... 1,261,241 1,049,609 683,200 683,200 683,200
Weighted average common and
common stock equivalent
shares outstanding.......... 1,261,241 1,059,963 728,708 727,573 726,459
OPERATING RATIO DATA:
Return on average total
assets...................... 1.07% 0.96% 0.54% 0.68% 0.61%
Return on average
stockholders' equity........ 10.00 10.02 7.45 9.60 9.30
Net interest margin.......... 4.38 4.46 4.43 4.82 4.38
Loans to deposits ratio...... 78.24 77.27 72.22 70.41 69.34
Leverage capital ratio....... 10.77 10.32 6.87 7.01 6.81
ASSET QUALITY RATIOS:
Nonperforming assets to total
assets...................... 0.63% 0.91% 2.00% 1.58% 2.34%
Nonperforming loans to total
loans....................... 0.02 0.58 0.83 0.89 0.98
Net loan charge-offs to
average loans(1)............ 0.34 0.19 1.01 0.97 1.11
Allowance for possible loan
losses to total loans(1).... 1.64 1.78 1.47 1.50 1.54
Allowance for possible loan
losses to nonperforming
loans(1).................... 7,333.39 280.35 160.63 146.76 132.46
</TABLE>
- --------
(1) Ratios are exclusive of acquired loans, acquired reserve for loan losses,
and activity in the acquired reserve for loan losses associated with the
1992 acquisition of certain assets and the assumption of certain
liabilities of the former Chariho-Exeter Credit Union.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The results of operations of First Financial Corp. and its wholly-owned
subsidiary, First Bank and Trust Company ("Company"), depend primarily on its
net interest income, which is the difference between interest and dividend
income on interest-earning assets and interest expense on its interest-bearing
liabilities. Its interest-earning assets consist primarily of loans and
investment securities, while its interest-bearing liabilities consist
primarily of deposits, securities sold under agreements to repurchase and the
Senior Debenture. The Company's net income is also affected by its level of
noninterest income, including fees and service charges, as well as by its
noninterest expenses, such as salary and employee benefits, provisions to the
allowance for possible loan losses, occupancy costs and, when necessary,
expenses related to other real estate owned (OREO) and to the administration
of non-performing and other classified assets.
The Company reported net income for 1997 of $1,311,733, as compared to
$1,043,677 for 1996, or an increase of 25.7%. Diluted earnings per share
amounted to $1.04 per share for 1997, based on 1,261,241 weighted average
shares outstanding, as compared to $.98 per share for 1996, based on 1,059,963
weighted average shares outstanding. Also, in 1997, the Company's return on
average assets (ROA) improved to 1.07% from .96% in 1996. The Company's return
on average equity (ROE) was 10.00% in 1997, compared with 10.02% in 1996. The
improvement in net income is primarily the result of an increase in net
interest income and a reduction in the provision for possible loan losses,
which were offset somewhat by a decrease in noninterest income, and an
increase in noninterest expense and provision for income taxes. In general,
the Company's improvement in earnings is attributable to its ability to: (i)
increase average interest-earning assets funded from the net proceeds of the
1996 public offering, along with deposits and other borrowings; (ii) increase
loan originations; and (iii) improved asset quality.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, the difference between interest income and interest
expense, is the single largest contributor to the Company's results of
operations. In 1997, net interest income rose $512,548 or 11.0%, to $5,165,806
from $4,653,258 in 1996. The primary reason for this increase was due to an
increase in interest-earning assets of $13.7 million, or 13.2%, offset
somewhat by a 16 basis point decrease in average net interest spread to 3.46%
in 1997, as compared to 3.62% in 1996. The increase in average interest-
earning assets was funded largely from the net proceeds of the public
offering, deposit growth and other borrowings. Increases in average
stockholders' equity and an increase in average noninterest-bearing deposits,
accounted for a decrease in average net interest margin of only 8 basis points
to 4.38% in 1997 as compared to the 16 basis point decrease in net interest
spread.
Interest income totaled $9,969,127 in 1997, an increase of $1,101,644, or
12.4% over the prior year. The $13.7 million increase in average interest-
earning assets was primarily responsible for the improvement in interest
income. During 1997, loan demand was solid. Nonetheless, the composition of
loans to average interest-earning assets decreased to 64.2% during 1997, from
65.6% during 1996. This decrease was primarily the result of the purchase of
nearly $10.5 million in mortgage backed securities in the latter part of 1996.
These securities which were placed in the Company's available-for-sale
investment portfolio, produced yields which were lower than the blended yield
on average interest-earning assets. Consequently, despite a relatively stable
interest rate environment, the slight change in the mix of average interest-
earning assets accounted for a 6 basis point reduction in average earning
asset yield to 8.45% in 1997 from 8.51% in 1996.
Interest expense amounted to $4,803,321 in 1997, an increase of $589,096, or
14.0% over the $4,214,225 reported in 1996. This increase was largely
attributable to a $10.1 million increase in average interest-bearing
liabilities, and a 10 basis point increase in cost of funds to 4.99% during
1997, from 4.89% during 1996. Of the
18
<PAGE>
increase in average interest-bearing liabilities, average time deposits
increased $3.5 million and average securities sold under agreements to
repurchase increased $7.5 million. Lower cost NOW, savings and money market
deposits decreased $1.0 million. The increase in securities sold under
agreements to repurchase was used to fund the purchase of the mortgage backed
securities. Despite the gathering of new deposits and the shifting of existing
deposits into higher cost time deposits, the Company's cost of funds would
have remained flat at 4.85% in both 1997 and 1996 were it not for the increase
in volume and rate of the securities sold under agreements to repurchase.
19
<PAGE>
The following table sets forth certain information relating to the Company's
average balance sheet and reflects the average yield on assets and average
cost of liabilities for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities. Average balances are derived from daily balances. Loans are net
of unearned discount. Non-accrual loans are included in the average balances
used in calculating this table.
AVERAGE BALANCES AND INTEREST RATES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------
1997 1996 1995
-------------------------- -------------------------- -------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
-------- -------- ------- -------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans................... $ 75,714 $7,401 9.77% $ 68,437 $6,739 9.85% $61,043 $5,994 9.82%
Investment securities
taxable--AFS........... 26,608 1,695 6.37 18,180 1,165 6.41 13,575 758 5.58
Investment securities
taxable--HTM........... 11,717 672 5.74 13,828 772 5.58 14,357 831 5.79
Securities purchased
under agreements to
resell................. 3,496 175 5.01 3,456 173 5.01 2,796 149 5.33
Federal Home Loan Bank
stock.................. 423 26 6.15 348 18 5.17 -- -- --
-------- ------ ---- -------- ------ ---- ------- ------ ----
TOTAL INTEREST-EARNING
ASSETS................. 117,958 9,969 8.45 104,249 8,867 8.51 91,771 7,732 8.43
------ ---- ------ ---- ------ ----
NONINTEREST-EARNING
ASSETS:
Cash and due from banks. 2,238 1,886 2,073
Premises and equipment.. 2,141 1,739 1,810
Other real estate owned. 717 1,077 1,206
Allowance for possible
loan losses............ (1,903) (1,847) (2,086)
Other assets............ 1,450 1,101 875
-------- -------- -------
TOTAL NONINTEREST-
EARNING ASSETS......... 4,643 3,956 3,878
-------- -------- -------
TOTAL ASSETS............ $122,601 $108,205 $95,649
======== ======== =======
INTEREST-BEARING
LIABILITIES:
Deposits:
Interest-bearing demand
and NOW deposits...... $ 3,282 64 1.95 $ 2,550 50 1.96 $ 2,642 56 2.12
Savings deposits....... 17,740 465 2.62 19,295 513 2.66 22,216 582 2.62
Money market deposits . 1,499 36 2.40 1,659 40 2.41 2,149 55 2.56
Time deposits ......... 60,151 3,321 5.52 56,655 3,164 5.59 46,008 2,736 5.95
Securities sold under
agreements to
repurchase............. 10,590 647 6.11 3,067 185 6.03 -- -- --
Senior debenture........ 2,946 270 9.16 2,894 262 9.05 2,818 240 8.52
-------- ------ ---- -------- ------ ---- ------- ------ ----
TOTAL INTEREST-BEARING
LIABILITIES............ 96,208 4,803 4.99 86,120 4,214 4.89 75,833 3,669 4.84
NONINTEREST-BEARING
LIABILITIES:
Noninterest-bearing
deposits............... 12,124 10,965 12,397
Other liabilities....... 1,158 700 473
-------- -------- -------
TOTAL NONINTEREST-
BEARING LIABILITIES.... 13,282 11,665 12,870
STOCKHOLDERS' EQUITY.... 13,111 10,420 6,946
-------- -------- -------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY... $122,601 $108,205 $95,649
======== ======== =======
NET INTEREST INCOME..... $5,166 $4,653 $4,063
====== ====== ======
NET INTEREST SPREAD..... 3.46% 3.62% 3.59%
==== ==== ====
NET INTEREST MARGIN..... 4.38% 4.46% 4.43%
==== ==== ====
</TABLE>
20
<PAGE>
The following table describes the extent to which changes in interest rates
and changes in volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to changes attributable to: (i) changes in volume (changes in volume
multiplied by prior rate); and (ii) changes in rate (changes in rate
multiplied by prior volume). Changes in rate/volume have been allocated to
volume variances throughout this table. Loans are net of unearned discount.
Non-accrual loans are included in the average balances used in calculating
this table.
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
COMPARED WITH COMPARED WITH COMPARED WITH
DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
-------------------- --------------------- --------------------
INCREASE INCREASE (DECREASE) INCREASE
(DECREASE) DUE TO DUE TO (DECREASE) DUE TO
-------------------- --------------------- --------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ------ ------ ----- ------ ------ ---- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans................. $ 717 $(55) $ 662 $ 727 $ 18 $ 745 $ 412 $ 68 $ 480
Investment securities
taxable-- AFS........ 537 (7) 530 294 113 407 (59) 196 137
Investment securities
taxable-- HTM........ (122) 22 (100) (29) (30) (59) 213 131 344
Securities purchased
under agreements to
resell, and other.... 6 4 10 50 (8) 42 (82) 59 (23)
------ ---- ------ ------ ----- ------ ----- ---- ------
TOTAL INTEREST-EARNING
ASSETS................. $1,138 $(36) $1,102 $1,042 $ 93 $1,135 $ 484 $454 $ 938
====== ==== ====== ====== ===== ====== ===== ==== ======
INTEREST-BEARING
LIABILITIES:
Interest-bearing
demand and NOW
deposits............. $ 14 -- $ 14 $ (2) $ (4) $ (6) $ (5) $ (2) $ (7)
Savings deposits...... (40) (8) (48) (78) 9 (69) (144) (8) (152)
Money market deposits. (4) -- (4) (12) (3) (15) (8) (3) (11)
Time deposits......... 197 (40) 157 594 (166) 428 674 475 1,149
Securities sold under
agreements to
repurchase........... 459 3 462 185 -- 185 -- -- --
Senior debenture...... 5 3 8 7 15 22 15 46 61
------ ---- ------ ------ ----- ------ ----- ---- ------
TOTAL INTEREST-BEARING
LIABILITIES............ $ 631 $(42) $ 589 $ 694 $(149) $ 545 $ 532 $508 $1,040
====== ==== ====== ====== ===== ====== ===== ==== ======
NET CHANGE IN NET
INTEREST INCOME........ $ 507 $ 6 $ 513 $ 348 $ 242 $ 590 $ (48) $(54) $ (102)
====== ==== ====== ====== ===== ====== ===== ==== ======
</TABLE>
Provision for Possible Loan Losses
The provision for possible loan losses was $250,000 in 1997, compared to
$455,000 in 1996. The $205,000 reduction in the provision for possible loan
losses was strictly a function of asset quality. As compared to year-end 1996,
the Company's watch list loans decreased to $2.5 million from $3.2 million;
impaired loans to $1.4 million from $1.7 million; and impaired loans requiring
a specific reserve decreased to $.9 million from $1.4 million with a decrease
in the specific reserve for impaired loans to $237,000 from $376,000. The
aggressive approach to loan charge-offs during the year drove up the ratio of
net loan charge-offs to average loans to .34% from .19%, but also assisted in
reducing nonaccrual loans at year end to just $16,477 or 0.02% to total loans.
The increase in 30-89 days delinquent loans to $490,437 from $195,841 at the
end of 1996 was more a reflection of an abnormally low level of delinquencies
at the end of 1996 than a deterioration of asset quality in 1997.
21
<PAGE>
Noninterest Income
The following table identifies the major sources of noninterest income.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------
1997 1996 1995
---- ---- ----
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Service charges and fees on deposit accounts................. $317 $307 $285
Safe deposit box rental...................................... 25 26 25
Other service fees .......................................... 32 37 37
Gain on sale of securities .................................. -- 56 --
Gain on sale of loans........................................ 46 69 94
Loan servicing fees.......................................... 33 21 15
Other........................................................ 12 20 18
---- ---- ----
$465 $536 $474
==== ==== ====
</TABLE>
Noninterest income decreased $70,886 in 1997, to $465,397 from $536,283 in
1996. This decrease was primarily due to a $56,105 gain on sale of securities
in 1996 without a similar transaction in 1997. Generally, the Company's
intention is not to sell securities prior to maturity. However, in order to
utilize a capital loss tax carryforward, which was scheduled to expire at the
end of 1996, a security was sold and the tax carryforward was utilized.
Service charges and fees on deposit accounts increased $10,000, or 3.4%, to
$317,000 primarily as a result of more stringent imposition of fees and growth
in the Company's total deposits. The gain on sale of the guaranteed portion of
SBA loans decreased $23,000 in 1997 largely due to the increased competition
in this business market. Loan servicing fees increased $12,119, or 59.5%, to
$32,504 primarily due to growth in the Company's loan servicing portfolio.
Noninterest Expense
The following table identifies the major components of noninterest expense
for the respective periods presented:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
--------------------
1997 1996 1995
------ ------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Salaries and employee benefits......................... $1,802 $1,654 $1,566
Occupancy expense ..................................... 375 364 337
Equipment expense...................................... 219 200 196
OREO (gains) losses, write-downs, and carrying costs,
net................................................... 22 68 188
Other operating expenses:
FDIC insurance premium............................... 11 2 95
Computer service fees................................ 193 162 151
Regulatory examination fees.......................... 5 5 15
Legal and professional fees.......................... 158 131 68
Directors' fees...................................... 60 64 59
Postage.............................................. 45 48 44
Advertising.......................................... 62 100 45
Office supplies, forms, stationery, printing, etc. .. 99 103 78
Miscellaneous........................................ 290 276 251
------ ------ ------
$3,341 $3,177 $3,093
====== ====== ======
</TABLE>
22
<PAGE>
Total noninterest expense in 1997, was $3,341,269 as compared to $3,177,282
in 1996, an increase of $163,987 or 5.2%. The largest expense items accounting
for this increase were the $148,000 increase in salaries and employee
benefits; the $30,000 increase in occupancy and equipment expense; the $31,000
increase in computer service fees and; the $27,000 increase in legal and
professional fees. These increases were offset by a $46,000 decrease in OREO
carrying and disposition costs and a $38,000 decrease in advertising.
Salaries and benefits increased $148,000 or 8.9% in 1997. This increase
reflected an increase in staffing levels associated with the June 1997 opening
of the in-store branch in Wal-Mart in North Kingstown, Rhode Island. During
1997 the number of full time equivalent employees reached a high of 46 from 40
at the beginning of the year. Also, effective January 1, 1997, the Company
adopted a matching savings incentive plan, also known as a 401(k) plan, which
increased benefit costs by $32,000. During 1997 the Company undertook two
major projects, namely, the opening of the North Kingstown branch, and an
upgrade of its voice and data communications systems. These projects account
for the $11,000 increase in occupancy expense through the incurrence of rental
expense and the amortization of leasehold improvements. The upgrade in
communication systems involved the purchase of state-of-the-art computer
hardware and licensing of software applications. Depreciation charges
associated with these capital expenditures accounted for the increase of
$19,000 in equipment expense. The state-of-the-art processing capabilities and
overall enhancement of information systems was primarily responsible for the
$31,000 increase in computer service fees. 1997 represented the first full
year in which the Company operated in a publicly-held and publicly-traded
environment. In connection therewith, the Company incurred typical legal and
professional fees related to this public environment. These fees included
costs associated with preparation and production of public filings and
shareholder reports; listing fees; annual meeting costs; transfer agent costs;
and other similar costs. For this reason, legal and professional fees
increased $27,000 in 1997. OREO carrying and disposition costs decreased
$46,000 primarily due to the elimination of the need to write-down the
property's carrying value in 1997, compared to a $50,000 write-down in 1996,
along with a decrease in the foreclosed property portfolio from an average of
$1,077,000 during 1996 to an average of $717,000 during 1997. Other increases
or decreases in general and administrative expenses, including advertising,
were largely due to the Company's increased item processing, greater
efficiency and productivity, and decisions to increase or curtail
discretionary programs, projects and spending.
Income Taxes
Income tax expense amounted to $728,201 in 1997, or an effective tax rate of
35.7%. The effective rate in 1996 was 33.0%. The Company's combined federal
and state (net of federal benefit) statutory income tax rate was 39.94% in
1997 and 1996. The Company's effective combined federal and state tax rate was
lower than the statutory rate primarily due to the exclusion from state
taxable income interest income on U.S. Treasury obligations and certain
government agency debt securities in 1997 and 1996 and, the utilization of a
capital loss carryforward in 1996. Deferred tax assets and liabilities are
reflected at currently enacted income tax rates applicable to the period in
which the deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, assets and liabilities
are adjusted through the provision for income taxes.
FINANCIAL CONDITION
Total Assets
The Company's total assets increased $5.9 million, or 4.9%, from $121.4
million at December 31, 1996, to $127.3 million at December 31, 1997. The
increase in total assets primarily occurred within the Company's loan
portfolio which increased $5.2 million. The remainder of the increase took
place within premises and equipment which increased $.8 million. The primary
funding sources for the rise in total assets were: (i) $5.4 million increase
in total deposits; (ii) nearly $1.1 million in net income, less dividends
paid; offset by (iii) $.7 million decrease in securities sold under agreements
to repurchase.
Investment Securities
The Company's total investment securities portfolio decreased $3.1 million
to $39.1 million at December 31, 1997, from $42.2 million at December 31,
1996.
23
<PAGE>
At December 31, 1997, securities which were classified as held-to-maturity
were carried at amortized cost of $12,467,740, with a market value of
$12,462,016. Securities classified as available-for- sale were carried at a
market value of $26,598,634, with an amortized cost of $26,403,000. At
December 31, 1997, government agency debt securities and collateralized
mortgage obligations were classified as held-to-maturity which is consistent
with the Company's intent and ability. The available-for-sale segment of
investment securities was comprised of U.S. Treasury securities, government
agency discount notes and mortgage backed securities.
The securities in which the Company may invest are subject to regulation
and, for the most part, are limited to securities which are considered
investment grade securities. In addition, the Company has an internal
investment policy which restricts investments to: (i) United States treasury
securities; (ii) obligations of United States government agencies and
corporations; (iii) collateralized mortgage obligations, including securities
issued by the Federal National Mortgage Association (FNMA), the Government
National Mortgage Association (GNMA), and the Federal Home Loan Mortgage
Corporation (FHLMC); (iv) securities of states and political subdivisions; (v)
corporate debt, all of which must be considered investment grade by a
recognized rating service; and (vi) corporate stock. In addition to achieving
a rate of return which is consistent with the overall risk profile of the
investment portfolio, the Company views the immediate purpose of its
investment securities as a ready source of liquidity and as a management tool
against interest rate risk embedded within the Company's balance sheet.
Generally, the Company invests in fixed rate government and agency obligations
with a maturity not to exceed two years. Single index floating rate or step-up
securities generally have final maturities which do not exceed five years at
time of purchase. Consequently, the Company's exposure to significant market
swings is somewhat controlled. At December 31, 1997, the Company's investment
securities had net unrealized gains of $189,910 as compared to net unrealized
gains of $23,832 at December 31, 1996.
During 1996, the Company sold an investment security which was classified as
available-for-sale at a gain of $56,105 in order to utilize a capital loss tax
carryforward which was scheduled to expire at the end of 1996. Nonetheless,
despite this sales transaction and the segmentation of its securities
portfolio, the Company anticipates that it will hold all securities for their
intended purpose.
Loans
Total loans, net of unearned discount, amounted to $77.7 million at December
31, 1997, up $5.2 million, or 7.1%, from $72.5 million at the end of 1996. The
increase in total loans was predominately in the commercial and commercial
real estate portfolio, which grew $7.1 million, while residential real estate,
home equity lines of credit and consumer loans declined $1.9 million. At
December 31, 1997, total loans represented 61.0% of total assets and 78.2% of
total deposits compared to 59.7% and 77.2%, respectively, at the end of 1996.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Commercial.................. $ 6,418 8.3% $ 5,075 7.0% $ 3,549 5.5%
Commercial real estate...... 45,977 59.2 40,226 55.4 32,413 50.0
Residential real estate..... 21,464 27.6 22,978 31.6 23,658 36.5
Home equity lines of credit. 2,839 3.7 3,088 4.3 3,672 5.7
Consumer.................... 1,057 1.2 1,236 1.7 1,497 2.3
------- ----- ------- ----- ------- -----
77,755 72,603 64,789
Unearned discount........... 75 67 88
------- ------- -------
77,680 100.0% 72,536 100.0% 64,701 100.0%
===== ===== =====
Allowance for possible loan
losses..................... 1,597 1,942 1,828
------- ------- -------
Net loans................... $76,083 $70,594 $62,873
======= ======= =======
</TABLE>
24
<PAGE>
In 1997, the Company encountered solid loan demand from small businesses.
The Company believes a primary reason for this demand was the desire of small
business borrowers to seek banking relationships with banks which were
responsive to their needs, and the success of the Company in meeting those
needs. The increase in commercial and commercial real estate loans reflected
the Company's renewed emphasis on: (i) small business lending; (ii) obtaining
loan guarantees from the SBA; and (iii) cash-flow analysis and an overall
assessment of the borrower's financial strength and ability to repay with a
secondary view towards collateral values.
The Bank offers a full range of consumer lending products including
residential mortgages and home equity lines of credit, new and used automobile
loans, passbook and certificate of deposit loans, and other personal secured
and unsecured loans. Although the Bank makes an effort to price these loans
competitively, it faces substantial competition from mortgage and consumer
finance companies.
Non-Performing Assets
Non-performing assets include non-performing loans and other real estate
owned (OREO). The non-performing loans category includes loans on which the
accrual of interest is discontinued when the collectibility of principal or
interest is in doubt, or when payments of principal or interest have become 90
days past due and have arrearages that have not been eliminated. In certain
instances, non-performing loans may also include loans that have become 90
days past due but remain on accrual status because the value of the collateral
securing the loan is sufficient to cover principal and interest and the loan
is in the process of collection. OREO consists of real estate acquired through
foreclosure proceedings. In addition to the preceding two categories, the
Company may, under appropriate circumstances, restructure loans as a
concession to a borrower. At December 31, 1997, 1996, and 1995 no troubled
debt restructurings were included in the Company's loan portfolio.
The following table sets forth information regarding non-performing assets
and delinquent loans 30-89 days past due as to interest or principal, and held
by the Company at the dates indicated. The amounts and ratios shown are
exclusive of the loans and allowance for possible loan losses acquired in the
Chariho-Exeter Credit Union Acquisition.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996 1995
---- ------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Loans past due 90 days or more but not included in
non-accrual loans................................... $-- $ -- $ 17
Non-accrual loans.................................... 17 428 519
---- ------ ------
Total non-performing loans 17 428 536
Other real estate owned.............................. 782 676 1,470
---- ------ ------
Total non-performing assets.......................... $799 $1,104 $2,006
==== ====== ======
Delinquent loans 30-89 days past due................. $490 $ 196 $ 266
==== ====== ======
Non-performing loans as a percent of gross loans..... 0.02% 0.64% 0.91%
Non-performing assets as a percent of total assets... 0.65% 0.95% 2.11%
Delinquent loans 30-89 days past due as a percent of
gross loans......................................... 0.67% 0.29% 0.45%
</TABLE>
Allowance for Possible Loan Losses
The allowance for possible loan losses is established through provisions
charged against income. Assessing the adequacy of the allowance for possible
loan losses involves substantial uncertainties and is based upon management's
evaluation of the amounts required to meet estimated charge-offs in the loan
portfolio after weighing various factors. Among the factors are: (i) the risk
characteristics of the loan portfolio generally; (ii) the quality of specific
loans; (iii) the level of non-accruing loans; (iv) current economic
conditions; (v) trends in delinquencies and prior charge-offs; and (vi) the
value of the underlying collateral. Ultimate loan losses may vary
significantly from current estimates. The Company reviews non-performing and
performing loans to
ascertain whether any impairment exists within the loan portfolio. The Company
evaluates these problem loans
25
<PAGE>
and estimates the potential loss exposure when assessing the adequacy of the
allowance for possible loan losses. Because the allowance for possible loan
losses is based on various estimates and includes a high degree of judgment,
subsequent changes in general economic conditions and the economic prospects
of the borrowers may require changes in those estimates.
The following table is an analysis of the Allowance for Possible Loan Losses
over the last three years. This table excludes the acquired loans and related
allowance.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
-------------------------
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
AVERAGE LOANS OUTSTANDING .......................... $70,854 $62,846 $57,048
======= ======= =======
ALLOWANCE FOR POSSIBLE LOAN LOSSES AT BEGINNING OF
YEAR............................................... $ 1,200 $ 862 $ 764
CHARGED-OFF LOANS:
Commercial........................................ -- 8 48
Commercial Real Estate:
Non-owner occupied 1-4 family................... -- 18 47
Non-owner occupied multi-family................. -- 30 411
Commercial...................................... 25 -- 158
Residential Real Estate:
Owner occupied 1-4 family....................... 46 22 --
Non-owner occupied 1-4 family................... 111 36 35
Home Equity Lines of Credit....................... 74 -- 5
Consumer.......................................... 11 23 11
------- ------- -------
Total charged-off loans......................... 267 137 715
------- ------- -------
RECOVERIES ON LOANS PREVIOUSLY CHARGED OFF:
Commercial ....................................... -- 5 44
Commercial Real Estate:
Non-owner occupied 1-4 family................... -- -- --
Non-owner occupied multi-family ................ -- -- 67
Commercial ..................................... -- 3 19
Residential Real Estate:
Owner occupied 1-4 family....................... 8 -- --
Non-owner occupied 1-4 family .................. -- -- --
Home Equity Lines of Credit....................... -- -- --
Consumer.......................................... 17 12 8
------- ------- -------
Total recoveries................................ 25 20 138
------- ------- -------
NET LOANS CHARGED-OFF .............................. 242 117 577
PROVISION FOR POSSIBLE LOAN LOSSES ................. 250 455 675
------- ------- -------
ALLOWANCE FOR POSSIBLE LOAN LOSSES AT END OF YEAR... $ 1,208 $ 1,200 $ 862
======= ======= =======
Net loans charged-off to average loans.............. 0.34% 0.19% 1.01%
Allowance for possible loan losses to gross loans at
end of year........................................ 1.64 1.78 1.47
Allowance for possible loan losses to non-performing
loans.............................................. 7332.94 280.35 160.63
Net loans charged-off to allowance for possible loan
losses at beginning of year........................ 20.17 13.57 75.52
Recoveries to charge-offs........................... 9.36 14.60 19.30
</TABLE>
26
<PAGE>
The following table summarizes the gross activity in OREO during the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------------
1997 1996 1995
----- ------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year ..................... $ 676 $1,470 $ 945
Property acquired................................. 461 183 1,257
Sales and other adjustments ...................... (355) (927) (607)
Write-downs (charged to operations) .............. -- (50) (125)
----- ------ ------
Balance at end of year............................ $ 782 $ 676 $1,470
===== ====== ======
The balance of OREO at December 31, 1997 consisted
of:
Land development ............................... $ 219
1-4 Family residential real estate ............. 245
Multi-Family (5 or more) residential properties. --
Commercial real estate ......................... 318
-----
$ 782
=====
</TABLE>
Deposits and Borrowings
The Company devotes considerable time and resources to gathering deposits
through its retail branch network system. Total deposits increased $5.4
million, or 5.8%, to $99.3 million at December 31, 1997, from $93.9 million at
the end of 1996. Total demand deposits increased $1.9 million, while savings
and money market accounts increased $.6 million. The preponderance of deposit
growth occurred within time deposits which increased $2.9 million. Of this
increase, one year time deposits grew $11.8 million while the Company's 18 and
36 month variable rate certificate of deposit decreased $8.5 million. The
Company's depositors, concerned that interest rates would decline in the near-
term, shifted their deposits from the longer term variable deposit product to
the shorter term fixed rate deposit product.
The opening of the Bank's new in-store branch in the North Kingstown Wal-
Mart store in June 1997 did not significantly contribute to the growth in the
Bank's deposits in 1997. Management believes that this was the case because
the new de novo branch was not opened until half-way through the year and the
fact that the area of North Kingstown where the Wal-Mart store is located is
still largely under development.
Along with its deposit gathering efforts, the Company relied on borrowing
from securities sold under agreements to repurchase to leverage its capital.
At December 31, 1997, securities sold under agreements to repurchase amounted
to $10.1 million, compared to $10.8 million at December 31, 1996.
Asset/Liability Management
The principal objective of the Company's asset and liability management is
to minimize interest rate risk on net interest income and stockholders'
equity. This objective is accomplished by managing the ratio of interest rate
sensitive assets to interest rate sensitive liabilities within specified
maturities or repricing dates. The Company's actions in this regard are taken
under the guidance of the Asset/ Liability Management Committee which includes
members of the Company's senior management and two members of the Company's
Board of Directors. The Asset/Liability Management Committee is actively
involved in formulating the economic assumptions that the Company uses in its
financial planning and budgeting process and establishes policies which
control and monitor the Company's sources, uses and pricing of funds.
The effect of interest rate changes on assets and liabilities is analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring the interest rate sensitivity "gap." An asset or
liability is interest rate sensitive within a specific time period if it will
mature or reprice within that time period. The interest rate sensitivity "gap"
is defined as the difference between interest-earning assets and interest-
bearing liabilities maturing or repricing within a given time period. A gap is
considered positive when
27
<PAGE>
the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities. A gap is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a positive gap would tend to
adversely affect net interest income, while a negative gap would tend to
result in an increase in net interest income. During a period of rising
interest rates, a positive gap would tend to result in an increase in net
interest income while a negative gap would tend to affect net interest income
adversely.
The Company has historically sought to maintain a relatively narrow gap
position and has, in some instances, foregone investment in higher yielding
assets where such investment, in management's opinion, exposed the Company to
undue interest rate risk. However, the Company does not attempt to perfectly
match interest rate sensitive assets and liabilities and will selectively
mismatch its assets and liabilities to a controlled degree where it considers
it both appropriate and prudent to do so. In managing its interest rate risk
exposure, the Company does not engage in derivative financial instruments for
hedging or speculative purposes. Other than fixed rate loan commitments, the
Company is prohibited, by internal policy, from engaging in the use of off-
balance sheet financial instruments.
There are a number of relevant time periods in which to measure the
Company's gap position, such as at the 3, 6, and 12 month points and beyond in
the maturity schedule. Management tends to focus most closely on the gap up to
the one year point in making its principal funding and investing decisions.
The following table presents the repricing schedule for the Company's
interest-earning assets and interest-bearing liabilities at December 31, 1997:
<TABLE>
<CAPTION>
WITHIN OVER THREE OVER ONE OVER FIVE
THREE TO TWELVE YEAR TO YEARS TO OVER TEN
MONTHS MONTHS FIVE YEARS TEN YEARS YEARS TOTAL
-------- ---------- ---------- --------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Securities purchased
under agreements to
resell, and other ... $ 3,878 $ -- $ -- $ -- $ -- $ 3,878
Investment securities. 7,366 10,062 15,549 6,089 -- 39,066
Loans................. 8,727 25,937 29,732 13,664 -- 78,060
-------- -------- ------- ------- ------- --------
Total interest-earning
assets................. 19,971 35,999 45,281 19,753 121,004
INTEREST-BEARING
LIABILITIES:
Money Market accounts. 235 684 446 -- -- 1,365
Savings deposits and
NOW accounts......... 1,815 5,609 14,625 -- -- 22,049
Time deposits......... 26,098 31,669 4,953 -- -- 62,720
Securities sold under
agreements to
repurchase........... 5,105 2,500 2,500 -- -- 10,105
Senior debenture...... -- -- 2,947 -- -- 2,947
-------- -------- ------- ------- ------- --------
Total interest-bearing
liabilities............ 33,253 40,462 25,471 -- -- 99,186
-------- -------- ------- ------- ------- --------
NET INTEREST SENSITIVITY
GAP.................... $(13,282) $ (4,463) $19,810 $19,753 -- $ 21,818
======== ======== ======= ======= ======= ========
CUMULATIVE GAP.......... $(13,282) $(17,745) $ 2,065 $21,818 $21,818 $ 21,818
======== ======== ======= ======= ======= ========
NET INTEREST SENSITIVITY
GAP AS A PERCENT OF
TOTAL ASSETS........... (10.4)% (3.5)% 15.6% 15.5% -- 17.2%
======== ======== ======= ======= ======= ========
CUMULATIVE GAP AS A
PERCENT OF TOTAL
ASSETS................. (10.4)% (13.9)% 1.7% 17.2% 17.2% 17.2%
======== ======== ======= ======= ======= ========
</TABLE>
28
<PAGE>
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable-rate
loans, have features which restrict changes in interest rates both on a short-
term basis and over the life of the asset. Further, in the event of a change
in interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in calculating the table.
By using simulation modeling techniques, the Company is able to measure its
interest rate risk exposure as determined by the impact of sudden movements in
interest rates on net interest income and equity. This exposure is termed
"earnings-at-risk" and "equity-at-risk". At December 31, 1997, the Company's
earnings-at-risk under a (plus/minus)200 basis point interest rate shock test
measured a negative 5.1% in a worst case scenario. Under a similar test, the
Company's equity-at-risk measured a negative 15.25% of market value of equity at
December 31, 1997. At December 31, 1997, the Company's earnings-at-risk and
equity-at-risk fell well within tolerance levels established by internal policy.
Liquidity
Liquidity is defined as the ability to meet current and future financial
obligations of a short-term nature. The Company further defines liquidity as
the ability to respond to the needs of depositors and borrowers and to earning
enhancement opportunities in a changing marketplace. Primary sources of
liquidity consist of deposit inflows, loan repayments, securities sold under
agreement to repurchase, maturity of investment securities and sales of
securities from the available-for-sale portfolio. These sources fund the
Bank's lending and investment activities.
At December 31, 1997, cash and due from banks, securities purchased under
agreements to resell, and short-term investments (unpledged and maturing
within one year) amounted to $16.9 million, or 13.3% of total assets.
Management is responsible for establishing and monitoring liquidity targets as
well as strategies and tactics to meet these targets. Through membership in
the Federal Home Loan Bank of Boston (FHLB), the Company has access to both
short and long-term borrowings of nearly $9.0 million, which could assist the
Company in meeting its liquidity needs and funding its asset mix. At December
31, 1997, the Company held state and municipal demand deposits of $1.0 million
which it considered highly volatile. Nonetheless, the Company believes that
there are no adverse trends in the Company's liquidity or capital reserves,
and the Company believes that it maintains adequate liquidity to meet its
commitments.
Capital Resources
Total stockholders' equity of the Company at December 31, 1997 was $13.7
million, as compared to $12.6 million at December 31, 1996. The increase of
$1.1 million primarily resulted from $1.3 million in net income, less
dividends declared.
The Bank is subject to the leverage and risk-based capital ratio
requirements of the FDIC. The Bank is deemed to be "well capitalized" by the
FDIC and is classified as such for FDIC insurance- assessment purposes. At
December 31, 1997, the Bank's Leverage Capital Ratio was 10.43%, as compared
to 9.85% at December 31, 1996. The FDIC's minimum Leverage Capital Ratio for
"adequately capitalized" financial institutions is 3%, although this minimum
leverage ratio applies only to certain of the most highly-rated banks. Other
institutions are subject to higher requirements.
The risk-based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning assets and off-
balance sheet items to broad risk categories. According to these standards,
the Bank had a Tier I Risk-Based Capital Ratio of 16.52% and a Total Risk-
Based Capital Ratio of 17.78% at December 31, 1997, as compared to a Tier I
Risk-Based Capital Ratio of 14.71% and a Total Risk-
29
<PAGE>
Based Capital Ratio of 15.96% at December 31, 1996. The minimum risk-based
Tier I and Total Capital Ratios at each of these dates were 4.0% and 8.0%,
respectively.
The capital structure of the Company is subject to the capital ratio
requirements of the Federal Reserve Bank, which happens to be the same
requirements which FDIC imposes on the Bank.
At December 31, 1997, the Company's Leverage Capital Ratio was 10.77%, as
compared to 10.32% at December 31, 1996. The Company's Tier I Risk-Based
Capital Ratio was 17.50% and its Total Risk-Based Capital Ratio was 18.76% at
December 31, 1997, and 15.78% and 17.03%, respectively, at December 31, 1996.
Year 2000 Compliance
The efficient operation of the Company's business is highly dependent on its
computer software programs and operating systems. Virtually all of these
programs and systems are furnished, supported and maintained by correspondent
institutions, computer service and system providers, and software vendors. As
the year 2000 approaches, a critical business issue has emerged regarding how
existing application software programs and operating systems can accommodate
this date value. As a result, the year 1999 could be the maximum date value
these systems will be able to accurately process. Operating in a highly
regulated environment, the Company and the Bank are well aware of the
importance placed on this issue by the Federal Deposit Insurance Corporation,
Federal Reserve Bank, Rhode Island Department of Business Regulation and the
Securities and Exchange Commission. The company has adopted a Year 2000 Plan
which calls for completion of a risk assessment, identification, reprogramming
and testing of all programs and systems no later than December 31, 1998.
Further, the Plan also requires all programs and systems to be fully tested
and Year 2000 compliant by June 30, 1999.
The Company is in constant communication with its outside vendors, with whom
it is reliant, to ensure that their timetable and progress is consistent with
that of the Company. The Company does not anticipate that the costs to be
incurred in connection with Year 2000 compliance will be material to its
financial condition or results of operations.
COMPARISON OF 1996 WITH 1995
The Company reported net income for 1996 of $1,043,677, as compared to
$517,777 for 1995, or an increase of 101.6%. The improvement in net income is
primarily the result of an increase in net interest income, a reduction in the
provision for possible loan losses, and an increase in noninterest income, all
of which were offset somewhat by an increase in noninterest expense and
provision for income taxes. In general, the Company's improvement in earnings
is attributable to its ability to: (i) increase interest-earning assets funded
from the net proceeds of the public offering, along with deposits and other
borrowings; (ii) increase loan originations; (iii) improve net interest
margins; and (iv) improve asset quality.
During 1996, the Company completed a public offering of its common stock and
issued 550,000 shares while increasing stockholders' equity by $4.5 million.
The increased capital allowed the Company to grow its balance sheet without
impairing its capital position. Total assets increased $21.1 million or 21.0%
to $121.4 million at the end of 1996. This growth occurred through a $4.3
million; or 4.8% increase in deposits, to $93.9 million; a $10.8 million
increase in securities sold under agreements to repurchase; the $4.5 million
in net proceeds from the public offering; and nearly $.9 million in net
income, less common stock dividends.
Net Interest Income
In 1996, net interest income rose $589,911, or 14.5%, to $4,653,258 from
$4,063,347 in 1995. The primary reason for this increase was due to an
increase in average interest-earing assets of $12.5 million, or 13.6% and a
slight increase in average net interest spread to 3.63% in 1996, as compared
to 3.59% in 1995. The increase in average earning assets was funded largely
from the net proceeds of the public offering, deposit growth and other
borrowings. Increases in average stockholders' equity, offset somewhat by a
decrease in average noninterest-
30
<PAGE>
bearing deposits, coupled with a relatively flat average net interest spread
accounted for the 3 basis point increase in average net interest margin to
4.46% in 1996.
Interest income totaled $8,867,483 in 1996, an increase of $1,135,464, or
14.7% over the prior year. The $12.5 million increase in average interest-
earning assets was primarily responsible for the improvement in interest
income. During 1996, loan demand was solid and the composition of average
interest-earning assets between loans and investments remained relatively
constant from 1995 to 1996. The interest rate environment also remained
relatively flat, resulting in an 8 basis point increase in average earnings
asset yield to 8.51% in 1996 from 8.43% in 1995.
Interest expense amounted to $4,214,225 in 1996, an increase of $545,553, or
14.9% over the $3,668,672 reported in 1995. The increase was attributable to a
$10.3 million increase in average interest-bearing liabilities and a 5 basis
point increase in average cost of funds. During 1996, average interest-bearing
demand and NOW, savings, and money market deposits decreased $3.4 million
while higher cost average time deposits increased $10.6 million. Also, higher
cost securities sold under agreements to repurchase increased on average by
$3.1 million. Despite the impact of a declining short term interest rate
environment, the shifting of existing core savings deposits into higher cost
time deposits along with gathering new deposits into higher cost time deposits
accounted for the increase in average cost of funds to 4.89% in 1996 from
4.84% in 1995.
In the latter part of 1996, the Company entered into a series of contracts
to sell securities under agreements to repurchase. The proceeds from these
agreements were used to purchase $10,490,000 of mortgage backed securities
with a yield of 7.93%, at an average borrowing cost of 6.03%. The purpose of
this transaction was to leverage the Company's capital position with the
intent to ultimately increase the Company's return on stockholders' equity.
Although the transaction added nearly $60,000 to net interest income in 1996,
the spreads from this sole transaction were narrower than from the Company's
other investing and financing activities. Consequently, the net interest
spread and net interest margin would have been 3.67% and 4.53%, respectively,
without this single transaction.
Provision for Possible Loan Losses
The provision for possible loan losses was $455,000 in 1996, compared to
$675,000 in 1995. The reduction in the provision was primarily the result of
fewer net charge-offs during 1996, thus eliminating the necessity to replenish
the reserve for net charge-offs, which was the case in 1995. Due to the
overall improvement in asset quality, net charge-offs amounted to $117,076 in
1996, compared to $577,413 in 1995. The 1996 provision for possible loan
losses was used primarily to allow for the overall growth of the Company's
portfolio.
Noninterest Income
Noninterest income increased $62,425 in 1996, to $536,283 from $473,858 in
1995. This increase primarily was due to a $56,105 gain on sale of securities.
Generally, the Company's intention is not to sell securities prior to
maturity. However, in order to utilize a capital loss tax carryforward, which
was scheduled to expire at the end of 1996, a security was sold and the tax
carryforward was utilized.
Service charges and fees on deposit accounts increased $21,647, or 7.6%, to
$307,060 primarily as a result of more stringent imposition of fees, revisions
to the fee schedule of various deposit products and, growth in the Company's
total deposits. The gain on sale of the guaranteed portion of SBA loans
decreased $25,065 in 1996 largely due to the increased competition in this
business market.
Noninterest Expense
Total noninterest expense in 1996 was $3,177,282 as compared to $3,092,911
in 1995, an increase of $84,371, or 2.7%. The largest expense items accounting
for this increase were the $88,000 increase in salaries and employee benefits;
the $63,000 increase in legal and professional fees and; the $55,000 increase
in
31
<PAGE>
advertising costs. These increases were offset by a $120,000 decrease in OREO
carrying and disposition costs and a $93,000 decrease in FDIC insurance
premiums.
Salaries and employee benefits increased $88,000, or 5.6% in 1996. This
increase reflected a general pay adjustment for nearly all employees, and
higher payroll taxes, health insurance and retirement benefit costs. The
increase was offset somewhat by an increase in deferred loan origination costs
and a decrease in full time equivalent staffing from 43 at the beginning of
the year to 40 at the end of 1996. OREO carrying and disposition costs
declined $120,000, or 64% solely as a result of a decrease in the OREO
portfolio which declined nearly $795,000, or 54%. In 1996, the Company's FDIC
insurance assessment decreased $93,000. Effective January 1, 1996 the Bank's
annual FDIC insurance assessment was reduced to the minimum statutory
requirement. The Bank qualified for this rate on the basis of its strong
capital position and supervisory evaluation. Legal and professional fees rose
$63,000, or 92.6% in 1996. This increase was attributable to fees typically
incurred in connection with reporting requirements applicable to public
companies, along with professional fees associated with an assessment and
evaluation of the Company's voice and data processing and communications
systems. Other increases or decreases in general and administrative expenses,
including advertising, were largely due to the Company's increased item
processing, greater efficiency and productivity, and decisions to increase or
curtail discretionary programs, projects and spending.
Income Taxes
Income tax expense amounted to $513,582 in 1996, or an effective tax rate of
32.7%. The effective rate in 1995 was 33.0%. The Company's combined federal
and state (net of federal benefit) statutory income tax rate was 39.94% in
1996 and 39.28% in 1995. The Company's effective combined federal and state
tax rate was lower than the statutory rate primarily due to the utilization of
a capital loss carryforward in 1996 and, the exclusion from state taxable
income interest income on U.S. Treasury obligations and certain government
agency debt securities in 1996 and 1995.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Refer to "Asset/Liability Management" within Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
32
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of Directors of First Financial Corp.:
We have audited the accompanying consolidated balance sheets of First
Financial Corp. (a Rhode Island corporation) and subsidiary as of December 31,
1997 and 1996, and the related consolidated statements of income,
stockholders' equity and cash flows for each of the years in the three year
period ended December 31, 1997. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
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 financial position of First
Financial Corp. and subsidiary as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Arthur Andersen LLP
Boston, Massachusetts
January 14, 1998
33
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
------
CASH AND DUE FROM BANKS.............................. $ 2,837,014 $ 1,988,713
------------ ------------
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL...... 3,878,000 2,376,000
------------ ------------
LOANS HELD FOR SALE.................................. 380,000 160,000
------------ ------------
INVESTMENT SECURITIES (Notes 1 and 3):
Held-to-maturity (market value: $12,462,016 in 1997
and $13,747,464 in 1996).......................... 12,467,740 13,780,519
Available-for-sale (amortized cost: $26,403,000 in
1997 and $28,354,439 in 1996)..................... 26,598,634 28,411,326
------------ ------------
Total investment securities........................ 39,066,374 42,191,845
------------ ------------
FEDERAL HOME LOAN BANK STOCK......................... 447,700 348,100
------------ ------------
LOANS (Notes 1, 8 and 10):
Commercial......................................... 6,418,373 5,074,679
Commercial real estate............................. 45,976,986 40,225,717
Residential real estate............................ 21,464,343 22,978,397
Home equity lines of credit........................ 2,838,377 3,088,134
Consumer........................................... 1,056,791 1,236,216
------------ ------------
77,754,870 72,603,143
Less--Unearned Discount............................ 75,107 66,716
Allowance for possible loan losses (Notes 4 and
13)............................................... 1,596,613 1,942,457
------------ ------------
Net loans.......................................... 76,083,150 70,593,970
------------ ------------
OTHER REAL ESTATE OWNED (Note 1)..................... 782,190 675,607
------------ ------------
PREMISES AND EQUIPMENT, net (Notes 5 and 8).......... 2,458,550 1,645,280
------------ ------------
OTHER ASSETS......................................... 1,376,889 1,433,485
------------ ------------
TOTAL ASSETS......................................... $127,309,867 $121,413,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
DEPOSITS:
Demand............................................. $ 13,198,956 $ 11,270,046
Savings and money market accounts.................. 23,371,357 22,749,700
Time deposits (Note 6)............................. 62,719,558 59,856,363
------------ ------------
Total deposits..................................... 99,289,871 93,876,109
------------ ------------
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE (Note
7).................................................. 10,105,000 10,778,000
------------ ------------
ACCRUED EXPENSES AND OTHER LIABILITIES............... 1,255,823 1,294,594
------------ ------------
SENIOR DEBENTURE, net of unamortized discount of
$53,460 in 1997 and $105,604 in 1996 (Note 13)...... 2,946,540 2,894,396
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 8)...............
STOCKHOLDERS' EQUITY (Notes 2, 3, 12 and 16):
Common Stock, $1 par value
Authorized--5,000,000 shares
Issued--1,328,041 shares.......................... 1,328,041 1,328,041
Surplus............................................ 4,431,380 4,431,380
Retained earnings.................................. 7,982,792 6,923,308
Unrealized gain on securities available-for-sale,
net of taxes...................................... 117,380 34,132
------------ ------------
13,859,593 12,716,861
Less--Treasury stock, at cost, 66,800 shares....... 146,960 146,960
------------ ------------
Total stockholders' equity......................... 13,712,633 12,569,901
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $127,309,867 $121,413,000
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
34
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans (Note 1)......... $7,400,873 $6,738,492 $5,994,034
Interest on investment securities--
U.S. Government and agency obligations.... 1,532,872 1,558,517 1,432,729
Collateralized mortgage obligations....... 91,684 134,144 154,783
Mortgage backed securities................ 727,637 243,994 --
Marketable equity securities and other.... 40,838 19,503 1,320
Interest on cash equivalents (Note 1)....... 175,223 172,833 149,153
---------- ---------- ----------
Total interest income..................... 9,969,127 8,867,483 7,732,019
---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits........................ 3,886,454 3,766,620 3,429,019
Interest on reverse repurchase agreements... 646,622 185,291 --
Interest on debenture (Note 13)............. 270,245 262,314 239,653
---------- ---------- ----------
Total interest expense.................... 4,803,321 4,214,225 3,668,672
---------- ---------- ----------
Net interest income....................... 5,165,806 4,653,258 4,063,347
PROVISION FOR POSSIBLE LOAN LOSSES (Note 1)... 250,000 455,000 675,000
---------- ---------- ----------
Net interest income after provision for
possible loan losses..................... 4,915,806 4,198,258 3,388,347
---------- ---------- ----------
NONINTEREST INCOME:
Service charges on deposits................. 317,176 307,060 285,413
Gain on sale of securities.................. -- 56,105 --
Gain on loan sales.......................... 46,410 69,402 94,467
Other....................................... 101,811 103,716 93,978
---------- ---------- ----------
Total noninterest income.................. 465,397 536,283 473,858
---------- ---------- ----------
NONINTEREST EXPENSE:
Salaries and employee benefits (Note 11).... 1,801,661 1,653,929 1,566,105
Occupancy expense........................... 375,294 364,414 337,032
Equipment expense........................... 218,767 200,498 196,172
Other real estate owned net losses, and
expenses................................... 22,128 67,658 187,776
Computer services........................... 193,392 162,470 150,603
Deposit insurance assessments............... 11,127 1,500 95,483
Other operating expenses.................... 718,900 726,813 559,740
---------- ---------- ----------
Total noninterest expense................. 3,341,269 3,177,282 3,092,911
---------- ---------- ----------
Income before provision for income taxes.. 2,039,934 1,557,259 769,294
PROVISION FOR INCOME TAXES (Note 9)........... 728,201 513,582 251,517
---------- ---------- ----------
Net income.................................... $1,311,733 $1,043,677 $ 517,777
========== ========== ==========
Earnings per share:
Basic..................................... $ 1.04 $ 0.99 $ 0.76
========== ========== ==========
Diluted................................... $ 1.04 $ 0.98 $ 0.71
========== ========== ==========
Weighted average common shares outstanding.... 1,261,241 1,049,609 683,200
Weighted average equivalent shares............ -- 10,354 45,508
---------- ---------- ----------
Weighted average common and common stock
equivalent shares outstanding................ 1,261,241 1,059,963 728,708
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
35
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
UNREALIZED
GAIN (LOSS)
ON
SECURITIES
AVAILABLE TOTAL
COMMON RETAINED FOR SALE, TREASURY STOCKHOLDERS'
STOCK SURPLUS EARNINGS NET OF TAXES STOCK EQUITY
---------- ---------- ---------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1994................... $ 750,000 $ 500,000 $5,571,013 $(114,893) $(146,960) $ 6,559,160
Net income.............. -- -- 517,777 -- -- 517,777
Dividends declared ($.11
per share)............. -- -- (75,152) -- -- (75,152)
Change in net unrealized
gain (loss) on
securities available-
for-sale............... -- -- -- 189,804 -- 189,804
---------- ---------- ---------- --------- --------- -----------
Balance, December 31,
1995................... 750,000 500,000 6,013,638 74,911 (146,960) 7,191,589
Net income.............. -- -- 1,043,677 -- -- 1,043,677
Dividends declared ($.12
per share)............. -- -- (134,007) -- -- (134,007)
Exercise of stock
options and related tax
effect................. 28,041 (41,744) -- -- -- (13,703)
Issuance of 550,000
shares of common stock,
net of offering costs.. 550,000 3,973,124 -- -- -- 4,523,124
Change in net unrealized
gain (loss) on
securities available-
for-sale............... -- -- -- (40,779) -- (40,779)
---------- ---------- ---------- --------- --------- -----------
Balance, December 31,
1996................... 1,328,041 4,431,380 6,923,308 34,132 (146,960) 12,569,901
Net income.............. -- -- 1,311,733 -- -- 1,311,733
Dividends declared ($.20
per share)............. -- -- (252,249) -- -- (252,249)
Change in net unrealized
gain (loss) on
securities available-
for-sale............... -- -- -- 83,248 -- 83,248
---------- ---------- ---------- --------- --------- -----------
Balance, December 31,
1997................... $1,328,041 $4,431,380 $7,982,792 $ 117,380 $(146,960) $13,712,633
========== ========== ========== ========= ========= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
36
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................... $ 1,311,733 $ 1,043,677 $ 517,777
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for possible loan
losses.......................... 250,000 455,000 675,000
Depreciation and amortization.... 231,723 185,076 171,201
(Gains) losses on OREO........... (9,522) (6,681) 112,302
Gain on sale of securities....... -- (56,105) --
Gain on sales of loans........... (46,410) (69,402) (94,467)
Proceeds from sales of loans..... 1,209,421 890,652 1,002,982
Loans originated for sale........ (1,386,340) (981,250) (908,515)
Net increase in deferred loan
fees............................ 46,816 30,330 37,297
Net (accretion) on investment
securities held-to-maturity..... (10,730) (40,619) (11,698)
Net (accretion) investment
securities available-for-sale... (66,649) (103,136) (89,580)
Net increase (decrease) in
unearned discount............... 8,391 (21,425) 7,327
Net decrease (increase) in other
assets.......................... 56,596 (314,535) (264,888)
Accretion of discount on
debenture....................... 202,566 199,064 192,312
Net (decrease) increase in
accrued expenses and other
liabilities..................... (266,589) 457,584 124,512
------------ ------------ ------------
Net cash provided by operating
activities...................... 1,531,006 1,668,230 1,471,562
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of
investment securities held-to-
maturity ......................... 13,573,509 22,766,655 10,318,259
Proceeds from sale and maturities
of investment securities
available-for-sale................ 30,233,468 21,914,591 32,380,000
Purchase of investment securities
held-to-maturity ................. (12,250,000) (18,865,456) (11,804,178)
Purchase of investment securities
available-for-sale................ (28,215,380) (38,099,980) (32,183,850)
Purchase of Federal Home Loan Bank
stock............................. (99,600) -- (348,100)
Net increase in loans.............. (6,258,403) (8,368,347) (8,534,422)
Purchase of premises and equipment. (1,044,993) (13,463) (152,944)
Sales of OREO...................... 366,955 984,416 616,274
------------ ------------ ------------
Net cash used in investing
activities........................ (3,694,444) (19,681,584) (9,708,961)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand
accounts.......................... 1,928,910 (1,213,387) 448,760
Net increase (decrease) in savings
and money market accounts......... 621,657 (1,442,281) (7,847,890)
Net increase in time deposits...... 2,863,195 6,941,235 13,805,346
Net (decrease) increase in reverse
repurchase agreements............. (673,000) 10,778,000 --
Net proceeds on issuance of common
stock............................. -- 4,523,124 --
Exercise of stock options, net of
tax effect........................ -- (13,703) --
Dividends paid..................... (227,023) (96,170) (75,152)
------------ ------------ ------------
Net cash provided by financing
activities........................ 4,513,739 19,476,818 6,331,064
------------ ------------ ------------
</TABLE>
37
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS...................... $ 2,350,301 $ 1,463,464 $ (1,906,335)
CASH AND CASH EQUIVALENTS, BEGINNING OF
YEAR.................................. 4,364,713 2,901,249 4,807,584
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR. $ 6,715,014 $ 4,364,713 $ 2,901,249
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid........................ $ 4,755,368 $ 3,834,580 $ 3,606,104
============ ============ ============
Income taxes paid.................... $ 787,242 $ 327,250 $ 331,250
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH
TRANSACTIONS:
Transfer of loans to OREO............ $ 461,002 $ 183,032 $ 1,257,259
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
38
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
First Financial Corp. and its wholly-owned subsidiary First Bank and Trust
Company ("Company"), after elimination of all intercompany transactions and
balances. Certain reclassifications have been made to prior year balances to
conform with the current year presentation.
Cash and Cash Equivalents
For the purpose of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks and securities purchased under agreements
to resell, which represent short-term investments in government securities
purchased from another institution.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reported period. Actual results could differ from those estimates.
Loans
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment
of a Loan," as amended by SFAS No. 118 (SFAS No. 114, as amended). A loan is
impaired when, based on current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. SFAS No. 114, as amended, requires
that impaired loans be measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, as a practical
expedient, at the loan's observable market price or the face value of the
collateral if the loan is collateral-dependent. Currently, all impaired loans
have been measured through the latter method. All loans on nonaccrual status
are considered to be impaired under SFAS No. 114. All adversely classified
loans at December 31, 1997 and 1996 are also considered to be impaired. When
the measure of the impaired loan is less than the recorded investment in the
loan, the impairment is recorded through a valuation allowance. All loans are
individually evaluated for impairment according to the Company's normal loan
review process, including overall credit evaluation and rating, nonaccrual
status and payment experience. Loans identified as impaired are further
evaluated to determine the estimated extent of impairment. For collateral-
based loans, the extent of impairment is the shortfall, if any, between the
collateral value less costs to dispose of such collateral and the carrying
value of the loan.
Loans held for sale are carried at the lower of cost or fair value.
Interest on commercial, real estate and consumer loans is accrued based on
the principal amounts outstanding. The Company's policy is to discontinue the
accrual of interest on loans when scheduled payments become past due in excess
of 90 days, and when, in the judgment of management, the ultimate
collectibility of principal or interest becomes doubtful. When a loan is
placed on nonaccrual status, all interest previously accrued but not collected
is generally reversed against interest income in the current period. Interest
income is recognized on an accrual basis for impaired loans, until such loans
are placed on nonaccrual status. The Company recognizes interest income on
these nonaccrual loans on a cash basis when the ultimate collectibility of
principal is no longer considered doubtful. Otherwise, cash payments on
nonaccrual loans are applied to principal.
39
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Provision and Allowance for Possible Loan Losses
The balance of the allowance and the amount of the annual provision charged
to expense are estimated amounts based on past loan loss experience, changes
in the character and size of the loan portfolio, current and expected economic
conditions, and other pertinent factors. Ultimate losses may vary from the
current estimates. These estimates are reviewed periodically, and as
adjustments become necessary, they are reported as an expense in the periods
in which they become known. The allowance is maintained at a level considered
by management to be adequate to cover reasonably foreseeable loan losses.
Losses are charged against the allowance for possible loan losses when
management believes that the collectibility of principal is unlikely.
Investment Securities
Investments in equity securities that have readily determinable fair values
and all investments in debt securities are classified as either held-to-
maturity, available-for-sale or trading. Debt securities that management has
the positive intent and ability to hold to maturity are classified as held-to-
maturity and are carried at cost, adjusted for the amortization of premium or
the accretion of discount.
Debt and equity securities with readily determinable market values which are
bought and held principally for the purpose of selling them in the near term
are classified as trading securities and are carried at fair value, with
unrealized gains and losses included in current earnings. At December 31, 1997
and 1996, the Company had no securities classified as trading.
Debt and equity securities not classified as either held-to-maturity or
trading are classified as available-for-sale and are carried at fair value,
with unrealized after-tax gains and losses reported as a separate component of
stockholders' equity.
Income Taxes
The Bank accounts for income taxes using the asset and liability method of
accounting under which deferred taxes are recognized for the future tax
consequences of the temporary differences between the financial statement and
tax basis of assets and liabilities, using the enacted tax rates expected to
be in effect when the amounts related to such temporary differences are
realized or settled. As changes in tax laws or rates are enacted, deferred
assets and liabilities will be adjusted accordingly through the provision for
income taxes.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-
line method over the estimated useful lives of the assets.
The following is a summary of the lives over which the Company computes
depreciation:
<TABLE>
<S> <C>
Buildings and Improvements................................... 10-40 years
Leasehold Improvements....................................... 10 years
Furniture and Fixtures....................................... 10-20 years
Equipment.................................................... 5-10 years
</TABLE>
When property is retired or otherwise disposed of, the asset and accumulated
depreciation are removed from the accounts, and any resulting gain or loss is
reflected in the consolidated statements of income. Costs of major additions
and improvements are capitalized, and expenditures for maintenance and repairs
are charged to operations as incurred.
40
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are
to be sold and are initially recorded at fair value at the date of foreclosure
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management and the real estate is carried at the lower of
carrying amount or fair value less cost to sell. Expenses from operations and
changes in valuations are included in other real estate owned (gains) losses
and expenses.
Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If an asset being tested
for recoverability was acquired in a business combination, the related
goodwill is included as part of the asset grouping in determining
recoverability. In instances where goodwill is identified with assets that are
subject to an impairment loss, the carrying amount of the identified goodwill
is eliminated before making any reduction of the carrying amounts of impaired
long-lived assets and identifiable intangibles.
The Company evaluates the recoverability of its carrying amounts of long-
lived assets based on estimated cash flows to be generated by each of such
assets as compared to the original estimates used in measuring such assets. To
the extent impairment is identified, this Company would reduce the carrying
value of such assets. To date the Company has not had any such impairments.
Earnings Per Share
The Company has implemented SFAS No. 128, "Earnings per Share," which is
effective for fiscal periods ending after December 15, 1997. This standard
requires presentation of both basic and diluted earnings per share on the face
of the consolidated statements of income. Basic earnings per share is
determined by dividing net income by the weighted average number of common
shares outstanding. Diluted earnings per share is determined by dividing net
income by the weighted average number of common shares and common stock
equivalent shares outstanding. Common stock equivalent shares represent the
assumed exercise of outstanding stock options during 1996 and 1995, net of
shares assumed to be repurchased using the treasury stock method, if dilutive.
Prior period amounts have been restated to conform to current year
presentation.
(2) PUBLIC OFFERING
On May 13, 1996, the Securities and Exchange Commission simultaneously
declared effective the Company's Registration Statement on Form S-1 filed
under the Securities Act of 1933, as amended, and its Registration Statement
on Form 8-A filed under the Securities Exchange Act of 1934, as amended. The
Registration Statement related to the public offering of 550,000 shares of
common stock. On May 13, 1996 the Company entered into an agreement with an
underwriter to purchase from the Company the shares of the common stock at the
public offering price of $9.75 per share, less an underwriting discount of
$.58 per share. On May 17, 1996, the Company received from the underwriter the
net proceeds of the public offering in the amount of $5,043,500 exclusive of
$520,376 in expenses incurred in connection with the offering.
41
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(3) INVESTMENT SECURITIES
The estimated market value and amortized cost at December 31, 1997 and 1996
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Held-to-maturity--
U.S. Government & agency
obligations................... $11,750,000 $ 5,411 $10,311 $11,745,100
Collateralized mortgage
obligations................... 717,740 1,012 1,836 716,916
----------- -------- ------- -----------
$12,467,740 $ 6,423 $12,147 $12,462,016
=========== ======== ======= ===========
Available-for-sale--
U.S. Government & agency
obligations................... $17,527,771 $ 36,039 $ 4,478 $17,559,332
Mortgage backed securities..... 8,580,132 146,750 221 8,726,661
Marketable equity security and
other......................... 295,097 17,544 -- 312,641
----------- -------- ------- -----------
$26,403,000 $200,333 $ 4,699 $26,598,634
=========== ======== ======= ===========
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Held-to-maturity--
U.S. Government & agency
obligations................... $11,399,314 $ 4,665 $34,268 $11,369,711
Collateralized mortgage
obligations................... 2,381,205 5,311 8,763 2,377,753
----------- -------- ------- -----------
$13,780,519 $ 9,976 $43,031 $13,747,464
=========== ======== ======= ===========
Available-for-sale--
U.S. Government & agency
obligations................... $17,669,642 $ 38,565 $12,321 $17,695,886
Mortgage backed securities..... 10,684,297 28,043 -- 10,712,340
Marketable equity security..... 500 2,600 -- 3,100
----------- -------- ------- -----------
$28,354,439 $ 69,208 $12,321 $28,411,326
=========== ======== ======= ===========
</TABLE>
During 1996, the Company sold 2,150 shares of a marketable equity security
with a cost basis of $11,250 at a gain of $56,105 in order to utilize a
capital loss tax carryforward which was scheduled to expire at the end of
1996. There were no sales of securities during the years ended December 31,
1997 and 1995.
A schedule of the maturity distribution of U.S. Government and agency
obligations is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------
HELD-TO-MATURITY AVAILABLE-FOR-SALE
----------------------- -----------------------
ESTIMATED ESTIMATED
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Within one year................. $ 2,250,000 $ 2,248,985 $ 9,830,367 $ 9,841,432
Over one year to five years..... 9,500,000 9,496,115 7,697,404 7,717,890
----------- ----------- ----------- -----------
$11,750,000 $11,745,100 $17,527,771 $17,559,332
=========== =========== =========== ===========
</TABLE>
42
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
At December 31, 1997, approximately $3,000,000 of debt securities maturing
in the one-to-five-year period are subject to periodic rate adjustment within
one year.
At December 31, 1997, the collateralized mortgage obligations have principal
payment windows which extend through September 1998.
During 1996, the Company purchased $10,490,000 of Government National
Mortgage Association, 30 year, 8.50% coupon, mortgage backed securities at a
premium of $301,587, which is being amortized using the level yield method. At
the time of purchase, assuming certain prepayment rates, the securities had an
estimated average life of 8.1 years. However, actual maturities and the
average life may differ as borrowers have the right to prepay obligations
without incurring a prepayment penalty.
Investment securities having a book value of $11,985,298 and $12,637,297, at
December 31, 1997 and 1996, respectively, were pledged as collateral for
repurchase agreements, public deposits and other purposes, as required by law.
(4) ALLOWANCE FOR POSSIBLE LOAN LOSSES
In 1992, the Company acquired certain assets and assumed certain deposit
liabilities of the former Chariho-Exeter Credit Union ("Chariho"). The Company
and the State of Rhode Island Depositors Economic Protection Corporation
("DEPCO") established a reserve for possible loan losses of $3,850,000 for
loans acquired. This reserve is available only for loans of Chariho existing
as of the acquisition date. The following analysis summarizes activity for
both the acquired reserve and the Company's reserve for possible loan losses.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Company Reserve:
Balance at beginning of year........... $1,199,617 $ 861,693 $ 764,106
Provision............................ 250,000 455,000 675,000
Loan charge-offs..................... (267,012) (136,899) (715,507)
Recoveries........................... 25,717 19,823 138,094
---------- ---------- ----------
Balance at end of year................. 1,208,322 1,199,617 861,693
---------- ---------- ----------
Acquired Reserve:
Balance at beginning of year........... 742,840 966,347 1,493,201
Loan charge-offs..................... (341,118) (230,016) (528,210)
Recoveries (costs)................... (13,431) 6,509 1,356
---------- ---------- ----------
Balance at end of year................. 388,291 742,840 966,347
---------- ---------- ----------
Total Reserve............................ $1,596,613 $1,942,457 $1,828,040
========== ========== ==========
</TABLE>
As set forth in the Chariho Acquisition Agreement, the remaining balance, if
any, in the acquired reserve at May 1, 1999, less an amount equal to 1% of the
remaining acquired loans, must be refunded to DEPCO. Conversely, in the event
the reserve is inadequate, additional loan charge-offs will reduce the amount
owed on the debenture (Note 13) issued to DEPCO in connection with the
acquisition. At December 31, 1997, the remaining balance of acquired loans was
$4,032,910.
43
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
At December 31, 1997 and 1996, the Company's recorded investment in impaired
loans was $1,394,092 and $1,658,514, respectively, of which $884,121 and
$1,359,343, respectively, was determined to require a valuation allowance of
$237,030 and $375,674 as calculated under SFAS No. 114, as amended. The
average recorded investment in impaired loans during 1997 and 1996 was
$1,760,040 and $1,558,661, respectively. For the years ended December 31, 1997
and 1996, interest income on impaired loans totaled $167,818 and $153,972,
respectively.
At December 31, 1997 and 1996, nonaccrual loans totaled $16,477 and
$427,893, respectively. Had nonaccrual loans been accruing, interest income
would have increased by $248, $10,195 and $57,357 for the years ended December
31, 1997, 1996 and 1995, respectively. During 1996, the Company satisfactorily
resolved a loan which was on nonaccrual status at December 31, 1995, and
recorded approximately $47,000 in cash basis interest income.
(5) PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
---------- ----------
<S> <C> <C>
Land and improvements............................... $ 676,294 $ 673,407
Buildings and improvements.......................... 1,263,718 1,254,336
Leasehold improvements.............................. 413,096 --
Furniture, fixtures and equipment................... 1,430,662 1,175,866
---------- ----------
3,783,770 3,103,609
Less--Accumulated depreciation...................... 1,325,220 1,458,329
---------- ----------
$2,458,550 $1,645,280
========== ==========
</TABLE>
(6) TIME DEPOSITS
At December 31, 1997, scheduled maturities of time deposits are as follows:
<TABLE>
<CAPTION>
$100,000
MATURITY OR MORE OTHER TOTAL
-------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
1998............................................. $8,253 $42,716 $50,969
1999............................................. 200 4,144 4,344
2000............................................. 823 4,338 5,161
2001............................................. 304 798 1,102
2002............................................. 419 725 1,144
------ ------- -------
$9,999 $52,721 $62,720
====== ======= =======
</TABLE>
Included in total time deposits are $15,870,000 of certificates of deposit
subject to repricing on a quarterly basis (indexed to the three month yield on
U.S. Treasury bills). Of these time deposits, $8,977,000 have remaining
maturities of one year or less.
44
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(7) FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
At December 31, 1997, the Company had no outstanding advances and had an
unused borrowing capacity of $8,954,000 with the Federal Home Loan Bank of
Boston, of which $2,352,000 was in the form of an overnight line of credit.
During 1996, the Company entered into a series of contracts to sell
securities under agreements to repurchase. The proceeds from these agreements
were used to purchase the Company's mortgage backed securities portfolio
which, along with other securities, collateralized the agreements. The
following table represents scheduled maturities and interest rates of these
agreements at December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED
MATURITY AVERAGE RATE AMOUNT
-------- ------------ -----------
<S> <C> <C>
February 11, 1998................................. 5.85% $ 5,105,000
September 18, 1998................................ 6.27 2,500,000
September 17, 1999................................ 6.47 2,500,000
---- -----------
6.11% $10,105,000
==== ===========
</TABLE>
At December 31, 1997, the Company's risk with counterparties to securities
sold under repurchase agreements was approximately $866,814. The amount at
risk with counterparties represents the excess of the greater of the carrying
value or estimated market value of underlying collateral plus related accrued
interest receivable over the total repurchase borrowing and related accrued
interest payable.
Securities sold under repurchase agreements averaged $10,590,000 and
$3,067,000 during 1997 and 1996, respectively. The maximum amounts outstanding
at any month end were $10,778,000 during 1997 and 1996. The weighted average
interest rate was 6.11% during 1997 and 6.03% during 1996.
(8) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases the land on which its Cranston branch office is located,
and building space in which its North Kingstown in-store branch is located.
The annual rental expense under these leases is as follows:
<TABLE>
<S> <C>
1998............................................................. $43,500
1999............................................................. 32,700
2000............................................................. 25,000
2001............................................................. 25,000
2002............................................................. 10,416
</TABLE>
The leases contain renewal options commencing in May 1999 and extending to
May 2012. Under the terms of the rental options, the annual rental expense for
both leases will not exceed $63,563.
Litigation
As of December 31, 1997, the Company was involved in certain lawsuits that
arose in the ordinary course of business. Management has reviewed these
actions with legal counsel and has taken into consideration the views of legal
counsel as to the outcome of the litigation. In management's opinion, final
disposition of such lawsuits will not have a materially adverse effect on the
Company's financial position or results of operations.
45
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Employment Contract
In February 1996, the Company amended the employment agreement with its
chief executive officer. This agreement provides for, among other things, a
lump sum severance payment equal to 2.99 times annual base salary (as defined)
in the event of a "change-in-control" (as defined) and upon either elective or
involuntary termination thereafter. This agreement, which has an indefinite
term, provides for an annual increase in salary of not less than 5%.
Reserve Requirement
The Company is required to maintain reserve balances with the Federal
Reserve Bank under the Federal Reserve Act and Regulation D. Required
balances, including vault cash, were $342,000 and $290,000 as of December 31,
1997 and 1996, respectively.
Financial Instruments With Off-balance-sheet Risk and Concentration of Credit
Risk
In the normal course of business, the Company enters into various
commitments, such as commitments to extend credit and guarantees (including
standby letters of credit), which are not reflected in the accompanying
consolidated financial statements. These instruments 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 Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance-sheet instruments.
Off-balance-sheet instruments, whose contract amounts present credit risk,
include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1996
----------- ----------
<S> <C> <C>
Unused portion of existing lines of credit........ $7,837,277 $4,814,988
Unadvanced construction loans..................... 855,934 1,587,917
Firm commitments to extend credit................. 2,276,500 903,000
</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 require payment of a fee. Since some of the commitments may expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company 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.
The Company originates primarily residential and commercial real estate
loans and, to a lesser extent, commercial and installment loans to customers
primarily located in the State of Rhode Island and, to a lesser extent,
southeastern Massachusetts. The Company operates two branches in the
metropolitan Providence area, and two branches in Washington County, Rhode
Island. Its primary source of revenue is providing loans to customers who are
predominantly small and middle-market businesses and middle-income
individuals.
46
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(9) INCOME TAXES
The provision for income taxes consists of the following components:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996 1995
-------- --------- --------
<S> <C> <C> <C>
Federal--
Current................................... $665,201 $ 677,832 $332,667
Deferred (prepaid)........................ (3,250) (185,050) (82,400)
State....................................... 66,250 20,800 1,250
-------- --------- --------
$728,201 $ 513,582 $251,517
======== ========= ========
</TABLE>
The provision for income taxes differs from the amount computed by applying
the statutory rate of 34%, as summarized below:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Provision for income taxes at statutory
rate...................................... $693,578 $529,468 $261,560
State taxes, net of federal benefit........ 43,725 13,728 825
Utilization of capital loss carryforward... -- (19,075) --
Other...................................... (9,102) (10,539) (10,868)
-------- -------- --------
$728,201 $513,582 $251,517
======== ======== ========
</TABLE>
The approximate tax effects of temporary differences that give rise to gross
deferred tax assets and gross deferred tax liabilities at December 31, 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
-------- --------
<S> <C> <C>
Gross deferred tax assets:
Reserve for possible loan losses...................... $256,612 $240,788
Deferred loan origination fees........................ 56,508 37,781
OREO writedown........................................ 5,200 32,000
Supplemental executive pension plan................... 78,661 52,183
Accrued expenses...................................... 55,987 85,709
-------- --------
Gross deferred tax assets............................... 452,968 448,461
-------- --------
Gross deferred tax liabilities:
Depreciation.......................................... 161,200 157,200
Installment sales..................................... 27,768 30,511
-------- --------
Gross deferred tax liabilities.......................... 188,968 187,711
-------- --------
Net deferred tax asset.................................. $264,000 $260,750
======== ========
</TABLE>
A valuation reserve is provided when it is more likely than not that some
portion of the gross deferred tax asset will not be realized. No valuation
reserve was required as of December 31, 1997 or 1996.
47
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(10) RELATED PARTY TRANSACTIONS
Certain directors and executive officers of the Company, their immediate
families, companies in which they are principal owners, and trusts in which
they are involved are borrowers of the Company. These related party loans are
made on substantially the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with unrelated
persons, and do not involve more than normal risk of collectibility.
Related party loan activity was as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Balance at beginning of year......................... $1,384,981 $1,738,616
Originations....................................... 97,278 318,567
Payments........................................... (74,705) (517,847)
Other.............................................. (502,502) (154,355)
---------- ----------
Balance at end of year............................... $ 905,052 $1,384,981
========== ==========
</TABLE>
(11) EMPLOYEE BENEFIT PLAN
The Company is a member of the Financial Institutions Retirement Fund
(FIRF), a multiple employer pension plan. As a participant in FIRF, the
Company expenses its contributions to this plan, which is accounted for as a
defined contribution plan. The Company's pension expense was $55,413, $78,671
and $66,685 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Effective January 1, 1995, the Company established a nonqualified retirement
plan to provide supplemental retirement benefits to designated employees whose
pension benefits are otherwise limited by the Internal Revenue Code
regulations. A liability and transition asset of $121,707 were recorded, as of
the effective date, in accordance with SFAS No. 87, "Employer's Accounting for
Pensions".
The following table sets forth the non-qualified plan's funded status,
amounts recognized in the consolidated balance sheet as of December 31, 1997,
1996 and 1995 and related expense for the years ended December 31, 1997, 1996
and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Actuarial present value of benefit
obligations:
Vested accumulated benefit obligation.... $(263,233) $(221,781) $(187,451)
========= ========= =========
Projected benefit obligation............. $(365,941) $(329,525) $(322,747)
Plan assets at fair value................ 307,390 -- --
--------- --------- ---------
(58,551) (329,525) (322,747)
Unrecognized prior service cost.......... 199,891 228,447 257,003
Unrecognized net asset being recognized
over 10 years........................... (66,580) (91,323) (121,707)
Unrecognized gain........................ (30,603) (29,380) --
--------- --------- ---------
Prepaid/(Accrued) pension cost........... $ 44,157 $(221,781) $(187,451)
========= ========= =========
Net pension expense:
Service costs--benefits attributable to
service during the period............... $ 14,650 $ 14,163 $ 15,771
Interest cost on projected benefit
obligation.............................. 23,948 21,995 21,417
Amortization of unrecognized prior
service cost............................ 27,597 28,556 28,556
--------- --------- ---------
$ 66,195 $ 64,714 $ 65,744
========= ========= =========
</TABLE>
48
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
For calculating 1997, 1996 and 1995 pension costs for this nonqualified
plan the following assumptions were used:
<TABLE>
<S> <C>
Assumed discount rate........................................... 7.5%
Rate of increase in compensation level.......................... 5.0%
Amortization period for unrecognized prior service cost......... 10 years
</TABLE>
During 1996, the Company adopted the Financial Institutions Thrift Plan for
the benefit of its employees. The Plan, which is effective January 1, 1997, is
a qualified savings incentive plan under Internal Revenue Code section 401(k).
Under the terms of the Plan, the Company matches 50% of the first 6% of each
eligible employee's contribution. The Company's expense under this plan
amounted to $32,009 for the year ended December 31, 1997.
(12) STOCKHOLDERS' EQUITY
In November 1986, the Company granted a non-statutory option ("Stock Option
Agreement") to purchase 60,000 shares of common stock to its Chief Executive
Officer at an exercise price of $2.50 per share, the estimated market value of
the Company's stock at that time. These options were exercisable for a period
of 10 years from the date of grant. In February of 1996, the Company amended
the Stock Option Agreement to allow the offset of the shares otherwise
issuable under the Stock Option Agreement by the number of shares required to
exercise the options and pay the minimum withholding tax requirement. In May
1996, the options were exercised in connection with the public offering, under
the amended Stock Option Agreement. As a result of the exercise of the
options, 28,041 shares of the Company's Common Stock were issued. In
connection with the cashless exercise of these options, the Company paid the
minimum withholding tax requirement of $161,603 and recognized a tax benefit
of $147,900 on the deemed compensation to the recipient.
(13) CHARIHO-EXETER CREDIT UNION ACQUISITION
In May 1992, the Company entered into the Acquisition Agreement with the
receiver for Chariho and DEPCO. In connection with the Acquisition Agreement,
the Company entered into a Securities Purchase Agreement with DEPCO. Under
this agreement, the Company issued the Senior Debenture, a $3 million variable
rate debenture to DEPCO. The Company invested the proceeds on the issuance of
the debenture as a contribution of capital to the Bank. Under the terms of the
debenture, interest began to accrue on the third anniversary of the Senior
Debenture and is payable semiannually thereafter. The Senior Debenture bears
interest at the average five-year Treasury rate (indexed rate) plus 1% until
maturity and at the indexed rate plus 4% during the extension period.
A discount of $717,005 was recorded to reduce the carrying value of the
Senior Debenture at the date of issuance in recognition of its favorable
interest terms. This discount is being accreted over the initial term of the
Senior Debenture on the level yield method. The discount accretion for the
years ended December 31, 1997, 1996 and 1995 amounted to $202,566, $199,064
and $192,312, respectively, and is classified as interest expense in the
accompanying consolidated statements of income.
The Senior Debenture is scheduled to mature on May 31, 1999; however, the
Company may, at its option, extend the maturity date to May 1, 2002 for up to
one half of the then outstanding principal balance.
As discussed in Note 4, the Company may, through May 1, 1999, charge net
acquired loan losses in excess of the acquired loan loss reserve of $3,850,000
against the outstanding Senior Debenture to the extent of $3,000,000.
49
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required to disclose estimated fair values for certain of its
financial instruments. Financial instruments include such items as loans,
securities, deposits, swaps and other instruments, as defined.
Quoted market prices are used to estimate fair values where available. Many
of the Company's financial instruments, however, lack an available trading
market as characterized by a willing buyer and willing seller engaging in an
exchange transaction. It is the Company's general practice and intent to hold
the majority of its financial instruments, such as loans and deposits, to
maturity and not engage in trading or sales activities. Therefore, permitted
valuation techniques such as present value calculations, were used for the
purposes of this disclosure.
Management notes that reasonable comparability between financial
institutions may not necessarily be made due to the wide range of permitted
valuation techniques and numerous estimates which must be made given the
absence of active secondary markets for many of the financial instruments.
This lack of uniform valuation methodologies also introduces a greater degree
of subjectivity to these estimated fair values.
The methods and assumptions used to estimate the fair values of each class
of financial instruments are as follows:
Cash and Due from Banks, and Securities Purchased Under Agreements to
Resell. These items are generally short-term in nature and, accordingly, the
carrying amounts reported in the consolidated balance sheet are reasonable
approximations of their fair values.
Investment Securities Held-to-Maturity and Available-for-Sale. Fair values
are based principally on quoted market prices.
Loans. The fair value of accruing loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities
or for classified loans using a discount rate that reflects the risk inherent
in the loan.
The fair value of nonaccrual loans is based on the estimated market value of
the underlying collateral held.
Deposits. The fair value of demand, NOW, savings and money market deposits
is the amount payable on demand at the reporting date. The fair value of time
deposits is estimated using discounted value of contractual cash flows. The
discount rates are the rates currently offered for deposits of similar
remaining maturities.
Securities sold under agreements to repurchase. The face value is considered
to approximate its fair value.
Senior Debenture. The face value of the senior debenture is considered to
approximate its fair value.
Commitments to Extend Credit and Standby Letters of Credit. The fair value
of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present 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 amounts are not
material.
50
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
At December 31, 1997 and 1996, the estimated fair value of the Company's
financial instruments are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------
1997 1996
----------------------- -----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
ASSETS
------
Cash and due from banks and
securities purchased under
agreement to resell.......... $ 6,715,014 $ 6,715,014 $ 4,364,713 $ 4,364,713
Loans held for sale........... 380,000 416,298 160,000 168,000
Investment securities:
Held-to-maturity............ 12,467,740 12,462,016 13,780,519 13,747,464
Available-for-sale.......... 26,598,634 26,598,634 28,411,326 28,411,326
Federal Home Loan Bank stock.. 447,700 447,700 348,100 348,100
Loans--net.................... 76,083,150 77,583,000 70,593,970 71,011,000
LIABILITIES
-----------
Deposits...................... $99,289,871 $99,412,000 $93,876,109 $94,081,000
Securities sold under
agreements to repurchase..... 10,105,000 10,105,000 10,778,000 10,778,000
Senior debenture.............. 2,946,540 3,000,000 2,894,396 3,000,000
</TABLE>
51
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(15) THE COMPANY (PARENT COMPANY ONLY)
The condensed separate financial statements of the Company are presented
below.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
------
Cash and due from banks................................ $ 97,957 $ 55,119
Investment securities:
Available-for-sale (amortized cost: $3,578,030 in
1997 and $3,676,163 in 1996)........................ 3,577,365 3,676,698
Investment in subsidiary bank.......................... 12,884,343 11,629,111
Other assets........................................... 102,256 141,420
----------- -----------
Total assets....................................... $16,661,921 $15,502,348
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Senior debenture, net of unamortized discount.......... $ 2,946,540 $ 2,894,396
Other liabilities...................................... 2,748 38,051
----------- -----------
2,949,288 2,932,447
----------- -----------
Stockholders' Equity:
Common stock......................................... 1,328,041 1,328,041
Surplus.............................................. 4,431,380 4,431,380
Retained earnings.................................... 7,982,792 6,923,308
Unrealized gain on securities available-for-sale, net
of taxes............................................ 117,380 34,132
----------- -----------
13,859,593 12,716,861
Less--Treasury stock................................. 146,960 146,960
----------- -----------
Total stockholders' equity......................... 13,712,633 12,569,901
----------- -----------
Total liabilities and stockholders' equity......... $16,661,921 $15,502,348
=========== ===========
</TABLE>
52
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ---------
<S> <C> <C> <C>
Interest and dividend income................ $ 461,850 $ 252,993 $ 75,152
Interest and other expense.................. 380,180 287,348 239,653
---------- ---------- ---------
Income (loss) before income taxes and equity
in undistributed earnings of subsidiary.... 81,670 (34,355) (164,501)
Applicable income tax benefit............... (58,799) (56,418) (81,483)
---------- ---------- ---------
Income (loss) before equity in undistributed
earnings of subsidiary .................... 140,469 22,063 (83,018)
Equity in undistributed earnings of
subsidiary................................. 1,171,264 1,021,614 600,795
---------- ---------- ---------
Net income.................................. $1,311,733 $1,043,677 $ 517,777
========== ========== =========
</TABLE>
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
----------- ----------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................... $ 1,311,733 $ 1,043,677 $ 517,777
Adjustments to reconcile net income to
net cash provided by (used in) operating
activities--
Equity in undistributed earnings of
subsidiary............................ (1,171,264) (1,021,614) (600,795)
Accretion of discount on debenture..... 202,566 199,064 192,312
Net (accretion) on investment
securities............................ (98,254) (59,483) --
Net decrease in accrued expenses and
other liabilities..................... (210,471) (761,675) (34,142)
Net decrease (increase) in other
assets................................ 39,164 (141,420) --
----------- ----------- ---------
Net cash provided by (used in)
operating activities................ 73,474 (741,451) 75,152
----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investment
securities available-for-sale........... 7,700,000 2,700,000 --
Purchase of investment securities
available-for-sale...................... (7,503,613) (6,316,681) --
----------- ----------- ---------
Net cash provided by (used in)
investing activities................ 196,387 (3,616,681) --
----------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds on issuance of common stock. -- 4,523,124 --
Exercise of stock options, net of tax
effect.................................. -- (13,703) --
Dividends paid........................... (227,023) (96,170) (75,152)
----------- ----------- ---------
Net cash (used in) provided by
financing activities................ (227,023) 4,413,251 (75,152)
----------- ----------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS.. 42,838 55,119 --
CASH AND CASH EQUIVALENTS, BEGINNING OF
YEAR...................................... 55,119 -- --
----------- ----------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR..... $ 97,957 $ 55,119 $ --
=========== =========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid............................ $ 218,100 $ 212,550 $ 130,000
=========== =========== =========
</TABLE>
53
<PAGE>
FIRST FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(16) REGULATORY CAPITAL
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory--and possibly
additional discretionary--actions by regulators that, if undertaken, could
have a direct material effect on the Company's and the Bank's 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 quantitative
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 of ratios (set
forth in the table below) of total 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). As of December 31, 1997, the Company
and the Bank met all capital adequacy requirements to which they are subject
and are considered "well capitalized" by the federal banking agencies.
The December 31, 1995 Federal Deposit Insurance Corporation examination
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios
as set forth in the table. There are no conditions or events that management
believes have changed the Bank's category.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ADEQUACY ACTION
ACTUAL PURPOSES PROVISIONS
----------------- ---------------- ----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ----- ---------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
The Company:
Total capital (to risk
weighted assets)..... $14,574,000 18.76% $6,214,240 8.00% -- --
Tier I capital (to
risk weighted
assets).............. 13,595,000 17.50 3,107,120 4.00 -- --
Tier I capital (to
average assets)...... 13,595,000 10.77 3,788,520 3.00 -- --
The Bank:
Total capital (to risk
weighted assets)..... $13,741,000 17.78% $6,185,200 8.00% $7,731,500 10.00%
Tier I capital (to
risk weighted
assets).............. 12,767,000 16.52 3,092,000 4.00 4,638,900 6.00
Tier I capital (to
average assets)...... 12,767,000 10.43 3,674,700 3.00 6,124,500 5.00
As of December 31, 1996
The Company:
Total capital (to risk
weighted assets)..... $13,430,343 17.03% $6,309,745 8.00% -- --
Tier I capital (to
risk weighted
assets).............. 12,444,446 15.78 3,154,872 4.00 -- --
Tier I capital (to
average assets)...... 12,444,446 10.32 3,617,174 3.00 -- --
The Bank:
Total capital (to risk
weighted assets)..... $12,481,382 15.96% $6,255,397 8.00% $7,819,247 10.00%
Tier I capital (to
risk weighted
assets).............. 11,503,977 14.71 3,127,699 4.00 4,691,548 6.00
Tier I capital (to
average assets)...... 11,503,977 9.85 3,504,084 3.00 5,840,141 5.00
</TABLE>
54
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Items 10 through 13 are incorporated herein by reference to the Company's
definitive proxy statement to be filed with the Securities and Exchange
Commission.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(1) Exhibits
The exhibits listed in the Exhibit Index are filed with this Form 10-K or
are incorporated by reference into this Form 10-K.
(2) Financial Statements
The following financial statements and accountant's report have been filed
as Item 8 in Part II of this report:
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Income for the years ended December 31, 1997,
1996, and 1995
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996, and 1995
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
(3) Financial Statement Schedules
The Financial Data Schedule is included as Exhibit 27.1 to this Form 10-K
and certain other schedules are omitted because they are not applicable or
because the information is provided in Part II, Item 8, "Financial Statements
and Supplementary Data".
(4) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
55
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
REFERENCE NUMBER DESCRIPTION
--------- ------- -----------
<C> <C> <S>
3.1 --Amended and Restated Articles of Incorporation of the
(1) Registrant.
(1) 3.2 --By-Laws of Registrant.
4.1 --Specimen Certificate for Shares of the Registrant's Common
(1) Stock, $1.00 par value.
(1) 10.1 --Lease Agreement between the Bank and Angelo Archetto
regarding Cranston, Rhode Island property dated as of May
14, 1974.
(1) 10.2 --Acquisition Agreement between the Registrant, Maurice C.
Paradis, receiver for Chariho-Exeter Credit Union, and
the Rhode Island Depositors Economic Protection
Corporation (DEPCO) dated as of May 1, 1992.
(1) 10.3 --Senior Debenture issued by Registrant to DEPCO dated as of
May 1, 1992.
(1) 10.4 --Amended and Restated Employment Agreement between
Registrant and Patrick J. Shanahan, Jr. dated as of
February 6, 1996.
(1) 10.5 --Stock Option Agreement between Registrant and Patrick J.
Shanahan, Jr. dated as of November 24, 1986, and
Amendment No. 1 thereto dated as of February 22, 1996.
(1) 10.6 --Supplemental Executive Retirement Plan.
(1) 10.7 --Financial Institutions Retirement Fund Defined Pension
Plan--Summary Plan Description.
(1) 10.8 --Form of Deferred Compensation Agreement regarding
Directors' Fees.
(2) 10.9 --Financial Institutions Thrift Plan--Summary Plan
Description.
(2) 10.10 --Lease Agreement(s) between Bank and Wal-Mart Stores, Inc.,
dated as of January 27, 1997.
(3) 10.11 --Service Agreement dated as of April 1, 1997 by and between
First Bank and Trust Company and BISYS, Inc.
(Confidential treatment granted for certain portions of
the Exhibit).
(1) 21.1 --Subsidiaries of Registrant.
(4) 27.1 --Financial Data Schedule
(4) 27.2 --Financial Data Schedule, as restated, which was initially
filed on Form 10-K for the year ended December 31, 1996.
</TABLE>
- --------
(1) Incorporated by reference to the Registrant's Registration Statement of
Form S.1 (Registration No. 333-1654), as amended, which was initially
filed with the Securities and Exchange Commission on February 26, 1996.
(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q for the quarter ended March 31, 1997.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q for the quarter ended June 30, 1997.
(4) Filed herewith.
56
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report
to be signed on its behalf by the Undersigned, thereunto duly authorized.
FIRST FINANCIAL CORP.
/s/ Patrick J. Shanahan, Jr.
By: _________________________________
Patrick J. Shanahan, Jr.
Chairman, President and Chief
Executive Officer
Date: March 9, 1998
Pursuant to the requirements of the Securities Act of 1934, as amended, this
Report has been signed below by the following persons in the capacities and on
the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Patrick J. Shanahan, Jr. Chairman, President and March 9, 1998
____________________________________ Chief Executive Officer;
Patrick J. Shanahan, Jr. Director
/s/ Gary R. Alger Director March 9, 1998
____________________________________
Gary R. Alger
Director
____________________________________
Raymond F. Bernardo
/s/ Artin H. Coloian Director March 9, 1998
____________________________________
Artin H. Coloian
/s/ Joseph A. Keough Director March 9, 1998
____________________________________
Joseph A. Keough
/s/ Dr. Peter L. Mathieu, Jr. Director March 9, 1998
____________________________________
Dr. Peter L. Mathieu, Jr.
/s/ Joseph V. Mega Director March 9, 1998
____________________________________
Joseph V. Mega
/s/ John Nazarian, Ph.D. Director March 9, 1998
____________________________________
John Nazarian, Ph.D.
Director
____________________________________
William P. Shields
/s/ John A. Macomber Vice President, Treasurer March 9, 1998
____________________________________ and Chief Financial Officer
John A. Macomber
</TABLE>
57
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,837,014
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 3,878,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 26,598,634
<INVESTMENTS-CARRYING> 12,467,740
<INVESTMENTS-MARKET> 12,462,016
<LOANS> 77,679,763
<ALLOWANCE> 1,596,613
<TOTAL-ASSETS> 127,309,867
<DEPOSITS> 99,289,871
<SHORT-TERM> 10,105,000
<LIABILITIES-OTHER> 1,255,823
<LONG-TERM> 2,946,540
0
0
<COMMON> 1,328,041
<OTHER-SE> 12,384,592
<TOTAL-LIABILITIES-AND-EQUITY> 127,309,867
<INTEREST-LOAN> 7,400,873
<INTEREST-INVEST> 2,568,254
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 9,969,127
<INTEREST-DEPOSIT> 3,886,454
<INTEREST-EXPENSE> 4,803,321
<INTEREST-INCOME-NET> 5,165,806
<LOAN-LOSSES> 250,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 3,341,269
<INCOME-PRETAX> 2,039,934
<INCOME-PRE-EXTRAORDINARY> 2,039,934
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,311,733
<EPS-PRIMARY> 1.04
<EPS-DILUTED> 1.04
<YIELD-ACTUAL> 4.33
<LOANS-NON> 16,477
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,394,092
<ALLOWANCE-OPEN> 1,942,457
<CHARGE-OFFS> 608,130
<RECOVERIES> 12,286
<ALLOWANCE-CLOSE> 1,596,613
<ALLOWANCE-DOMESTIC> 1,596,613
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<RESTATED>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,988,713
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,376,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 28,411,326
<INVESTMENTS-CARRYING> 13,780,519
<INVESTMENTS-MARKET> 13,747,464
<LOANS> 72,696,427
<ALLOWANCE> 1,942,457
<TOTAL-ASSETS> 121,413,000
<DEPOSITS> 73,876,000
<SHORT-TERM> 10,778,000
<LIABILITIES-OTHER> 1,294,594
<LONG-TERM> 2,894,396
0
0
<COMMON> 1,328,041
<OTHER-SE> 11,241,860
<TOTAL-LIABILITIES-AND-EQUITY> 121,413,000
<INTEREST-LOAN> 6,738,492
<INTEREST-INVEST> 1,928,991
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 8,867,483
<INTEREST-DEPOSIT> 3,766,620
<INTEREST-EXPENSE> 4,214,225
<INTEREST-INCOME-NET> 4,653,258
<LOAN-LOSSES> 455,000
<SECURITIES-GAINS> 56,105
<EXPENSE-OTHER> 3,177,282
<INCOME-PRETAX> 1,557,259
<INCOME-PRE-EXTRAORDINARY> 1,557,259
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,043,677
<EPS-PRIMARY> 0.99
<EPS-DILUTED> 0.98
<YIELD-ACTUAL> 4.46
<LOANS-NON> 427,893
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,658,514
<ALLOWANCE-OPEN> 1,828,040
<CHARGE-OFFS> 366,915
<RECOVERIES> 26,332
<ALLOWANCE-CLOSE> 1,942,457
<ALLOWANCE-DOMESTIC> 1,942,457
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
