SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report: June 23, 1998
(Date of earliest event reported)
New England Community Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Delaware 0-14550 06-1116165
(State or other jurisdiction of (Commission (IRS Employer
incorporation) file number) Identification No.)
176 Broad Street, Windsor, Connecticut 06095
(Address of principal executive offices)
Telephone: (860) 610-3600
(Registrant's telephone number, including area code)
<PAGE>
Item 5. Other Events.
In connection with New England Community Bancorp, Inc.'s ("NECB")
acquisition of the Bank of South Windsor ("BSW"), certain documents filed by BSW
pursuant to Sections 12(i), 13(a), 13(c), 14 and 15(d) of the Securities
Exchange Act of 1934, as amended, are to be incorporated by reference into
NECB's Registration Statement filed on Form S-4 relating to the above referenced
acquisition. It is anticipated that such Registration Statement will be filed
with the Securities and Exchange Commission on, or about, June 26, 1998. As
such, BSW's Annual Report on Form 10-K for the year ended December 31, 1997 and
BSW's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 are
filed as exhibits hereto.
Item 7. Financial Statements and Exhibits.
(c) Exhibits.
Exhibit 99.1 Bank of South Windsor's Annual Report on Form 10-K for the
year ended December 31, 1997.
Exhibit 99.2 Bank of South Windsor's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1998.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned hereto duly authorized.
Dated: June 23, 1998 NEW ENGLAND COMMUNITY BANCORP, INC.
By:/S/ ANSON C. HALL
-----------------------------------------------------
Anson C. Hall
Vice President, Chief Financial Officer and Treasurer
<PAGE>
EXHIBIT INDEX
Exhibit 99.1 Bank of South Windsor's Annual Report on Form 10-K for the year
ended December 31, 1997.
Exhibit 99.2 Bank of South Windsor's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998.
FEDERAL DEPOSIT INSURANCE CORPORATION
Washington, D.C. 20006
FORM 10-K
-----------------------
{X} Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1997 FDIC Certificate Number 27504
{ } Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _______ to _______
Bank of South Windsor
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Connecticut 06-1239691
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
1695 Ellington Road, South Windsor, Connecticut 06074
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (860) 644-4412
- --------------------------------------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $5.00
- --------------------------------------------------------------------------------
(Title of class)
American Stock Exchange
- --------------------------------------------------------------------------------
(Name of each exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. {X}
The aggregate market value of the voting common stock held by nonaffiliates of
the registrant was $24,765,961 on March 20, 1998. On that date, 958,289 shares
of common stock were outstanding.
Documents Incorporated by Reference: None
This document contains 71 pages.
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1997 Form 10-K Contents
Part I
Item 1. Business .............................................. 3
Item 2. Properties ............................................ 17
Item 3. Legal Proceedings ..................................... 18
Item 4. Submission of Matters to a Vote of Security Holders ... 18
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters ......................... 19
Item 6. Selected Financial Data ............................... 20
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....... 21
Item 8. Financial Statements and Supplementary Data ........... 33
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................ 58
Part III
Item 10. Directors and Executive Officers of the Registrant .... 59
Item 11. Executive Compensation ................................ 61
Item 12. Security Ownership of Certain Beneficial Owners and
Management ......................................... 63
Item 13. Certain Relationships and Related Transactions ........ 65
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ........................................ 66
Signatures ............................................................... 69
2
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PART I
------
ITEM 1. BUSINESS
PROPOSED MERGER
On March 19, 1998, Bank of South Windsor (the "Bank") announced a definitive
agreement with New England Community Bancorp, Inc. ("NECB") to merge the Bank
into and with New England Bank & Trust Company, a wholly-owned subsidiary of
NECB. Under the proposed merger, which is subject to various conditions
including regulatory approvals and approval by the shareholders of both the Bank
and NECB (if legally required), each share of the Bank's common stock will
convert into 1.3204 shares of NECB common stock, subject to adjustment under
certain circumstances. In connection with the merger agreement, the Bank and
NECB entered into a stock option agreement dated March 19, 1998 pursuant to
which NECB will have an option to purchase 215,000 shares of the Bank's common
stock at $12.00 per share, which option is exercisable in certain circumstances.
Management expects that the proposed transaction will close in the third quarter
of 1998.
GENERAL
The Bank was chartered on May 18, 1988 under the laws of the State of
Connecticut. The Bank is subject to regulation by the State of Connecticut
Department of Banking (the "State") and by the Federal Deposit Insurance
Corporation (the "FDIC"). The Bank commenced operations on May 15, 1989. Based
in South Windsor, Connecticut the Bank operates two (2) banking offices located
in East Hartford and Vernon, Connecticut.
The Bank is engaged in the full service commercial and consumer banking
business. It emphasizes personalized banking services for individuals,
professionals and small- to medium-sized businesses. The Bank offers a full
range of commercial banking services, emphasizing short and long-term business
lending (including Small Business Administration (SBA) and Connecticut
Development Authority), as well as offering checking, savings, club and money
market accounts, certificates of deposit, customer repurchase agreements,
personal loans, residential mortgage loans, student loans, and MasterCard and
Visa credit cards. It also offers other consumer-oriented financial services as
well as safe deposit boxes. Individual retirement accounts are also offered to
its customers. Deposits are insured up to prescribed limits by the FDIC.
The Bank's retail service area is presently concentrated in the Connecticut
cities and towns of East Hartford, South Windsor and Vernon, but it also serves
other surrounding communities. Industrial, retail, professional service and
manufacturing organizations of varying sizes are situated within its service
area as well as homes and service businesses for the employees of these
industries and the residents thereof.
The Bank is not presently a member of the Federal Reserve System. As of December
31, 1997, the Bank is a member of the Federal Home Loan Bank of Boston.
Membership in the Federal Home Loan Bank provides the Bank with an additional
credit facility by way of access to fixed and variable rate advances available
under various optional terms.
As of December 31, 1997, the Bank had total assets of $155,123,000, loans of
$99,947,000, deposits of $132,903,000 and shareholders' equity of $10,837,000.
For more detailed information concerning the Bank's financial condition, see
ITEM 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS," and ITEM 8, "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA."
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EMPLOYEES
As of December 31, 1997, the Bank employed 69 persons on a full time equivalent
basis. Relations with employees are considered to be satisfactory.
COMPETITION
The Bank is the only depository institution headquartered in South Windsor.
However, competition for consumer services and deposits within the Bank's market
area is intense among commercial banks and other financial service institutions,
some of which are larger and have resources substantially greater than the Bank,
for obtaining deposits and making loans. Branches of other commercial banks are
located in the cities and towns within which the Bank does business.
The Bank also faces intense competition from savings banks, savings and loan
associations, credit unions and other financial institutions in its market area
for savings deposits, money market deposits, time deposits and commercial,
mortgage and consumer loans. Moreover, Connecticut thrift institutions are
permitted to offer some personal and business banking services in competition
with the Bank. Competition is heightened by the effect of state laws and
regulations which permit statewide branching and interstate banking.
The Bank stresses its local identity and community involvement in developing and
marketing its products and services. In addition, the Bank focuses on the small-
to medium-sized commercial customers, where it emphasizes personal, responsive
and efficient services. The Bank supplements this market focus by seeking to
demonstrate that it has the capacity and willingness to understand these
customers' financial needs and objectives. The Bank's market strategy includes
expanding this focus to its retail banking efforts.
REGULATION AND SUPERVISION
FIRREA
The Financial Institution Reform, Recovery and Enforcement Act of 1989
("FIRREA") restructured the regulation, supervision and deposit insurance of
savings and loan associations and federal savings banks whose deposits were
formerly insured by the Federal Savings and Loan Insurance Corporation
("FSLIC"). FSLIC was replaced by the Savings Association Insurance Fund ("SAIF")
administered by the FDIC. A separate fund, the Bank Insurance Fund ("BIF"),
which was essentially a continuation of the FDIC's then existing fund, was
established for banks and state savings banks.
The FDIC has developed a risk-based assessment system, under which the
assessment rate for an insured depository institution varies according to its
level of risk. An institution's risk category is based upon whether the
institution is well capitalized, adequately capitalized or less than adequately
capitalized and the institution's "supervisory subgroups": Subgroup A, B or C.
Subgroup A institutions are financially sound institutions with a few minor
weaknesses; Subgroup B institutions are institutions that demonstrate weaknesses
which, if not corrected, could result in significant deterioration; and Subgroup
C institutions are institutions for which there is a substantial probability
that the FDIC will suffer a loss in connection with the institution unless
effective action is taken to correct the area of weakness. Based on its capital
and supervisory subgroups, each BIF or SAIF member institution is assigned an
annual FDIC assessment rate per $100 of insured deposits varying between 0.23%
per annum (for well capitalized Subgroup A institutions) and 0.31% per annum
(for undercapitalized Subgroup C institutions). Well capitalized Subgroup B and
Subgroup C institutions will be assigned assessment rates per $100 of insured
deposits of 0.26% per annum and 0.29% per annum, respectively. On August 8,
1995, the FDIC approved an amendment to its regulation on assessments
establishing a new assessment rate schedule which would range from 0.04% to
0.31% for members of BIF. This new rate schedule took effect September 29, 1995.
On November 14, 1995 the FDIC voted to establish a new assessment rate schedule
which would range from zero to 0.27% for members of BIF, subject to certain
minimums. This new assessment rate schedule took effect January 1, 1996.
4
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FIRREA and the Crime Control Act of 1990 expanded the enforcement powers
available to federal banking regulators, including providing greater flexibility
to impose enforcement actions, expanding the persons dealing with a bank who are
subject to enforcement actions, and increasing the potential civil and criminal
penalties.
Under FIRREA, failure to meet capital guidelines could subject a banking
institution to a variety of enforcement remedies available to federal regulatory
authorities, including the imposition of a cease and desist order which,
depending on its terms, could severely restrict the institution's activities or
cause the termination of deposit insurance by the FDIC.
FDICIA
Enacted in December 1991, the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") substantially revised the bank regulatory provisions of
the Federal Deposit Insurance Act and several other federal banking statutes.
Among other things, FDICIA required federal banking agencies to broaden the
scope of regulatory corrective action taken with respect to banks that do not
meet minimum capital requirements and to take such actions promptly in order to
minimize losses to the FDIC. Under FDICIA, federal banking agencies were
required to establish minimum levels of capital (including both a leverage limit
and risk-based capital requirements) and specify for each capital measure the
levels at which depository institutions will be considered "well capitalized",
"adequately capitalized", "undercapitalized", "significantly undercapitalized"
or "critically undercapitalized". These minimum capital levels became effective
on December 19, 1992.
As of December 31, 1997 the Bank's total risk-based capital ratio was 11.92%,
its Tier 1 risk-based capital ratio was 10.66% and its Tier 1 leverage ratio was
6.89%. Under regulations adopted under the provisions of FDICIA, for an
institution to be well capitalized it must have a total risk-based capital ratio
of at least 10%, a Tier 1 risk-based capital ratio of at least 6% and a Tier 1
leverage ratio of at least 5% and not be subject to any specific capital order
or directive. For an institution to be adequately capitalized, it must have a
total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio
of at least 4% and a Tier 1 leverage ratio of at least 4% (or in some cases 3%).
Under the regulations, an institution will be deemed to be undercapitalized if
the bank has a total risk-based capital ratio that is less than 8%, a Tier 1
risk-based capital ratio that is less than 4% or a Tier 1 leverage ratio of less
than 4% (or in some cases 3%). An institution will be deemed to be significantly
undercapitalized if the bank has a total risk-based capital ratio that is less
than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a Tier 1
leverage ratio of less than 3% and will be deemed to be critically
undercapitalized if it has a ratio of tangible equity to total assets that is
equal to or less than 2%.
The FDIC has adopted a rule to implement the FDICIA requirement that risk-based
capital rules take account of interest rate risk. The rule focuses on
institutions having relatively high levels of measured interest rate risk and
considers the effect that changing interest rates would have upon the value of
an institution's assets, liabilities and off balance sheet positions.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) if the depository institution
would thereafter be undercapitalized. Undercapitalized depository institutions
are subject to growth limitations and prohibitions on the payment of interest
rates on deposits in excess of 75 basis points above the average market yields
for comparable deposits. In addition, such institutions must submit a capital
restoration plan which is acceptable to applicable federal banking agencies.
Significantly undercapitalized depository institutions may be subject to a
number of requirements and restrictions, including orders to sell sufficient
voting stock to become adequately capitalized, requirements to reduce total
assets or to cease accepting deposits from correspondent banks and restrictions
on senior executive compensation and on inter-affiliate transactions. Critically
undercapitalized institutions are subject to a number of additional
restrictions, including the appointment of a receiver or conservator.
Regulations promulgated under FDICIA also require that an institution monitor
its capital levels closely and notify its appropriate federal banking regulators
within 15 days of any material events that affect the capital position of the
5
<PAGE>
institution. FDICIA also contains a variety of other provisions that affect the
operations of the Bank, including certain reporting requirements, regulatory
standards and guidelines for real estate lending, "truth in savings" provisions,
the requirement that a depository institution give 90 days prior notice to
customers and regulatory authorities before closing any branch, certain
restrictions on investments and activities of state-chartered insured banks,
limitations on credit exposure between banks, restrictions on loans to a bank's
insiders, guidelines governing regulatory examinations and a prohibition on the
acceptance or renewal of brokered deposits by depository institutions that are
not well capitalized or are adequately capitalized and have not received a
waiver from the FDIC. FDICIA directs that each federal banking agency prescribe
standards for depository institutions and depository institution holding
companies relating to internal controls, information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth and quality, a maximum ratio of classified assets to capital, minimum
earnings sufficient to absorb losses, a minimum ratio of market value to book
value for publicly traded shares (if feasible) and such other standards as the
agency deems appropriate.
Finally, FDICIA limits the discretion of the FDIC with respect to deposit
insurance coverage by requiring that, except in very limited circumstances, the
FDIC's course of action in resolving a problem bank must constitute the "least
costly resolution" for BIF or SAIF, as the case may be. The FDIC has interpreted
this standard as requiring it not to protect deposits exceeding the $100,000
insurance limit in more situations than was previously the case.
For additional information regarding the capital ratios of the Bank, see ITEM 7,
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - Capital Resources."
Dividend Capability
On January 23, 1997, the Board of Directors of the Bank declared a dividend of
$.03 per share payable on February 21, 1997 to shareholders of record on January
23, 1997. This was the first dividend paid by the Bank on its stock since the
second quarter of 1994. The Bank subsequently paid quarterly dividends of $.03
per share on May, August and November 21, 1997. On February 5, 1998, the Board
of Directors of the Bank declared an increased dividend of $.05 per share
payable on February 27, 1998 to shareholders of record on February 13, 1998.
Under Connecticut law, the Bank may declare and pay cash dividends only from the
current year's and the prior two year's retained net profits as defined. For
additional information, see Note 13 of Notes to Financial Statements.
STATISTICAL INFORMATION
The following supplementary statistical information required under Guide 3
should be read in conjunction with the related financial statements and notes
thereto under ITEM 8 of this Form 10-K Report and ITEM 7, "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
Certain reclassifications have been made to the 1993 through 1996 statistical
information to conform with the 1997 presentation. The average balances
presented in the statistical information are based upon average daily amounts.
I. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates
and Interest Differential
See Part II, ITEM 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS," under the caption "Net Interest Income"
for the information required under this item.
II. Investment Portfolio
The following table presents the carrying value of securities available for sale
(at fair value) and held to maturity (at amortized cost), by type, at year end
for each of the last two years.
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December 31,
------------
1997 1996
---- ----
(in thousands)
Available for Sale:
- -------------------
U.S. Treasury $ 520 $ 764
U.S. Government agencies 17,585 14,653
Mortgage-backed securities 19,508 4,442
Obligations of states and political subdivisions 3,774 1,413
Other debt securities 520 2,645
Federal Home Loan Bank stock 1,295 967
-------- -------
Total $ 43,202 $24,884
======== =======
Held to Maturity:
- -----------------
U.S. Government agencies $ 1,000 $ 1,251
======== =======
On December 29, 1995, the Bank utilized the one-time transfer ability allowed by
the Financial Accounting Standards Board in its special report "A Guide to
Implementation of Financial Accounting Standards No. 115 on Accounting for
Certain Investments in Debt and Equity Securities" and reclassified certain
securities held to maturity to securities available for sale. Securities of
$7,921,000 were transferred from the held to maturity category to the available
for sale category. In connection with this reclassification, gross unrealized
gains of $32,000 and gross unrealized losses of $96,000 were recorded in
securities available for sale and in shareholders' equity (on a net of tax
basis).
For information regarding the fair value and unrealized gains and losses of the
Bank's investment portfolio, see Note 3 of Notes to Financial Statements.
The following table shows the maturities and weighted average yields of the
Bank's securities available for sale and held to maturity as of December 31,
1997. All amounts are stated at amortized cost. The weighted average yields on
income from tax-exempt obligations of states and political subdivisions have not
been adjusted to a tax equivalent basis, an adjustment that is not deemed to be
significant.
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<TABLE>
<CAPTION>
Maturity
------------------------------------------------------------------------------
After One Year After Five Years
But Within Five But Within Ten
Within One Year Years Years After Ten Years
--------------- --------------- --------------- ---------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Available for Sale:
- -------------------
U.S. Treasury $ -- --% $ 264 7.34% $ 256 6.11 $ -- --%
U.S. Government agencies 500 3.94 2,000 6.73 13,376 7.20 1,558 7.80
Mortgage-backed
securities (1) -- -- 323 7.00 18,977 6.97 -- --
Obligations of states
and political
subdivisions -- -- 500 3.97 630 4.85 2,636 5.04
Other debt securities -- -- 25 7.88 527 5.31 -- --
Federal Home Loan
Bank stock -- -- -- -- -- -- 1,295 6.50
------ ------ ------- ------
Total $500 3.94 $3,112 6.38 $33,766 7.03 $5,489 6.17
====== ====== ======= ======
Held to Maturity:
- -----------------
U.S. Government agencies $500 4.02% $ 500 4.50% $ -- --% $ -- --%
====== ====== ======= ======
</TABLE>
(1) Based upon final maturity of the individual loans in the mortgage-backed
pools.
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III. Loan Portfolio
The amounts of loans outstanding and the percent of the total represented by
each type on the dates indicated were as follows:
December 31,
---------------------------------------------
1997 1996
------------------ -----------------
Amount % Amount %
------ --- ------ ---
(dollars in thousands)
Real estate:
Construction $ 3,112 3 $ 1,801 2
Secured by 1 to 4 family
residential property 42,894 43 45,111 46
Secured by commercial
property 34,046 34 32,853 33
Commercial 15,523 16 13,158 13
Installment 4,372 4 6,153 6
------- --- ------- ---
Total 99,947 100 99,076 100
=== ===
Less: Reserve for loan losses 2,156 1,973
------- -------
Loans, net $97,791 $97,103
======= =======
The following table reflects maturity and repricing data for loans outstanding
as of December 31, 1997 (excluding loans in nonaccrual status).
(in thousands)
Fixed Rate Loans with a Remaining Maturity of:
Three months or less $ 1,297
Over three months through twelve months 1,771
Over one year through five years 11,232
Over five years 19,313
--------
Total fixed rate loans 33,613
--------
Floating Rate Loans with a Repricing Frequency of :
Quarterly or more frequently 23,447
Annually or more frequently, but less than quarterly 21,148
Every five years or more frequently, but less than annually 20,071
Less frequently than every five years 1,140
--------
Total floating rate loans 65,806
--------
Total loans $99,419
========
Commitments and Lines of Credit
Letters of credit represent extensions of credit granted in the normal course of
business which are not reflected in the Bank's financial statements. As of
December 31, 1997, the Bank was contingently liable for letters of credit of
$1,836,000, all of which represent standby letters of credit. In addition, the
Bank has issued lines of credit to customers. Borrowing under such lines of
credit are usually for the working capital needs of the borrower. As of December
31, 1997, the Bank had extended commitments on lines of credit in the aggregate
amount of $24,055,000, of which $15,000,000 represented commercial lines of
credit and $9,055,000 represented consumer lines of credit.
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Such amounts represent the portion of total commitments which had not been used
by customers as of December 31, 1997.
Nonperforming Assets
Certain risks are inherent in the Bank's lending activities. One measurement of
the amount of risk in the Bank's loan portfolio is the level of nonperforming
assets. Nonperforming assets include nonaccrual loans, 90 days past due and
still accruing interest, renegotiated loans due to a weakening in the financial
condition of the borrower and other real estate owned.
Generally, a loan (including a loan impaired under Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan"
(SFAS 114)) is classified as nonaccrual and the accrual of interest on such loan
is discontinued when the contractual payment of principal or interest has become
90 days past due or management has serious doubts about further collectibility
of principal or interest, even though the loan currently is performing; however,
loans that are well secured and in the process of collection may not have the
accrual of interest discontinued, at the judgment of management. When a loan is
placed on nonaccrual status, interest previously accrued but not collected is
reversed against current period interest income, except where the Bank has
determined that such loans are well secured as to principal and interest and are
in the process of collection. Interest earned thereafter is only included in
income to the extent that it is actually collected. Loans are removed from
nonaccrual status when they become current as to both principal and interest and
when future payments are estimated to be fully collectible.
Renegotiated loans are loans the terms of which have been renegotiated to
provide a reduction, forgiveness or deferral of interest or principal because of
a deterioration in the financial position of the borrower. Interest is only
recognized in current income at the renegotiated reduced rate and then only to
the extent such interest is deemed collectible and the borrower has demonstrated
repayment performance.
Other real estate owned, comprised of real estate acquired through foreclosure
or acceptance of deed in lieu of foreclosure, is carried at the lower of the
cost or fair market value less estimated selling costs. Property is transferred
to other real estate owned at the lower of cost or fair market value, with any
excess of cost over fair market value charged to the reserve for loan losses.
Any further decline in value based on subsequent changes to estimated fair
market value or any loss upon ultimate disposition of the property is charged
against the reserve for losses on other real estate owned.
As part of management's determination of nonperforming assets, management
reviews and identifies certain other assets which may be impaired based upon
current collateral and financial conditions. The accrual of interest on such
assets is discontinued at the judgment of management.
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The Bank's nonperforming assets (included in loans and other real estate owned
in the balance sheets) were as follows on the dates indicated:
Year Ended December 31,
-----------------------------
1997 1996
---- ----
(dollars in thousands)
Nonaccrual loans $ 528 $ 1,333
Renegotiated loans -- --
Loans 90 days past due and
still accruing interest 109 113
-------- --------
Total nonperforming loans 637 1,446
Other real estate owned (1) 244 1,392
-------- --------
Total nonperforming assets $ 881 $ 2,838
======== ========
Year-end loans and other
real estate owned (1) $100,191 $100,468
======== ========
Nonperforming assets as a
percentage of year-end
loans and other real
estate owned (1) .88% 2.82%
======== ========
Reserve for loan losses as a
percentage of
nonperforming loans 338.46% 136.45%
======== ========
Reserve for loan and other
real estate owned losses as
a percentage of
nonperforming assets 248.35% 71.28%
======== ========
(1) Before related reserve for losses.
The Bank did not have any loans where there was serious doubt (based on
information available to management at year-end) as to the borrowers' ability to
perform in accordance with loan terms which were not included in nonperforming
assets as of December 31, 1997.
For the year ended December 31, 1997, nonperforming asset activity was as
follows (in thousands):
Balance December 31, 1996 $ 2,838
Additions 532
Resolutions (2,115)
Charge-offs/write-downs (374)
--------
Balance December 31, 1997 $ 881
========
For the year ended December 31, 1997, income recognized on nonaccrual loans
outstanding was $25,000. Income that would have been recognized during 1997 on
such loans if such loans had been current in accordance with their original
terms and had been outstanding throughout the year (or since origination if held
for part of the year) was $52,000.
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IV. Summary of Loan Loss Experience
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Bank anticipates that credit losses will be
experienced in the normal course of business. Accordingly, management of the
Bank regularly monitors the adequacy of the reserve for loan losses. Management
has a formal credit review function to evaluate the credit and market risk of
loans on a periodic basis, which includes obtaining appraisals of assets
securing loans reflecting current market conditions. The Bank utilizes a loan
grading system methodology as well as evaluating impaired loans in accordance
with the standards of SFAS 114 to determine the appropriate level of the reserve
for loan losses. The loan grading system involves a review of the commercial,
real estate and consumer loan portfolios with added emphasis on the Bank's
larger commercial credits. Various factors are involved in determining the loan
grading, including the cash flow and financial status of the borrower, the
existence and nature of collateral, and economic conditions and their impact on
the borrower's industry. These reviews are dependent upon estimates, appraisals
and judgments which can change quickly due to economic conditions and the Bank's
perceptions as to how these conditions affect the debtor's economic prospects.
In accordance with the standards of SFAS 114, impaired loans within their scope
are measured based on the present value of expected future cash flows discounted
at the loan's original effective interest rate, or the observable market price
of the impaired loan or the fair value of the collateral if the loan is
collateral dependent. Any valuation reserve necessary under the standards is
considered in determining the level of the Bank's overall reserve for loan
losses. Quarterly, the reserve for loan losses is reviewed based on the most
recent loan data and is adjusted, in management's judgment, to the amount
necessary to maintain adequate reserve levels.
Loan losses or recoveries are charged or credited directly to the reserve. When
management decides that a loan has a substantial risk of noncollectability, that
portion of the principal of the asset deemed to be uncollectible is charged
against the reserve.
The following table summarizes loan balances at the end of each year and daily
averages; changes in the reserve for loan losses arising from loans charged-off
and recoveries on loans previously charged-off, by loan category; and additions
to the reserve which have been charged to expense.
12
<PAGE>
Year Ended December 31,
----------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Loans at end of year $99,947 $ 99,076 $ 97,446
======= ======== ========
Average amount of loans
outstanding during the year $99,971 $ 95,781 $101,119
======= ======== ========
Reserve at beginning of year $ 1,973 $ 2,657 $ 3,058
Loans charged-off:
Commercial -- 207 164
Loans secured by real estate:
Commercial and other 60 550 698
1 to 4 family residential 205 413 274
Construction -- -- 200
Installment 61 162 58
------- -------- --------
Total loans charged-off 326 1,332 1,394
------- -------- --------
Recoveries on loans previously
charged-off:
Commercial 4 85 27
Loans secured by real estate:
Commercial and other 21 75 --
1 to 4 family residential 81 8 26
Construction -- -- --
Installment 35 20 -
------- -------- --------
Total recoveries 141 188 53
------- -------- --------
Net loans charged-off 185 1,144 1,341
------- -------- --------
Additions to the reserve charged
to expense 368 460 940
------- -------- --------
Reserve at end of year $ 2,156 $ 1,973 $ 2,657
======= ======== ========
Net loans charged-off as a
percentage of average loans .19% 1.19% 1.33%
======= ======== ========
Reserve as a percentage of
year-end loans 2.16% 1.99% 2.73%
======= ======== ========
See Note 5 of Notes to Financial Statements for an analysis of the changes in
the reserve for other real estate owned losses.
As of December 31, 1997, the reserve for loan losses was deemed adequate by
management based on its estimate of the amounts required to absorb losses in the
Bank's loan portfolio and the value of the collateral securing the loans based
on known economic and real estate market conditions. This evaluation is
inherently subjective as it requires material estimates including the amounts
and timing of future cash flows expected to be received on impaired loans that
may be susceptible to significant change.
13
<PAGE>
Components of Reserve for Loan Losses
The following table presents the allocation of the reserve for loan losses by
loan categories:
December 31,
---------------------------------------------
1997 1996
--------------------- ---------------------
Amount % of Amount % of
of Loans to of Loans to
Reserve Total Loans Reserve Total Loans
------- ----------- ------- -----------
(dollars in thousands)
Commercial $ 193 16% $ 313 13%
Loans secured by real estate:
Commercial and other 869 34 758 33
1 to 4 family residential 274 43 410 46
Construction 64 3 40 2
Installment 40 4 37 6
Unallocated 716 - 415 -
------ ---- ------ ----
Total $2,156 100% $1,973 100%
====== ==== ====== ====
Deposits
Deposits obtained through offices of the Bank have traditionally been the
principal source of the Bank's funds for use in lending and other general
business purposes. The Bank's current deposit products offered include savings
accounts, personal and business checking accounts, Now accounts, club accounts,
money market deposit accounts and certificates of deposit ranging in terms from
30 days to five years. Included among these deposit products are Individual
Retirement Accounts as well as certificates of deposit with balances of $100,000
or more. The Bank's deposits are obtained primarily from residents of and
businesses located in its market area.
The following table sets forth the average balances of and average rates paid on
deposits for the years indicated:
December 31,
---------------------------------------------
1997 1996
--------------------- ---------------------
Average Average Average Average
Balance Rate Balance Rate
-------- ---- ------- ----
(dollars in thousands)
Demand $ 27,812 -% $ 25,135 -%
Now 11,808 1.50 11,680 1.69
Savings 27,091 2.28 29,293 2.26
Money market 7,065 2.24 6,070 2.41
Time 54,973 5.41 47,823 5.47
-------- --------
Total deposits $128,749 3.05 $120,001 3.02
======== ========
The increase in average deposits in 1997 compared to 1996 is reflective of the
continued growth of the Bank. Interest rates paid on deposits by the Bank are
competitive with rates paid by its competitors in its market area with the
exception of lead products which are offered at premium rates and target terms
that best suit the asset/liability needs of the Bank. The ability of the Bank to
attract and maintain deposits and the Bank's cost of
14
<PAGE>
funds on these deposits, has been and will continue to be, significantly
affected by economic and competitive conditions as well as the Bank's financial
condition.
Maturities of time deposits of $100,000 or more as of December 31, 1997 (in
thousands) were:
Three months or less $ 2,762
Over three months to six months 5,096
Over six months to twelve months 2,369
Over twelve months 946
-------
Total $11,173
=======
Return on Equity and Assets
See Part II, ITEM 6, "SELECTED FINANCIAL DATA".
15
<PAGE>
VII. Short-Term Borrowings
A summary of certain information regarding short-term borrowings is presented
below:
Year Ended December 31,
-----------------------
1997 1996
---- -----
(dollars in thousands)
Repurchase Agreements:
Average for the year:
Amount outstanding $ 868 $ --
Weighted average interest rate 3.50% --%
At year-end:
Amount outstanding $1,410 $ 95
Weighted average interest rate 3.50% 3.50%
Maximum amount outstanding at
any month-end during the year $1,410 $ 95
Treasury Tax and Loan Note:
Average for the year:
Amount outstanding $ 580 $ 510
Weighted average interest rate 4.77% 5.19%
At year-end:
Amount outstanding $ 700 $ 681
Weighted average interest rate 4.06% 4.63%
Maximum amount outstanding at
any month-end during the year $ 700 $ 700
Federal Home Loan Bank
Advances (under one year):
Average for the year:
Amount outstanding $5,407 $ 687
Weighted average interest rate 5.71% 5.59%
At year-end:
Amount outstanding $ -- $3,000
Weighted average interest rate --% 5.38%
Maximum amount outstanding at
any month-end during the year $9,500 $3,000
16
<PAGE>
ITEM 2. PROPERTIES
The table below sets forth information concerning leases for the Bank's office
locations as of December 31, 1997.
Lease
Year Square Expiration
Office Opened Feet Date
------ ------ ------ ----------
Main Office
1695 Ellington Road
South Windsor (A) 1989 11,917 05/31/99
East Hartford
290 Roberts Street 1992 4,964 03/04/02
Vernon
475 Talcottville Road 1992 6,652 09/30/02
(A)vOffice space partially subleased
As of December 31, 1997 the Bank provided traditional services from each of its
3 full-service offices. All offices are located in commercial or retail business
areas, and have parking facilities for customers. Drive-in teller facilities and
automated teller machines are available at all office locations. The Bank's
deposit support and information services operations are located in its branch
office in Vernon, Connecticut. The Bank relocated its deposit support and
information services operations into previously unused space at its Vernon
location in 1997. Charges taken in 1996 which are reflected in the financial
statements of the Bank include a charge of $21,000 related to the abandonment of
the Sullivan Avenue location and a charge of $73,000 related to the outsourcing
of the Bank's proof and items processing functions in November 1996.
The Bank closed its office located at 30 Hartford Turnpike, Vernon, in November
1996. The Bank recognized a net gain of approximately $85,000 on the sale of the
land, building and some of the furniture and equipment used by the former
branch.
The Bank currently owns no real property except for temporary ownership of
foreclosed properties while awaiting sale or other disposition. Rental expense
for leased premises with an average remaining term of approximately three years
and 5 months was $335,000 for the year ended December 31, 1997 and related
sublease income totaled $22,000.
The Bank leases certain facilities at a rate management believes was a market
rate at lease inception from a related party which includes a director as a
partner. The lease expires in May 1999 and allows for three renewal terms of
five years each. Rental expense under related party leases was $159,000 for each
of years ended December 31, 1997, 1996 and 1995.
17
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
Certain claims, suits and complaints arising in the ordinary course of business
have been filed or are pending against the Bank. These matters include a claim
by the Bank's former chief executive officer which is in the early stages of
discovery. In the opinion of management, based on discussions with legal
counsel, the outcome of these matters will not result in a significant adverse
effect on the financial condition or future operating results of the Bank. Due
to the early stage of the former chief executive officer's claim, future facts
and circumstances could alter management's opinion that this claim is not
expected to result in a significant adverse effect on the financial condition or
future operating results of the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.
18
<PAGE>
PART II
-------
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Bank's common stock was listed on the American Stock Exchange (AMEX) on
November 14, 1997 under the symbol "BSW". Prior to listing on the AMEX, there
had been limited trading in the common stock of the Bank since the commencement
of operations; however, management is aware of a number of securities dealers
who have handled transactions in the Bank's common stock. The range of high and
low bid quotations (as reported by securities dealers making a market in the
Bank's common stock) for 1996 and 1997 is shown below.
Dividend
High Low Declared
---- --- --------
Year Ended December 31, 1996:
First Quarter $ 7.00 $ 7.00 $ --
Second Quarter 7.50 7.00 --
Third Quarter 8.50 7.00 --
Fourth Quarter 8.50 7.75 --
Year Ended December 31, 1997:
First Quarter $ 8.50 $ 8.00 $.03
Second Quarter 9.13 8.25 .03
Third Quarter 10.50 9.00 .03
Fourth Quarter 22.50 10.50 .03
On January 23, 1997, the Board of Directors of the Bank declared its first cash
dividend since the second quarter of 1994. The dividend amounted to $.03 per
common share payable on February 21, 1997 to shareholders of record on January
23, 1997. The Bank subsequently paid quarterly dividends of $.03 per share on
May, August and November 21, 1997. On February 5, 1998, the Board of Directors
of the Bank declared an increased dividend of $.05 per share payable on February
27, 1998 to shareholders of record on February 13, 1998.
Holders of the Bank's common stock are entitled to dividends as and when
declared by the Bank's Board of Directors out of funds legally available for the
payment of dividends. The amount of future cash dividends, if any, will depend
on an analysis of the Bank's earnings, financial condition and capital
requirements, on any statutory and regulatory constraints that might be
applicable to the Bank, and on such other factors as the Board of Directors may
deem relevant. The Bank's ability to pay dividends is governed by Federal and
state law and depends upon the maintenance of minimum regulatory capital levels
and general business conditions. Under Connecticut law, the amount of dividends
that the Bank may pay is limited to the current year's and the prior two years'
retained net profits, as defined. In addition, dividends may not be paid by the
Bank unless minimum regulatory capital levels are maintained and other
regulatory requirements are satisfied.
The common stock of the Bank was held by 1,279 shareholders of record as of
December 31, 1997. Although exact information is not available, the Bank
believes that there are approximately an additional 150 beneficial owners.
19
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth, in summary form, certain financial data for each
of the years in the five year period ended December 31, 1997 and is qualified in
its entirety by the detailed information and financial statements presented
elsewhere herein.
As of or for the Year Ended December 31,
--------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
Statements of Operations Data:
Interest income $11,593 $9,786 $9,646 $8,684 $8,890
Interest expense 4,415 3,687 3,521 2,530 2,993
------- ------ ------ ------ ------
Net interest income 7,178 6,099 6,125 6,154 5,897
Provision for loan losses 368 460 940 1,750 787
------- ------ ------ ------ ------
Net interest income after
provision for loan losses 6,810 5,639 5,185 4,404 5,110
Noninterest income 1,133 1,142 1,073 606 965
Noninterest expense 5,984 5,504 5,543 5,391 5,057
------- ------ ------ ------ ------
Income (loss) before income taxes 1,959 1,277 715 (381) 1,018
Income taxes 738 494 211 55 255
------- ------ ------ ------ ------
Net income (loss) $ 1,221 $ 783 $ 504 $ (436) $ 763
======= ====== ====== ====== ======
Year-End Balance Sheet Data:
Total assets $155,123 $136,213 $129,556 $124,871 $124,619
Securities 44,202 26,135 15,517 14,716 19,597
Loans 99,947 99,076 97,446 100,873 92,611
Reserve for loan losses 2,156 1,973 2,657 3,058 1,855
Other real estate owned, net 212 1,342 588 477 891
Deposits 132,903 122,888 119,931 114,621 115,508
Funds borrowed 10,610 3,776 411 2,196 1,122
Shareholders' equity 10,837 9,261 8,612 7,872 7,420
Financial Ratios:
Return on average shareholders'
equity 12.42% 8.82% 6.05% (5.13)% 10.84%
Return on average total assets .82 .60 .39 (.35) .63
Efficiency ratio (1) 71.93 73.68 75.99 73.75 74.61
Average shareholders' equity as a
percentage of average
total assets 6.62 6.78 6.48 6.81 5.82
Total shareholders' equity as a
percentage of total assets
at year-end 6.99 6.80 6.65 6.30 5.95
Loans as a percentage of deposits
at year-end 75.20 80.62 81.25 88.01 80.18
Per Share Data:
Net income (loss):
Basic $ 1.29 $ .83 $ .54 $(.47) $1.01
Diluted 1.26 .83 .54 (.47) 1.01
Cash dividends declared .12 -- -- .08 --
Book value 11.31 9.84 9.15 8.50 9.78
Other Data:
Average common shares
outstanding Basic 945,610 941,239 941,239 926,004 758,424
Diluted 965,777 941,239 941,239 926,004 758,424
(1) Total noninterest expense (excluding foreclosed properties expense, net)
divided by net interest income plus noninterest income (excluding security
gains and losses).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
20
<PAGE>
AND RESULTS OF OPERATIONS
The following discussion and analysis presents a review of the financial
condition and results of operations of Bank of South Windsor (the "Bank"). This
review should be read in conjunction with the financial statements and other
financial data presented elsewhere herein.
On March 19, 1998, the Bank announced a definitive agreement with New England
Community Bancorp, Inc. ("NECB") to merge the Bank into and with New England
Bank & Trust Company, a wholly-owned subsidiary of NECB. Under the proposed
merger, which is subject to various conditions including regulatory approvals
and approval by the shareholders of both the Bank and NECB (if legally
required), each share of the Bank's common stock will convert into 1.3204 shares
of NECB common stock, subject to adjustment under certain circumstances. In
connection with the merger agreement, the Bank and NECB entered into a stock
option agreement dated March 19, 1998 pursuant to which NECB will have an option
to purchase 215,000 shares of the Bank's common stock at $12.00 per share, which
option is exercisable in certain circumstances. Management expects that the
proposed transaction will close in the third quarter of 1998.
Summary
For the year 1997, the Bank reported net income of $1,221,000 compared to net
income of $783,000 in 1996 and $504,000 in 1995. On a diluted per common share
basis, the Bank earned $1.26 per share in 1997, $.83 per share in 1996 and $.54
in 1995.
The operating results for the years ended December 31, 1997 and 1996 compared to
1995 reflect a significant reduction in the provision for loan losses associated
with the previously higher levels of nonperforming assets. The amounts provided
by the Bank as provisions for loan losses were $368,000 for 1997, $460,000 for
1996 and $940,000 for 1995. In addition, the Bank provided $30,000, $85,000 and
$100,000 in 1997, 1996 and 1995, respectively, as provisions for loss on other
real estate owned.
Asset quality continued to improve as nonperforming loans and other real estate
owned, net, were $849,000 as of December 31, 1997, or .6% of total assets,
reflecting decreases of 69.6% and 75.8% compared to December 31, 1996 and 1995
levels of $2,788,000 and $3,508,000, respectively. This decline was primarily
attributable to management's focused efforts on the resolution of nonperforming
assets on an individual basis during both 1996 and 1997. Loan charge-offs and
other real estate owned write-downs for 1997, 1996 and 1995 were $374,000,
$1,482,000 and $1,394,000, respectively.
Average assets for the year ended December 31, 1997 were $148,428,000, an
increase of $17,478,000 or 13.3% compared to average assets of $130,950,000 for
1996. Average interest earning assets increased by $17,839,000 in 1997 compared
to 1996, as a result of the higher average volume of the Bank's loan and
invested funds portfolios of $4,190,000 and $13,649,000, respectively. Average
assets for the year ended December 31, 1996 were $130,950,000, an increase of
$2,353,000 or 1.8% compared to average assets of $128,597,000 for 1995. Average
interest earning assets increased by $927,000 in 1996 compared to 1995, as a
result of the higher average volume of the Bank's invested funds portfolio of
$6,265,000 partially offset by the lower average volume of the Bank's loan
portfolio of $5,338,000.
21
<PAGE>
Asset Quality
The Bank grants commercial, residential and consumer loans principally in
Hartford and Tolland counties in Connecticut. Although the Bank has a
diversified loan portfolio, a significant portion of its borrowers' ability to
honor their contracts is dependent upon the real estate sector of the economy in
its market areas. Loans outstanding for which the primary source of repayment is
the sale of real estate collateral or cash flow from income producing properties
were approximately $37,158,000 as of December 31, 1997. Commercial loans
collateralized by real estate generally are underwritten with initial loan to
value ratios not exceeding 75% based upon an analysis of each borrower's
creditworthiness.
The nonperforming loan and asset loss reserve coverage ratio is dependent upon
several factors including the quality and estimated value of underlying
collateral held on nonperforming assets. The Bank's policy is to record other
real estate owned at the lower of cost or fair value minus costs to sell (i.e.,
market). Property is transferred to other real estate owned at the lower of cost
or estimated market value, with any cost over market value amount at the date of
transfer charged to the reserve for loan losses. Any further diminution in value
based on changes to estimated market value is charged to the reserve for other
real estate owned losses. The review and evaluation of nonperforming loans and
the carrying value of other real estate owned are performed quarterly. The
following table summarizes the Bank's collateral position on nonperforming
assets as of December 31, 1997.
Asset Net Realizable
Carrying Value of Unsecured
Value Collateral (1) Position
----- -------------- ----------
Nonaccrual loans $ 528 $514 $14
Loans 90 days past due and
still accruing interest 109 105 4
------ ---- ---
Nonperforming loans 637 619 18
Other real estate owned, net 212 212 --
------ ---- ---
Total nonperforming assets $ 849 $831 $18
====== ==== ===
Reserve for loan losses $2,156
======
Reserve for loan losses:
As a percentage of nonperforming
loans 338.5%
======
Represents the lesser of fair market value or the asset carrying value.
The Bank attempts to maintain an excess of the reserve for loan losses over the
unsecured portion of nonperforming assets to cover uncertainties in the loan
portfolio of a general or specific nature as a result of the Bank's credit
review function. Management believes, based upon its analysis of the loan
portfolio, the financial condition of specific borrowers and guarantors, the
collateral values securing its loans, current economic and real estate market
conditions, the level of nonperforming assets and loan charge-offs and other
related factors, that the reserve for loan losses was adequate as of December
31, 1997.
Net Interest Income
Net interest income, the difference between interest earned on interest earning
assets and interest expense incurred on interest bearing liabilities, is a
significant component of the Bank's income statement. Net interest income is
affected by changes in the volumes and rates of interest earning assets and
interest bearing liabilities, the volume of interest earning assets funded with
low cost deposits, noninterest bearing deposits and shareholders' equity, and
the level of nonperforming assets.
22
<PAGE>
The following table reflects the components of the Bank's net interest income,
setting forth, for each of the years in the three year period ended December 31,
1997, (i) average assets, liabilities and shareholders' equity, (ii) interest
income earned on interest earning assets and interest expense incurred on
interest bearing liabilities, (iii) average yields earned on interest earning
assets and average rates incurred on interest bearing liabilities, (iv) interest
rate spread (i.e., the average yield earned on interest earning assets less the
average rate incurred on interest bearing liabilities) and (v) interest rate
margin (i.e., net interest income divided by average interest earning assets).
Rates are not computed on a tax equivalent basis, an adjustment that is not
deemed to be significant. Nonaccrual loans have been included in the average
balances, thereby reducing the rates reflected in the following table.
23
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------- ------------------------------
Average Average Average Average Average Average
Balance Interest Rates Balance Interest Rates Balance Interest Rates
------- -------- ------- ------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS (dollars in thousands)
Interest earning assets:
Interest bearing deposits
with banks $ 472 $ 27 5.72% $ 743 $ 46 6.19% $ 784 $ 48 6.12%
Federal funds sold 2,331 132 5.66 3,162 169 5.34 4,715 274 5.81
Securities 36,776 2,471 6.72 22,025 1,412 6.41 14,166 848 5.99
Loans 99,971 8,963 8.97 95,781 8,159 8.52 101,119 8,476 8.38
-------- ------ -------- ------- --------- ------
Total interest earning
assets 139,550 11,593 8.31 121,711 9,786 8.04 120,784 9,646 7.99
-------- ------ -------- ------- --------- ------
Noninterest earning assets:
Cash and due from banks 6,577 6,493 6,619
Other real estate owned, net 593 1,098 221
Premises and equipment 923 1,210 1,437
Other assets 2,858 2,874 2,461
Reserve for loan losses (2,073) (2,436) (2,925)
-------- -------- ---------
Total noninterest
earning assets 8,878 9,239 7,813
-------- -------- ---------
Total assets $148,428 $130,950 $128,597
======== ======== =========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest bearing liabilities:
Deposits:
Now $ 11,808 177 1.50 $ 11,680 197 1.69 $ 11,675 204 1.75
Savings 27,091 619 2.28 29,293 662 2.26 32,344 727 2.25
Money market 7,065 158 2.24 6,070 146 2.41 7,068 165 2.33
Time 54,973 2,972 5.41 47,823 2,618 5.47 40,420 2,182 5.40
-------- ------ -------- ------- --------- ------
Total interest bearing
deposits 100,937 3,926 3.89 94,866 3,623 3.82 91,507 3,278 3.58
Short-term funds 6,855 367 5.35 1,197 64 5.35 3,909 243 6.22
Long-term funds 1,975 122 6.18 -- -- -- -- -- --
-------- ------ -------- ------- --------- ------
Total interest bearing
liabilities 109,767 4,415 4.02 96,063 3,687 3.84 95,416 3,521 3.69
-------- ------ -------- ------- ---------
Noninterest bearing liabilities:
Demand deposits 27,812 25,135 24,052
Other liabilities 1,020 876 797
-------- -------- ---------
Total noninterest
bearing liabilities 28,832 26,011 24,849
Shareholders' equity 9,829 8,876 8,332
-------- -------- ---------
Total liabilities
and shareholders'
equity $148,428 $130,950 $128,597
======== ======== ========
Net interest income $7,178 $ 6,099 $6,125
====== ======= ======
Interest rate spread 4.29% 4.20% 4.30%
==== ==== ====
Interest rate margin 5.14% 5.01% 5.07%
==== ==== ====
</TABLE>
24
<PAGE>
The following table presents an analysis of increases and decreases in interest
income and expense in terms of changes in volume and interest rates for the
three years ended December 31, 1997. The changes in interest due to both rate
and volume have been allocated to changes due to volume and changes due to rate
in proportion to the relationship of the absolute dollar amounts of the changes
in each. The table is not presented on a tax equivalent basis, an adjustment
that is not deemed to be significant.
<TABLE>
<CAPTION>
1997 vs. 1996 1996 vs. 1995
------------------------------ -----------------------------
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
---------------------- -----------------------------
Total Total
Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ------- -------- ------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Interest Income:
Loans $ 366 $ 438 $ 804 $ (453) $ 136 $(317)
Securities 988 71 1,059 500 64 564
Interest bearing deposits
with banks (16) (3) (19) (3) 1 (2)
Federal funds sold (46) 9 (37) (84) (21) (105)
------- ----- ------- ------- ----- -----
Total interest income 1,292 515 1,807 (40) 180 140
------- ----- ------- ------- ----- -----
Interest Expense:
Interest bearing deposits:
Now 2 (22) (20) -- (7) (7)
Savings (50) 7 (43) (69) 4 (65)
Money market 23 (11) 12 (24) 5 (19)
Time 387 (33) 354 405 31 436
------- ----- ------- ------- ----- -----
Total 362 (59) 303 312 33 345
Short-term funds 303 -- 303 (149) (30) (179)
Long-term funds 61 61 122 -- -- --
------- ----- ------- ------- ----- -----
Total interest expense 726 2 728 163 3 166
------- ----- ------- ------- ----- -----
Change in net interest income $ 566 $ 513 $ 1,079 $ (203) $ 177 $(26)
======= ====== ======= ======= ===== =====
</TABLE>
Average interest earning assets were $139,550,000, $121,711,000 and $120,784,000
for the years ended December 31, 1997, 1996 and 1995, respectively. Average
nonaccrual loans outstanding totaling $892,000, $2,054,000 and $2,674,000 for
1997, 1996 and 1995, respectively, are reflected in these amounts. Income lost
from the inability to earn on nonaccrual loans during 1997, 1996 and 1995 was
$27,000, $339,000 and $268,000, respectively. The ratio of average interest
earning assets to average total assets for the year was 94.0% in 1997 compared
to 92.9% in 1996 and 93.9% in 1995.
The Bank's interest rate spread was 4.29% for the year ended December 31, 1997
compared to 4.20% for 1996 and 4.30% for 1995. The ratio of net interest income
to average interest earning assets for the year was 5.14% in 1997 compared to
5.01% in 1996 and 5.07% in 1995. The increase in the Bank's interest rate spread
and the ratio of net interest income to average earning assets in 1997 compared
to 1996 is primarily attributable to a proportionately greater increase in the
average yield on earning assets compared with the average interest rate of
funds. This increase, in turn, is attributable in part to a decrease in average
nonaccrual loans of $1,162,000 or 56.6%, coupled with a decrease in average
other real estate owned in the amount of $505,000 or 46.0%, after charge-offs
and write-downs, during 1997 compared to 1996. These factors were partially
offset by a shift of interest bearing deposits to higher cost funds.
25
<PAGE>
The increase in net interest income in 1997 compared to 1996 of $1,079,000 or
17.7% reflects the higher average volume of the Bank's loan and invested funds
portfolios of $4,190,000 and $13,649,000, respectively, as well as the effect of
rate increases during the period. Average noninterest bearing demand deposits
increased by $2,677,000 or 10.6% during 1997 compared to 1996 which helped to
reduce the effect of the shift of interest bearing deposits to higher cost
funds.
The decrease in the Bank's interest rate spread and the ratio of net interest
income to average earning assets in 1996 compared to 1995 is primarily
attributable to a proportionately greater increase in the average interest rate
of funds compared with the average yield on earning assets. This increase, in
turn, is attributable in part to a shift of interest bearing deposits to higher
rate products.
Provision for Loan Losses
For the years ended December 31, 1997, 1996, and 1995, the provisions for loan
losses were $368,000, $460,000 and $940,000, respectively. Net charge-offs
totaled $185,000 for 1997 compared to $1,144,000 for 1996 and $1,341,000 for
1995. The reserve for loan losses was $2,156,000, $1,973,000 and $2,657,000 as
of December 31, 1997, 1996 and 1995, respectively, representing 2.16%, 1.99% and
2.73% of year-end loans. Nonperforming loans were $637,000, $1,446,000 and
$2,920,000 as of December 31, 1997, 1996 and 1995, respectively, representing
.64%, 1.46% and 3.00%, respectively, of outstanding loans. The reserve coverage
on nonperforming loans increased to 338.46% as of as of December 31, 1997 from
136.45% in 1996 and 90.99% as of year-end 1995.
The reserve for loan losses is established by management. Its adequacy is
monitored based on internal credit review and analysis of the loan portfolio
which considers current economic conditions and their probable effect on
borrowers, the amount of nonperforming loans and related collateral, the amount
of charge-offs during the period and other relevant factors. This evaluation is
inherently subjective as it requires material estimates including the amounts
and timing of future cash flows expected to be received on impaired loans that
may be susceptible to significant change.
The Bank has identified certain loans as impaired based upon management's belief
that it is probable that the borrower will be unable to pay all principal and
interest amounts in accordance with the loan agreement's contractual terms. The
Bank is required to account for the time value of money when determining the
adequacy of the Bank's reserve for loan losses for certain impaired loans.
Certain impaired loans are required to be measured based on the present value of
expected future cash flows discounted at the loan's original effective interest
rate. As a practical expedient, impairment may also be measured based on the
loan's observable market price or the fair value of the collateral if the loan
is collateral dependent. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a valuation
allowance. As of December 31, 1997 and 1996, Bank's recorded investment in
impaired loans was $1,187,000 and $888,000, respectively. Included in these
amounts as of December 31, 1997 and 1996 are $1,187,000 and $771,000,
respectively, for which the related reserves for loan losses are $212,000 and
$133,000, respectively. As of December 31, 1997, included in impaired loans is a
loan with a balance of $1,121,000 of which 63.15% of the balance is guaranteed
by the Small Business Administration. As of December 31, 1996, the recorded
investment in impaired loans for which no allowance is needed is net of $370,000
of previous direct chargeoffs and applications of cash interest payments against
the loan balances.
26
<PAGE>
Noninterest Income
Total noninterest income was $1,133,000 in 1997 compared to $1,142,000 in 1996
and $1,073,000 in 1995, representing a decrease of $9,000 or .8% in 1997 and an
increase of $69,000 or 6.4% in 1996. Service charges on deposit accounts
increased $15,000 or 2.2% in 1997 compared to 1996 and increased $96,000 or
15.9% in 1996 compared to 1995. The increase in 1996 is mainly the result of
increased service charges on deposit accounts reflecting the Bank's repricing of
these service charges during the fourth quarter of 1995.
Total net securities gains were $74,000 in 1997 compared to $22,000 in 1996 and
$38,000 in 1995.
The Bank's aggregate fair value of securities held to maturity was less than
carrying value by $24,000 as of December 31, 1997 and less than carrying value
by $33,000 as of December 31, 1996. Pursuant to Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (SFAS 115), securities available for sale are carried at fair
value and, therefore, market value includes net unrealized gains of $335,000 as
of December 31, 1997 and net unrealized losses of $197,000 as of December 31,
1996 which are reflected as a direct reduction (net of taxes) to shareholders'
equity.
For additional information regarding the Bank's securities portfolio, see Notes
1 and 3 of Notes to Financial Statements.
Noninterest Expense
Operating expenses increased $480,000 or 8.7% in 1997 from $5,504,000 in 1996.
The following table presents a comparison of the components of noninterest
expense.
<TABLE>
<CAPTION>
Year Ended Increase
December 31, (Decrease)
------------ ----------
1997 1996 Amount Percent
---- ---- ------ -------
<S> <C> <C> <C> <C>
(dollars in thousands)
Salaries and employee benefits $2,940 $2,554 $ 386 15.1%
Occupancy and equipment 939 963 (24) (2.5)
Computer services 301 281 20 7.1
Outside services 231 32 199 621.9
Printing and stationery 178 189 (11) (5.8)
Legal 151 161 (10) (6.2)
Marketing 150 142 8 (5.6)
Other real estate owned, net of gains 59 185 (126) (68.1)
FDIC insurance 15 18 (3) (16.7)
Other 1,020 979 41 4.2
------ ------ ----
Total noninterest expense $5,984 $5,504 $480 8.7
====== ====== ====
</TABLE>
Salaries and employee benefits were $386,000 or 15.1% higher in 1997 compared to
1996 reflecting scheduled employee annual salary increases and increased
incentive and bonus expenses. Also included in 1997 were expenses related to a
retirement benefit plan for the Bank's President and Chief Executive Officer,
effective January 1997, and a severance accrual for the Bank's former Chief
Financial Officer. Average full time equivalent employees remained unchanged
during 1997 compared to 1996. Although the Bank reduced staffing levels due to
the outsourcing of some back office operations, this reduction was offset by
expansion of the mortgage lending, branch administration and marketing
functions.
27
<PAGE>
The expenses related to outside services increased $199,000 or 621.9% for 1997
compared to 1996 and resulted from the outsourcing of the proof and items
processing functions in November 1996. The Bank reduced staffing in this area by
four and one-half full time equivalent employees, all of whom were hired by the
outsource firm.
The expenses related to the other real estate owned, net of gains decreased by
$126,000 or 68.1% principally as a result of the decreased amount of other real
estate owned by the Bank during 1997.
FDIC insurance expense decreased $3,000 or 16.7% for 1997 compared to 1996 as
increased deposit levels in 1997 were more than offset by a substantially lower
premium rate. Effective January 1, 1997, all insured institutions, including the
Bank, are required to pay the Financing Corporation (FICO) debt service
assessment in accordance with the Deposit Insurance Act of 1996. The FICO rates
are determined quarterly and are lower for members of the Bank Insurance Fund
(BIF). As a member of BIF, the Bank is subject to the additional quarterly
assessments and has included the FICO assessment in FDIC insurance expense in
1997.
The increase in other noninterest expense reflected increased expenses incurred
in 1997 on outside consultants engaged to assist management in the mortgage
lending and planning functions of the Bank and increased expenditures related to
equipment service contract and repair.
Operating expenses decreased $39,000 or .7% to $5,504,000 in 1996 from
$5,543,000 in 1995. The following table presents a comparison of the components
of noninterest expense.
Year Ended Increase
December 31, (Decrease)
----------- --------
1996 1995 Amount Percent
---- ---- ------ -------
(dollars in thousands)
Salaries and employee benefits $2,554 $ 2,749 $(195) (7.1)%
Occupancy and equipment 963 970 (7) (.7)
Computer services 281 283 (2) (.7)
Printing and stationery 189 181 8 4.4
Other real estate owned, net of gains 185 102 83 81.4
Legal 161 222 (61) (27.5)
Marketing 142 100 42 42.0
FDIC insurance 18 164 (146) (89.0)
Other 1,011 772 239 31.0
------ ------ ----
Total noninterest expense $5,504 $5,543 $(39) (.7)
====== ====== ====
Salaries and employee benefits were $195,000 or 7.1% lower in 1996 compared to
1995 primarily as a result of the recording of a $308,000 provision for
severance under an employment contract for a prior executive officer in the
first quarter of 1995. Partially offsetting this provision were increases in
salary and bonus expenses in 1996 related to employee scheduled annual salary
increases and increased incentive expense.
The expenses related to other real estate owned increased by $83,000 or 81.4%
principally as a result of the increased average amount of other real estate
owned by the Bank during 1996.
Legal fees decreased $61,000 or 27.5% mainly as a result of higher legal fees
paid during 1995 related to a proxy fight waged by dissident shareholders in
favor of a former Bank president.
Marketing expense increased $42,000 or 42.0%, primarily as a result of increases
budgeted in 1996 for advertising expenditures to promote the Bank and its
products.
FDIC insurance expense decreased $146,000 or 89.0% for 1996 compared to 1995 as
increased deposit levels in 1996 were more than offset by a lower premium rate.
During the third quarter of 1995, the FDIC announced
28
<PAGE>
substantially reduced premium rates for most banks effective June 1, 1995 and
during the fourth quarter of 1995 the FDIC instituted a further premium rate
reduction effective January 1, 1996.
The increase in other noninterest expense reflects a net increase in a number of
miscellaneous expense categories. The most significant of these categories
related to increased telephone expense as well as expenses incurred on outside
consultants engaged to assist management in the human resource and planning
functions of the Bank as well as the outsourcing of the proof and items
processing functions in November 1996.
Income Taxes
The provision for income taxes for the years ended December 31, 1997, 1996 and
1995 was $738,000, $494,000 and $211,000, respectively. The effective tax rates
were 37.7%, 38.7% and 29.5% for the years ended December 31, 1997, 1996 and
1995, respectively. Deferred tax assets, net of the valuation reserves, are
expected to be realized from the recognition of future taxable income, and the
reversal of existing deferred tax liabilities. For additional information
regarding the Bank's provision for income taxes, see Note 12 of Notes to
Financial Statements.
Liquidity
The liquidity of a banking institution reflects its ability to provide funds to
meet loan requests, to accommodate possible outflows in deposits and to take
advantage of interest rate market opportunities. Funding of loan requests,
providing for liability outflows and management of interest rate fluctuations
require continuous analysis in order to match the maturities of specific
categories of short-term loans and investments with specific types of deposits
and borrowings. Bank liquidity is thus normally considered in terms of the
nature and mix of a banking institution's sources and uses of funds. The Bank's
Asset and Liability Committee is responsible for implementing the Board of
Directors' policies and guidelines for the maintenance of prudent levels of
liquidity.
The Bank's principal sources of funds for operations are cash flows generated
from earnings, deposits, loan repayments, borrowings from correspondent banks
and securities sold under repurchase agreements. Such sources are supplemented
by interest bearing deposits with banks, Federal funds sold and unencumbered
securities available for sale. Brokered deposits were not utilized as a source
of funds during 1997 or 1996, and none were outstanding as of year-end.
Loans (including demand loans), securities and interest bearing deposits in
other banks maturing or repricing within one year aggregated $56,164,000 as of
December 31, 1997 as reflected in the table at the end of this section. These
amounts are supplemented by Federal funds sold which totaled $1,900,000 at
December 31, 1997. As of December 31, 1996, loans (including demand loans) and
securities maturing or repricing within one year were $55,712,000, interest
bearing deposits in other banks amounted to $532,000 and Federal funds sold
amounted to $330,000.
The Bank is a member of the Federal Home Loan Bank of Boston (the "FHLB"), which
makes substantial borrowings available to its members. The Bank maintains an
interest bearing demand deposit account with the FHLB through which the Bank can
access a $3,100,000 line of credit. This line of credit provides an alternate
source of funding for the Bank which would otherwise be dependent upon
commercial bank lines of credit or Federal funds purchased. In addition, the
Bank has the ability to obtain $57,400,000 and $35,500,000 as of December 31,
1997 and 1996, respectively, in advances from the FHLB.
Net cash provided by operating activities was $1,986,000, $1,728,000 and
$1,588,000 for the years ended December 31, 1997, 1996 and 1995, respectively,
reflecting increasing net interest income and reduced cash expenditures in 1997.
Net cash used for investing activities, which reflects the redeployment of funds
into the securities and loan portfolios, was $17,584,000 and $14,448,000 for
1997 and 1996, respectively, as compared to net cash provided by investing
activities in the amount of $2,114,000 for 1995, which reflects the increased
level of cash and cash equivalents at year-end. During 1997 and 1996, the Bank
experienced a net increase in securities of $17,211,000 and $10,827,000,
respectively, and net originations of loans totaling $1,314,000 and $4,418,000,
respectively.
29
<PAGE>
During 1995, the Bank experienced a net increase in securities of $425,000
offset by net loan repayments of $2,017,000.
The cash provided by financing activities of $16,890,000 for 1997 primarily
reflects net increases of $10,015,000 in deposits as well as a net increase in
borrowed funds of $6,834,000. The increase in borrowed funds reflected FHLB
advances totaling $8,500,000 at December 31, 1997, of which $2,000,000 matures
within two years, $2,500,000 matures within three years and $4,000,000 matures
within five years, which have been utilized to fund the Bank's growth. The FHLB
has the option of calling the $4,000,000 advance maturing in 2002 on November 8,
1999 provided that the FHLB has given the Bank at least five business days'
written notice of its intention to call the advance. The cash provided by
financing activities of $6,322,000 for 1996 primarily reflected a net increase
in certificates of deposit of $3,852,000 and an increase in borrowed funds of
$3,365,000 partially offset by a decrease of $895,000 of deposits other than
certificates of deposit. Net cash provided by financing activities was
$3,525,000 for 1995 reflecting a net increase in certificates of deposit of
$15,853,000 partially offset by net decreases of $10,832,000 and $1,496,000 of
deposits other than certificates of deposit and borrowed funds, respectively.
Closely related to the concept of liquidity is the management of interest
earning assets and interest bearing liabilities, which focuses on maintaining
stability in the interest rate spread, an important factor in earnings growth
and stability. Emphasis is placed on maintaining a controlled rate sensitivity
position to avoid wide swings in interest rate spreads and to minimize risk due
to changes in interest rates.
An asset or liability is considered rate sensitive within a specified period
when it matures or could be repriced within such period in accordance with its
contractual terms.
Interest rate risk of the Bank is managed by an Asset Liability Committee of the
Board of Directors which meets quarterly. The Management ALCO Committee, made up
of executive and senior officers of the Bank, meets monthly to assess interest
rate risk and review and recommend appropriate strategies to the Asset Liability
Committee.
30
<PAGE>
The following table sets forth the cumulative maturity distribution of the
Bank's interest earning assets and interest bearing liabilities as of December
31, 1997, the Bank's interest rate sensitivity gap (i.e., interest rate
sensitive assets less interest rate sensitive liabilities), the Bank's
cumulative interest rate sensitivity gap, the Bank's interest rate sensitivity
gap ratio (i.e., interest rate sensitive assets divided by interest rate
sensitive liabilities) and the Bank's cumulative interest rate sensitive gap
ratio.
<TABLE>
<CAPTION>
Maturity or Repricing Interval
----------------------------------------------------------------------------------
Over
1 - 90 90 - 180 180-365 1 - 5 5
Days Days Days Years Years Total
------- ------- ------- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Interest earning assets:
Loans $ 25,272 $ 6,098 $ 16,821 $ 31,303 $ 20,453 $ 99,947
Securities 5,037 1,223 1,414 2,778 33,750 44,202
Interest bearing deposits
with banks 204 95 -- 95 -- 394
Federal funds sold 1,900 -- -- -- -- 1,900
-------- -------- --------- --------- --------- ---------
Total 32,413 7,416 18,235 34,176 54,203 146,443
-------- -------- --------- --------- --------- ---------
Interest bearing liabilities:
Interest bearing deposits 22,640 25,068 12,044 8,295 34,867 102,914
Short-term borrowings 2,110 -- -- -- -- 2,110
Long-term borrowings -- -- -- 8,500 -- 8,500
-------- -------- --------- --------- --------- ---------
Total 24,750 25,068 12,044 16,795 34,867 $ 113,524
-------- -------- --------- --------- --------- =========
Interest rate sensitivity gap $ 7,663 $(17,652) $ 6,191 $ 17,381 $ 19,336
======== ======== ========== ========= =========
Cumulative interest rate
sensitivity gap $ 7,663 $ (9,989) $ (3,798) $ 13,583 $ 32,919
======== ======== ========== ========= =========
Interest rate sensitivity
gap ratio 1.31X .30X 1.51X 2.03X 1.55X
Cumulative interest rate
sensitivity gap ratio 1.31X .80X .94X 1.17X 1.29X
</TABLE>
The preceding table indicates the time periods in which interest earning assets
and interest bearing liabilities will mature or may reprice in accordance with
their contractual terms. However, this table does not necessarily indicate the
impact of general interest rate movements on the Bank's net interest yield
because the repricing of various categories of assets and liabilities is
discretionary and is subject to competitive and other pressures. As a result,
various assets and liabilities indicated as repricing within the same period
may, in fact, reprice at different times and at different rate levels. It also
should be noted that this table reflects certain assumptions regarding the
categorization of assets and liabilities and represents a one-day position; in
fact, variations occur daily as the Bank adjusts its interest rate sensitivity
throughout the year.
Capital Resources
The Bank is subject to capital adequacy guidelines issued by the FDIC. The FDIC
has risk-based capital guidelines for financial institutions, such as the Bank.
The minimum ratio of risk-based capital to risk-adjusted assets (including
certain off-balance sheet items such as standby letters of credit) is 4% and 8%
for Tier 1 and total capital, respectively. At least half of the total capital
is to be comprised of common equity and qualifying perpetual preferred stock,
less certain intangible assets and the disallowed portion of deferred tax assets
("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of mandatory
convertible debt securities, qualifying subordinated debt, other preferred stock
and a portion of the reserve for loan losses. As of December 31, 1997, the
Bank's Tier 1 and Total risk-based capital ratios were 10.66% and 11.92%,
respectively.
31
<PAGE>
In addition, the FDIC has minimum "leverage" ratio guidelines (Tier 1 capital as
of quarter-end to total quarterly average assets) for financial institutions.
These guidelines provide for a minimum leverage ratio of 3% for financial
institutions that meet certain specified criteria. Most financial institutions
(including the Bank) are required to maintain a leverage ratio of at least 100
to 200 basis points above the minimum ratio. As of December 31, 1997, the Bank's
leverage capital ratio was 6.89% compared to the FDIC required ratio of 4%.
Effects of Inflation
The impact of inflation on banks differs from the impact on nonfinancial
institutions. Banks, as financial intermediaries, have assets and liabilities
which may move in concert with inflation. This is especially true for banks with
a high percent of rate sensitive interest earning assets and interest bearing
liabilities. A bank can reduce the impact of inflation if it can manage its rate
sensitivity gap. The Bank attempts to structure its assets and liabilities and
manage its gap in a manner which will minimize the potential adverse effects of
inflation or other market forces on its profitability and capital position.
Year 2000
The Bank has reviewed its critical information systems for Year 2000 compliance
and has initiated plans to remedy any deficiencies in a timely manner. The Bank
relies upon third-party providers for its information processing and is
monitoring these providers to ensure the accurate and timely development and
implementation of their response to Year 2000 issues. The Bank also is
communicating with its data suppliers and customers regarding the Year 2000
issue. As a result of the review and action plan, the Bank believes the cost of
such remedial corrective actions are not material to the Bank's financial
position, results of operations or cash flows.
32
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and related documents are filed as part of
this annual report on Form 10-K on the following pages:
Page
Reports of Independent Public Accountants................................. 34
Balance Sheets as of December 31, 1997 and 1996........................... 35
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995..................................... 36
Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995................. 37
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995..................................... 38
Notes to Financial Statements............................................. 39
33
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Bank of South Windsor:
We have audited the accompanying balance sheets of Bank of South Windsor (a
Connecticut chartered bank) as of December 31, 1997 and 1996, and the related
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Bank of South Windsor as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Hartford, Connecticut
January 23, 1998 (except with respect to
the matter discussed in Note 15, as to
which the date is March 19, 1998)
34
<PAGE>
BALANCE SHEETS
Bank of South Windsor
<TABLE>
<CAPTION>
As of December 31,
-------------------------
(dollars in thousands, except per share data) 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and Due from Banks $ 7,591 $ 7,731
Interest Bearing Deposits with Banks 394 532
Federal Funds Sold 1,900 330
Securities Available for Sale - at market value
(amortized cost of $42,867 in 1997 and $25,081 in 1996) 43,202 24,884
Securities Held to Maturity - at amortized cost
(market value of $976 in 1997 and $1,218 in 1996) 1,000 1,251
--------- ---------
Total Securities 44,202 26,135
--------- ---------
Loans 99,947 99,076
Less: Reserve for Loan Losses (2,156) (1,973)
--------- ---------
Net Loans 97,791 97,103
--------- ---------
Other Real Estate Owned, Net 212 1,342
Premises and Equipment 1,009 928
Accrued Interest Receivable 1,085 902
Income Taxes:
Current -- 275
Deferred 257 386
--------- ---------
Total Income Taxes 257 661
--------- ---------
Other Assets 682 549
--------- ---------
Total Assets $ 155,123 $ 136,213
========= =========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Noninterest Bearing $ 29,989 $ 28,271
Interest Bearing 102,914 94,617
--------- ---------
Total Deposits 132,903 122,888
Funds Borrowed 10,610 3,776
Accrued Interest Payable 140 131
Current Income Taxes 312 --
Other Liabilities 321 157
--------- ---------
Total Liabilities 144,286 126,952
--------- ---------
Commitments and Contingencies (Notes 1, 2, 3, 9 and 13)
Shareholders' Equity:
Common Stock - par value $5 per share:
Authorized shares - 1,300,000
Issued shares - 958,289 in 1997 and 941,239 in 1996 4,791 4,706
Additional Paid-in Capital 3,799 3,730
Net Unrealized Gains (Losses) on Securities Available for
Sale, Net of Taxes 198 (116)
Retained Earnings 2,049 941
--------- ---------
Total Shareholders' Equity 10,837 9,261
--------- ---------
Total Liabilities and Shareholders' Equity $ 155,123 $ 136,213
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
35
<PAGE>
STATEMENTS OF OPERATIONS
Bank of South Windsor
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
(dollars in thousands, except per share data) 1997 1996 1995
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest Income:
Interest and Fees on Loans $ 8,963 $ 8,159 $ 8,476
Interest and Dividends on Investments:
Interest 2,401 1,349 770
Dividends 70 63 78
Interest on Federal Funds Sold 132 169 274
Interest on Interest Bearing Deposits with Banks 27 46 48
-------- ------- -------
Total Interest Income 11,593 9,786 9,646
-------- ------- -------
Interest Expense:
Interest on Deposits 3,926 3,623 3,278
Interest on Funds Borrowed 489 64 243
-------- ------- -------
Total Interest Expense 4,415 3,687 3,521
-------- ------- -------
Net Interest Income 7,178 6,099 6,125
Provision for Loan Losses 368 460 940
-------- ------- -------
Net Interest Income after Provision for Loan Losses 6,810 5,639 5,185
-------- ------- -------
Noninterest Income:
Service Charges on Deposit Accounts 714 699 603
Commissions and Fees 186 234 250
Securities Gains, Net 74 22 38
Other 159 187 182
-------- ------- -------
Total Noninterest Income 1,133 1,142 1,073
-------- ------- -------
Noninterest Expense:
Salaries and Employee Benefits 2,940 2,554 2,749
Occupancy and Equipment 939 963 970
Computer Services 301 281 283
Outside Services 231 32 --
Printing and Stationery 178 189 181
Legal 151 161 222
Marketing 150 142 100
Other Real Estate Owned, Net of Gains 59 185 102
FDIC Insurance 15 18 164
Other 1,020 979 772
-------- ------- -------
Total Noninterest Expense 5,984 5,504 5,543
-------- ------- -------
Income Before Income Taxes 1,959 1,277 715
Income Taxes 738 494 211
-------- ------- -------
Net Income $ 1,221 $ 783 $ 504
======== ======= =======
Average Common Shares Outstanding:
Basic 945,610 941,239 941,239
Diluted 965,777 941,239 941,239
Net Income Per Common Share:
Basic $ 1.29 $ 0.83 $ 0.54
======== ======== ========
Diluted $ 1.26 $ 0.83 $ 0.54
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
36
<PAGE>
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Bank of South Windsor
<TABLE>
<CAPTION>
Net
Unrealized
Gains (Losses)
Additional on Securities Retained
Common Paid-in Available Earnings
(dollars in thousands, except per share amounts) Stock Capital for Sale (Deficit) Total
- --------------------------------------------------- ---------- ------------ --------------- ------------ -------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 $4,706 $ 3,730 $(218) $(346) $ 7,872
Net Income -- -- -- 504 504
Decrease in Net Unrealized Losses on Securities
Available for Sale, Net of Taxes -- -- 236 -- 236
------- ------- ------- ----- --------
Balance, December 31, 1995 4,706 3,730 18 158 8,612
Net Income -- -- -- 783 783
Increase in Net Unrealized Losses on Securities
Available for Sale, Net of Taxes -- -- (134) -- (134)
------- ------- ------- ----- --------
Balance, December 31, 1996 4,706 3,730 (116) 941 9,261
Net Income -- -- -- 1,221 1,221
Common Stock Cash Dividends ($.12 per share) -- -- -- (113) (113)
Exercise of Stock Options (17,050 shares) 85 69 -- -- 154
Decrease in Net Unrealized Losses on Securities
Available for Sale, Net of Taxes -- -- 314 -- 314
------- ------- ------- ------ --------
Balance, December 31, 1997 $4,791 $3,799 $198 $2,049 $ 10,837
======= ======= ======= ====== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
37
<PAGE>
STATEMENTS OF CASH FLOWS
Bank of South Windsor
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
(dollars in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities:
Net Income $1,221 $ 783 $ 504
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Provision for Loan Losses 368 460 940
Provision for Depreciation and Amortization 290 346 318
Provision for Losses on Other Real Estate Owned 30 85 100
Securities Gains, Net (74) (22) (38)
Net Gain on Sales of Other Real Estate Owned (45) (19) (86)
Net Gain on Sales of Premise and Equipment -- (85) --
Amortization (Accretion) of Premiums/Discounts
on Securities 23 30 64
Decrease in Deferred Income Tax Asset 129 262 87
Decrease in Deferred Loan Fees, Net of Costs (87) (32) (69)
(Increase) Decrease in Accrued Interest Receivable (183) (165) 32
Increase in Accrued Interest Payable 9 -- 54
Other, Net 305 85 (318)
------- ------- -------
Net Cash Provided by Operating Activities 1,986 1,728 1,588
------- ------- -------
Investing Activities:
Securities Available for Sale:
Proceeds from Sales of Securities 22,926 5,142 575
Proceeds from Maturities of Securities 2,292 1,546 1,325
Purchases of Securities (42,679) (17,515) (2,325)
Securities Held to Maturity:
Proceeds from Maturities of Securities 250 -- --
(Originations) Repayments of Loans, Net (1,314) (4,418) 2,017
Purchases of Premises and Equipment (314) (117) (110)
Proceeds from Sales of Other Real Estate Owned 1,255 690 632
Proceeds from Sales of Premises and Equipment
-- 224 --
------- ------- -------
Net Cash (Used for) Provided by Investing
Activities (17,584) (14,448) 2,114
------- ------- -------
Financing Activities:
Net Increase (Decrease) in Deposits Other Than
Certificates of Deposit 3,811 (895) (10,832)
Net Increase in Certificates of Deposit 6,204 3,852 15,853
Net Increase (Decrease) in Funds Borrowed 6,834 3,365 (1,496)
Net Proceeds from Exercise of Stock Options 154 -- --
Cash Dividends Paid (113) -- --
------- ------- --------
Net Cash Provided by Financing Activities 16,890 6,322 3,525
------- ------- --------
Net Increase (Decrease) in Cash and Cash 1,292 (6,398) 7,227
Equivalents
Cash and Cash Equivalents at Beginning of Year 8,593 14,991 7,764
------- ------- --------
Cash and Cash Equivalents at End of Year $ 9,885 $ 8,593 $ 14,991
======= ======= ========
Supplemental Information on Cash Paid For:
Interest $ 4,406 $ 3,687 $ 3,467
Income Taxes Paid, Net 242 99 345
Noncash Investing and Financing Activities:
Transfer of Securities Held to Maturity to Securities
Available for Sale -- -- 7,921
Decrease (Increase) in Unrealized Loss on Securities
Available for Sale Recognized in Shareholders' 314 (134) 236
Equity
Transfer from Loans to Other Real Estate Owned 117 1,456 757
</TABLE>
The accompanying notes are an integral part of these financial statements.
38
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Bank of South Windsor
1. Summary of Significant Accounting Policies
Organizational Structure
- ------------------------
Bank of South Windsor (the "Bank") is a state bank organized under the laws of
the State of Connecticut engaged in the commercial banking business. The Bank
operates through its main office located in South Windsor, Connecticut, and its
branches located in East Hartford and Vernon, Connecticut. The Bank's primary
source of income is interest received on loans to customers. Bank customers
include small- to mid-sized businesses as well as individuals residing within
the Bank's service area.
Basis of Financial Statement Presentation
- -----------------------------------------
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 income and expenses during the reporting periods. Future
operating results could vary from the amounts derived from management's
estimates and assumptions. Certain amounts for prior years have been
reclassified to conform to the current year presentation.
Securities
- ----------
Debt securities held to maturity are stated at cost, adjusted for amortization
of premiums and accretion of discounts, because management has the intent and
ability to hold these investments in debt securities to maturity. The initial
determination to include debt securities as held to maturity is made at the time
of acquisition.
Securities available for sale, including marketable equity securities, are
recorded at fair value with any valuation adjustments, net of tax, reflected in
shareholders' equity. Securities available for sale are securities that are not
held to maturity or for trading. Included as securities available for sale are
securities that are purchased in connection with the Bank's asset/liability risk
management strategy that may be sold in response to changes in interest rates,
prepayment risk or other factors.
Subsequent to the time of acquisition, transfers to the held to maturity
portfolio from securities available for sale are made at fair value at the time
of transfer, and any resultant premium or discount is being recognized over the
remaining expected average life of the security. The specific identification
method is used to determine the cost of securities sold on the trade date.
Unrealized losses deemed not recoverable and considered other than temporary
declines in value are charged to noninterest income as a security loss.
Loans
Loans are stated at their principal amounts outstanding net of unearned income.
Generally, interest on loans is recorded as income based upon rates applied to
principal amounts outstanding. In determining income recognition on loans,
generally no interest is recognized with respect to loans on which a default of
interest or principal has occurred for a period of ninety days or more and
collection of any portion of the loan is considered to be doubtful, or for a
lesser period if circumstances indicate collection of any portion of the loan is
doubtful. Loan origination fees and certain direct loan origination costs are
deferred, and the net fee or cost is recognized in interest income using the
level yield method over the contractual life of the loan. When loans are
prepaid, sold or participated out, the unamortized portion of
39
<PAGE>
deferred fees is recognized as income at that time. As of December 31, 1997 and
1996, net deferred loan fees were approximately $33,000 and $120,000,
respectively.
The reserve for loan losses is established through a provision charged to
expense. A charge against the reserve occurs when management believes that the
collection of some or all of a loan's principal is unlikely. The reserve
represents an amount which, in management's judgment, will be adequate to absorb
losses on existing loans that may become uncollectible. Management's judgment in
determining the adequacy of the reserve is based on the evaluation of individual
performing and impaired loans, the risk characteristics of the loan portfolios,
the assessment of current economic and real estate market conditions, estimates
of the current value of underlying collateral, past and current loan loss
experience and other relevant factors.
The Bank has identified certain loans as impaired based upon management's belief
that it is probable that the borrower will be unable to pay all principal and
interest amounts in accordance with the loan agreement's contractual terms. The
Bank is required to account for the time value of money when determining the
adequacy of the Bank's reserve for loan losses for certain impaired loans.
Certain impaired loans are required to be measured based on the present value of
expected future cash flows discounted at the loan's original effective interest
rate. As a practical expedient, impairment may also be measured based on the
loan's observable market price or the fair value of the collateral if the loan
is collateral dependent. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a valuation
allowance. Interest payments received on impaired loans are recorded as interest
income unless collection of the remaining recorded investment is doubtful, at
which time payments received are recorded as reductions of principal.
Premises and equipment
Premises and equipment are stated at original cost, less accumulated
depreciation and amortization of approximately $233,000 and $299,000 as of
December 31, 1997 and 1996, respectively. Depreciation of premises and equipment
and amortization of leasehold improvements are computed on a straight-line basis
over the estimated useful lives of the assets. Leasehold improvements are
amortized on a straight- line basis over the shorter of the terms of the lease
or the estimated useful lives of the improvements.
Other real estate owned
Other real estate owned, comprised of real estate acquired through foreclosure
or acceptance of a deed in lieu of foreclosure, is carried at the lower of cost
or fair market value less estimated selling costs. Property is transferred to
other real estate owned at the lower of cost or fair market value, with any
excess of cost over fair market value charged to the reserve for loan losses.
Any further decline in value based on subsequent changes to estimated fair
market value or any loss upon ultimate disposition of the property is charged
against the reserve for losses on other real estate owned.
Securities sold under repurchase agreements
The Bank enters into sales of securities under repurchase agreements. Such
agreements are treated as financings, and the obligations to repurchase
securities sold are reflected as liabilities and the securities underlying the
agreements remain in the securities accounts in the balance sheets. The
securities underlying the agreements are held as collateral in a third party
safekeeping account for the benefit of counterparties.
40
<PAGE>
Cash flows
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, interest bearing deposits with banks and Federal funds sold.
Income taxes
Items of income and expense recognized in different time periods for financial
reporting purposes and for purposes of computing income taxes currently payable
(temporary differences) give rise to deferred income taxes which are reflected
in the financial statements. A deferred tax liability or asset is recognized for
the estimated future tax effects, based upon enacted law, attributed to
temporary differences. If applicable, the deferred tax asset is reduced by the
amount of any tax benefits that, based upon available evidence, are not expected
to be realized.
Related party transactions
Directors and officers of the Bank and their associates have been customers of,
and have had transactions with the Bank, and management expects that such
persons will continue to have such transactions in the future. In the opinion of
management, all deposit accounts, loans, services and commitments comprising
such transactions were made in the ordinary course of business, on substantially
the same terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with other customers who are not directors
or officers, and the transactions did not involve more than normal risks of
collectibility or favored treatment or terms, or present other unfavorable
features. See Notes 4 and 13 for further details regarding related party
transactions.
Earnings per share
The Bank adopted Statement of Financial Accounting Standards No. 128, "Earnings
per Share" (SFAS 128), effective December 15, 1997. Upon adoption of SFAS 128,
all prior period earnings per share data were restated to conform with the new
statement. The Statement replaces the presentation of primary earnings per share
with the presentation of basic earnings per share. It also requires the
presentation of basic and diluted earnings per share in the statement of
operations. Basic earnings per common share were computed by dividing net income
by the weighted average number of shares of common stock outstanding during the
year (945,610 shares, 941,239 shares and 941,239 shares for the years ended
December 31, 1997, 1996 and 1995, respectively). Diluted earnings per common
share were computed by dividing net income by the weighted average number of
shares of common stock outstanding during the year, increased by the number of
shares issuable on the exercise of stock options, if dilutive, based upon the
treasury stock method. The effect of the stock options in 1997 was to increase
shares used in the diluted earnings per share calculation by 20,167 shares. The
effect of the stock options outstanding in 1996 and 1995 was anti-dilutive and
therefore not reflected in the computation of per common share amounts.
Dividend capability
Under Connecticut law, the Bank may declare and pay cash dividends only from the
current year's and the prior two year's retained net profits, as defined (see
Note 13).
New accounting standard
During 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). This Statement establishes standards for separately reporting
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. Components of
comprehensive income represent changes in equity resulting from transactions and
other events and circumstances from nonowner sources. This Statement is
effective for fiscal years beginning after December 15, 1997, and
41
<PAGE>
reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Bank plans to adopt the new disclosure
standard prospectively, effective January 1, 1998.
2. Regulatory Matters
The Bank is 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
Bank's financial statements.
The regulations require the Bank to meet specific capital adequacy guidelines
that involve quantitative measures of the Bank's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tier 1 leverage capital (as defined in the regulations) to
total average assets (as defined), and minimum ratios of Tier 1 and total
capital (as defined) to risk weighted assets (as defined). To be considered
adequately capitalized (as defined) under the regulatory framework for Prompt
Corrective Action, the Bank must maintain minimum Tier 1 leverage, Tier 1
risk-based and total risk-based ratios as set forth in the table.
As of December 31, 1997 and 1996, management believes that the Bank has met all
capital adequacy requirements to which it is subject. To be categorized as well
capitalized, the Bank must maintain the ratios set forth in the following table.
Management believes that there are no events or conditions which have occurred
that would change its category.
42
<PAGE>
The Bank's capital amounts and ratios were (dollars in thousands):
<TABLE>
<CAPTION>
To Be Well Capitalized
Capital Adequacy Under Prompt Corrective Action
-------------------------------- ---------------------------------
Actual Required Required
Amount Ratio Ratio Amount Ratio
------------------ -------- ---------------------------------
<S> <C> <C> <C> <C> <C>
December 31, 1997:
Tier 1 Leverage Capital (to
Total Average Assets) $10,639 6.89% 4.00% $7,719 5.00%
Tier 1 Capital (to Risk Weighted
Assets) $10,639 10.66% 4.00% $5,990 6.00%
Total Capital (to Risk Weighted
Assets) $11,898 11.92% 8.00% $9,983 10.00%
December 31, 1996:
Tier 1 Leverage Capital (to
Total Average Assets) $ 9,377 6.94% 4.00% $6,758 5.00%
Tier 1 Capital (to Risk Weighted
Assets) $ 9,377 9.56% 4.00% $5,885 6.00%
Total Capital (to Risk Weighted
Assets) $10,612 10.82% 8.00% $9,808 10.00%
</TABLE>
43
<PAGE>
3. Securities
As of December 31, 1997 and 1996, the amortized cost and fair values of
securities were:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- -------------- -------------- ------------
(in thousands)
<S> <C> <C> <C> <C>
1997
----
Available for sale:
U.S. Treasury $ 520 $ -- $ -- $ 520
U.S. Government agencies 17,434 152 1 17,585
Mortgage-backed securities 19,300 219 11 19,508
Obligations of states and
political subdivisions 3,766 18 10 3,774
Other debt securities 552 -- 32 520
Federal Home Loan Bank stock 1,295 -- -- 1,295
------- ---- ----- -------
$42,867 $389 $ 54 $43,202
======= ==== ===== =======
Held to maturity:
U.S. Government agencies $ 1,000 $ -- $ 24 $ 976
======= ==== ===== =======
1996
----
Available for sale:
U.S. Treasury $ 776 $ -- $ 12 $ 764
U.S. Government agencies 14,796 45 188 14,653
Mortgage-backed securities 4,405 45 8 4,442
Obligations of states and
political subdivisions 1,430 2 19 1,413
Other debt securities 2,707 6 68 2,645
Federal Home Loan Bank stock 967 -- -- 967
------- ---- ----- -------
$25,081 $ 98 $ 295 $24,884
======= ==== ===== =======
Held to maturity:
U.S. Government agencies $ 1,251 $ -- $ 33 $ 1,218
======= ==== ===== =======
</TABLE>
44
<PAGE>
As of December 31, 1997, the amortized cost and fair value of debt securities
available for sale and held to maturity, by contractual maturity, are summarized
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
------------------ ------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- -------- -------- --------
<S> <C> <C> <C> <C>
(in thousands)
Due in one year or less $ 500 $ 499 $ 500 $ 500
Due after one year through five years 2,789 2,804 500 476
Due after five years through ten years 14,789 14,873 -- --
Due after ten years 4,194 4,223 -- --
Mortgage-backed securities 19,300 19,508
------- ------- ------ -----
$41,572 $41,907 $1,000 $ 976
======= ======= ====== =====
</TABLE>
For the years ended December 31, 1997, 1996 and 1995, proceeds from the sale of
securities available for sale were $22,926,000, $5,142,000, and $575,000,
respectively. Gross gains of $127,000, $22,000, and $62,000 were realized on
sales for the years ended December 31, 1997, 1996 and 1995, respectively, and
gross losses of $53,000, and $24,000 and were realized on sales for the years
ended December 31, 1997 and 1995, respectively. There were no gross losses
realized from the sales of securities available for sale during 1996.
On December 29, 1995, the Bank utilized the one-time transfer ability allowed by
the Financial Accounting Standards Board in its special report "A Guide to
Implementation of Financial Accounting Standards No. 115 on Accounting for
Certain Investments in Debt and Equity Securities" and reclassified certain
securities held to maturity to securities available for sale. Securities of
$7,921,000 were transferred from the held to maturity category to the available
for sale category. In connection with this reclassification, gross unrealized
gains of $32,000 and gross unrealized losses of $96,000 were recorded in
securities available for sale and in shareholders' equity (on a net of tax
basis).
As of December 31, 1997 and 1996, securities with a book value of $4,558,000 and
$3,428,000, respectively, were pledged as collateral for repurchase agreements,
treasury tax and loan payments and other deposits held by the Bank.
4. Loans
As of December 31, 1997 and 1996, the composition of the loan portfolio was:
1997 1996
---- ----
(in thousands)
Real estate:
Construction $ 3,112 $ 1,801
Secured by 1 to 4 family residential property 42,894 45,111
Secured by commercial property 34,046 32,853
------- -------
80,052 79,765
Commercial 15,523 13,158
Installment 4,372 6,153
------- -------
Total loans $99,947 $99,076
======= =======
The Bank grants commercial, residential and consumer loans primarily in Hartford
and Tolland counties in Connecticut. Although the Bank has a diversified loan
portfolio, a significant portion of its borrowers'
45
<PAGE>
ability to honor their contracts is dependent on the real estate sector of the
economy in its market area. Loans outstanding for which the primary source of
repayment is the sale of real estate collateral or cash flow from income
producing properties were approximately $37,158,000 and $34,654,000 as of
December 31, 1997 and 1996, respectively. Commercial loans collateralized by
real estate generally are underwritten with initial loan to value ratios not
exceeding 75% based upon an analysis of each borrower's creditworthiness.
The Bank services certain loans that it has sold without recourse to third
parties prior to 1995. The aggregate of loans serviced for others approximated
$10,551,000 and $11,963,000 as of December 31, 1997 and 1996, respectively.
As of December 31, 1997 and 1996, loans to related parties totaled approximately
$1,649,000 and $2,214,000, respectively. For the year ended December 31, 1997,
new loans of approximately $421,000 were granted to these parties and payments
of approximately $986,000 were received. Related parties include directors and
executive officers of the Bank, their respective affiliates in which they have a
controlling interest and their immediate family members. Such loans were made in
the ordinary course of business and on terms substantially comparable to loan
transactions with others, and all such transactions were approved by the Board
of Directors. All new loans and payments subsequent to an individual ceasing to
serve in a related party capacity are not included in the above totals. All
related party loans were current as to principal and interest for the years
ended December 31, 1997 and 1996.
5. Reserves for Loan and Other Real Estate Owned Losses
The reserves for loan and other real estate owned losses are based on estimates,
and ultimate losses may vary from the current estimates. These estimates are
reviewed periodically and, as adjustments become necessary, they are reflected
in operations in the periods in which they became known.
An analysis of the changes in the reserves for loan and other real estate owned
losses is as follows:
Year Ended December 31,
-------------------------------
1997 1996 1995
---- ---- ----
(in thousands)
Reserve for loan losses:
Balance, beginning of year $ 1,973 $ 2,657 $ 3,058
Provision charged to expense 368 460 940
Loan charge-offs (326) (1,332) (1,394)
Recoveries 141 188 53
------- ------- -------
Balance, end of year $ 2,156 $ 1,973 $ 2,657
======= ======= =======
46
<PAGE>
Year Ended December 31,
---------------------------
1997 1996 1995
---- ---- ----
(in thousands)
Reserve for other real estate owned losses:
Balance, beginning of year $ 50 $ 115 $ 15
Provision charged to expense 30 85 100
Other real estate owned write-downs (48) (150) --
---- ----- ----
Balance, end of year $ 32 $ 50 $115
==== ===== ====
6. Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans 90 days past due and still
accruing interest, renegotiated loans due to a weakening in the financial
condition of the borrower and other real estate owned. In addition to nonaccrual
loans and loans 90 days past due and still accruing interest, the Bank's
impaired loans include $1,121,000 and $65,000 of accruing loans as of December
31, 1997 and 1996, respectively. For the years ended December 31, 1997 and 1996,
the average recorded investment in impaired loans was $626,000 and $1,266,000,
respectively. As of December 31, 1997 and 1996, nonperforming assets were:
1997 1996
---- ----
(in thousands)
Nonaccrual loans $528 $1,333
Loans 90 days past due and still
accruing interest 109 113
Renegotiated loans -- --
Other real estate owned, net 212 1,342
---- ------
Total nonperforming assets $849 $2,788
==== ======
For the years ended December 31, 1997 and 1996, had interest been accrued at
original contractual rates on nonaccrual and renegotiated loans, interest income
would have increased by approximately $27,000 (from $25,000) and $339,000 (from
zero), respectively. For the years ended December 31, 1997 and 1996, interest
income on impaired loans of $78,000 and $5,000, respectively, was recognized. As
of December 31, 1997 and 1996, no significant additional funds were committed to
customers whose loans were nonperforming.
47
<PAGE>
As of December 31, 1997 and 1996, the Bank's recorded investment in impaired
loans and the related valuation allowance (which is included in the reserve for
loan losses) were:
1997 1996
---------------------- -------------------
Impaired Valuation Impaired Valuation
Loans Allowance Loans allowance
----- --------- -------- ---------
(in thousands)
Valuation allowance required $1,187 $212 $771 $133
No valuation allowance required -- -- 117 --
------ ---- ---- ----
Total impaired loans $1,187 $212 $888 $133
====== ==== ==== ====
As of December 31, 1997, included in impaired loans is a loan with a balance of
$1,121,000 of which 63.15% of the balance is guaranteed by the Small Business
Administration. As of December 31, 1996, the recorded investment in $370,000 of
previous direct chargeoffs and applications of cash interest payments against
the loan balances.
7. Premises and Equipment
As of December 31, 1997 and 1996, premises and equipment consisted of:
1997 1996
---- ----
(in thousands)
Leasehold improvements $ 716 $ 617
Furniture and equipment 1,946 1,912
------- -------
2,662 2,529
Less accumulated depreciation and amortization (1,653) (1,601)
------- -------
$ 1,009 $ 928
======= =======
Provisions for depreciation and amortization on premises and equipment of
$233,000, $299,000 and $318,000 in 1997, 1996 and 1995, respectively, were
included in occupancy and equipment expense. Included in other noninterest
expense in 1996 is $95,000 of costs which represent the write-off of the net
book value of leasehold improvements and furniture and equipment related to the
relocation of the Bank's operations center in 1997.
48
<PAGE>
8. Deposits
As of December 31, 1997 and 1996, deposits were:
1997 1996
---- ----
(in thousands)
Time:
30 to 365 day certificates $ 26,945 $ 27,545
18 month to four year certificates 14,424 11,504
Five year and over certificates 3,246 3,118
Time certificates in denominations
of $100,000 or more 11,173 7,417
Club accounts 28 35
-------- --------
55,816 49,619
-------- --------
Savings and money market accounts:
Regular savings 26,548 26,980
Money market 6,973 6,544
-------- --------
33,521 33,524
-------- --------
Demand and Now accounts:
Now 13,605 11,509
Regular checking 29,961 28,236
-------- --------
43,566 39,745
-------- --------
Total deposits $132,903 $122,888
======== ========
Interest expense on time deposits in denominations of $100,000 or more was
$524,000, $210,000 and $153,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
9. Funds Borrowed
Funds borrowed consisted of the following:
December 31,
---------------
1997 1996
------- ------
(in thousands)
Securities sold under repurchase agreements $ 1,410 $ 95
Demand notes issued to the U.S. Treasury 700 681
Federal Home Loan Bank advances 8,500 3,000
------- ------
Total $10,610 $3,776
======= ======
A summary of securities sold under repurchase agreements as of December 31, 1997
follows (dollars in thousands):
Repurchase Borrowing Carrying Fair
Collateral securities Amount Rate Value Value
- ------------------------- ------- --------- -------- --------
U.S. Government agencies $ 1,410 3.50% $ 3,029 $ 3,029
As of December 31, 1997 and 1996, the securities sold under repurchase
agreements provided for the repurchase of identical securities.
49
<PAGE>
Securities sold under repurchase agreements averaged $868,000 during 1997. The
Bank commenced the sale of securities under repurchase agreements on December
31, 1996. The maximum amount outstanding at any month-end during 1997 and 1996
was $1,410,000 and $95,000, respectively. The weighted average interest rate was
3.50% in 1997 and 1996.
As of December 31, 1997 and 1996, Federal Home Loan Bank of Boston (the "FHLB")
advances consisted of:
Maturing Year Interest
Ending December 31, Rates 1997 1996
------------------ ----- ---- ----
(in thousands)
1997 5.38% $ -- $3,000
1999 5.99 2,000 --
2000 6.41 2,500 --
2002 5.71 4,000 --
------ ------
$8,500 $3,000
====== ======
The FHLB has the option of calling the advance maturing in 2002 on November 8,
1999 provided that the FHLB has given the Bank at least five business days'
written notice of its intention to call the advance. The Bank's FHLB stock
collateralizes these advances. In addition, mortgage loans and otherwise
unencumbered investment securities qualified as collateral available to the FHLB
were pledged to secure these advances, unused credit lines and letters of credit
issued by the FHLB.
As a member of the FHLB, the Bank has access to a pre-approved line of credit up
to 2% of the Bank's total assets ($155,123,000) and the capacity to borrow up to
30% of total assets. The Bank had no outstanding advances on the line of credit
as of December 31, 1997 and 1996. In accordance with an agreement with the FHLB,
the Bank is required to maintain qualified collateral, as defined in the FHLB
Statement of Credit Policy, to collateralize outstanding advances. The Bank
exceeded this requirement as of December 31, 1997.
10. Stock Options
The Bank has stock option arrangements which provide for granting of options to
key employees to purchase Bank common stock at prices equal to or less than the
fair market value at the date of grant. In 1990, the Bank established a
Non-Qualified Stock Option Plan and reserved 127,600 shares of common stock for
issuance under this plan to employees and Directors of the Bank. Under the Plan,
the option price is equal to the fair value of the Banks common stock on the
date the options are granted. Once granted, options under the Plan are
exercisable and expire ten years from the grant date.
On May 22, 1997, shareholders approved the allocation of 40,000 shares of common
stock for a 1997 Incentive Stock Option Plan. Under the Plan, the option price
is not less than the fair value of the Bank's common stock on the date the
options are granted. Once granted, one half of the options become exercisable in
one year and the remaining options become exercisable two years after the date
of the grant. Options expire ten years from the grant date.
A summary of transactions under the Bank's stock option arrangements follows:
Number
of Option Price
Shares Per Share
------ ---------
50
<PAGE>
Outstanding December 31, 1995 and 1994 121,550 $9.09
Granted 5,000 7.50
------- ------------
Outstanding December 31, 1996 126,550 7.50 - 9.09
Granted 16,540 9.25 - 21.75
Exercised (17,050) 9.09
------- ------------
Outstanding December 31, 1997 126,040 7.50 - 21.75
=======
Options exercisable as of December 31, 1997 109,500 7.50 - 9.09
Shares of common stock available for future =======
grants as of December 31, 1997 24,510
=======
As of January 1, 1996, the Bank adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation". This Statement
establishes financial accounting and reporting standards for stock-based
employee compensation plans. The Bank has chosen to continue following the
existing accounting rules for stock option accounting but disclose what the
impact would have been had the new standards been adopted. These disclosures
must show what earnings and earnings per share for years beginning after
December 15, 1994 would have been had the standard's new accounting been
applied. However, companies must apply the recommended accounting only to grants
made in fiscal years beginning after December 15, 1994. The options granted by
the Bank in 1997 and 1996 had no significant impact on reported net income or
income per common share in 1997, 1996 or 1995.
11. Benefit Plans
Employee Savings and Profit Sharing Plan
- ----------------------------------------
The Bank sponsors a savings and profit sharing plan (the "Savings Plan") under
Section 401(k) of the Internal Revenue Code, covering all employees who meet
certain age and service requirements. The Savings Plan has a discretionary
non-contributory profit sharing feature and also allows for voluntary employee
contributions. Bank profit sharing contributions are based on profitability and
other appropriate factors as determined by the Board of Directors. No profit
sharing contributions were made for 1997, 1996 or 1995.
The Savings Plan allows participants to make contributions by salary deduction
of up to the maximum amount allowed pursuant to Section 401(k) of the Internal
Revenue Code. Effective January 1, 1997, the Bank increased its matching
contribution to the rate of 35 cents per dollar on employee contributions up to
the first 5% of the employee's compensation. Employee contributions in excess of
5% of the employee's compensation are not matched by the Bank. Employee
contributions vest immediately while the Bank's matching contributions vest
after 5 years.
Total contributions made by the Bank and participants in 1997, 1996 and 1995
were $77,000, $70,000 and $78,000, respectively. Contributions by the Bank
included in the total contribution amounts were $10,000, $10,000 and $11,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
Postretirement Benefits
- -----------------------
The Bank does not provide postretirement benefits other than the Savings Plan
described above.
12. Income Taxes
For the years ended December 31, 1997, 1996 and 1995, the provision for Federal
and state income taxes was:
51
<PAGE>
1997 1996 1995
---- ---- ----
(in thousands)
Current:
Federal $ 516 $ 146 $ 166
State 170 53 64
----- ---- ----
686 199 230
----- ---- ----
Deferred:
Federal 76 295 43
State 21 35 1
----- ---- ----
97 330 44
----- ---- ----
Change in valuation allowance for deferred tax asset (45) (35) (63)
----- ---- ----
Total $738 $494 $211
===== ==== ====
The following is a reconciliation of the statutory Federal income tax rate of
34% applied to income before taxes with income tax expense for the years ended
December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Federal income tax at statutory rate $ 666 $ 434 $ 243
Increase (decrease) resulting from:
Connecticut corporation tax, net of Federal tax benefit 127 88 47
Dividends received deduction -- -- (4)
Change in the valuation allowance
for deferred tax asset (45) (35) (63)
Other (10) 7 (12)
------ ----- -----
Income tax expense $ 738 $ 494 $ 211
====== ===== =====
</TABLE>
52
<PAGE>
As of December 31, 1997 and 1996, the tax effects of temporary differences that
give rise to the deferred tax assets and liabilities were:
1997 1996
----- ----
(in thousands)
Deferred tax assets:
Reserve for loan losses $ 452 $ 538
Deferred loan fees -- 10
Net unrealized loss on securities available for sale -- 82
Capital loss carryforward 58 58
Accumulated depreciation and amortization on premises
and equipment 96 28
Other -- 9
----- ----
Total gross deferred tax asset 606 725
----- ----
Valuation allowance for deferred tax asset (104) (149)
----- ----
Deferred tax liabilities:
Discount on loans 51 93
Deferred loan fees 12 --
Prepaid expenses 42 97
Net unrealized gain on securities available for sale 138 --
Other 2 --
----- ----
Total gross deferred tax liability 245 190
----- ----
Net deferred tax asset $ 257 $ 386
===== =====
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon taxes paid in the past which are available to be recovered and
upon the generation of future taxable income during the periods in which those
temporary differences reverse. Management considers the estimated timing of the
reversal of deferred tax liabilities, projected future taxable income and tax
planning strategies in making this assessment.
13. Commitments and Contingencies
Under Connecticut law, the Bank may declare and pay cash dividends only from the
current year's and the prior two years' retained net earnings, as defined. As of
December 31, 1997, all of the Bank's retained earnings was available for
dividend declaration without prior regulatory approval.
The Bank is required by regulation to maintain with a Federal Reserve Bank
reserve balances based principally on deposits outstanding. These reserve
balances, included in cash and due from banks, were approximately $1,080,000 and
$920,000 as of December 31, 1997 and 1996, respectively.
The Bank leases certain branch facilities under lease agreements which expire at
various dates through September 30, 2002. For the years ended December 31, 1997
and 1996, rental expense under these lease agreements was $335,000 and $318,000,
respectively, and related sublease income was $22,000 for each of the years.
53
<PAGE>
The Bank leases certain facilities at a rate which management believes was a
market rate at lease inception from a related party which includes one Bank
director as a partner. The lease expires in May 1999 and allows for three
renewal terms of five years each. Rental expense under related party leases was
approximately $159,000 for each of years ended December 31, 1997, 1996 and 1995.
As of December 31, 1997, future minimum payments under noncancellable operating
leases with initial or remaining terms of one year or more consisted of the
following:
Year Amount
--- ------
(in thousands)
1998 $311
1999 206
2000 155
2001 155
2002 74
----
$901
====
Certain claims, suits and complaints arising in the ordinary course of business
have been filed or are pending against the Bank. These matters include a claim
by the Bank's former chief executive officer which is in the early stages of
discovery. In the opinion of management, based on discussions with legal
counsel, the outcome of these matters will not result in a significant adverse
effect on the financial condition or future operating results of the Bank. Due
to the early stage of the former chief executive officer's claim, future facts
and circumstances could alter management's opinion that this claim is not
expected to result in a significant adverse effect on the financial condition or
future operating results of the Bank.
Legal fees, including fees for loan workouts, collections and foreclosures, paid
to related parties were approximately $110,000, $127,000 and $166,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. As of
December 31, 1997 and 1996, these financial instruments included commitments to
extend lines of credit of $24,055,000 and $23,346,000, respectively, and
outstanding letters of credit of $1,836,000 and $702,000, respectively, all of
which represented standby letters of credit. 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.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The Bank may or may not obtain
collateral in connection with the issuance of standby letters of credit.
These financial instruments involve, to varying degrees, elements of credit and
interest rate risk. The Bank's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument is represented by
the contractual amount of those instruments. The Bank uses the same credit
policies in making commitments as they do for existing loans. The credit risk of
these financial instruments is controlled through credit approvals, limits,
monitoring procedures and the receipt of collateral deemed necessary.
14. Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments", requires disclosure of estimated fair values
for certain of its financial instruments.
54
<PAGE>
Financial instruments include such items as loans, securities, deposits and
other financial instruments as defined in the Statement.
The Statement requires that where available, quoted market prices be used to
estimate fair values. Many of the Bank'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 Bank'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,
valuation techniques permitted by the Statement, such as present value
calculations, were used by the Bank 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, Interest Bearing Deposits with Banks and Federal Funds
Sold. These items are generally short-term in nature and, accordingly, the
carrying amounts reported in the balance sheets are reasonable approximations of
their fair values.
Securities Available for Sale and Held to Maturity. 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. The
fair value of nonaccrual loans is estimated by discounting the future cash flows
using a discount rate that reflects the risk inherent in the loan.
Accrued Interest Receivable. The carrying amount of accrued interest receivable
approximates its fair value.
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 the discounted value of contractual cash flows. The
discount rates are the rates currently offered for deposits of similar remaining
maturities.
Funds Borrowed. The fair value of Federal Home Loan Bank advances is estimated
using the discounted value of contractual cash flows. Repurchase agreements and
other borrowed funds consist of short-term liabilities and the carrying amounts
approximate their fair values.
Accrued Interest Payable. The carrying amount of accrued interest payable
approximates 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 of letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligation with the counterparties at the
reporting date. The fair value of commitments to extend credit and standby
letters of credit was not significant and therefore not disclosed as of December
31, 1997 and 1996.
55
<PAGE>
As of December 31, 1997 and 1996, the carrying amounts and estimated fair values
of the Bank's financial instruments were as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------- ------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C>
ASSETS:
Cash and Due from Banks $ 7,591 $ 7,591 $ 7,731 $ 7,731
Interest Bearing Deposits with Banks 394 394 532 532
Federal Funds Sold 1,900 1,900 330 330
Securities:
Available for Sale 43,202 43,202 24,884 24,884
Held to Maturity 1,000 976 1,251 1,218
Loans, Net 97,791 100,158 97,103 98,128
Accrued Interest Receivable 1,085 1,085 902 902
LIABILITIES:
Deposits 132,903 133,052 122,888 122,765
Funds Borrowed 10,610 10,561 3,776 3,776
Accrued Interest Payable 140 140 131 131
</TABLE>
OTHER UNRECOGNIZED
FINANCIAL INSTRUMENTS:
None
56
<PAGE>
15. Subsequent Event
On March 19, 1998, the Bank announced a definitive agreement with New England
Community Bancorp, Inc. ("NECB") to merge the Bank into and with New England
Bank & Trust Company, a wholly-owned subsidiary of NECB. Under the proposed
merger, which is subject to various conditions including regulatory approvals
and approval by the shareholders of both the Bank and NECB (if legally
required), each share of the Bank's common stock will convert into 1.3204 shares
of NECB common stock, subject to adjustment under certain circumstances. In
connection with the merger agreement, the Bank and NECB entered into a stock
option agreement dated March 19, 1998 pursuant to which NECB will have an option
to purchase 215,000 shares of the Bank's common stock at $12.00 per share, which
option is exercisable in certain circumstances. Management expects that the
proposed transaction will close in the third quarter of 1998.
57
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
A summary of unaudited quarterly results of operations of 1997 and 1996 follows:
- --------------------------------------------------------------------------------
(dollars in thousands, except per share data) Three Months Ended
- --------------------------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
1997
- ----
Interest Income $2,589 $2,904 $3,040 $3,060
Interest Expense 984 1,123 1,156 1,152
------ ------ ------ ------
Net Interest Income 1,605 1,781 1,884 1,908
Provision for Loan Losses 105 105 79 79
Noninterest Income 307 321 256 249
Noninterest Expense 1,452 1,515 1,488 1,529
Income Taxes 144 191 231 172
------ ------ ------ ------
Net Income $ 211 $ 291 $ 342 $ 377
====== ====== ====== ======
Net Income Per Common Share:
Basic $ .22 $ .31 $ .37 $ .39
Diluted .22 .31 .37 .36
Cash Dividends Declared .03 .03 .03 .03
1996
- ----
Interest Income $2,352 $2,408 $2,449 $2,577
Interest Expense 891 895 933 968
------ ------ ------ ------
Net Interest Income 1,461 1,513 1,516 1,609
Provision for Loan Losses 126 126 126 82
Noninterest Income 256 262 273 351
Noninterest Expense 1,208 1,328 1,380 1,588
Income Taxes 159 134 113 88
------ ------ ------ ------
Net Income $ 224 $ 187 $ 170 $ 202
====== ====== ====== ======
Net Income Per Common Share:
Basic $ .24 $ .20 $ .18 $ .21
Diluted .24 .20 .18 .21
Note - See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for discussion of significant variations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
58
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
Director's Name, Age and Past Five Years' Principal Occupation(s)
Positions with the Bank and Other Directorships
- ----------------------- -----------------------------------------
<S> <C>
Directors with terms expiring in 1998
Barbara Barbour (59) Former co-owner and President, for more than
Director, Chairwoman of the Board five years, B & B Associates, Inc. (printing company);
and Executive Committee; Member of Chairwoman, since 1991, Bank of South Windsor;
Loan, ALCO and Budget Committees Director, since 1989, Bank of South Windsor.
Richard S. Kelley (65) President, for more than five years, RSK Kellco, Inc.
Director; Member of Audit (real estate development company); Director, since 1989,
and Executive Committees Bank of South Windsor.
Robert J. Smith (60) President, for more than five years, Smith Brothers
Director; Chairman of Budget Committee; Insurance, Inc.; Director, since 1989, Bank of
Member of ALCO, Executive and South Windsor.
Facilities Committees
Directors with terms expiring in 1999
Wayne C. Gerlt (50) Attorney, for more than five years, in private practice;
Director; Chairman of Personnel Committee; Director, since 1989, Bank of South Windsor.
Member of Audit Committee
Edward F. Havens (73) Co-owner, for more than five years, Imperial Oil
Director; Member of Loan, Executive and Plumbing Company; Director, since 1989,
and Personnel Committees Bank of South Windsor.
Barbara M. Perry (50) Owner, since 1996, Harmony Enterprises; Field
Director; Member of Loan, Community Coordinator, for three years, Connecticut Housing
Reinvestment Act and Personnel Committees Coalition; previously, Director of Housing, Urban
League of Greater Hartford; Director, since 1989,
Bank of South Windsor.
Directors with terms expiring in 2000
Salvatore Garofalo (61) Retired, for more than five years; former President,
Director S & R Sanitation Company; Director, since 1989,
Bank of South Windsor.
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Walter J. Kupchunos, Jr. (57) Sheriff of Hartford County since 1995;
Director; Member of Loan, ALCO Treasurer for more than five years,
and Personnel Committees Walmark, Inc.; Director, since 1989,
Bank of South Windsor.
Raymond H. Lefurge, Jr. (49) Partner, for more than five years,
Director; Chairman of Audit Committee; Lefurge & Gilbert, P.C.(public accounting firm);
Member of Loan and Budget Committees Director, since 1989, Bank of South Windsor.
John J. Mitchell (63) President, for more than five years, Mitchell Fuel
Director; Chairman of ALCO and Facilities Company; Director, since 1989,
Committees; Member of Loan, Audit and Bank of South Windsor.
Community Reinvestment Act Committees
J. Brian Smith (55) Senior Vice President, for more than five years,
Director; Chairman of Community Reinvestment Smith Brothers Insurance, Inc.; Director,
Act Committee; Member of Audit and since 1989, Bank of South Windsor.
Personnel Committees.
Officer's Name Age Past Five Year's Principal Occupation(s)
- -------------- --- ----------------------------------------
John R. Dunn 50 Director, President and Chief Executive Officer,
since 1996, Bank of South Windsor; President,
January 1995 to December 1995, Shawmut Bank
New York; President November 1993 to January 1995,
Shawmut Mortgage Corp.; Executive Vice President,
prior to November 1993, Shawmut National Corp.
Robert O. Ciraco 53 Executive Vice President and Chief Lending Officer,
for more than five years, Bank of South Windsor.
Solomon Kerensky 60 Secretary, for more than five years, Bank
of South Windsor; Partner, for more than five years,
Kahan, Kerensky & Capossela (law firm).
</TABLE>
Directors J. Brian Smith and Robert J. Smith are brothers. There are no family
relationships among the executive officers. There were no arrangements or
undertakings between any of the directors or executive officers pursuant to
which he or she was selected as a director or executive officer.
60
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Bank, during the
past three years to Executive Officers of the Bank:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term Compensation
-------------------------------------------------------
Annual Compensation Awards Payouts
---------------------------------- ------------------------- --------------------------
Other Restricted
Annual Stock Options/ LTIP All Other
Name and Salary Bonus Compensation Award(s) SARs Payouts Compensation
Principal Position Year ($) ($) ($) (D) ($) (#) ($) ($)(E)
- --------------------- ------- ---------- -------- -------------- ------------ --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John R. Dunn 1997 150,000 25,000 - - 11,448 - 14,400
President and 1996 127,561(A) 25,000 - - 5,000 - 14,400
Chief Executive Officer 1995 not applicable - - - - -
Robert O. Ciraco 1997 95,000 25,000 - - 5,092 - 1,080
Executive Vice 1996 92,025 12,000 - - - - 1,200
President 1995 90,100 31,857 - - - - 855
Wayne von Hardenberg 1997 85,000(B) - - - - - -
Senior Vice President 1996 82,913 10,000 - - - - -
and Chief Financial Officer 1995 80,000 16,429 - - - - -
Peter F. Govoni 1997 14,513(C) - - - - - -
Senior Vice President 1996 not applicable - - - - -
1995 not applicable - - - - -
</TABLE>
(A) Under the terms of an employment agreement effective February 20, 1996, Mr.
Dunn receives a base salary of $150,000, salary increases and bonuses as
determined by the Board of Directors of the Bank, family country club
membership, vacation, insurance and other fringe benefits commensurate with
his position as President and Chief Executive Officer. If Mr. Dunn retires
on or after reaching age 55, he or his designated beneficiary or his estate
will be entitled to receive payments equal to $50,000 per year for ten
years starting at the age of 65. If he is terminated for reasons other than
for cause after reaching age 51 but before reaching age 55, he will be
entitled to a pro rata portion of those benefits. Upon a change in control
of the Board of Directors, this retirement benefit accelerates.
(B) Mr. von Hardenberg resigned his position with the Bank effective May 29,
1997 in order to pursue other interest.
(C) Amount shown for 1997 reflects less than a full year of compensation for
Mr. Govoni who was employed by the Bank on October 27, 1997 at an annual
salary of $80,000.
(D) Amounts of "Other Annual Compensation" earned by the named executive
officers for 1997 did not meet the threshold reporting requirements.
(E) "All Other Compensation" includes the following: (1) an annual car
allowance in the amount of $14,400 paid to Mr. Dunn, and (2) employee
savings plan matching contributions were paid on behalf of Mr. Ciraco in
the amounts of $1,080, $1,200 and $855 during the years ended December 31,
1997, 1996 and 1995, respectively.
61
<PAGE>
Stock Options and Stock Appreciation Rights
The following table contains information concerning the grant of stock options
under the Bank's 1997 Incentive Stock Option Plan to the Executive Officers of
the Bank as of the end of the last fiscal year.
Individual Grants
--------------------------------------------------------
% of Total
Options/
Options/ SARs Exercise
SARs Granted to or Base
Granted Employees in Price Expiration
Name (#) (1) Fiscal Year ($/Share) Date
- ---- ------- ------------ --------- ----------
John R. Dunn 8,000 48.37 9.25 05/22/07
3,448 20.85 21.75 12/18/07
Robert O. Ciraco 4,000 24.18 9.25 05/22/07
1,092 6.60 21.75 12/18/07
Option/SAR Exercises and Holdings
The following table sets forth information with respect to the named executives,
concerning the unexercised options held as of the end of the fiscal year. No
options were exercised.
Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End
Option/SAR Values
<TABLE>
<CAPTION>
Number of Unexercised Value of Unexercised In-The-
Value Realized ($) Options/SARs at Money Options/SARs at
(Market price at Fiscal Year-End (#) Fiscal Year-End ($)
Shares acquired exercise less -------------------------- ------------------------------
Name on exercise (#) exercise price) Exercisable Unexecisable Exercisable Unexecisable
- ---- --------------- ------------------ ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
John R. Dunn - - 5,000 11,448 37,500 148,994
Robert O. Ciraco - - - 5,092 - 60,751
</TABLE>
Director Compensation
During 1997 each director of the Bank, with the exception of Mr. Dunn, received
fees for services as a director of the Bank. Such fees were $250 per Board of
Directors meeting attended. All directors, except Mr. Dunn, were paid for
attending meetings of committees of the Board of Directors. The fees paid for
attending committee meetings were $100 per meeting. In addition, Mr. Kerensky
received $100 for each Executive Committee meeting he attended and Mrs. Barbour
received a fee of $1,000 per quarter as Chairwoman.
Executive Employment Agreements
The Bank has entered into employment and/or change in control agreements with
certain of its executive officers. In addition to the agreement outlined in the
"Summary Compensation Table", Mr. Dunn is entitled to 2.99 times his base salary
plus life, health and disability insurance benefits for a three year period in
the event of termination following a change in control of the Bank, as defined
in the agreement.
62
<PAGE>
Mr. Ciraco's change in control agreement provides for a base severance payment
of an amount equal to two (2) times his base salary plus two (2) times his bonus
awarded for performance in the calendar year prior to the change in control
payable not later than three (3) months from the date his employment with the
Bank terminates. Additionally, the Bank shall maintain Mr. Ciraco's health
insurance coverage for a period of two (2) years from the date of termination of
his employment.
Mr. Govoni's change in control agreement provided for a base severance payment
of an amount equal to one-quarter (.25) times his base salary which was payable
by the Bank to Mr. Govoni for the year in which the change in control occurs.
Severance payments under this agreement are payable to Mr. Govoni not later than
three (3) months from the date his employment with the Bank terminates.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
So far as is known to the Bank, the Bank had one owner of more than 5% of common
stock as of February 28, 1998, as reflected in the table below.
Name and Address of Amount and Nature of
Title of Class Beneficial Owner Beneficial Ownership Percent of Class
-------------- --------------------- -------------------- ----------------
Common Stock New England Community 88,396 9.39
Bancorp, Inc.
176 Broad Street
Windsor, CT 06095
63
<PAGE>
According to information furnished to the Bank by its directors and executive
officers, as of February 28, 1998, the directors and executive officers,
individually and as a group, beneficially owned shares of Bank common stock as
follows:
Amount
and
Nature of
Beneficial
Beneficial Owner Ownership Percent of Class
- --------------- ----------- ----------------
Directors:
Barbara Barbour 31,114 (1) 3.02
Salvatore Garofalo 42,708 (1)(2) 4.15
Wayne C. Gerlt 14,736 (1)(3) 1.43
Edward F. Havens 17,086 (1) 1.66
Richard S. Kelley 34,268 (1) 3.33
Walter J. Kupchunos, Jr. 12,885 (1)(4) 1.25
Raymond H. Lefurge, Jr. 13,100 (1)(5) 1.27
John J. Mitchell 21,053 (1) 2.05
Barbara M. Perry 6,661 (1) *
J. Brian Smith 15,536 (1) 1.51
Robert J. Smith 15,536 (1) 1.51
Executive Officers:
John R. Dunn 7,828 (6) *
Robert O. Ciraco 668 *
Solomon Kerensky 9,889 (1) *
All directors and officers
as a group (14 persons) 243,068 (7) 23.62
* Indicates ownership of less than one percent (%) of the class.
(1) Includes 5,500 shares subject to currently exercisable options granted
under the Bank's 1990 Stock Option Plan.
(2) Includes 37,208 shares owned by Mrs. Garofalo.
(3) Includes 1,437 shares owned by Mrs. Gerlt.
(4) Includes 5,558 shares owned by Mrs. Kupchunas.
(5) Includes 300 shares held by Mr. Lefurge, Jr. as custodian for his children.
(6) Includes 5,000 shares subject to currently exercisable options granted
under the Bank's 1990 Stock Option Plan.
(7) Includes 71,000 shares subject to currently exercisable options.
64
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Directors and officers of the Bank and their associates have been customers of,
and have had transactions with the Bank, and management expects that such
persons will continue to have such transactions in the future. In the opinion of
management, all deposit accounts, loans, services and commitments comprising
such transactions were made in the ordinary course of business, on substantially
the same terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with other customers who are not directors
or officers, and the transactions did not involve more than normal risks of
collectibility or favored treatment or terms, or present other unfavorable
features. The maximum aggregate amount of indebtedness of the directors and
executive officers as a group during 1997 was $2,258,000. There were no
directors or executive officers whose maximum indebtedness to the Bank exceeded
10% of the Bank's capital during 1997.
The Bank presently leases its Main Office at 1695 Ellington Road, South Windsor
from RSK-Kellco, Inc., of which Director Richard S. Kelley is the owner. The
lease was originally entered into on February 6, 1989 and provided for an annual
rental of $147,002 in years one through five and $158,919 in years six through
ten. The Bank has the option to renew the lease for three additional five year
terms. Based on an opinion from an independent commercial real estate appraisal
firm, management believes that the terms of the lease are at least equal to the
terms of leases of space in comparable buildings in South Windsor at such time
as the lease was executed.
The law firm of Kahan, Kerensky & Capossela, of which Secretary Solomon Kerensky
is a partner, served as general counsel to the Bank and received fee
compensation for legal services performed on its behalf paid at the law firm's
usual and customary billing rates, which are comparable to rates charged by
other law firms for like services. For the year ended December 31, 1997, the law
firm of Kahan, Kerensky & Capossela was paid aggregate fees of $100,778 by the
Bank. The private law practice of Director Wayne C. Gerlt receives fee
compensation for legal services performed on behalf of the Bank paid at the law
firm's usual customary billing rates which are comparable to rates charged by
other area law firms for like services. For the year ended December 31, 1997,
the Law Offices of Wayne C. Gerlt was paid aggregate fees of $9,367 by the Bank.
65
<PAGE>
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) The financial statements listed in the index set forth in ITEM 8
of this annual report on Form 10-K are filed as part of this
annual report.
(2) The following schedule and related documents are filed as part
of this annual report on Form 10-K on the following pages:
Page
----
Report of Independent Public Accountants on Schedule II ...... 67
Schedule II - Loans to Officers, Directors
Principal Security Holders,
and any Associations of the
Foregoing Persons............................... 68
All other schedules for which provision is made in the applicable
accounting regulations are not applicable or appear in ITEM 8 of
this annual report on Form 10-K.
(b) Reports on Form 8-K:
Form 8-K filed on December 2, 1997.
Item 5 - Other Events
Reported that on November 14, 1997, Bank of South Windsor began
trading its common stock, par value $5.00 per share, on the
American Stock Exchange (Symbol: BSW).
(c) Exhibits
4. A statement regarding computation of per share earnings is
omitted because the computation can be clearly determined from
the material contained in this report.
66
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Bank of South Windsor:
We have audited, in accordance with generally accepted auditing standards, the
financial statements included in this Form 10-K, and have issued our report
thereon dated January 23, 1998 (except with respect to the matter discussed in
Note 15, as to which the date is March 19, 1998). Our audit was made for the
purpose of forming an opinion on those statements taken as a whole. The schedule
listed in the accompanying index is the responsibility of the Bank's management
and is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Hartford, Connecticut
January 23, 1998 (except with respect
to the matter in Note 15, as to which
the date is March 19, 1998)
67
<PAGE>
SCHEDULE II
Loans to Officers, Directors, Principal Security Holders
and any Associates of the Foregoing Persons
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Col. A Col. B Col. C Col. D Col. E
<S> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------
Name of Beginning Balance Amounts Amounts Ending Balance
Borrower* as of 1/1/97 Additions Collected Charged off as of 12/31/97
- ---------------------------------------------------------------------------------------------------------------------------
Directors $2,214,447 $420,456 $985,850 $ - $1,649,053
- ---------------------------------------------------------------------------------------------------------------------------
Col. A Col. B Col. C Col. D Col. E
- ---------------------------------------------------------------------------------------------------------------------------
Name of Beginning Balance Amounts Amounts Ending Balance
Borrower* as of 1/1/96 Additions Collected Charged off as of 12/31/96
- ---------------------------------------------------------------------------------------------------------------------------
Directors $3,176,109 $1,341,354 $2,303,016** $ - $2,214,447
- ---------------------------------------------------------------------------------------------------------------------------
Col. A Col. B Col. C Col. D Col. E
- ---------------------------------------------------------------------------------------------------------------------------
Name of Beginning Balance Amounts Amounts Ending Balance
Borrower* as of 1/1/95 Additions Collected Charged off as of 12/31/95
- ---------------------------------------------------------------------------------------------------------------------------
Directors $3,820,656 $761,553 $1,406,100** $ - $3,176,109
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
* All loans to officers, directors, principal security holders and any
associates of the foregoing persons were incurred as customers in the normal
course of business. These loans were made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other customers and did not involve more than the
normal risk of collectibility.
** Includes $1,143,878 and $171,728 in credit facilities obtained by directors
and officers no longer employed by the Bank at December 31, 1996 and 1995,
respectively.
68
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Bank of South Windsor
Date March 26, 1998 By /s/ John R. Dunn
---------------- ---------------------------
John R. Dunn
President and Chief Executive Officer
69
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Board of Directors
/s/ Barbara Barbour March 26, 1998
- ----------------------------------------------- ------------------
Barbara Barbour, Chairperson of the Board Date
/s/ John R. Dunn March 26, 1998
- ----------------------------------------------- ------------------
John R. Dunn, Director, President and Chief Date
Executive Officer
/s/ Salvatore Garofalo March 26, 1998
- ----------------------------------------------- ------------------
Salvatore Garofalo, Director Date
- ----------------------------------------------- ------------------
Wayne C. Gerlt, Director Date
/s/ Edward F. Havens March 26, 1998
- ----------------------------------------------- ------------------
Edward F. Havens, Director Date
/s/ Richard S. Kelley March 26, 1998
- ----------------------------------------------- ------------------
Richard S. Kelley, Director Date
/s/ Walter Kupchunos, Jr. March 26, 1998
- ----------------------------------------------- ------------------
Walter Kupchunos, Jr., Director Date
/s/ Raymond H. Lefurge, Jr. March 26, 1998
- ----------------------------------------------- ------------------
Raymond H. Lefurge, Jr., Director Date
/s/ John J. Mitchell March 26, 1998
- ----------------------------------------------- ------------------
John J. Mitchell, Director Date
/s/ Barbara M. Perry March 26, 1998
- ----------------------------------------------- ------------------
Barbara M. Perry, Director Date
70
<PAGE>
/s/ J. Brian Smith March 26, 1998
- ----------------------------------------------- ------------------
J. Brian Smith, Director Date
- ----------------------------------------------- ------------------
Robert J. Smith, Director Date
71
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON D.C. 20006
FORM 10 - Q
[ X ] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended March 31, 1998 FDIC Certificate Number 27504
-------------- -----
BANK OF SOUTH WINDSOR
- --------------------------------------------------------------------------------
(Exact name of registrant as specified its charter)
Connecticut 06-1239691
- -------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
1695 Ellington Road, South Windsor, Connecticut 06074
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (860) 644-4412
--------------------------------
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $5.00 par value - 958,289 shares as of May 11, 1998
- --------------------------------------------------------------------------------
1
<PAGE>
BANK OF SOUTH WINDSOR
FORM 10 - Q
INDEX
Page
Item 1. Financial Statements
Balance Sheets as of
March 31, 1998 (unaudited) and
December 31, 1997 .................................. 3
Statements of Operations for the
Three Months Ended
March 31, 1998 and 1997 (unaudited) ................ 4
Statements of Changes in Shareholders' Equity
for the Three Months Ended
March 31, 1998 and 1997 (unaudited) ................. 5
Statements of Cash Flows for the
Three Months Ended
March 31, 1998 and 1997 (unaudited) ................. 6
Notes to Condensed Financial Statements (unaudited) .... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................. 11
Other Information ........................................................ 18
Signatures ............................................................... 19
2
<PAGE>
BALANCE SHEETS
Bank of South Windsor
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997
- ----------------------------------------------------------------------------------------------------------
(UNAUDITED) (NOTE 1)
<S> <C> <C>
Assets
Cash and Due from Banks $ 6,605 $ 7,591
Interest Bearing Deposits with Banks 291 394
Federal Funds Sold 6,000 1,900
Securities Available for Sale - at market value
(amortized cost of $42,160 in 1998 and $42,867 in 1997) 42,410 43,202
Securities Held to Maturity - at amortized cost
(market value of $465 in 1998 and $976 in 1997) 500 1,000
-------- --------
Total Securities 42,910 44,202
-------- --------
Loans 95,827 99,947
Less: Reserve for Loan Losses (2,171) (2,156)
-------- --------
Net Loans 93,656 97,791
-------- --------
Other Real Estate Owned, Net - 212
Premises and Equipment 988 1,009
Accrued Interest Receivable 1,030 1,085
Deferred Income Taxes 292 257
Other Assets 836 682
-------- --------
Total Assets $152,608 $155,123
======== ========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Noninterest Bearing $ 29,643 $ 29,989
Interest Bearing 99,310 102,914
-------- --------
Total Deposits 128,953 132,903
Funds Borrowed 11,895 10,610
Accrued Interest Payable 145 140
Current Income Taxes 133 312
Other Liabilities 300 321
-------- --------
Total Liabilities 141,426 144,286
-------- --------
Commitments and Contingencies
Shareholders' Equity: Common Stock - par value $5 per share:
Authorized shares - 1,300,000
Issued shares - 958,289 4,791 4,791
Additional Paid-in Capital 3,799 3,799
Net Unrealized Gains on Securities Available for
Sale, Net of Taxes 147 198
Retained Earnings 2,445 2,049
-------- --------
Total Shareholders' Equity 11,182 10,837
-------- --------
Total Liabilities and Shareholders' Equity $152,608 $155,123
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
STATEMENTS OF OPERATIONS
Bank of South Windsor
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997
- ------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Interest Income:
Interest and Fees on Loans $2,398 $2,135
Interest and Dividends on Investments:
Interest 671 431
Dividends 21 16
Interest on Federal Funds Sold 30 1
Interest on Interest Bearing Deposits with Banks 4 6
------ ------
Total Interest Income 3,124 2,589
------ ------
Interest Expense:
Interest on Deposits 966 893
Interest on Funds Borrowed 159 91
------ ------
Total Interest Expense 1,125 984
------ ------
Net Interest Income 1,999 1,605
Provision for Loan Losses 90 105
------ ------
Net Interest Income after Provision for Loan Losses 1,909 1,500
------ ------
Noninterest Income:
Service Charges on Deposit Accounts 137 177
Commissions and Fees 46 70
Securities Gains, Net 12 27
Other 21 33
------ ------
Total Noninterest Income 216 307
------ ------
Noninterest Expense:
Salaries and Employee Benefits 808 705
Occupancy and Equipment 213 227
Computer Services 70 81
Outside Services 66 57
Printing and Stationery 52 44
Legal 33 41
Marketing 17 25
Other Real Estate Owned, Net of Gains (146) 48
Other 303 224
------ ------
Total Noninterest Expense 1,416 1,452
------ ------
Income Before Income Taxes 709 355
Income Taxes 265 144
------ ------
Net Income $ 444 $ 211
====== ======
Average Common Shares Outstanding:
Basic 958,289 941,239
Diluted 1,035,596 941,239
Net Income Per Common Share:
Basic $.46 $.22
Diluted $.43 $.22
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Bank of South Windsor
<TABLE>
<CAPTION>
Net
Unrealized
Gains (Losses)
Additional on Securities
Common Paid-in Available Retained
(dollars in thousands, except per share amounts) Stock Capital for Sale Earnings Total
- ------------------------------------------------------ ---------- ------------- --------------- ------------ ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $4,706 $3,730 $(116) $ 941 $ 9,261
Comprehensive Income (Loss):
Net Income -- -- -- 211 211
Increase in Net Unrealized Losses on Securities
Available for Sale, Net of Taxes -- -- (232) -- (232)
------ ------ ----- ------ -------
Total Comprehensive Income (Loss) -- -- -- -- (21)
Common Stock Cash Dividends ($.03 per share) -- -- -- (28) (28)
------ ------ ----- ------ -------
Balance, March 31, 1997 $4,706 $3,730 $(348) $1,124 $ 9,212
====== ====== ===== ====== =======
Balance, December 31, 1997 $4,791 $3,799 $ 198 $2,049 $10,837
Comprehensive Income (Loss):
Net Income -- -- -- 444 444
Decrease in Net Unrealized Gains on Securities
Available for Sale, Net of Taxes -- -- (51) -- (51)
------ ------ ----- ------ -------
Total Comprehensive Income -- -- -- -- 393
Common Stock Cash Dividends ($.05 per share) -- -- -- (48) (48)
------ ------ ----- ------ -------
Balance, March 31, 1998 $4,791 $3,799 $ 147 $2,445 $11,182
====== ====== ===== ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
STATEMENTS OF CASH FLOWS
Bank of South Windsor
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
(DOLLARS IN THOUSANDS) 1998 1997
- ---------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C>
Operating Activities:
Net Income $ 444 $ 211
------- ----------
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Loan Losses 90 105
Provision for Depreciation and Amortization 72 76
Provision for Losses on Other Real Estate Owned - 30
Securities Gains, Net (12) (27)
Net Gain on Sales of Other Real Estate Owned (92) (15)
Amortization (Accretion) of Premiums/Discounts on Securities 34 13
(Increase) Decrease in Deferred Income Tax Asset (35) 94
Decrease (Increase) in Accrued Interest Receivable 55 (41)
Increase in Accrued Interest Payable 5 14
Other, Net (249) (44)
------- ----------
Net Cash Provided by Operating Activities 312 416
------- ----------
Investing Activities:
Securities Available for Sale:
Proceeds from Sales of Securities 4,962 3,860
Proceeds from Maturities of Securities 1,611 156
Purchases of Securities (5,920) (7,962)
Securities Held to Maturity:
Proceeds from Maturities of Securities 500 --
Repayments (Originations) of Loans, Net 3,957 (2,307)
Purchases of Premises and Equipment (35) (27)
Proceeds from Sales of Other Real Estate Owned 337 451
------- ----------
Net Cash Provided by (Used for) Investing Activities 5,412 (5,829)
------- ----------
Financing Activities:
Net (Decrease) Increase in Deposits Other than Certificates of Deposit (3,142) 521
Net (Decrease) Increase in Certificates of Deposit (808) 1,266
Net Increase in Funds Borrowed 1,285 6,839
Cash Dividends Paid (48) (28)
------- ----------
Net Cash (Used for) Provided by Financing Activities (2,713) 8,598
------- ----------
Net Increase in Cash and Cash Equivalents 3,011 3,185
Cash and Cash Equivalents at Beginning of Period 9,885 8,593
------- ----------
Cash and Cash Equivalents at End of Period $12,896 $ 11,778
======= ========
Supplemental Information on Cash Paid For:
Interest $ 1,120 $ 970
Income Taxes 444 --
Noncash Investing and Financing Activities:
Increase in Unrealized Loss on Securities Available for Sale
Recognized in Shareholders' Equity (51) (232)
Transfer from Loans to Other Real Estate Owned -- --
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited)
Bank of South Windsor
Note 1 - Basis Of Presentation
- ------------------------------
Bank of South Windsor (the "Bank") is a state chartered bank organized under the
laws of the State of Connecticut engaged in the commercial banking business.
Based in South Windsor, Connecticut the Bank operates two (2) branch banking
offices located in East Hartford and Vernon, Connecticut. Its primary source of
revenue is providing loans to customers, who are predominantly small- to
mid-sized businesses as well as individuals generally residing within the Bank's
service area.
The balance sheet as of March 31, 1998 and the statements of operations,
shareholders' equity and cash flows for the three month periods ended March 31,
1998 and 1997 have been prepared by the Bank without audit. Certain amounts for
prior periods have been reclassified to conform with the current period
presentation.
In the opinion of management, the financial statements have been prepared in
conformity with generally accepted accounting principles for interim financial
statements and include all adjustments necessary to present fairly the financial
position of the Bank as of March 31, 1998 and the results of operations, changes
in shareholders' equity and cash flows for the three month periods ended March
31, 1998 and 1997. Results of operations for the three months ended March 31,
1998 are not necessarily indicative of results for any other period.
The balance sheet as of December 31, 1997, which has been included for
comparative purposes, has been condensed from the audited statements for the
year then ended. Certain information and note disclosures normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements should be
read in conjunction with the financial statements and notes thereto included in
the Bank's annual report on Form 10-K for the year ended December 31, 1997.
Note 2 - Merger Agreement
- -------------------------
On March 19, 1998, the Bank announced a definitive agreement with New England
Community Bancorp, Inc. ("NECB") to merge the Bank into and with New England
Bank & Trust Company, a wholly-owned subsidiary of NECB. Under the proposed
merger, which is subject to various conditions including regulatory approvals
and approval by the shareholders of both the Bank and NECB (if legally
required), each share of the Bank's common stock will convert into 1.3204 shares
of NECB common stock, subject to adjustment under certain circumstances. In
connection with the merger agreement, the Bank and NECB entered into a stock
option agreement dated March 19, 1998 pursuant to which NECB will have an option
to purchase 215,000 shares of the Bank's common stock at $12.00 per share, which
option is exercisable in certain circumstances. Management expects that the
proposed transaction will close in the third quarter of 1998.
7
<PAGE>
Note 3 - Securities
- -------------------
Securities available for sale and held to maturity, by type, were:
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31, 1997
-------------------------------- ------------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-------------- --------------- --------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Available For Sale:
U.S. Treasury $ 518 $ 520 $ 520 $ 520
U.S. Government agencies 12,218 12,377 17,434 17,585
Mortgage-backed securities 21,981 22,103 19,300 19,508
Obligations of states and
political subdivisions 5,848 5,844 3,766 3,774
Other debt securities 300 271 552 520
Federal Home Loan Bank stock 1,295 1,295 1,295 1,295
------- ------- ------- -------
$42,160 $42,410 $42,867 $43,202
======= ======= ======= =======
Held To Maturity:
U.S. Government agencies $ 500 $ 465 $ 1,000 $ 976
======= ======= ======= =======
</TABLE>
Securities classified as available for sale are carried on the Bank's balance
sheet at fair value while securities classified as held to maturity are carried
at amortized cost.
Note 4 - Loans
- --------------
The composition of the loan portfolio was:
<TABLE>
<CAPTION>
MARCH 31, DEC. 31,
1998 1997
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Real estate:
Construction $ 3,388 $ 3,112
Secured by 1 to 4 family residential property 40,396 42,894
Secured by commercial property 32,278 34,046
-------- --------
76,062 80,052
Commercial 15,513 15,523
Installment 4,252 4,372
-------- -------
Total loans $95,827 $99,947
======= =======
</TABLE>
8
<PAGE>
Note 5 - Reserves for Loan and Other Real Estate Owned Losses
- -------------------------------------------------------------
Changes in the reserves were:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------------------
1998 1997
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Reserve for loan losses:
Balance, beginning of year $2,156 $1,973
Provision charged to expense 90 105
Loan charge-offs (163) (18)
Recoveries 88 6
------ ------
Balance, end of period $2,171 $2,066
====== ======
Reserve for other real estate owned losses:
Balance, beginning of year $ 32 $ 50
Provision (reversed) charged to expense (32) 30
Other real estate owned write-downs -- --
------ ------
Balance, end of period $ -- $ 80
====== ======
</TABLE>
Note 6 - Per Common Share Data
- ------------------------------
The Bank adopted Statement of Financial Accounting Standards No. 128, "Earnings
per Share" (SFAS 128), effective December 15, 1997. Upon adoption of SFAS 128,
all prior period earnings per share data were restated to conform with the new
statement. The Statement replaced the presentation of primary earnings per share
with the presentation of basic earnings per share. It also requires the
presentation of basic and diluted earnings per share in the statements of
operations. Basic earnings per common share were computed by dividing net income
by the weighted average number of shares of common stock outstanding during the
period (958,289 shares and 941,239 shares for the periods ended March 31, 1998
and 1997, respectively). Diluted earnings per common share were computed by
dividing net income by the weighted average number of shares of common stock
outstanding during the period, increased by the number of shares issuable on the
exercise of stock options, if dilutive, based upon the treasury stock method.
The effect of the stock options in 1998 was to increase shares used in the
diluted earnings per share calculation by 77,307 shares. The effect of the stock
options outstanding in 1997 was anti-dilutive and therefore not reflected in the
computation of per common share amounts.
Note 7 - Comprehensive Income
- -----------------------------
The Bank adopted Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS 130) effective January 1, 1998. This Statement
established standards for separately reporting comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. Components of comprehensive income
represent changes in equity resulting from transactions and other events and
circumstances from nonowner sources. This Statement is effective for fiscal
years beginning after December 15, 1997, and reclassification of financial
statements for earlier periods provided for comparative purposes is required.
Comprehensive income for the periods ended March 31, 1998 and 1997 is as
follows:
9
<PAGE>
<TABLE>
<CAPTION>
MARCH 31,
------------------------------
1998 1997
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
Net income $444 $211
Other comprehensive income, net of tax
Unrealized gains (losses) on securities:
Change in unrealized holding gains (losses)
arising during the period (39) (205)
Less: reclassification adjustment for gains
included in net income (12) (27)
---- ----
Comprehensive income (loss) $393 $(21)
==== ====
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTH PERIODS
-------------------------------------
ENDED MARCH 31, 1998 AND 1997
-----------------------------
SUMMARY - For the three months ended March 31, 1998, the Bank reported net
income of $444,000, or $.43 per diluted common share, compared to net income of
$211,000, or $.22 per diluted common share, for the same period in 1997. Net
interest income increased $394,000 or 24.5% in 1998 compared to 1997 mainly due
to increased volumes in the Bank's securities portfolio. Included in first
quarter 1998 earnings is a gain recorded on the sale of other real estate owned
of $92,000 compared to $15,000 for the same period in 1997.
The amount provided by the Bank as a provision for loan losses was $90,000 for
the first three months of 1998 compared to $105,000 for the same period in 1997.
In addition, the Bank provided $30,000 in 1997 as a provision for other real
estate owned losses. The Bank reversed the remaining balance in the reserve for
other real estate owned losses in the amount of $32,000 following the sale of
the remaining property during the first quarter of 1998.
Asset quality improved as nonperforming loans and other real estate owned were
$630,000 as of March 31, 1998 or .4% of total assets, reflecting decreases of
25.8% and 72.1% compared to December 31, 1997 and March 31, 1997 levels of
$849,000 and $2,257,000, respectively. This decline is indicative of the success
of management's focused efforts on the resolution of nonperforming assets on an
individual basis during the period. Loan and other real estate owned charge-offs
and write-downs were $163,000 in the first three months of 1998 compared to
$18,000 for the same period in 1997.
ASSET QUALITY - The Bank grants commercial, residential and consumer loans
principally in Hartford and Tolland counties in Connecticut. Although the Bank
has a diversified loan portfolio, a significant portion of its borrowers'
ability to honor their contracts is dependent upon the real estate sector of the
economy in its market areas. Loans outstanding for which the primary source of
repayment is the sale of real estate collateral or cash flow from income
producing properties were approximately $35,666,000 as of March 31, 1998.
The Bank's reserve for loan losses as a percentage of nonperforming loans
increased to 344.6% as of March 31, 1998 from 338.5% as of December 31, 1997 and
149.5% as of March 31, 1997. The nonperforming loan coverage ratio is dependent
upon several factors including the quality and estimated value of underlying
collateral held on nonperforming loans. The review and evaluation of
nonperforming loans and the carrying value of other real estate owned are
performed quarterly. The following table summarizes the balances of
nonperforming assets for the dates indicated.
MARCH 31, DEC. 31, MARCH 31,
1998 1997 1997
---- ---- ----
(IN THOUSANDS)
Nonaccrual loans $630 $528 $1,377
Loans 90 days past due and
still accruing interest -- 109 5
---- ---- ------
Nonperforming loans 630 637 1,382
Other real estate owned, net -- 212 875
---- ---- ------
Total nonperforming assets $630 $849 $2,257
==== ==== ======
The continued decline in nonperforming assets from $2,257,000 as of March 31,
1997 to $630,000 as of March 31, 1998 reflects management's focused efforts on
their resolution. Nonperforming loans and other real estate owned as of March
31, 1998 reflects a decrease of 25.8% from December 31, 1997 and a drop of 72.1%
from
11
<PAGE>
March 31, 1997. Contributing to the actual decline for the first quarter of 1998
compared to year-end 1997 were loan charge-offs $163,000.
NET INTEREST INCOME - Net interest income, the difference between interest
earned on interest earning assets and interest expense incurred on interest
bearing liabilities, is a significant component of the Bank's operating results.
Net interest income is affected by changes in the volumes and rates of interest
earning assets and interest bearing liabilities, the volume of interest earning
assets funded with low cost deposits, noninterest bearing deposits and
shareholders' equity, and the level of nonperforming assets.
The following table summarizes net interest income, as reflected in the schedule
presented on page 16, for the three months ended March 31, 1998 and 1997. The
effects of the changes in volume and interest rates on net interest income
during the three months ended March 31, 1998 and 1997 are shown in the schedule
on page 17.
CHANGE FROM
THREE MONTHS ENDED PRIOR YEAR
MARCH 31, INCREASE
--------- --------
1998 1997 AMOUNT PERCENT
---- ---- ------ -------
(DOLLARS IN THOUSANDS)
Interest income $3,124 $2,589 $535 20.7%
Interest expense 1,125 984 141 14.3
------ ------ ---- ----
Net interest income $1,999 $1,605 $394 24.5
====== ====== ====
Average interest earning assets increased by $16,853,000 or 13.2% to
$144,301,000 for the three months ended March 31, 1998 from $127,448,000 from
the same period in 1997 reflecting growth in the Bank's invested funds
portfolio.
The Bank's interest rate spread was 4.71% for the quarter ended March 31, 1998
compared to 4.31% for the same period in 1997. The ratio of net interest income
to average interest earning assets was 5.62% for the three months ended March
31, 1998 compared to 5.11% for the same period in 1997. The increase in the
Bank's interest rate spread in 1998 compared to 1997 is primarily attributable
to a proportionately greater increase in the average yield on earning assets
compared with the average interest rate of funds. The increase in the average
yield on earning assets, in turn, is attributable principally to the Bank's
decrease in average nonperforming assets of $1,783,000 or 70.7%, after
charge-offs and write-downs, during the first three months of 1998 compared to
the same period in 1997.
The increase in net interest income of $394,000 or 24.5% reflects increases in
the average volume of the Bank's invested funds portfolio of $18,938,000 as well
as increased interest and fees on loans in the amount of $263,000. In addition,
average noninterest bearing demand deposits increased by $3,750,000 or 15.1%
during the first quarter of 1998 compared to 1997 which helped reduce the Bank's
cost of funds and thus had a positive effect on net interest income.
PROVISION FOR LOAN LOSSES - For the three months ended March 31, 1998 and 1997,
the provisions for loan losses were $90,000 and $105,000, respectively. Net loan
charge-offs totaled $163,000 for the first quarter of 1998 compared to $12,000
for the same period in 1997. The reserve for loan losses was $2,171,000 or 2.27%
of outstanding loans as of March 31, 1998 compared to $2,066,000 or 2.04% of
outstanding loans as of March 31, 1997. Nonperforming loans were $630,000 as of
March 31, 1998 and $1,382,000 as of March 31, 1997, representing .66% and 1.36%,
respectively, of outstanding loans. The reserve coverage on nonperforming loans
increased to 344.60% as of March 31, 1998 from 338.46% as of year-end 1997 and
from 149.49% as of March 31, 1997.
12
<PAGE>
The reserve for loan losses is established by management. Its adequacy is
monitored based on internal credit review and analysis of the loan portfolio
which considers current economic conditions and their probable effect on
borrowers, the amount of nonperforming loans and related collateral, the amount
of charge-offs during the period and other relevant factors. This evaluation is
inherently subjective because it requires material estimates including the
amounts and timing of future cash flows expected to be received on impaired
loans that may be susceptible to significant change.
NONINTEREST INCOME - Total noninterest income decreased by $91,000 or 29.6% to
$216,000 in the first quarter of 1998 from $307,000 for the same period in 1997.
This decrease resulted primarily from decreased service charges on deposit
accounts in the amount of $40,000 related to lower average levels of overdrafts
and decreased commissions and fees in the amount of $24,000 related to the sale
of merchant credit card processing during the third quarter of 1997.
During the first quarter of 1998, the Bank recognized total net securities gains
of $12,000 on the sale of several securities available for sale compared to
$27,000 for the same period in 1997.
NONINTEREST EXPENSE - Operating expenses decreased $36,000 or 2.5% to $1,416,000
in the first three months of 1998 from $1,452,000 in 1997. The following table
presents a comparison of the components of noninterest expense.
THREE MONTHS ENDED INCREASE
MARCH 31, (DECREASE)
--------- ----------
1998 1997 AMOUNT PERCENT
(DOLLARS IN THOUSANDS)
Salaries and employee benefits $ 808 $ 705 $103 14.6%
Occupancy and equipment 213 227 (14) (6.2)
Computer services 70 81 (11) (13.6)
Outside services 66 57 9 15.8
Printing and stationery 52 44 8 18.2
Legal 33 41 (8) (19.5)
Marketing 17 25 (8) (32.0)
Other real estate owned, net (146) 48 (194) (404.2)
Other 303 224 79 35.3
------ ------ ----
Total noninterest expense $1,416 $1,452 $(36) (2.5)
====== ====== ====
Salaries and employee benefits were $103,000 or 14.6% higher in 1998 compared to
1997 reflecting scheduled employee annual salary increases and increased
mortgage origination commissions as well as higher group medical and bonus
accrual expenses. Average full time equivalent employees increased 2.5 persons
during the first quarter of 1998 compared to 1997.
The expenses related to other real estate owned, net decreased by $194,000 or
404.2% principally as a result of the sale of the remaining property during the
first quarter of 1998. The sale resulted in a gain of $92,000 as well as the
reversal of the remaining $32,000 reserve for other real estate losses and the
recovery of $16,000 of insurance expenses and $6,000 of property taxes
previously paid on this property.
The increase in other noninterest expenses reflected a net increase in a number
of miscellaneous expense categories. The most significant of these categories
were increased telephone expenses incurred in 1998 resulting from the relocation
of the Bank's operation center and increased expenditures related to increased
mortgage originations for the secondary market.
PROVISION FOR INCOME TAXES - The provision for income taxes for the quarters
ended March 31, 1998 and 1997 was $265,000 and $144,000, respectively,
representing effective tax rates of 37.4% and 40.6%, respectively. For
13
<PAGE>
the three months ended March 31, 1998 and 1997, the Bank recorded income tax
expense at rates that approximate statutory tax rates.
LIQUIDITY - The liquidity of a banking institution reflects its ability to
provide funds to meet loan requests, to accommodate possible outflows in
deposits and to take advantage of interest rate market opportunities. Funding of
loan requests, providing for liability outflows and management of interest rate
fluctuations require continuous analysis in order to match the maturities of
specific categories of short-term loans and investments with specific types of
deposits and borrowings. Bank liquidity is thus normally considered in terms of
the nature and mix of a banking institution's sources and uses of funds. The
Bank's Asset Liability Committee is responsible for implementing the Board of
Directors' policies and guidelines for the maintenance of prudent levels of
liquidity.
The Bank's principal sources of funds for operations are cash flows generated
from earnings, deposits, loan repayments, borrowings from correspondent banks
and securities sold under repurchase agreements. Such sources are supplemented
by interest bearing deposits with banks, Federal funds sold and unencumbered
securities available for sale. Brokered deposits were not utilized as a source
of funds during 1998 or 1997, and none were outstanding as of quarter-end.
The Bank is a member of the Federal Home Loan Bank of Boston (the "FHLB"), which
makes substantial borrowings available to its members. The Bank maintains an
interest bearing demand deposit account with the FHLB through which the Bank can
access a $3,100,000 line of credit. This line of credit provides an alternate
source of funding for the Bank which would otherwise be dependent upon
commercial bank lines of credit or Federal funds purchased. In addition, the
Bank has the ability to obtain $54,832,000 as of March 31, 1998, in advances
from the FHLB.
The inflow and outflow of funds is detailed in the Bank's statements of cash
flows for the three months ended March 31, 1998 and 1997 and is summarized
below.
During the quarter ended March 31, 1998, cash and cash equivalents have
increased by $3,011,000, as net cash provided by operating activities and
investing activities exceeded the $2,713,000 of net cash used for financing
activities.
Net cash provided by investing activities was $5,412,000 for the three months
ended March 31, 1998. During the first three months of 1998, the Bank
experienced net repayments of loans totaling $3,957,000 and realized $337,000 in
proceeds from the sale of other real estate owned.
The net cash used for financing activities of $2,713,000 for the first three
months of 1998 primarily reflected net decreases in deposits of $3,950,000 which
were partially offset by a net increase in funds borrowed of $1,285,000. The
increase in funds borrowed represented higher amounts of customer repurchase
agreements.
Closely related to the concept of liquidity is the management of interest
earning assets and interest bearing liabilities, which focuses on maintaining
stability in the interest rate spread, an important factor in earnings growth
and stability. Emphasis is placed on maintaining a controlled rate sensitivity
position to avoid wide swings in interest rate spreads and to minimize risk due
to changes in interest rates.
An asset or liability is considered rate sensitive within a specified period
when it matures or could be repriced within such period in accordance with its
contractual terms.
Interest rate risk of the Bank is managed by an Asset Liability Committee of the
Board of Directors which meets quarterly. The Management ALCO Committee, made up
of executive and senior officers of the Bank, meets monthly to assess interest
rate risk and review and recommend appropriate strategies to the Asset Liability
Committee.
CAPITAL RESOURCES - The Bank is subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
14
<PAGE>
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Bank's financial statements.
The regulations require the Bank to meet specific capital adequacy 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 classifications are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tier 1 leverage capital (as defined in banking regulations)
to total average assets (as defined), and minimum ratios of Tier 1 and total
capital (as defined) to risk-weighted assets (as defined). To be considered
adequately capitalized (as defined) under the regulatory framework for Prompt
Corrective Action, the Bank must maintain minimum Tier 1 leverage, Tier 1
risk-based and total risk-based ratios as set forth in the table.
As of March 31, 1998, management believes that the Bank has met all capital
adequacy requirements to which it is subject. To be categorized as well
capitalized, the Bank must maintain the ratios set forth in the following table.
Management believes that there are no events or conditions which have occurred
that would change its category.
The Bank's actual capital amounts and ratios were (dollars in thousands):
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
CAPITAL ADEQUACY UNDER PROMPT CORRECTIVE ACTION
-------------------------------------------- ------------------------------------
ACTUAL REQUIRED REQUIRED
AMOUNT RATIO RATIO AMOUNT RATIO
----- ----- ----- ------ -----
<S> <C> <C> <C> <C> <C>
March 31, 1998:
Tier 1 Leverage Capital (to
Total Average Assets) $11,035 7.14% 4.00% $7,728 5.00%
Tier 1 Capital (to Risk-
Weighted Assets) $11,035 11.38% 4.00% $5,816 6.00%
Total Capital (to Risk-
Weighted Assets) $12,259 12.65% 8.00% $9,693 10.00%
</TABLE>
On February 15, 1998, the Board of Directors of the Bank declared an increased
cash dividend of $.05 per common share payable on February 27, 1998 to
shareholders of record on February 13, 1998. Subsequent to March 31, 1998, the
Board of Directors of the Bank declared a cash dividend of $.05 per common share
payable on May 27, 1998 to shareholders of record on May 13, 1998.
15
<PAGE>
Average Balance Sheet, Net Interest Income and Interest Rates
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATES BALANCE INTEREST RATES
------- ------- ----- ------- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
Interest bearing deposits with banks $ 315 $ 4 5.15% $ 467 $ 6 5.21%
Federal funds sold 2,253 30 5.40 77 1 5.27
Securities 44,055 692 6.37 27,141 447 6.68
Loans 97,678 2,398 9.96 99,763 2,135 8.68
----------- -------- --------- --------
Total interest earning assets 144,301 3,124 8.78 127,448 2,589 8.24
----------- -------- --------- --------
Noninterest earning assets:
Cash and due from banks 6,377 6,554
Other real estate owned, net 28 1,223
Premises and equipment 993 914
Other assets 5,313 2,483
Reserve for loan losses (2,211) (2,011)
----------- ---------
Total noninterest earning assets 10,500 9,163
----------- --------
Total assets $ 154,801 $ 136,611
=========== =========
Liabilities and Shareholders' Equity
Interest bearing liabilities:
Deposits:
Now $ 12,687 47 1.50 $ 11,309 42 1.51
Savings 25,913 144 2.25 26,596 149 2.27
Money market 5,859 34 2.35 6,521 36 2.24
Time 55,813 741 5.38 50,459 666 5.35
----------- -------- --------- --------
Total interest bearing deposits 100,272 966 3.91 94,885 893 3.82
Short-term funds 3,280 32 3.96 6,786 91 5.44
Long-term funds 8,500 127 6.06 -- -- --
----------- -------- --------- --------
Total interest bearing liabilities 112,052 1,125 4.07 101,671 984 3.93
----------- -------- --------- --------
Noninterest bearing liabilities:
Demand deposits 28,644 24,894
Other liabilities 3,040 616
----------- ---------
Total noninterest bearing liabilities 31,684 25,510
Shareholders' equity 11,065 9,430
----------- ---------
Total liabilities and shareholders' equity $ 154,801 $ 136,611
=========== =========
Net interest income $ 1,999 $ 1,605
======== =======
Interest rate spread 4.71% 4.31%
======= ======
Interest rate margin 5.62% 5.11%
======= ======
</TABLE>
Computed on an annualized basis. Average balances for loans includes nonaccrual
and renegotiated balances.
16
<PAGE>
Rate/Volume Analysis
- --------------------
<TABLE>
<CAPTION>
FIRST QUARTER OF 1998 VS.
FIRST QUARTER OF 1997
----------------------------------------------
INCREASE (DECREASE)
DUE TO CHANGE IN
------------------------------- TOTAL
AVERAGE AVERAGE INCREASE
VOLUME RATE (DECREASE)
------- -------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Interest Income:
Loans $ (19) $ 282 $ 263
Securities 261 (16) 245
Interest bearing deposits with banks (2) -- (2)
Federal funds sold 29 -- 29
------ ----- -----
Total interest income 269 266 535
------ ----- -----
Interest Expense:
Interest bearing deposits:
Now 5 -- 5
Savings (5) -- (5)
Money market (4) 2 (2)
Time 65 10 75
------ ----- -----
Total 61 12 73
Short-term funds (39) (20) (59)
Long-term funds 64 63 127
------ ----- -----
Total interest expense 86 55 141
------ ----- -----
Change in net interest income $ 183 $ 211 $ 394
====== ===== =====
</TABLE>
The changes in interest due to both rate and volume have been allocated to the
changes due to volume and changes due to rate in proportion to the relationship
of the absolute dollar amounts of the changes in each.
17
<PAGE>
OTHER INFORMATION
On March 19, 1998, the Bank announced a definitive agreement with New England
Community Bancorp, Inc. ("NECB") to merge the Bank into and with New England
Bank & Trust Company, a wholly-owned subsidiary of NECB. Under the proposed
merger, which is subject to various conditions including regulatory approvals
and approval by the shareholders of both the Bank and NECB (if legally
required), each share of the Bank's common stock will convert into 1.3204 shares
of NECB common stock, subject to adjustment under certain circumstances. In
connection with the merger agreement, the Bank and NECB entered into a stock
option agreement dated March 19, 1998 pursuant to which NECB will have an option
to purchase 215,000 shares of the Bank's common stock at $12.00 per share, which
option is exercisable in certain circumstances. Management expects that the
proposed transaction will close in the third quarter of 1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BANK OF SOUTH WINDSOR
--------------------------------
(Registrant)
Date: May 13, 1998 /s/ John R. Dunn
---------------- --------------------------------
John R. Dunn
President and Chief
Executive Officer
Date May 13, 1998 /s/ Kathleen H. Demers
--------------- --------------------------------
Kathleen H. Demers
Vice President and Controller
