.<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[xx] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-14853
EASTERN BANCORP, INC.
----------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 03-0304472
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
537 Central Avenue, Dover, New Hampshire 03820
- ---------------------------------------- --------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (603) 749-2150
Securities registered pursuant to Section 12(b) of the Act:
(Not applicable)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
----------------------------------------------------------------------
(Title of class)
Indicate by check mark whether the registrant (l) 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 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.
Yes No X
----- -----
Based upon the closing price of the registrant's common stock as of
December 5, 1996, the aggregate market value of the voting stock held by
nonaffiliates of the registrant is $65,045,338. Solely for purposes of this
calculation, the shares held by officers and directors of the registrant are
deemed to be shares held by affiliates.
The number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date is:
Class: Common Stock, par value $0.01 per share.
Outstanding at December 5, 1996: 3,683,526 shares.
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
PRELIMINARY NOTE IN REGARD TO FORWARD-LOOKING STATEMENTS. This annual
report on Form 10-K contains forward-looking statements. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes," "anticipates," "plans," "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of
important factors that could cause the registrant's actual results to differ
materially from those contemplated by such forward-looking statements. These
factors include, without limitation, those set forth below under the caption
"Certain Factors That May Affect Future Results."
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS. The following important
factors, among others, could cause actual results to differ materially from
those contemplated by forward-looking statements made in this annual report on
Form 10-K or presented elsewhere by management from time to time. Defined terms
used elsewhere in this annual report have the same meanings herein as therein.
A number of uncertainties exist that could affect the Company's future
operating results, including, without limitation, the Bank's continued ability
to originate quality loans (loan originations increased significantly for fiscal
1996 compared to fiscal 1995), fluctuation of interest rates, real estate market
conditions in the Bank's lending areas, general and local economic conditions,
the Bank's continued ability to attract and retain deposits, the Company's
ability to control costs, new accounting pronouncements, and changing regulatory
requirements.
A new concern involves regulatory and stockholder approval of the
Agreement and Plan of Reorganization (the Merger Agreement) dated November
13, 1996 by and among the Company. The Bank, and Vermont Financial Services
Corp. (VFSC) which is described in Item 1 and note 20 of the notes to
consolidated financial statements. While management does not anticipate a
negative response from the regulatory bodies or the stockholders of the
Company or VFSC, failure to approve the agreement could materially impact the
future performance of the Company because of distraction of management's
attention, fees, and restrictions on interim operations.
The Merger Agreement sets forth certain restrictions on activities of the
Company and its subsidiaries which are not in the ordinary and usual course of
business consistent with past practices and must be adhered to until the
effective date of the Merger. These restrictions include ,but are not limited
to, (i) the execution of any material contract or incurrence of any material
obligation outside the ordinary course of business, (ii) the declaration or
payment of any dividends or other distributions to stockholders that are in any
way inconsistent with prior practices, (iii) the amendment, in any material
respect, of the Company's employee benefit plans or employment contracts, (iv)
the issuance of any shares of its capital stock or grant of any options except
in fulfillment of pre-existing option plans, (v) the incurrence of any
additional debt obligation except in the ordinary course of business consistent
with past practices or to any capital expenditures above certain monetary
limits, (vi) and the making of any loans or extensions of credit other than
those which are on customary terms, conditions and standards.
As a result of the Deposit Insurance Funds Act of 1996 the Secretary of the
Treasury is to review recommendations in 1997 for the establishment of a common
charter for banks and savings associations. Accordingly, the Bank may be
required to convert its federal savings bank charter to either a national bank
charter, a state depository institution charter, or a newly designed charter.
The Company may also become regulated at the holding company level by the Board
of Governors of the Federal Reserve System (Federal Reserve) rather than by the
OTS. Regulation by the Federal Reserve could subject Eastern to capital
requirements that are not currently applicable to the Company as a holding
company under OTS regulation and may result in statutory limitations on the
type of business activities in which the Company may engage at the holding
company level, which business activities currently are not restricted. The
Company is unable to predict whether such initiatives will result in enacted
legislation requiring a charter change and if so whether the charter change
would significantly impact the Company's operations.
Revenue generated by the Company is highly dependent on its asset/liability
management policies. While
2
<PAGE>
management has considerable experience in asset/liability management, future
changes in the general direction of interest rates and the overall economy could
negatively impact net interest margin. Currently, a 100 basis point increase or
decrease would not impact net interest margin by more than ten percent.
The Company's operating results are negatively affected by its
nonperforming assets. Management strives to reduce nonperforming assets. (The
Company was unable to reduce nonperforming assets during the first quarter of
fiscal 1996 primarily because of increased delinquencies in the Bank's consumer
loan portfolio. Nonperforming assets began to decrease again during the second
quarter of fiscal 1996 and continued to decline through the fourth quarter of
fiscal 1996). Future changes in the national or local economy, fluctuations in
interest rates, and changes in the real estate market could limit or prevent
future nonperforming asset reduction and negatively impact results.
Operating results are affected by the adequacy of the Company's loan loss
reserve to cover loan losses. Management has considerable experience in
evaluating the loan portfolio; however, changes in the national or local economy
or fluctuations in interest rates could create the need for additional
provisions, thereby adversely affecting operating results.
Other significant recurrent sources of income for the Company include gain
on sale of loans, service fees on loans sold, and customer service fees. Gain
on sale of loans and service fees on loans sold are affected by market
conditions. Customer service fees are a function of customer banking activity.
If the Company were to fail to maintain or grow these sources of income, the
Company's operating results would be adversely affected.
Because of these and other factors, past financial performance should not
be considered an indicator of future performance. Investors should not solely
use historical trends to anticipate future results and should be aware that the
trading price of the Company's common stock may be subject to wide fluctuations
in response to quarter-to-quarter variations in operating results, general
conditions in the thrift industry, changes in earnings estimates and
recommendations by analysts or other events.
EASTERN BANCORP, INC. Eastern Bancorp, Inc. ("Eastern" or the "Company"), a
Delaware corporation, was incorporated in April 1986 for the purpose of becoming
the savings and loan holding company of Vermont Federal Bank, FSB (VFB), a
federally chartered stock savings bank headquartered in Williston, Vermont. On
July 30, 1986, following approval by VFB's stockholders and regulatory
authorities, the Company became the holding company for VFB.
All per share information contained herein has been adjusted to reflect the
Company's June 19, 1996 three-for-two stock split paid to stockholders of record
on June 5, 1996.
On November 13, 1996, the Company entered into the Merger Agreement
pursuant to which the Company will merge with and into VFSC and the Bank will
become a wholly-owned subsidiary of VFSC (the Merger). Consumation of the
Merger is conditioned, among other things, upon stockholder approval and
regulatory approval. The Merger is described in more detail in Eastern's
Current Report on Form 8-K dated November 21, 1996.
On August 31, 1989, the Company acquired Rockingham Bancorp (Rockingham).
Rockingham has been dissolved. On October 1, 1995, the Company merged First
Savings of New Hampshire (FS) with and into VFB to form one unified bank under
the name Vermont Federal Bank, FSB (the FS-VFB Merger), and moved the primary
operations of the holding company to Dover, New Hampshire. Rockingham, no
longer a bank holding company, has been dissolved.
All references herein to the "Bank" are to VFB and FS as one consolidated
entity following the FS-VFB Merger.
The Company is currently conducting business as a nondiversified savings
and loan holding company. At September 30, 1996, the Company's principal assets
on an unconsolidated basis consisted of the outstanding capital stock of the
Bank and $3.4 million of short-term investments and investment securities. See
note 18 of notes to consolidated financial statements. The Company also owns
Vermont Service Corporation (VSC), a real estate development company which it
purchased from VFB in December 1991. VSC and its subsidiary, Vermont East Coast
Company (VECC), are joint venture partners in the ownership of development
rights in a mobile home
3
<PAGE>
association known as "Williston Woods." At present, the Company is not
significantly engaged in operating business activities other than management of
its investments and operations through the Bank, VSC, and VECC. See note 1 of
notes to consolidated financial statements.
As a nondiversified savings and loan holding company, the Company is
subject to Office of Thrift Supervision (OTS) regulations, examinations,
supervision, and reporting requirements.
Eastern's executive offices are located at 537 Central Avenue, Dover, New
Hampshire 03820 (telephone 603-749-2150).
VERMONT FEDERAL BANK, FSB AND SUBSIDIARIES. VFB is a federally chartered
stock savings bank. On October 1, 1995, FS was merged with and into VFB to form
one consolidated bank operating 25 branches, 15 located in Vermont and 10
located in New Hampshire. Based on total assets at September 30, 1996, the
Bank was the largest Savings Association Insurance Fund (SAIF)-insured
institution in Vermont and the Bank's Vermont assets were the sixth largest of
all depository institutions in Vermont.
VFB was founded as a mutual building and loan association in 1895. Its
deposits have been insured by the SAIF, which is administered by the Federal
Deposit Insurance Corporation (FDIC), and has been a member of the Federal Home
Loan Bank (FHLB) System since 1936. In 1973, VFB changed its name from
Burlington Federal Savings and Loan Association to Vermont Federal Savings and
Loan Association. In July 1983, VFB changed its charter to a federal mutual
savings bank and changed its name to Vermont Federal Bank, FSB. On November 17,
1983, VFB converted to a federal stock savings bank.
The corporate headquarters of the Bank are located at 282 Williston Road,
Williston, Vermont 05495 (telephone 802-879-9000).
ROCKINGHAM BANCORP AND FIRST SAVINGS OF NEW HAMPSHIRE. Prior to the FS-VFB
Merger, Rockingham was the holding company of FS and was not significantly
engaged in operating business activities other than through the operations of
FS. FS was a New Hampshire chartered stock savings and loan association
established in 1892, with nine offices in southeastern New Hampshire as of
September 30, 1995. In October 1992, FS changed its name from First Savings and
Loan Association of New Hampshire to First Savings of New Hampshire. Following
the FS-VFB Merger, FS branches retained the use of the "First Savings of New
Hampshire" name and began operating as a division of VFB. Eastern Bancorp
dissolved Rockingham and assumed its assets and liabilities. Following the FS-
VFB Merger, deposits formerly held by FS are insured by SAIF. The business
formerly conducted by FS is discussed together with that of VFB below.
In October 1991 and August 1992, FS was the successful bidder for certain
of the assets and liabilities of the former Iona Savings Bank (Iona) of Tilton,
NH and Seacoast Savings Bank (Seacoast) of Dover, NH. As a result of these
transactions, FS acquired approximately $93.7 million in deposits.
The corporate headquarters of the FS division are located at One Center
Street, P.O. Box 310, Exeter, New Hampshire, 03833 (telephone 603-778-4268).
GENERAL BUSINESS OF THE BANK. The business of the Bank consists primarily
of attracting deposits from the general public and originating and servicing
first mortgage loans on one- to four-family homes and consumer loans (including
second mortgage home equity loans and lines of credit, mobile home loans, motor
vehicle loans and other types of personal loans). The Bank also makes
commercial real estate loans and some non-real estate commercial loans which, in
most instances, are secured by equipment, accounts receivable and inventory.
The Bank has made and continues to make a limited number of first mortgage loans
on investment properties and leisure homes. The Bank also invests in federal
government and agency obligations and other investment securities permitted by
applicable law and regulations, including mortgage backed securities.
The principal sources of funds for the Bank's lending and investment
activities are deposits, amortization and prepayment of loans, sales of loans,
and borrowings. The Bank's principal sources of income are interest and fees on
loans and investments, gains on sales of loans originated for sale, and fees on
deposit products and from servicing loans for other investors. The Bank's
principal expenses are interest paid on deposit accounts and borrowings, general
and administrative expenses (including losses from other real estate
operations), and provisions for loan losses.
4
<PAGE>
The Bank is subject to comprehensive regulation, examination, and
supervision by the OTS and the FDIC. The Bank is also subject to additional
regulation by the Board of Governors of the Federal Reserve System (Federal
Reserve Board) relating to reserves required to be maintained against deposits
and certain other matters.
MARKET AREA. The Bank's Vermont operations are headquartered in Williston,
Vermont. At September 30, 1996, the Bank operated six offices in Chittenden
County and nine offices elsewhere throughout the state. Based on the most
recent census data, approximately 80 percent of Vermont's population resides in
VFB's market areas.
At September 30, 1996, there were six FS offices in Rockingham County, New
Hampshire, one office in Merrimack County, New Hampshire, one office in Belknap
County, New Hampshire, and two offices in Strafford County, New Hampshire.
SUBSIDIARY CORPORATIONS
As of September 30, 1996, the Bank had two subsidiaries, Eastern Real
Estate Corporation (EREC) and Investment Alternative Financial Services
Corporation (IAFS). In March 1991, VFB organized EREC for the purpose of
selling an industrial park which the Bank had previously acquired through
foreclosure. As of September 30, 1996, the Bank's investment in EREC was
$469,000 which includes approximately $36,000 in unsecured loans.
IAFS, currently inactive, was formed in January, 1995 as a wholly owned
subsidiary of the Bank for the purpose of facilitating the delivery of mutual
fund investments and annuities on bank premises by an independent investment
broker. As of September 30, 1996, VFB's investment in IAFS was approximately
$31,000.
As of September 30, 1996, the Bank had liquidated and dissolved its
subsidiary, Long Bay II Corporation (LBII). LBII was established in 1991 to
hold title to a residential real estate development previously owned by a
borrower of, and foreclosed by, FS. Following the FS-VFB Merger, the Bank was a
majority owner of LBII, together with the former Dartmouth Bank, a participant
in the original development loan. The property, which was sold in August 1996,
was located on Lake Winnipesaukee in Laconia, NH, and consisted of approximately
130 approved homesites and a limited number of boat slips.
In addition, FS invested $50,000 of capital along with several other thrift
institutions in Bankers Cooperative Mortgage Services, Inc. (Bankers
Cooperative) in 1985. Bankers Cooperative is operated by independent management
and originates mortgage loans throughout New Hampshire. Bankers Cooperative
originates mortgages for sale in the secondary market and provides servicing for
loans. FS has not provided Bankers Cooperative with any financing or purchased
loans from or sold loans to Bankers Cooperative. FS refers customers to and
accepts applications for Bankers Cooperative from individuals desiring fixed-
rate mortgage loans. Following the FS-VFB Merger, VFB assumed FS's ownership
rights in Bankers Cooperative. Subsequent to September 30, 1995, Bankers
Cooperative sold its mortgage servicing portfolio and other assets. The first
payment from the proceeds of this sale in the amount of $75,000 was received in
December 1995, and another payment is expected during December 1996. Some
monies are being held in escrow until all Department of Revenue certifications
are received. Final distributions will be made in 1998 after applicable
statutes of limitations expire.
VSC is wholly-owned by the Company. At September 30, 1996, the Company's
investment in this subsidiary totaled $743,000. Since VSC's founding in 1971,
it and its subsidiary, VECC, have participated in joint ventures involving the
purchase and sale of land, construction, and the sale of several condominium
projects. VSC and VECC were joint venture partners in the mobile home
development known as "Williston Woods." On September 28, 1993, VSC sold a
portion of Williston Woods to the residents of the park for $2.2 million,
retaining development rights to the thirty-four unsold lots. The proceeds in
excess of the book value of the project were used to reduce the carrying value
of the development rights to build the unsold units.
EMPLOYEES
At September 30, 1996, the Bank employed 409 full-time equivalent employees
(FTEs), and Eastern employed three and a half FTEs. Management considers
relations with its employees to be good. The Bank's employees are not
represented by any collective bargaining group. See note 12 of notes to
consolidated financial
5
<PAGE>
statements.
COMPETITION
The Bank experiences competition in attracting and retaining deposit
accounts and in making mortgage and other loans. The primary factors in
competing for deposit accounts are interest rates, the range of financial
products offered, convenience of office locations, and flexibility of office
hours. Direct competition for deposit accounts comes from other savings
institutions, commercial banks, credit unions, and brokerage firms. Additional
competition for deposit accounts comes from money market and bond funds and from
various types of corporate and government securities. The primary factors in
competing for loans are interest rates, loan origination fees, and the range of
lending products offered. Competition for origination of first mortgage loans
normally comes from other savings institutions, mortgage banking firms, credit
unions, and commercial banks.
The Bank's operating strategies are directed toward providing a wide range
of financial products for customers which it serves or will serve in the future.
A number of commercial and savings banks, which are larger and have greater
resources than the Bank, operate in the Bank's market areas.
ASSET/LIABILITY MANAGEMENT
As a holding company for the Bank, Eastern does not engage in any business
activities, other than through the Bank, the management of its investments, and
VSC. The Bank's principal business consists of attracting deposits from the
general public and making residential mortgage and consumer loans. The Bank's
profitability depends in part on the amount of net interest income, non-interest
income or fees and miscellaneous income, non-interest expense, and provisions
for loan losses.
One of the principal factors in maintaining planned levels of net interest
income is the ability to anticipate fluctuations in future net interest income
because of changes in interest rates and to design effective strategies to cope
with such fluctuations. The balancing of the changes in income from interest
earning assets and the expense of interest bearing liabilities is done through
asset/liability management. The Bank primarily uses computer simulation models
to assess interest rate risk under different scenarios of rising and falling
interest rates. The Bank also reviews traditional GAP analysis (GAP). GAP is
the difference between interest earning assets and interest bearing liabilities
maturing or repricing within designated time periods. The Company believes that
computer simulation provides a more reliable estimation of future net interest
income than traditional GAP analysis because sophisticated models can simulate
changes in prepayment speeds on amortizing assets, and the effect of lifetime
and period interest rate caps on adjustable rate assets and liabilities, and
early withdrawal options on certificates of deposit under varying interest rate
assumptions. Asset/liability management strategies are reviewed on an ongoing
basis and revised based on changes in interest rate levels and general economic
conditions.
The most significant components of the Company's asset management program
have involved emphasizing adjustable rate mortgage lending for the Bank's own
portfolio and the sale of long term fixed rate loans in the secondary market.
Cash flow from the amortization and prepayments on loans and investments
increased in 1996 compared to 1995 as rates declined during mid-year which
increased prepayment speeds. This increased the available funds for purchases of
portfolio investments, mortgage backed securities and loans.
The most significant components of the Company's liability management
program have involved the following: (1) promoting low cost non-interest and
interest bearing demand deposit accounts; (2) the use of early withdrawal
penalties on certificates of deposit to assist in maintaining maturity and cost
structure; and (3) extending the term on fixed-rate fixed-term liabilities to
match the increase in fixed-rate assets outlined in the asset management
components above.
Eastern's one-year GAP position has decreased from the previous year due to
decreases in consumer loans and investment and mortgage backed securities
maturing within one year and an increase in certificates of deposit maturing
within one year. These developments more than offset a decrease in borrowings
maturing within one year. For an institution such as Eastern with a positive
one-year GAP, the amount of income earned on its assets fluctuates more than the
cost of its liabilities in response to changes in the prevailing rates of
interest during the one-year period. Accordingly, in a rising interest rate
environment, institutions with a positive one-year GAP will experience a greater
increase in the yield on their assets than in the cost of funds of their
liabilities. Conversely, the cost of funds of institutions with a positive GAP
will decrease less than the yield on their assets in a falling
6
<PAGE>
interest rate environment. Institutions with a negative one-year GAP face the
opposite situation. A rising interest rate environment imposes risks on
institutions with a negative GAP because more of their liabilities than their
assets adjust during the year as a result of the increase in interest rates.
Accordingly, the increase in the cost of funds on the liabilities of
institutions with a negative one-year GAP is greater than the increase in the
yield on their assets.
Table 4, in Part II, Item 7, in Management's Discussion and Analysis of
Financial Condition and Results of Operations incorporated herein by reference
sets forth the estimated maturity/repricing structure of the Company's interest-
earning assets and interest-bearing liabilities at September 30, 1996.
Management believes the prepayment and attrition rates used in Table 4 to be
reasonable based on the Bank's experience.
LENDING ACTIVITIES
GENERAL. The Bank has traditionally concentrated its lending activities
primarily on the origination of conventional first mortgage loans for the
purchase, construction, or refinance of residential real property, and these
loans continue to be the primary focus of the Bank's lending activities. In
recent years, however, in order to improve their net interest margin, the Bank
placed additional emphasis on consumer lending activities. The Bank's consumer
loan portfolio includes second mortgage home equity loans and lines of credit,
mobile home loans, motor vehicle loans, and other types of personal loans. The
volume of commercial real estate loans and other commercial loans in the Bank's
portfolio has varied considerably over the last decade. Deterioration in local
economic conditions caused the Bank to curtail origination of such loans from
fiscal 1990 through fiscal 1992, but slight economic improvements allowed such
loan originations to increase thereafter.
The largest portion of the Bank's loans have been made to home buyers on
the security of residential dwellings. At September 30, 1996, the total loan
portfolio of the Bank amounted to $495.1 million (before allowance for loan
losses and other deductions), representing 57.0 percent of the Company's total
assets. At that date, 54.0 percent of the total outstanding loans consisted of
loans secured by first mortgages on residential properties, 27.7 percent of the
total outstanding loans were consumer loans, and 18.3 percent were commercial
and multi-family residential loans.
Approximately 69.5 percent of the Bank's residential mortgage loans,
together with the majority of the Bank's consumer loans, have adjustable rate
features. Approximately 80 percent of the Bank's portfolio of non-real estate
and real estate commercial loans have adjustable rate features. At September
30, 1996, adjustable rate loans represented 74.7 percent of the total loan
portfolio of the Bank.
During fiscal 1989 through 1991, the Bank experienced a significant
increase in the level of nonperforming assets, due to the economic recession in
Vermont and New Hampshire and its effect on the ability of borrowers to repay
loans. The Bank focused during the period of 1992 through 1996 on reducing
nonperforming loans through various monitoring techniques and collection
efforts. See "Nonperforming Assets."
For additional information on loans, see note 3 of notes to consolidated
financial statements.
LOAN ORIGINATIONS. All real estate mortgage loans originated by the Bank
are secured by real estate located primarily in Vermont and New Hampshire as a
result of the Bank's commitment to serve the mortgage credit needs of the
communities in which their offices operate.
During fiscal 1996, the Bank originated $163.3 million in residential real
estate mortgage loans compared with $95.2 million in fiscal 1995. Mortgage
production for the year increased primarily as a result of increased refinancing
activity during the second and third quarters of fiscal 1996. Home purchase
activity comprised approximately 47 percent of production with refinancing
activity comprising approximately 53 percent of production. Production volumes
dropped during the fourth quarter of fiscal 1996 as a result of higher interest
rates and reduced refinancing activity.
ONE- TO FOUR-FAMILY FIRST MORTGAGE LOANS. At September 30, 1996, the Bank
offered various adjustable rate mortgage (ARM) programs for one- to four-family
residential loans. Adjustment periods available to customers ranged from one
year up to five years. Indices used in these programs were corresponding U.S.
Treasury Securities, adjusted to a constant maturity corresponding with the
adjustment period of the ARM program selected by the borrower. Most of the ARM
loans contained periodic interest rate caps of 2 percent
7
<PAGE>
annually and 6 percent life. ARM loans originated during fiscal 1996 were
significantly concentrated in the one-, three-, and five-year adjustable rate
programs. Although adjustable rate mortgage loans allow the Bank to increase
the sensitivity of its asset base to changes in interest rates, subject to the
effect of interest rate caps, the terms of such loans may also increase the
likelihood of delinquencies in periods of high interest rates, particularly if
such loans are discounted ARMs. ARM loans made by the Bank do not have negative
amortization features.
In addition to its adjustable rate loan products, the Bank also offers
fixed rate mortgage loans. The volume of originations of such loans depends in
large part on the level of interest rates. It has been the Bank's experience
that there is significant demand for fixed rate loans during periods of lower
interest rates. In fiscal 1996, the spread between adjustable rate loans and
long term fixed rate loans narrowed. Fixed rate loan originations increased
dramatically as a result. The terms of fixed rate loans generally provide for
repayment of principal for a fixed term ranging from 15 to 30 years.
The Bank's loan prepayment experience relating to each of fixed and
adjustable rate mortgage loans, which are typically amortized over 15 to 30
years, indicates that such loans will be outstanding for a period of
approximately 4 to 8 years, depending on fluctuations in interest rates. During
the last several years, the Bank experienced an increase in prepayments, which
shortened the period mortgage loans remained outstanding, primarily as a result
of a general decline in interest rates. As a result of falling interest rates in
mid fiscal 1996, the number of prepayments increased during fiscal 1996.
CONSUMER LOANS. Consistent with applicable regulations, the Bank had an
outstanding balance of consumer loans at September 30, 1996, totaling $136.9
million, or 27.7 percent of total loans. The Bank makes various types of
consumer loans including second mortgage loans, home improvement loans, personal
loans (secured and unsecured), mobile home loans, motor vehicle loans (new and
used), credit cards, and loans secured by deposit accounts. Of the $136.9
million outstanding consumer loan balance at September 30, 1996, $76.9 million
or 56.2 percent were home equity loans and $40.1 million or 29.3 percent were
mobile home loans. Mobile home loans may have a maximum term of up to 25 years,
although it has been the Bank's experience that such loans remain outstanding
for a period substantially shorter than their contractual term.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY RESIDENTIAL MORTGAGE LOANS;
COMMERCIAL LOANS. The Bank makes mortgage loans for the acquisition and
development of commercial real estate and multi-family residential properties,
consisting primarily of office buildings, small retail shopping centers and
apartment buildings. The Bank has offered non-real estate commercial loans
which, in most instances, are secured by equipment, accounts receivable, and
inventory. Commencing in fiscal 1990, VFB took steps to curtail its commercial
real estate lending activities in response to economic conditions and the level
of its nonperforming assets. In light of the reduced demand for such loans in
New England, the Bank did not originate a significant amount of new commercial
real estate loans in fiscal 1992. Beginning in fiscal 1993, the economic
conditions in each of New Hampshire and Vermont started to improve slightly and
the Bank's nonperforming assets began to decline which allowed commercial loan
originations to start increasing at the Bank. As of September 30, 1996,
commercial real estate and multi-family residential mortgage loans totaled $83.2
million, or 16.8 percent of the total loan portfolio of the Bank. As of
September 30, 1996, non-real estate commercial loans totaled $7.3 million or 1.5
percent of the total loan portfolio of the Bank.
CONSTRUCTION LOANS. The Bank makes mortgage loans to individuals,
builders, and developers for, among other things, the construction of primary
residences, income-producing properties, condominium projects, and land
development. At September 30, 1996, such loans totaled $9.9 million or 2.0
percent of the Company's total loans before net items. Construction loans are
project-oriented, generally for terms of three years or less, and are made at
floating rates based on the prime rate. Land development loans totaled $3.5
million or 0.71 percent of total loans receivable before net items at September
30, 1996.
Commercial real estate and multi-family residential construction lending
entails additional risks (such as availability of take-out financing, ability of
borrower to lease space prior to completion of project, completion of building
in accordance with take-out financing agreements, ability of borrower to cover
cost overruns, and ability of borrower to cover loan interest if leasing of
space is not complete) beyond those associated with mortgage lending. The Bank
seeks to minimize these risks by, among other things, limiting the loan size and
generally lending for construction of properties within its market areas to
borrowers who are experienced in the type of construction for which the loan is
made.
8
<PAGE>
SECONDARY MARKET ACTIVITY. Although the Bank generally originates all
fixed rate loans for sale, the Bank may originate such loans for its own
portfolio. The Bank also originates some treasury indexed ARM loans for sale.
Mortgage loans held for sale are carried at the lower of aggregate cost or
market value. The Bank generally seeks to originate all loans to permit sale of
such loans in the secondary market if desired. All loans sold are currently
sold without recourse.
The Bank usually continues to collect payments on whole loans and loan
participations sold as they become due, and to inspect the property and
otherwise service the loans. The Bank pays the participating lender an agreed
yield on the participant's portion of the loan. This yield is usually less than
the interest paid by the borrower thereon, with the present value of the
difference being capitalized by the Bank as an "excess service fee asset" and
recognized as income at the time of the sale to the extent, if any, that it
exceeds a normal servicing fee over the expected life of the loan. This asset is
amortized over the estimated life of the loans sold using the level yield
method. See Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations for further information.
During fiscal 1996, the Bank sold or securitized and sold $139.3 million in
loans and loan participations compared to $61.0 million sold or securitized and
sold in fiscal 1995. At September 30, 1996, the Bank was servicing $647.7
million of loans which were owned by others. As of September 30, 1996, $44.2
million, or 8.9 percent of the loans receivable of the Bank, were serviced by
others. At September 30, 1996, the Bank had commitments to sell mortgage loans
of approximately $17.4 million compared to $10.1 million at the end of fiscal
1995. At September 30, 1996, the Bank had $9.4 million in fixed rate and $1.1
million in adjustable rate residential mortgage loans held for sale.
During fiscal 1996 and 1995, the Bank purchased mortgage servicing rights
(PMSR) to service $54.1 million and $106.0 million, respectively, in residential
first mortgage loans. Premiums paid to purchase PMSR totaled $594,000 and
$971,000 in fiscal 1996 and 1995, respectively. The Bank capitalized $1.4
million in servicing rights retained on loans originated and sold during fiscal
year 1996 compared to $566,000 during fiscal 1995. Servicing rights are
amortized over five years, with the expense included in service fees on loans
sold. The accelerated amortization expense will offset the increase in loan
servicing income initially, with a rise in servicing income expected in later
years. The purchase or retention of servicing rights allows the Bank to
increase its servicing portfolio while using existing capacity. The Bank
intends to continue purchasing and retaining, servicing rights to increase use
of existing capacity and generate additional loan service fee income. While the
Bank's overall goal is to increase its servicing portfolio, management's
perception of market conditions in March of 1995 led to the sale of
approximately $162.6 million in PMSR. The sale allowed the Bank to reduce the
number of states in which it services loans from over twenty states to six
states.
9
<PAGE>
LOAN PORTFOLIO COMPOSITION. The following table sets forth certain
information concerning the Company's loan portfolio, before allowance for loan
losses and other net items, in dollar amounts and in percentages, by type of
security and by type of loan.
<TABLE>
<CAPTION>
At September 30,
- ---------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994(a) 1993(a) 1992(a)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Total mortgage loans $267,672 54.0% $224,042 48.7% $198,792 46.6% $198,981 46.9% $215,713 50.3%
Total consumer loans 136,927 27.7 142,328 31.0 142,308 33.4 142,719 33.7 121,134 28.2
Total commercial loans 90,486 18.3 93,136 20.3 85,330 20.0 82,441 19.4 92,248 21.5
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total loans receivable
(before net items) $495,085 100.0% $459,506 100.0% $426,430 100.0% $424,141 100.0% $429,095 100.0%
-------- ----- -------- ----- -------- ----- -------- ---- -------- -----
-------- ----- -------- ----- -------- ----- -------- ---- -------- -----
Residential construction loans $ 9,939 2.0% $ 5,386 1.2% $ 9,930 2.3% $ 7,394 1.7% $ 7,354 1.7%
Permanent loans 485,146 98.0 454,120 98.8 416,500 97.7 416,747 98.3 421,741 98.3
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total loans receivable
(before net items) $495,085 100.0% $459,506 100.0% $426,430 100.0% $424,141 100.0% $429,095 100.0%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) In-substance foreclosure loans in the amounts of $3.6 million, $5.8 million,
and $8.0 million, respectively, were not reclassified to loans in accordance
with SFAS No. 114 due to lack of appropriate detail to make the required
reclassifications.
10
<PAGE>
MATURITY AND RATE SENSITIVITY OF LOAN PORTFOLIO. The following table sets
forth the estimated maturity/repricing structure of the loans (before net items)
maturing or repricing in the loan portfolios of the Bank based on repricing
dates, contractual maturities, and loan amortizations. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less. Adjustable rate loans are reported as
having a term equal to the interest rate adjustment period. The dollar amount
of all loans which have fixed or floating or adjustable interest rates is also
shown.
<TABLE>
<CAPTION>
As of September 30, 1996
- -------------------------------------------------------------------------------------
Greater
Within 1-5 than
1 year years 5 years Total
-------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate construction - fixed rate $ 6,574 $ -- $ -- $ 6,574
Real estate construction - adjustable rate 3,365 -- -- 3,365
Commercial - fixed rate 2,035 2,146 17,079 21,260
Commercial - adjustable rate 62,134 4,652 2,440 69,226
- -------------------------------------------------------------------------------------
</TABLE>
LOAN COMMITMENTS. The Bank issues commitments to prospective borrowers to
make loans conditioned upon the occurrence of certain events and under certain
specific terms. Loan commitments are generally issued for the origination of
long-term, permanent loans for the financing of residential properties by
prospective purchasers. Loan commitments are also made for construction loans
and combined construction permanent loans which are for one- to four-family,
commercial, multi-unit residential, and income producing properties. At
September 30, 1996, the Bank had aggregate outstanding loan commitments of $93.5
million. Commitments to originate approved mortgage loans generally expire
within 20 days.
It is the general policy of the Bank to make commitments to lend at the
market rates of interest and the amount of points prevailing at the time the
application is made. The proportion of the total value of commitments derived
from any particular category of loan varies from time to time and depends upon
market conditions and demand.
For further information on loan commitments, see note 13 of notes to
consolidated financial statements.
INCOME FROM LENDING ACTIVITIES. The Bank realizes interest and other fee
income from its lending activities. Interest income includes amortization of
discounts on loans purchased and amortization of deferred loan fees. The Bank
also receives loan fees and charges related to existing loans, which include
late charges, assumption fees, and servicing fees.
CLASSIFICATION OF CERTAIN ASSETS. As a SAIF-insured and OTS regulated
savings association, the Bank is required to classify its assets in accordance
with applicable regulations. An asset is considered "substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Assets so classified must have a
well-defined weakness or weaknesses. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified as
"doubtful" have all of the weaknesses inherent in those classified "substandard"
with the added characteristic that the weaknesses present make "collection or
liquidation in full" on the basis of currently existing facts, conditions and
values, "highly questionable and improbable." Assets classified "loss" are those
considered "uncollectible" and of such value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. When an
insured institution classifies problem assets as "substandard" or "doubtful," it
is required to establish general allowances for loan losses in an amount deemed
prudent by management. General allowances represent loss allowances which have
been established to recognize the inherent risk associated with lending
activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When an insured institution classifies problem
assets as "loss," it is required either to establish a specific allowance for
losses equal to 100 percent of the amount of the assets so classified or to
charge off such amount. An OTS-regulated institution's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the OTS, which can order the establishment of additional
11
<PAGE>
general loss allowances. The effect of establishing specific loss reserves for
problem assets classified as "loss" will be to reduce the institution's
regulatory capital by the amount of such specific loss reserves net of any tax
benefit.
At September 30, 1996, classified assets included $7.0 million of
performing loans and $7.9 million of nonperforming loans. This compares to
September 30, 1995 classified assets that included $7.0 million of performing
loans and $11.0 million of nonperforming loans. See "Nonperforming Assets." The
decrease in classified assets during fiscal 1996 was a result of the continued
efforts of the Bank to aggressively workout classified loans and market and sell
foreclosed property.
The following table details classified assets by category.
<TABLE>
<CAPTION>
1996 1995
- ---------------------------------------------------------------------------------------------------
SUBSTANDARD DOUBTFUL LOSS Substandard Doubtful Loss
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Commercial real estate $ 6,564 $-- $-- $ 6,148 $ -- $--
Commercial non-real estate 3,152 -- -- 6,454 301 --
Consumer 2,631 -- 81 2,230 82 64
Residential mortgage 2,515 -- -- 2,720 -- --
------- --- --- ------- ---- ---
Total classified loans 14,862 -- 81 17,552 383 64
Other real estate owned 3,611 -- -- 5,398 -- --
------- --- --- ------- ---- ---
Total classified assets $18,473 $-- $81 $22,950 $383 $64
------- --- --- ------- ---- ---
------- --- --- ------- ---- ---
- ---------------------------------------------------------------------------------------------------
</TABLE>
The Bank also classifies loans as "special mention." These loans are those
that, while current or accruing, warrant close attention by management because
of potential credit weaknesses. Such loans totaled $2.0 million at September
30, 1996 compared to $2.9 million at September 30, 1995. Included in loans
classified substandard and special mention at September 30, 1996 are a total of
$1.6 million of loans where known information about possible credit problems of
the borrowers has caused management concern as to the ability of the borrowers
to comply with the present loan repayment terms and which may result in such
loans becoming nonperforming in subsequent periods.
At September 30, 1996, the Company's allowance for loan losses totaled $2.9
million. As of September 30, 1996, the Company believes its loan loss reserve
is adequate to cover the potential loan losses currently in its portfolio.
Although the Bank has considerable experience in evaluating classified loans,
because of the impact of such factors as the overall economy and the fluctuation
of interest rates on such loans, there can be no assurance that the provisions
made to the Bank's loan loss reserve will prove adequate, and, to the extent
that additional provisions to the Bank's loan loss reserve are required in the
future, the Company's results of operations would be adversely affected.
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by corresponding with the borrower. In most
cases, deficiencies are cured promptly. If the delinquency cannot otherwise be
cured, the Bank institutes appropriate legal action to foreclose on the property
securing the loan and may seek to obtain a deficiency judgment against the
borrower.
A decision as to whether and when to initiate foreclosure proceedings is
based upon such factors as the amount of the outstanding loan in relation to the
original indebtedness, the extent of delinquency, and the borrower's ability and
willingness to cooperate in curing deficiencies. Foreclosures are conducted in
accordance with state laws in the respective states where the Bank does
business.
When the Bank acquires real estate through foreclosure or deed in lieu of
foreclosure, such real estate is recorded at the lower of the carrying value of
the loan or the fair value minus selling costs based upon a current appraisal
made for the Bank.
In May 1993, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 114, "Accounting by
Creditors for Impairment of a Loan," which was amended in October 1994 by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure." The Statements, which were adopted by the Company on October 1,
1995, generally require all
12
<PAGE>
creditors to account for impaired loans, except those loans that are accounted
for at fair value or at the lower of cost or fair value, at the present value of
the expected future cash flows discounted at the loan's effective interest rate.
In addition, criteria for classification of a loan as an in-substance
foreclosure were modified in such a way that classification need be made only
when the lender is in possession of the collateral. The adoption of SFAS Nos.
114 and 118 had no material impact on the Company's financial condition or
results of operations. In-substance foreclosure loans for fiscal 1996 and 1995
were reclassified to loans in accordance with SFAS No. 114. Fiscal years 1994,
1993, and 1992 were not reclassified due to lack of appropriate detail to make
the required reclassifications.
NONPERFORMING ASSETS. The following table sets forth information regarding
nonperforming assets (loans over 90 days past due and non-accruing, troubled
debt restructurings, in-substance foreclosures and real estate acquired through
foreclosure) at the dates indicated. Nonperforming loans are loans on which the
Company has stopped accruing interest income (i.e., loans over 90 days past due
and restructured troubled debt).
<TABLE>
<CAPTION>
(Dollars in thousands) At September 30,
- --------------------------------------------------------------------------------------------------------------
1996(b) 1995 1994(c) 1993(c) 1992(c)
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Nonperforming loans:
Residential real estate $ 1,779 $ 2,422 $ 1,509 $ 2,479 $ 3,093
Commercial 3,693 6,872 2,509 6,832 4,148
Consumer 2,473 1,782 1,436 1,582 1,387
------- ------- ------- ------- -------
Total nonperforming
loans 7,945 11,076 5,454 10,893 8,628
In-substance foreclosures (a) -- -- 3,610 5,818 7,968
Other real estate owned (a) 3,611 5,398 5,273 8,706 10,290
Other repossessed assets 448 310 232 142 418
------- ------- ------- ------- -------
Total nonperforming
assets $12,004 $16,784 $14,569 $25,559 $27,304
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Restructured
troubled debt
Performing $ 4,154 $ 4,801 $ 2,996 $ 1,462 $ 2,269
Nonperforming
(included above) -- 985 2,003 2,162 --
Impaired performing 1,819 -- -- -- --
Impaired nonperforming 952 -- -- -- --
(included above) ------- ------- ------- ------- -------
Total $ 6,925 $ 5,786 $ 4,999 $ 3,624 $ 2,269
------- ------- ------- ------- -------
------- ------- ------- ------- -------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Performing real estate owned of $3.8 million, $4.1 million, and $2.8
million is not included
at September 30, 1994, 1993, and 1992, respectively. There was no performing
real estate owned for fiscal 1996
or 1995.
(b) Impaired loans included in the nonperforming loans for fiscal 1996 were
$3.5 million.
(c) In-substance foreclosures were not reclassified to loans in accordance
with SFAS No. 114 due to the
lack of appropriate detail required to make reclassifications.
There were no loans over 90 days past due that were accruing at September
30, 1996. The Company did not recognize approximately $772,000, $893,000, and
$272,000 in interest income during fiscal 1996, 1995, and 1994, respectively,
due to interest not accrued or collected on nonperforming loans.
The decrease in nonperforming assets during fiscal 1996 was due primarily
to a decrease in nonperforming commercial loans and a decrease in other real
estate owned. At September 30, 1996, there was approximately $6.0 million in
performing restructured troubled debt. See notes 3 and 5 of notes to
consolidated financial statements and Table 5 of Item 7, Management's Discussion
and Analysis of Financial Condition and Results of Operations incorporated
herein by reference for further information regarding nonperforming loans,
troubled debt restructurings and other real estate owned.
13
<PAGE>
ALLOWANCE FOR LOAN LOSSES. The following is a detailed summary of activity
in the allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Years Ended September 30,
- --------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $3,622 $3,718 $4,722 $4,802 $5,031
Allowances acquired in acquisi-
tions -- -- -- 260 748
Charge offs:
Commercial 1,246 1,014 1,221 1,027 2,735
Consumer 476 558 537 457 354
Residential mortgage 168 482 356 383 441
------- ------- ------- ------- -------
Total charge offs 1,890 2,054 2,114 1,867 3,530
------- ------- ------- ------- -------
Recoveries:
Commercial 135 93 205 148 319
Consumer 49 40 89 35 51
Residential mortgage 47 3 19 14 65
------- ------- ------- ------- -------
Total recoveries 231 136 313 197 435
------- ------- ------- ------- -------
Net Charge offs 1,659 1,918 1,801 1,670 3,095
------- ------- ------- ------- -------
Provisions 895 1,822 797 1,330 2,118
------- ------- ------- ------- -------
Balance at end of period $2,858 $3,622 $3,718 $4,722 $4,802
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Net charge offs to average loans
outstanding 0.36% 0.44% 0.44% 0.40% 0.74%
- --------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE>
The following table shows the allocation of the allowance for loan losses for
the periods indicated.
<TABLE>
<CAPTION>
At September 30,
- ------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1996 1995 1994(a) 1993(a) 1992(a)
- ------------------------------------------------------------------------------------------------------------------------
Total (b)% Total (b)% Total (b)% Total (b)% Total (b)%
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $1,352 18.3% $1,817 20.3% $2,460 20.0% $2,857 19.4% $2,906 21.5%
Residential mortgage 428 54.0 519 48.7 648 46.6 889 46.9 1,129 50.3
Consumer 1,078 27.7 1,286 31.0 610 33.4 976 33.7 767 28.2
------ ----- ------- ----- ------ ----- ------ ----- ------ -----
Total $2,858 100.0% $3,622 100.0% $3,718 100.0% $4,722 100.0% $4,802 100.0%
------ ----- ------- ----- ------ ----- ------ ----- ------ -----
------ ----- ------- ----- ------ ----- ------ ----- ------ -----
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) In-substance foreclosure loans were not reclassified to loans in accordance
with SFAS No. 114 due to lack of appropriate detail to make the required
reclassifications.
(b) Percent of loans in each category to total loans.
For further information, see note 4 of notes to consolidated financial
statements.
15
<PAGE>
INVESTMENT ACTIVITIES
The Bank has authority to invest in various types of liquid assets,
including short-term U.S. Treasury obligations and securities of various federal
agencies, certificates of deposit at insured banks and savings institutions,
bankers' acceptances, and federal funds. Subject to various restrictions, the
Bank also may invest a portion of its assets in commercial paper, corporate debt
securities, and mutual funds whose assets conform to the investments that the
Bank is authorized to make directly.
It is the Bank's current policy to maintain levels of liquid assets above
the minimum required by federal regulations. See "Regulation - Federal Home
Loan Bank System." The Bank increases or decreases its liquid investments
depending upon the availability of funds and comparative yields on liquid
investments in relation to return on loans. The Bank's liquid investments
primarily involve bank certificates of deposit and United States Government and
agency obligations.
The Company's investment activities have been principally in mortgage
backed and other marketable investment securities. See note 18 of notes to
consolidated financial statements.
16
<PAGE>
A summary of investment and mortgage backed securities classified as held-to-
maturity and available-for-sale are as follows:
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------------------
1996 1995 1994
------------------------------------------------------------------------------------
HELD-TO-MATURITY QUOTED Quoted Quoted
AMORTIZED MARKET Amortized market Amortized market
(Dollars in thousands) COST VALUE cost value cost value
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
United States Government and
related obligations $ 27,075 $ 26,844 $ 20,997 $ 20,988 $ 11,671 $ 11,518
Municipal bonds 247 248 1,251 1,247 1,307 1,297
Certificates of deposit -- -- -- -- 402 402
FHLB debentures 20,469 19,852 19,000 19,051 17,000 16,462
Corporate debentures 1,002 1,002 1,011 1,008 2,020 1,990
-------- -------- -------- -------- -------- --------
Total investment securities $ 48,793 $ 47,946 $ 42,259 $ 42,294 $ 32,400 $ 31,669
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Mortgage backed securities by issuer:
Fixed rate:
FHLMC $ 26,679 $ 26,246 $ 36,832 $ 36,541 $ 39,377 $ 37,891
FNMA 165,116 157,792 195,644 190,409 213,099 196,783
GNMA 99 99 128 131 4,573 5,142
Adjustable rate:
FHLMC 3,788 3,620 19,039 19,169 15,844 15,627
FNMA 11,415 11,116 12,348 11,977 13,809 12,776
GNMA 37,759 37,996 6,142 6,439 -- --
-------- -------- -------- -------- -------- --------
Total mortgage backed securities $244,856 $236,869 $270,133 $264,666 $286,702 $268,219
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
<CAPTION>
September 30,
------------------------------------------------------------------------------------
1996 1995 1994
------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE QUOTED Quoted Quoted
AMORTIZED MARKET Amortized market Amortized market
(Dollars in thousands) COST VALUE cost value cost value
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
Marketable equity securities $ -- $ 3 $ 2 $ 31 $ 2 $ 24
Mutual fund -- -- 4,440 4,139 4,208 3,848
-------- -------- -------- -------- -------- --------
Total investment securities $ -- $ 3 $ 4,442 $ 4,170 $ 4,210 $ 3,872
-------- -------- -------- -------- -------- --------
Mortgage backed securities by issuer:
Other $ 1 $ 6 $ 1 $ 7 $ 1 $ 6
-------- -------- -------- -------- -------- --------
Total mortgage backed securities $ 1 $ 6 $ 1 $ 7 $ 1 $ 6
-------- -------- -------- -------- -------- --------
Total investment and mortgage
backed securities available -for- sale $ 1 $ 9 $ 4,443 $ 4,177 $ 4,211 $ 3,878
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
See note 2 of notes to consolidated financial statements for further
information.
17
<PAGE>
SOURCES OF FUNDS
GENERAL. Deposit accounts are the principal source of funds for use in
lending and other general business purposes. In addition to deposit accounts,
funds are derived from loan repayments, sales of loans, loan participations and
advances from the FHLB of Boston and from other borrowings, including proceeds
from securities sold under agreement to repurchase. Scheduled loan repayments
are a relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates, money market rates, and
general economic conditions. Borrowings may be used on a short-term basis to
compensate for reductions in normal sources of funds such as deposit inflows at
less than projected levels. They may also be used on a longer-term basis to
support expanded lending activities. Savings institutions have access to the
Federal Reserve Board's discount window under certain circumstances, but to date
this has not been a source of borrowing for the Bank.
In fiscal 1996, the Company's sources of funds consisted of interest on its
investment securities portfolio and dividends of $2.7 million received from the
Bank. See note 18 of notes to consolidated financial statements.
DEPOSITS. The Bank has a wide variety of deposit programs designed to
attract both short-term and long-term deposits from the general public. The
Bank reviews the deposit accounts it offers on a systematic basis in order to
determine whether such accounts continue to meet the Bank's and the Company's
asset/liability management objectives with respect to their GAP position and
maximization of their net interest margin. This review includes an analysis of
the cost of funds, the available investment opportunities for the funds, and the
profits that would be available to the Bank at that time based on this analysis.
The Bank seeks to maximize its net interest income by promoting products which
provide the most cost-effective source of funds. In fiscal 1989, the Bank began
a direct mail marketing program designed to attract demand deposit accounts.
The program offers seven different types of checking accounts, of which one is
totally free of service charges and transaction fees. The intent of the program
is to attract core deposit accounts with the purpose of expanding the deposit
relationship into other savings, mortgage, and consumer loan products. In
August 1995, the New Hampshire branches adopted this same deposit program. In
addition to lowering the Bank's cost of funds by increasing lower cost deposit
balances, VFB also has increased its demand deposit fee income and improved its
employee and branch utilization through this program.
Although the Bank's primary market areas are in Vermont and New Hampshire,
it also draws depositors from Massachusetts, southern Maine, New York, and the
Province of Quebec in Canada. As of September 30, 1996, less than 7 percent of
the deposit accounts of the Bank were held by persons who reside outside Vermont
and New Hampshire.
The following table presents the maturities of the Company's certificates
of deposit in amounts of $100,000 or more at September 30, 1996 by time
remaining to maturity. The Bank refrains from attracting large, short-term
deposits, especially those with negotiated rates and maturities.
At September 30, 1996
- --------------------------------------------------------------------------------
(Dollars in thousands)
Matures:
3 months or less $5,509
Over 3 through 6 months 7,137
Over 6 through 12 months 7,943
Over 12 months 7,257
-------
$27,846
-------
-------
- --------------------------------------------------------------------------------
18
<PAGE>
The following tables set forth a summary of the Company's borrowings and
interest rates applicable to such borrowings at and for the periods indicated.
At September 30,
- --------------------------------------------------------------------------------
(Dollars in thousands)
Summary of short term borrowings: 1996 1995 1994
---- ---- ----
Year-end balance $120,800 $121,132 $ 64,760
Weighted average interest rate 5.71% 6.01% 4.98%
Years ended September 30,
-------------------------
1996 1995 1994
---- ---- ----
Highest month end balance $120,800 $140,257 $134,000
Approximate average balance 98,774 101,034 99,628
Approximate weighted average interest rate 5.81% 5.91% 4.45%
- --------------------------------------------------------------------------------
At September 30, 1996, the Bank had $273,000 outstanding in a capital lease
obligation used to purchase certain data processing equipment. The lease is set
to expire in August 1998. See note 6 of notes to consolidated financial
statements.
REGULATION
SAVINGS AND LOAN HOLDING COMPANY REGULATION
GENERAL. Under the Home Owners Loan Act (HOLA), as amended by the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), savings and
loan holding companies, including the Company, are subject to regulation,
supervision and examination by, and the reporting requirements of, the OTS.
The HOLA prohibits a savings and loan holding company such as Eastern,
directly or indirectly, from (i) acquiring control of, or acquiring by merger or
purchase of assets, another savings institution or savings and loan holding
company without the prior written approval of the OTS; (ii) acquiring more than
5 percent of the issued and outstanding shares of voting stock of another
savings institution or savings and loan holding company without prior OTS
approval, with certain exceptions; or (iii) acquiring or retaining control of a
financial institution that does not have SAIF or BIF insurance of accounts. The
HOLA allows the OTS to approve transactions resulting in the creation of
multiple savings and loan holding companies controlling savings institutions
located in more than one state in both supervisory and non-supervisory
transactions, subject to the requirement that, in non-supervisory transactions,
the law of the state in which the savings institution to be acquired is located
must expressly authorize the proposed acquisition. As a result, the Company may,
with the prior approval of the OTS, acquire control of savings institutions
located in states other than Vermont and New Hampshire if the acquisition is
expressly permitted by the laws of the state in which the savings institution to
be acquired is located.
Transactions engaged in by a savings association or one of its subsidiaries
with affiliates of the savings institution are generally subject to the
restrictions contained in Sections 23A and 23B of the Federal Reserve Act.
Section 23A imposes both quantitative and qualitative restrictions on such
transactions, while Section 23B requires, among other things, that all such
transactions be on terms substantially the same, and at least as favorable to
the depository institution, as in a comparable transaction with an unaffiliated
party.
RESTRICTIONS ON ACTIVITIES OF SAVINGS AND LOAN HOLDING COMPANIES. As a
savings and loan holding company, the Company is prohibited from engaging in any
activities other than (i) furnishing or providing management services for the
Bank; (ii) conducting an insurance agency or escrow business; (iii) holding,
managing, or liquidating assets owned or acquired from the Bank; (iv) holding or
managing properties used or occupied by the Bank; (v) acting as trustee under
deeds of trust; (vi) engaging in any other activity in which savings and loan
holding companies were authorized by regulation to engage as of March 5, 1987;
and (vii) engaging in any activity which the Federal Reserve Board by regulation
has determined to be permissible for bank holding companies under Section 4(c)
of the Bank Holding Company Act (BHCA) (unless the OTS, by regulation, prohibits
or limits any such activity for savings and loan holding companies). The
activities which the Federal Reserve Board by regulation has permitted for bank
holding companies under Section 4(c) of the BHCA generally consist of those
activities that the Federal Reserve Board has found to be so closely related to
banking or
19
<PAGE>
managing or controlling banks as to be a proper incident thereto, and include,
among other things, various lending activities, certain real and personal
property leasing activities, certain securities brokerage activities, acting as
an investment or financial advisor subject to certain conditions, and providing
management consulting to depository institutions subject to certain conditions.
Prior OTS approval is required to commence any such activity.
The Company could be prohibited from engaging in any activity (including
those otherwise permitted under the HOLA) not allowed for bank holding companies
if the Bank failed to constitute a qualified thrift lender. See "Regulation-
Savings Institution Regulation - Qualified Thrift Lender Requirement."
POSSIBLE LIABILITY FOR OBLIGATIONS OF SUBSIDIARIES. The Federal Deposit
Insurance Corporation Improvement Act of 1991 (FDICIA) requires any company that
controls a savings institution that becomes undercapitalized, in connection with
the submission of a capital restoration plan by the savings institution, to
guarantee that the institution will comply with the plan and to provide
appropriate assurances of performance. The aggregate liability of any such
controlling company under such guaranty is limited to the lesser of (i) 5
percent of the savings institution's assets at the time it becomes
undercapitalized, or (ii) the amount necessary to bring the savings institution
into capital compliance as of the time the institution fails to comply with the
terms of its capital plan.
SAVINGS INSTITUTION REGULATION
GENERAL. As a SAIF-insured savings institution, the Bank is subject to
supervision and regulation by the OTS. Under OTS regulations, the Bank is
required to obtain audits by independent accountants and to be examined
periodically by the OTS. Examinations must be conducted no less frequently than
every 12 months. The Bank is subject to assessments by the OTS and FDIC to
cover the costs of such examinations. The OTS may revalue assets of the Bank,
based upon appraisals, and require the establishment of specific reserves in
amounts equal to the difference between such revaluation and the book value of
the assets. The OTS also is authorized to promulgate regulations to ensure the
safe and sound operations of savings institutions and may impose various
requirements and restrictions on the activities of savings institutions. FIRREA
requires that the regulations and policies of the OTS for the safe and sound
operations of savings institutions be no less stringent than those established
by the Office of the Comptroller of the Currency (OCC) for national banks.
CAPITAL REQUIREMENTS. The capital standards established by the OTS for
savings institutions must generally be no less stringent than those applicable
to national banks. The OTS has adopted capital standards under which savings
associations must maintain (i) "core capital" in an amount not less than 3
percent of adjusted total assets, (ii) "tangible capital" in an amount not less
than 1.5 percent of total adjusted assets, and (iii) risk-based capital equal to
8.0 percent of risk-weighted assets.
Under OTS regulations, "core capital" includes common stockholders' equity,
noncumulative perpetual preferred stock and related surplus, and minority
interests in the equity accounts of consolidated subsidiaries, less intangible
assets and the lesser of the fair market value or 90 percent of the fair market
value of readily marketable PMSRs, subject to certain conditions. The term
"tangible capital" is defined as core capital minus intangible assets, provided,
however, that savings institutions may include 90 percent of the fair market
value of readily marketable PMSRs as tangible capital, subject to certain
conditions. Total capital, for purposes of the risk-based capital requirement,
equals the sum of core capital plus supplementary capital (which includes, among
other items, perpetual preferred stock not counted as core capital, limited life
preferred stock, subordinated debt, and general loan and lease loss allowances
up to 1.25 percent of risk-weighted assets less certain deductions). The amount
of supplementary capital that may be counted towards satisfaction of the total
capital requirement may not exceed 100 percent of core capital, and OTS
regulations require the maintenance of a minimum ratio of core capital to total
risk-weighted assets of 4.0 percent. In determining total risk-weighted assets
for purposes of the risk-based requirement, (i) each off-balance sheet asset
must be converted to its on-balance sheet credit equivalent amount by
multiplying the face amount of each such item by a credit conversion factor
ranging from 0 percent to 100 percent (depending upon the nature of the asset),
(ii) the credit equivalent amount of each off-balance sheet asset (after giving
effect to the calculation in clause (i) above) and the book value of each on-
balance sheet asset must be multiplied by a risk factor ranging from 0 percent
to 100 percent (again depending upon the nature of the asset), and (iii) the
resulting amounts are added together with total assets and constitute total
risk-weighted assets.
In determining compliance with the capital standards, a savings institution
must deduct from core capital its entire investment in and loans to any
subsidiary engaged as principal in activities not permissible for a national
20
<PAGE>
bank, other than subsidiaries (i) engaged in such non-permissible activities
solely as agent for their customers; (ii) engaged in mortgage banking
activities, or (iii) that are themselves savings institutions, or companies the
only investment of which is another savings institution acquired prior to May 1,
1989.
At September 30, 1996, the Bank exceeded required minimum levels of
regulatory capital. See "Selected Financial Data," "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Stockholders'
Equity," and note 11 of notes to consolidated financial statements.
FDICIA defines an institution as either well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, or critically
undercapitalized, imposing progressively more scrutiny and restrictions on an
institution with less favorable capitalizations. The definitions are based on an
institution's ability to meet all of the capitalization requirements imposed on
the institution by its primary federal regulator, in the case of the Bank, the
OTS. Well capitalized institutions and adequately capitalized institutions are
defined to be institutions which exceed, or simply meet, all relevant capital
requirements, respectively. Undercapitalized and significantly undercapitalized
are defined to be institutions which fail to meet, or significantly fail to
meet, all such capital requirements, respectively. The level of capital below
which an institution is deemed to be critically undercapitalized may not be less
than 2 percent of total assets nor more than 65 percent of the required minimum
level of capital under the leverage limit. The Bank was defined as well
capitalized as of September 30, 1996.
The OTS has promulgated regulations under FDICIA requiring savings
associations classified as adequately capitalized to have (i) a ratio of total
capital to risk-weighted assets of 8.0 percent or greater, (ii) a ratio of core
capital to risk-weighted assets of 4.0 percent or greater, and (iii) a ratio of
core capital to adjusted total assets of either (A) 4.0 percent or greater, or
(B) 3.0 percent or greater if the savings association is rated composite 1 under
the CAMEL rating system in the most recent examination of the savings
association. Savings associations which fail the foregoing capitalization
requirements are subject to prompt corrective action, as described below.
Capital requirements higher than the generally applicable minimum institution
requirements may be established for a particular savings institution if the OTS
determines that the institution's capital was or may become inadequate in view
of its particular circumstances. The management of the Bank does not anticipate
that the prompt corrective action required under the FDICIA for undercapitalized
institutions will have a material impact upon the operations of the Bank as long
as current capital levels are maintained.
The OTS has published a description of the methodologies used in
calculating an interest rate risk component for the risk-based capital
requirement. FDICIA requires that those methodologies take adequate account of
(i) interest rate risk, (ii) concentration of credit risk, (iii) the risks of
nontraditional activities, and (iv) the actual performance and expected risk of
loss on multi-family mortgages.
Any insured depository institution which falls below the minimum capital
standards will be subject to numerous restrictions and possibly severe
administrative sanctions, including closure.
QUALIFIED THRIFT LENDER REQUIREMENT. In order for the Bank to exercise the
powers granted to federally chartered savings institutions and maintain full
access to FHLB advances, it must constitute a "qualified thrift lender" (QTL).
This requires its qualified thrift investments to continue to equal or exceed 65
percent of portfolio assets on a monthly average basis in 9 out of every 12
months. QTL status is determined monthly for the preceding 12-month period.
Qualified thrift investments generally consist of (i) various housing related
loans and investments (such as residential construction and mortgage loans, home
improvement loans, mobile home loans, home equity loans and mortgage backed
securities), (ii) certain obligations of the FSLIC, the FDIC, the FSLIC
Resolution Fund, and the Resolution Trust Corporation (RTC) (for limited
periods of time), and (iii) shares of stock issued by any Federal Home Loan
Bank, the Federal Home Loan Mortgage Corporation, or the Federal National
Mortgage Corporation (shares of stock of the latter two entities not to exceed
20 percent of an association's portfolio assets). Other types of housing related
assets, together with certain consumer loans, may be categorized as qualified
thrift investments in an amount not to exceed 20 percent in the aggregate of
portfolio assets. For purposes of the QTL test, the term "portfolio assets"
means the savings institution's total assets minus goodwill and other intangible
assets, the value of property used by the savings institution to conduct its
business, and liquid assets held by the savings institution in an amount up to
20 percent of its total assets.
OTS regulations provide that any savings institution that fails to
constitute a QTL must either convert to a bank charter, other than a savings
bank charter (but must retain its SAIF insurance until its conversion to BIF
membership), or limit its future investments and activities (including branching
and payments of dividends) to
21
<PAGE>
those permitted for both savings institutions and national banks. Additionally,
any such savings institution that does not convert to a bank charter will be
ineligible to receive further FHLB advances and, beginning three years after the
loss of QTL status, will be required to repay all outstanding FHLB advances and
dispose of or discontinue any preexisting investment or activities not permitted
for both savings institutions and national banks. Further, within one year of
the loss of QTL status, the holding company of a savings institution that does
not convert to a bank charter must register as a bank holding company and will
be subject to all statutes applicable to bank holding companies. Management of
the Bank does not anticipate any difficulty in meeting the 65 percent QTL test
under current conditions.
As a result in the Deposit Insurance Funds Act of 1996 the Secretary of the
Treasury is to review recommendations in 1997 for the establishment of a common
charter for banks and savings associations. Accordingly, the Bank may be
required to convert its federal savings bank charter to either a national bank
charter, a state depository institution charter, or a newly designed charter.
The Company may also become regulated at the holding company level by the Board
of Governors of the Federal Reserve System (Federal Reserve) rather than by the
OTS. Regulation by the Federal Reserve could subject Eastern to capital
requirements that are not currently applicable to the Company as a holding
company under OTS regulation and may result in statutory limitations on the
type of business activities in which the Company may engage at the holding
company level, which business activities currently are not restricted. The
Company is unable to predict whether such initiatives will result in enacted
legislation requiring a charter change and if so whether the charter change
would significantly impact the Company's operations.
LIQUIDITY. Savings institutions are required to maintain an average daily
balance of liquid assets (including cash, certain time deposits, certain
bankers' acceptances, certain corporate debt securities and highly rated
commercial paper, securities of certain mutual funds and specified United States
government, state or federal agency obligations) equal to a monthly average of
not less than a specified percentage of the average daily balance of the savings
institution's net withdrawable deposits plus short-term borrowings. Under HOLA,
this liquidity requirement may be changed from time to time by the OTS to any
amount within the range of 4 percent to 10 percent depending upon economic
conditions and the deposit flows of member institutions. The liquidity
requirement currently is 5 percent. Savings institutions also are required to
maintain an average daily balance of short-term liquid assets at a specified
percentage (currently 1 percent) of the total of the average daily balance of
its net withdrawable deposits and short-term borrowings. At September 30, 1996,
the Bank was in compliance with these liquidity requirements.
LOANS TO ONE BORROWER LIMITATIONS. The HOLA requires savings institutions
to comply with the loans to one borrower limitations applicable to national
banks, subject to various exceptions and additional provisions for the financing
of sales of OREO and other items. In general, national banks may make loans to
one borrower in amounts up to 15 percent of the bank's unimpaired capital and
surplus, plus an additional 10 percent of capital and surplus for loans secured
by readily marketable collateral. At September 30, 1996, the Bank had loans to
one borrower limits of approximately $8.9 million.
COMMERCIAL REAL PROPERTY LOANS. The HOLA limits the aggregate amount of
commercial real estate loans that a federal savings institution may make to an
amount not in excess of 400 percent of the savings institution's capital,
subject to the discretion of the OTS, but does not require divestiture of loans
made prior to 1989.
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations limiting capital
distributions by savings associations (including dividends, stock repurchases
and cash-out mergers) classify every savings association as a tier 1
institution, a tier 2 institution, or a tier 3 institution, depending on its
level of regulatory capital both before and after giving effect to a proposed
capital distribution. A tier 1 institution (i.e., one that both before and after
a proposed capital distribution has net capital equal to or in excess of its
fully phased-in regulatory capital requirement applicable as of January 1, 1995)
may, subject to any otherwise applicable statutory or regulatory requirements or
agreements entered into with the regulators, make capital distributions in any
calendar year up to the higher of (i) 75 percent of its net income over the most
recent four quarter period or (ii) 100 percent of its net income to date during
the calendar year plus the amount that would reduce by one-half its "surplus
capital ratio" (i.e., the percentage by which the association's capital-to-
assets ratio exceeds the ratio of its fully phased-in capital requirement to its
assets) at the beginning of the calendar year. No regulatory approval of the
capital distribution is required, but prior notice must be given to the OTS.
For purposes of this regulation, as of September 30, 1996, the Bank was a tier 1
institution.
22
<PAGE>
LIMITATION ON EQUITY RISK INVESTMENTS. Under applicable regulations,
savings institutions are generally prohibited from investing directly in equity
securities and real estate (other than that used for offices and related
facilities or acquired through, or in lieu of, foreclosure or on which a
contract purchaser has defaulted). In addition, OTS regulations limit the
aggregate investment by savings institutions in certain equity risk investments,
including equity securities, real estate, service corporations and operating
subsidiaries and loans for the purchase of land and construction loans made
after February 27, 1987 on non-residential properties with loan-to-value ratios
exceeding 80 percent. At September 30, 1996, the Bank was in compliance with the
requirements of the equity risk investment limitations.
INTERSTATE BANKING
National reciprocal interstate banking became effective in Vermont in 1990.
This legislation permits an out-of-state bank holding company to acquire control
of a Vermont bank or bank holding company, subject to the approval of the
Commissioner of Banking, if the law of the state in which the out-of-state bank
holding company has its greatest concentration of deposits permits reciprocal
acquisitions by Vermont institutions.
National reciprocal interstate banking became effective in New Hampshire in
1990. This legislation permits an out-of-state bank or bank holding company to
establish new banks or affiliate with existing banks and bank holding companies
in New Hampshire. The legislation establishes procedures for the creation of
new banks in New Hampshire and the acquisition of five percent or more of a New
Hampshire bank or bank holding company by an out-of-state bank or bank holding
company, including an application requirement to the New Hampshire Board of
Trust Company Incorporation.
The Riegle-Neal Interstate Bank and Branching Efficiency Act of 1994 (the
Interstate Banking Act), enacted in September 1994, eliminated many barriers to
interstate acquisitions by bank holding companies commencing in 1995, and will
eliminate many barriers to interstate branching commencing in 1997, subject to
the right of individual states to opt out of certain provisions of the
Interstate Banking Act in these regards.
Commencing in September 1995, bank holding companies which meet specified
capital and management adequacy standards are eligible to acquire banks in other
states. Until 1997, except for transactions which could have been made prior to
enactment of the Interstate Banking Act, an interstate holding company system
will need to retain a separate bank charter in each state where its subsidiaries
conduct banking business. Various restrictions on such acquisitions will still
apply after 1995, including (1) federal and state antitrust laws, as currently
in effect; (2) prohibitions on a single holding company system accounting for
more than 10 percent of all deposits nationwide or, subject to various opt-in
and opt-out provisions for individual states on a nondiscriminatory basis,
accounting for 30 percent or more of deposits in any state; (3) state-imposed
prohibitions on acquiring banks within up to five years after they commence
operations; and (4) compliance by the acquiror with Community Reinvestment Act
(CRA) and fair lending laws.
Commencing on June 1, 1997, banks will be permitted to cross state lines to
merge with other banks, subject to the ability of individual states to adopt
various nondiscriminatory opt-in and opt-out provisions. Vermont adopted an
accelerated opt-in provision effective May 30, 1996 and therefore, after such
date banks outside Vermont can merge with banks located in Vermont provided that
such bank's jurisdiction of incorporation provides similar interstate banking
provisions. New Hampshire did not adopt an accelerated opt-in provision,
therefore, the opt-in provision becomes effective June 1, 1997. Antitrust and
anticoncentration restrictions will apply as described above. It will not be
necessary to keep multiple state charters in effect or to have a holding company
system. Generally, all banks that are parties to a proposed post-1997 merger
must satisfy applicable CRA, management quality, and capital adequacy standards.
DE NOVO branching across state lines will be permissible if the host state
has a law expressly permitting out-of-state banks to establish DE NOVO branches
in such state, commencing in 1997, state laws restricting branching within a
state will continue to apply to both federally chartered and state chartered
institutions. States may also impose instate standards in such areas as CRA,
fair lending, and consumer protection.
The Vermont, New Hampshire, and federal legislation may significantly
increase the competition faced by the Bank over time.
23
<PAGE>
INSURANCE OF DEPOSITS
Federal deposit insurance is required for all federal and state chartered
savings institutions. Savings institutions' deposits are insured to a maximum of
$100,000 for each insured depositor by the SAIF. As a SAIF-insured institution,
the Bank is subject to regulation and supervision by the FDIC.
Pursuant to FDICIA, the FDIC has promulgated regulations establishing a
risk-based assessment system for the insurance premiums payable to SAIF by
members based on the institution's perceived risk to the SAIF. The FDIC
determines the institution's deposit premiums according to the following two-
step process. First, the institution will be designated either (i) well
capitalized, (ii) adequately capitalized, or (iii) undercapitalized based on the
same capital standards used by the OTS in determining whether "prompt corrective
action" is required under FDICIA. Next, the institution is further
subcategorized on the basis of other relevant factors such as the review of the
institution by its primary regulators and an analysis of the institution's
financial statements to determine whether the institution poses either (i)
little risk, (ii) demonstrated weaknesses, or (iii) high risk. Deposit premiums
will be the highest for high risk, undercapitalized institutions and the lowest
for little risk, well capitalized institutions. The assessment imposed on the
Bank may vary depending on SAIF revenue and expense levels, the risk
classification applied to the Bank, and FDIC policy.
Legislation was signed into law on September 30, 1996 in order to
recapitalize the SAIF. Depository institutions were assessed a rate of 65.7
basis points per $100 of SAIF assessable deposits as of March 31, 1995. The one-
time special assessment was due on October 1, 1996 and payable on November 27,
1996. The Bank was assessed $3.8 million (pretax).
The FDIC is proposing lower insurance premium rates on SAIF insured
deposits scheduled to become effective January 1, 1997. The proposed rates
range from 0 to 27 basis points based upon the strength of the institution.
The new rates could be effective October 1, 1996 for those institutions not
subject to FICO assessments. Beginning January 1, 1997 until December 31, 1999,
BIF insured institutions will pay an annual rate of approximately 1.29 basis
points for every $100 of domestic deposits as FICO assessments. Likewise, SAIF
insured institutions will pay an annual rate of approximately 6.44 basis points
for every $100 of domestic deposits. Beginning in 2000, both banks and thrifts
will pay an equal rate of 2.43 basis points per $100 of domestic deposits. BIF
and SAIF would be merged on January 1, 1999 provided the bank and savings
association charters are merged by that date.
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Bank System consists of 12 regional FHLBs, each
subject to supervision and regulation by the Federal Housing Finance Board (the
FHFB). The FHLBs provide a central credit facility for member savings
institutions. The Bank, as a member of the FHLB of Boston, owns specified
amounts of capital stock in that FHLB. The maximum amount which the FHLB of
Boston will advance fluctuates from time to time in accordance with changes in
policies of the FHFB and the FHLB of Boston, and the maximum amount generally is
reduced by borrowings from any other source and predicated on the institution's
continued compliance with the QTL definition. See "Regulation - Savings
Institution Regulation - Qualified Thrift Lender Requirement."
FEDERAL RESERVE SYSTEM
Federal Reserve Board regulations require savings institutions to maintain
nonearning reserves against their transaction accounts (primarily NOW and
regular checking accounts) and nonpersonal time deposits (those which are
transferable or held by a person other than a natural person) with an original
maturity of less than 1 1/2 years. At September 30, 1996, the Bank was in
compliance with these requirements. These reserves may be used to satisfy
liquidity requirements imposed by the OTS. Because required reserves must be
maintained in the form of vault cash or a non-interest-bearing account at a
Federal Reserve Bank, the effect of this reserve requirement is to reduce the
amount of the institution's interest-earning assets.
Savings institutions also have the authority to borrow from the Federal
Reserve "discount window" after they have exhausted all FHLB sources. FDICIA
places limitations upon a Federal Reserve Bank's ability to extend advances to
undercapitalized and critically undercapitalized depository institutions,
including a prohibition on advances outstanding to an undercapitalized
institution for more than 60 days in any 120-day period.
24
<PAGE>
TAXATION
FEDERAL. The Company, on behalf of itself and its subsidiaries, files a
September 30 tax year consolidated federal income tax return and reports income
and expenses under the accrual method of accounting.
Under the applicable provision of the Internal Revenue Code of 1986, as
amended and in effect on December 15, 1996, savings institutions generally are
taxed in the same manner as other corporations. Historically, however,
qualifying savings institutions, such as the Bank, that met certain definitional
tests relating to the nature of their supervision, income, assets, and business
operations, were allowed to establish a reserve for bad debts and each tax year
were permitted to deduct reasonable additions to that reserve on "qualifying
real property loans" using the more favorable of two alternative methods: (i) a
method based on the institution's actual loss experience (the "experience
method") or (ii) a method based on a specified percentage of the institution's
taxable income (the "percentage of taxable income method"). "Qualifying real
property loans" were, with certain exceptions, loans secured by interests in
improved real property or secured by interests in real property which was to be
improved out of the proceeds of such loans. The addition to the reserve for
nonqualifying loans was computed under the experience method.
Under the percentage of taxable income method, a qualifying institution
could deduct 8 percent of its modified taxable income for any taxable year,
subject to certain limitations. Under the experience method, a qualifying
savings institution could deduct an amount based on average yearly loan losses
over the current and the previous five taxable years, subject to certain
limitations. In the fiscal year 1996, the Bank used the experience method due
to the amount of its loan charge-offs. See notes 4 and 10 of notes to
consolidated financial statements.
In August, 1996, provisions repealing certain thrift bad debt rules were
passed by Congress as part of "The Small Business Job Protection Act of 1996."
These provisions generally eliminated the rules described above for tax years
beginning after December 31, 1996. Therefore, for tax years ending on or after
September 30, 1997, the Bank will calculate its bad debt deduction based upon
the level of loan charge-offs actually incurred for tax purposes during these
years. Furthermore, the Bank will have to recapture its applicable excess
reserves over a six-year period pursuant to provisions passed as part of the
legislation. In general, the Bank's applicable excess reserves will be equal to
its tax reserves as of September 30, 1996, less its tax reserves as of the close
of its base year on September 30, 1988. Deferred taxes have been provided for
this liability, and, therefore, no additional financial statement charge will
occur as a result of this recapture.
In general, distributions that the Bank makes to the Company in excess of
its current and accumulated earnings and profits would be considered to be made
wholly or partly out of the Bank's frozen base year's tax reserves for which no
deferred taxes have been provided. Such distributions out of the Bank's frozen
tax year's tax reserve generally would be included in the Bank's taxable income.
Distributions in redemption of stock or in complete or partial liquidation of
the Bank generally will be treated as being made first out of the Bank's frozen
base year's tax reserves, then out of the Bank's current and accumulated
earnings and profits, and then out of such amounts as may be proper.
The Company's federal income tax returns have been examined and audited or
closed without audit by the Internal Revenue Service for tax years through
September 30, 1993.
STATE. Vermont imposes a monthly franchise tax on savings institutions
that generally is equal to 0.000040 of the average monthly deposit for such
taxable month held in Vermont by the savings institution. The tax is payable
quarterly and is subject to certain limitations and minimums set forth in the
applicable statute.
The Company is subject to Vermont non-bank corporate income tax at a
maximum rate of 8.25 percent of Vermont net income allocated or apportioned to
Vermont, subject to certain limitations and minimums set forth in the applicable
statute. For this purpose, Vermont net income generally is equal to federal
taxable income with certain adjustments.
New Hampshire imposes a business profits tax on business organizations
which subjects the taxable business profits of such organizations allocable to
New Hampshire to a 7 percent tax. Taxable business profits are computed with
reference to federal taxable income, subject to apportionment to New Hampshire
and certain other
25
<PAGE>
adjustments, set forth in the applicable statute. The business profits tax may
be reduced (but not below zero) by a credit for Business Enterprise taxes paid.
The New Hampshire Business Enterprise Tax (BET) generally applies to companies
subject to the business profits tax, and is imposed on a separate company basis.
The tax is calculated at .25 percent of the sum of compensation expense,
interest expense, and dividends paid, subject to apportionment to New Hampshire
and certain other adjustments.
26
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information with respect to the
executive officers of the Company at September 30, 1996. All officers serve at
the discretion of the Board of Directors, and there are no arrangements or
understandings regarding any such person's term of office as an officer, except
that Mr. Cobb has an employment contract with the Company pursuant to which he
serves as an officer of the Company and Mr. Humphrey has an employment contract
with the Company and the Bank pursuant to which he serves as an officer of those
companies.
Age at
September 30,
Name 1996 Position(s) Held With the Company
- --------------------------------------------------------------------------------
John A. Cobb 52 President and Chief Executive
Officer; Chief Executive Officer
of the Bank
E. David Humphrey 54 Executive Vice President; President
and Chief Operating Officer
of the Bank
Janine K. Pinel 30 Chief Financial Officer and Vice
President
Robert K. Hamme 54 Treasurer and Corporate Secretary;
Senior Vice President of the Bank
- --------------------------------------------------------------------------------
Information concerning the principal occupations of the executive officers
of the Company during at least the last five years is set forth below.
John A. Cobb was elected president, chief operating officer, and a director
of the Company in August 1988, and in February 1989 Mr. Cobb became the
Company's chief executive officer. He also currently serves as chief executive
officer and as a director of the Bank. He has a Bachelors degree from West
Virginia University and is a Certified Public Accountant.
E. David Humphrey joined the Bank on November 30, 1991 and during fiscal
1992 began serving as its president and chief operating officer. He also serves
on the Bank's and the Company's boards of directors. Before joining the Bank, he
served as president, chief executive officer, and a director of Eureka Savings
Bank in Overland Park, Kansas from 1988 through 1991. He holds a Bachelor of
Science degree in Business Administration from West Virginia University.
Janine K. Pinel joined the Company in June 1994 as vice president of
accounting. In February 1995, Mrs. Pinel became the chief financial officer of
the Company. Prior to joining the Company, Mrs. Pinel had been employed by
Schering Plough Corporation in New Jersey from April 1992 through February 1993
and by Ernst & Young LLP from August 1988 through April 1992. She holds a
Bachelor of Science degree from Clemson University and is a Certified Public
Accountant. Mrs. Pinel is a member of the Vermont Society of CPAs, the American
Institute of CPAs, the Financial Executives Institute, and the National
Association for Female Executives.
Robert K. Hamme is a senior vice president, chief financial officer and
corporate secretary of the Bank. He also serves as treasurer and corporate
secretary of the Company. Before joining the Bank in March 1993, he served as
senior vice president, treasurer and corporate secretary of Bank of Vermont in
Burlington, Vermont. He is a Certified Public Accountant and a member of both
the Pennsylvania and Vermont Society of Certified Public Accountants. Mr. Hamme
is a graduate of Susquehanna University, with a Bachelor of Science degree in
Accounting.
27
<PAGE>
ITEM 2. PROPERTIES
The Company's headquarters are located at 537 Central Avenue, Dover, New
Hampshire 03820. The Bank's main office is located at 282 Williston Road,
Williston, Vermont 05495. At September 30, 1996, the Bank had 15 branch offices
in Vermont, including its main office, all of which have ATMs, and two remote
site ATMs; and nine branch offices in New Hampshire, eight of which had ATMs,
and one remote site ATM. The Bank continually considers the strategic value of
additional branch offices and remote service locations. The decision to apply
for regulatory approval of such additional facilities depends upon management's
assessment of marketing and economic conditions, the availability of suitable
locations and the proximity of branches of competing institutions. Management
believes its existing facilities are currently adequate to conduct the Company's
business.
The following table sets forth certain information with respect to each of
the Bank's offices. At September 30, 1996, the total net carrying value of the
offices owned by the Bank and the leasehold improvements of leased offices was
$8.2 million.
<TABLE>
<CAPTION>
Owned Lease Net Carrying Value Branch
Date opened or Expiration as of Office Area
Location or acquired Leased Date September 30, 1996 by Sq. Ft.
- ----------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
VERMONT
Williston (main office) 1990 Leased 2000 $ 247 40,000
Burlington 1976 Leased 2003 356 7,227
Rutland (ATM only) 1969 Leased 1996 3 2,140
Montpelier 1972 Owned - 232 6,600
Essex Junction 1976 Leased 1998 109 1,505
Vergennes 1972 Leased 2000 18 2,000
St. Albans 1979 Owned - 374 4,893
North Avenue
(Burlington) 1980 Owned - 301 1,656
Williston Road
(South Burlington) 1981 Owned - 558 3,400
Randolph 1981 Leased 1997 14 1,248
Middlebury 1981 Owned - 157 2,940
Windsor 1983 Owned - 137 4,100
Shelburne (ATM only) 1985 Leased 1998 15 200
Bennington 1988 Owned - 393 4,100
Colchester 1989 Leased 1998 27 2,100
Rutland-Woodstock 1988 Owned - 603 6,000
Rutland - Route 7 1996 Ground lease 2005 652 3,500
Hurricane Lane (Williston 1996 Leased 2000 193 18,500
non-branch office)
NEW HAMPSHIRE
Dover 1992 Owned - 1,049 15,742
Dover (ATM only) 1992 Ground lease 1997 13 204
Durham 1992 Ground lease 2003 73 3,123
Tilton 1991 Owned - 128 5,118
Exeter (main office) 1962 Owned - 1,260 10,908
Exeter (branch) 1977 Owned - 217 1,364
Stratham 1979 Owned - 297 3,644
Raymond 1979 Owned - 272 3,644
Hampstead 1980 Owned - 292 3,644
Franklin 1982 Owned - 161 4,350
------
$8,151
------
------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
The Bank owns and leases computers, peripheral equipment, and terminals
which are used for the purpose of providing data processing service to the Bank.
The net book value at September 30, 1996 of the computer equipment owned was
approximately $3.5 million.
ITEM 3. LEGAL PROCEEDINGS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
From August 4, 1986 to April 30, 1995, the common stock of the Company
traded on the Nasdaq National Market under the symbol "VFBK." Effective May 1,
1995, the Company changed its Nasdaq National Market symbol to "EBCP."
The following table sets forth market price information (last reported
sales price) for the common stock of the Company for the periods indicated. All
per share information has been adjusted to reflect the Company's June 19, 1996
three-for-two stock split paid to stockholders of record on June 5, 1996.
<TABLE>
<CAPTION>
Cash dividend Stock price Stock price
Fiscal Year paid high low
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1996:
Fourth quarter ended September 30, 1996 $.14 $22.25 $16.00
Third quarter ended June 30, 1996 .12 17.67 15.17
Second quarter ended March 31, 1996 .12 17.50 15.67
First quarter ended December 31, 1995 .11 19.67 14.67
- ------------------------------------------------------------------------------------------------------
1995:
Fourth quarter ended September 30, 1995 $.08 $16.00 $14.17
Third quarter ended June 30, 1995 .07 15.00 12.33
Second quarter ended March 31, 1995 .07 14.33 12.50
First quarter ended December 31, 1994 .03 14.83 10.83
- ------------------------------------------------------------------------------------------------------
1994:
Fourth quarter ended September 30, 1994 $.03 $16.33 $13.33
Third quarter ended June 30, 1994 .03 15.67 10.25
Second quarter ended March 31, 1994 .03 12.33 10.42
First quarter ended December 31, 1993 .02 12.50 9.50
- ------------------------------------------------------------------------------------------------------
</TABLE>
Payment of cash dividends in future periods is subject to, among other
things, Company earnings, tax and regulatory considerations, and certain
contractual restrictions in the Merger Agreement.
29
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The following tables summarize certain selected consolidated financial data
of the Company at the dates or for the periods indicated. This information
should be read in conjunction with the consolidated financial statements and
notes thereto. See also Part II, Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
FINANCIAL CONDITION At September 30,
- ---------------------------------------------------------------------------------------------------------
AND OTHER DATA: (Dollars in thousands, except per share amounts)
1996 1995 1994 1993 1992 (a)
---- ---- ---- ---- --------
<S> <C> <C> <C> <C> <C>
Total assets $868,678 $846,085 $819,236 $776,504 $739,263
Investment and mortgage
backed securities 305,701 319,056 325,612 283,494 243,861
FHLB stock 9,283 9,283 8,923 7,514 7,411
Net loans 488,786 453,992 418,859(b) 417,302(b) 422,574(b)
Allowance for loan losses 2,858 3,622 3,718 4,722 4,802
Nonperforming assets 12,004 16,784 14,569 25,559 27,304
Excess of cost over net
assets acquired 3,528 3,908 4,290 4,670 5,111
Deposits 641,286 616,350 584,389 571,954 573,183
Borrowings 153,909 161,882 171,988 142,874 109,743
Stockholders' equity 63,580 60,983 57,203 54,683 49,968
Stockholders' equity per share 17.41 17.07 16.15 15.66 14.49
Number of banking offices 25 23 23 23 23
<CAPTION>
Years Ended September 30,
- ---------------------------------------------------------------------------------------------------------
OPERATING DATA:
1996 1995 1994 1993 1992(a)
---- ---- ---- ---- -------
<S> <C> <C> <C> <C> <C>
Interest income 61,273 $60,098 $51,546 $49,066 $49,898
Interest expense 32,340 32,218 25,613 25,881 30,427
------ ------ ------ ------ ------
Net interest income 28,933 27,880 25,933 23,185 19,471
Provision for loan losses 895 1,822 797 1,330 2,118
Gain (loss) on sale of
investment and mortgage
backed securities net 808 -- 443 (40) 295
Other non-interest income 10,465 10,017 7,579 8,248 8,050
Other real estate owned
operations expense 1,358 3,054 2,726 4,122 4,349
Other non-interest expense 32,594 26,479 24,466 22,349 19,819
------ ------ ------ ------ ------
Income before taxes and
accounting change 5,359 6,542 5,966 3,592 1,530
Federal and state tax expense 2,055 2,347 2,307 878 513
Cumulative effect of accounting -- -- -- 1,000 --
change ------ ------ ------ ------ ------
Net income $3,304 $4,195 $3,659 $3,714 $1,017
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net income per common
and common equivalent
share before cumulative
effect of accounting change $0.87 $1.13 $1.00 $0.77 $0.29
Net income per common
and common equivalent share 0.87 1.13 1.00 1.05 0.29
Cash dividends paid
per share (c) 0.49 0.24 0.10 0.07 0.05
Dividend payout ratio 56.32% 21.30% 10.00% 6.96% 18.18%
Increase (decrease) in deposits $24,936 $31,961 $12,435 $(1,229) $103,143
- ---------------------------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
OPERATING DATA: Years Ended September 30,
- ---------------------------------------------------------------------------------------------------------
(continued)
1996 1995 1994 1993 1992(a)
---- ---- ---- ---- -------
<S> <C> <C> <C> <C> <C>
Loans originated:
Mortgage $163,255 $ 95,195 $177,088 $198,033 $182,827
Consumer 38,219 32,560 52,702 45,527 40,799
Commercial 13,585 34,931 16,524 12,243 6,531
Total loans originated
and purchased 268,131 174,612 247,933 279,066 244,452
Loans sold or securitized
and sold 139,339 61,021 148,767 196,076 160,506
Loans serviced for others 647,653 563,021 666,732 617,984 438,077
Loans purchased or acquired 53,072 11,926 1,619 23,263 70,497
<CAPTION>
SIGNIFICANT STATISTICAL Years Ended September 30,
- ---------------------------------------------------------------------------------------------------------
DATA:
1996 1995 1994 1993 1992(a)
---- ---- ---- ---- -------
<S> <C> <C> <C> <C> <C>
Combined yield on loan,
investment and mortgage
backed security portfolio 7.94% 7.83% 7.07% 7.18% 8.46%
Total cost of funds 4.54 4.49 3.70 3.93 5.34
Interest rate spread (d) 3.40 3.34 3.37 3.25 3.12
Net interest margin (e) 3.75 3.63 3.55 3.40 3.30
Return on average assets 0.40 0.50 0.46 0.49 0.16
Return on average equity 5.20 6.95 6.60 7.15 2.06
Average equity to average
assets 7.64 7.26 6.94 6.89 7.54
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
REGULATORY CAPITAL OF SUBSIDIARY
(Dollars in thousands) At September 30, 1996
VERMONT FEDERAL BANK ACTUAL REQUIRED EXCESS
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Core $56,152 6.5% $25,819 3.0% $30,333
Tangible 56,152 6.5 12,909 1.5 43,243
Risk-based 58,929 12.3 38,276 8.0 20,653
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(a) All 1992 information includes results of acquisitions by FS during fiscal
1992. See Item 1, General, under the heading "Rockingham Bancorp and First
Savings of New Hampshire."
(b) In-substance foreclosure loans were not reclassified to loans in accordance
with SFAS No. 114 because of the lack of appropriate detail to make
required reclassifications.
(c) The quarterly cash dividend paid to stockholders was increased from $0.01
per share to $0.02 per share in January 1993, increased to $0.03 per share
in January 1994, increased to $0.07 per share in January 1995, increased to
$0.08 per share in July 1995, increased to $0.11 per share in November
1995, increased to $0.12 per share in January 1996, and increased to $0.14
per share in July 1996.
(d) Difference between combined yield on loan, investment and mortgage backed
securities portfolios, and total cost of funds.
(e) Net interest income divided by average earning assets.
31
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Management's discussion and analysis should be read in conjunction with the
consolidated financial statements, the notes thereto and other financial and
statistical information contained in this Annual Report on Form 10-K.
During fiscal 1996, the Company operated as the nondiversified unitary
savings and loan holding company of the Bank. The Company also owns VSC, a real
estate development company, which together with its subsidiary company, VECC, is
a joint venture partner in the ownership of development rights in a mobile home
development known as "Williston Woods."
The Company conducted its fiscal 1996 business primarily through the Bank,
which provided retail banking services to customers in its geographic regions.
The Bank operated fifteen branch locations in Vermont, including six in
Chittenden County, which is the state's most populous county, and operated ten
branch locations in New Hampshire, seven of which are in the New Hampshire
seacoast region. The Bank offered a variety of checking, savings, and
certificate of deposit products to meet its customers' deposit needs. The Bank
used such deposits to fund loans and other investment purchases. It used
borrowings when deposit inflows were not sufficient to fund these asset
acquisitions. Primary lending activities were residential mortgage and consumer
lending, including second mortgage and mobile home loans. The Bank originated
only a limited number of commercial loans because of the lack of quality
commercial loan demand in the lending areas.
On November 13, 1996, the Company entered into the Merger Agreement
together with the Bank and VFSC. Pursuant to the merger described in the Merger
Agreement, the Company will merge with and into VFSC and the Bank will become a
wholly-owned subsidiary of VFSC. Consummation of the Merger is conditioned,
among other things, upon stockholder approval and regulatory approval. The
Merger is described in more detail in Eastern's Current Report on Form 8-K dated
November 21, 1996.
All per share information has been adjusted to reflect the Company's June
19, 1996 three-for-two stock split paid to stockholders of record on June 5,
1996.
On October 1, 1995, the Company merged its two subsidiary banks, First
Savings of New Hampshire and Vermont Federal Bank, FSB, to form one unified
bank, Vermont Federal Bank, FSB. The New Hampshire branches retained the name of
First Savings of New Hampshire, operating as a division of Vermont Federal Bank,
FSB.
Certain prior year financial disclosures contained herein refer to VFB and
FS as the "Banks," which operated independently during fiscal 1995. Disclosures
that refer to operations during fiscal 1996 and subsequently refer to the Banks
as one consolidated entity (the Bank).
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED SEPTEMBER 30, 1996 AND 1995
The Company's results of operations have varied significantly from year to
year, for the reasons set below. Prior years' results should not be considered
as predictors of results in subsequent years. Notwithstanding the foregoing,
management does not expect that certain provisions of the Merger Agreement,
which require the Company and the Bank to operate in the ordinary course of
business consistent with past practice and to observe certain restrictions on
capital expenditures, dividends, and other similar matters, to have a material
adverse effect on the future results of operation.
GENERAL
The Company had net income during fiscal 1996 of $3.3 million or $0.87 per
share, compared with net income for fiscal 1995 of $4.2 million or $1.13 per
share. The decrease in fiscal 1996 net income compared to fiscal 1995 net
income resulted primarily from a non-recurring charge of $3.8 million (pre-tax)
for the SAIF
32
<PAGE>
special assessment by the FDIC. This special assessment was mandated by
legislation signed into law on September 30, 1996, to recapitalize the SAIF
Fund. Without giving effect to this one-time assessment, earnings for fiscal
year 1996 would have been $5.7 million, or $1.50 per share. Return on assets
would have been 0.69 percent and return on equity would have been 9.01 percent
without the SAIF assessment. Significantly offsetting the decrease in net
income due to this assessment was a $0.9 million decrease in the provision for
the loan losses, a $0.8 million gain on sale of investment and mortgage backed
securities, and a $1.7 million decrease in OREO expense.
TABLE 1
ANALYSIS OF AVERAGE RATES AND BALANCES
The following table sets forth the Company's average balances and average
rates for the period indicated.
<TABLE>
<CAPTION>
Years ended September 30, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST RATE Interest Rate Interest Rate
AVERAGE INCOME/ EARNED/ Average income/ earned/ Average income/ earned/
BALANCE EXPENSE PAID balance expense paid balance expense paid
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Loans(a) $463,230 $41,561 8.97% $435,058 $38,549 8.86% $414,064 $32,856 7.94%
Investment and mortgage
backed securities(b) 308,160 19,712 6.40 333,214 21,549 6.48 315,525 18,690 5.93
-------- -------- -------- -------- -------- --------
Total interest-earning assets 771,390 61,273 7.94 768,272 60,098 7.83 729,589 51,546 7.07
Other real estate owned 4,351 10,313 16,702
Non-interest-earning assets 56,464 52,667 52,659
-------- -------- --------
Total assets $832,205 $831,252 $798,950
-------- -------- --------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Savings $116,429 3,064 2.63 $126,794 3,384 2.67 $139,413 3,736 2.68
Interest-bearing checking 142,049 3,527 2.48 130,003 3,485 2.68 131,013 2,919 2.23
Time deposits 316,317 17,525 5.54 285,857 14,798 5.18 262,987 11,097 4.22
Borrowings 137,292 8,224 5.99 175,523 10,551 6.01 158,397 7,861 4.96
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities 712,087 32,340 4.54 718,177 32,218 4.49 691,810 25,613 3.70
-------- -------- -------- -------- -------- --------
Non-interest-bearing deposits 51,031 47,219 44,895
Other non-interest bearing
liabilities 5,514 5,469 6,825
-------- -------- --------
Total liabilities 768,632 770,865 743,530
Stockholders' equity 63,573 60,387 55,420
-------- -------- --------
Total liabilities and
stockholders' equity $832,205 $831,252 $798,950
-------- -------- --------
Net interest income $28,933 $27,880 $25,933
------- ------- -------
Net interest spread (c) 3.40 3.34 3.37
Net interest margin (d) 3.75 3.63 3.55
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes nonperforming loans and loan fees considered an adjustment of yield
but does not include the undisbursed portion of loans in process.
(b) The rate earned on investment and mortgage backed securities reflects
tax-exempt income on a fully taxable equivalent basis.
(c) Average yield on all interest-earning assets during the period less average
cost of all interest-bearing liabilities.
(d) Net interest income divided by average interest-earning assets.
NET INTEREST INCOME
Net interest income increased $1.0 million in fiscal 1996 to $28.9 million
from $27.9 million in fiscal 1995. A $1.1 million increase in interest income
on interest earning assets was partially offset by the $122,000 increase in
interest expense on deposits and borrowings. Items affecting net interest
income were interest rates, the ability of the Company's assets and liabilities
to react to changes in interest rates, and the balance and mix of the Company's
financial assets and liabilities. See Tables 1 through 4 for average balance,
average rate, and repricing information.
Interest income from loans increased $3.0 million during fiscal 1996.
Higher interest rates, during the second half of fiscal 1996, resulted in a 11
basis point increase in the average yield on the loan portfolios for the
33
<PAGE>
entire year. The average yield increased from 8.86 percent in fiscal 1995 to
8.97 percent in fiscal 1996 as adjustable-rate mortgages repriced at higher
rates. Fixed-rate mortgages, priced principally by reference to long-term
interest rates, originated at interest rates between 6.5 and 9.5 percent during
fiscal 1996. Adjustable rate mortgages, priced by reference to short term
indices such as the U.S. Treasury constant one-year maturity indexes, increased
their yields as they repriced to higher interest rates. This matched the
overall increase in their respective indexes. The Company expects that if
interest rates in fiscal 1997 remain unchanged from fiscal 1996 rates, loan
yields attributable to adjustable-rate mortgages will remain relatively stable.
If interest rates fall, loan refinancing activity should increase and loan
yields should fall due to repayment of higher rate loans as well as repricing of
variable rate loans. If interest rates rise, loan yields should increase due to
repricing of variable rate loans.
Investment interest income decreased $1.8 million to $19.7 million during
fiscal 1996 from $21.5 million during fiscal 1995, due primarily to a decrease
in average balances of $25.1 million and a decrease in the weighted average
yield of 8 basis points. The Company does not invest a significant amount in
derivative securities or similar type securities. At September 30, 1996, the
Company's mortgage backed securities included $13.2 million of collateralized
mortgage obligations (CMOs). The Company considers these bonds relatively low
risk derivative securities because the Company expects them to react to changes
in interest rates in a way that is not materially different from other fixed
rate mortgage backed securities in the held-to-maturity portfolio. The Company
expects that if interest rates remain unchanged, the yield on investment and
mortgage backed securities should remain relatively stable. If interest rates
decline, portfolio yields should fall due to increases in prepayment speeds and
premium amortization. If interest rates increase, reinvestment of principal
repayments should lead to higher portfolio yields.
TABLE 2
COMPONENTS OF INVESTMENT INCOME
The following table sets forth the components of investment income for the
periods indicated.
<TABLE>
<CAPTION>
(As a percentage of average investment Fiscal years ended September 30,
and mortgage backed securities) 1996 1995 1994
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income 6.58% 6.67% 6.45%
(Premium amortization), discount accretion, net (0.18) (0.19) (0.52)
- --------------------------------------------------------------------------------------------------
Total investment income 6.40% 6.48% 5.93%
- --------------------------------------------------------------------------------------------------
</TABLE>
Interest expense on deposits increased $2.4 million during fiscal 1996
compared to fiscal 1995. The weighted average rate on interest-bearing deposits
increased 21 basis point to 4.20 percent correlating to the increase in market
interest rates. At September 30, 1996, non-interest bearing deposits were 8.73
percent of total deposits, and interest-bearing NOW accounts were 12.51 percent
of total deposits. These deposits provide the Company with a source of low-cost
funds due their insensitivity to changes in interest rates.
34
<PAGE>
TABLE 3
RATE/VOLUME ANALYSIS
The following table reconciles changes in interest income and interest
expense of the Company for the periods indicated due to changes in average
balances, rates, or a combination of both. Loan fees not considered as an
adjustment to yield have been excluded from the analysis.
<TABLE>
<CAPTION>
Years ended September 30,
- ----------------------------------------------------------------------------------------------------------------------------
1996 v. 1995 Increase (decrease) 1995 v. 1994 Increase (decrease)
------------------------------------------ --------------------------------------------
AVERAGE Average
AVERAGE AVERAGE RATE AND Average Average rate and
(Dollars in thousands) RATE BALANCE BALANCE TOTAL rate balance balance Total
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loan portfolio $484 $2,497 $31 $3,012 $3,833 $1,666 $194 $5,693
Investment and
mortgage backed
securities portfolios (234) (1,621) 18 (1,837) 1,715 1,048 96 2,859
- ----------------------------------------------------------------------------------------------------------------------------
Total 250 876 49 1,175 5,548 2,714 290 8,552
- ----------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposit accounts 1,100 1,284 65 2,449 3,096 630 189 3,915
Borrowings (36) (2,299) 8 (2,327) 1,660 850 180 2,690
- ----------------------------------------------------------------------------------------------------------------------------
Total 1,064 (1,015) 73 122 4,756 1,480 369 6,605
- ----------------------------------------------------------------------------------------------------------------------------
Net change in net
interest income $(814) $1,891 $(24) $1,053 $792 $1,234 $(79) $1,947
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest expense on borrowed funds decreased $2.3 million to $8.2 million
during fiscal 1996 from $10.5 million during fiscal 1995. The decrease resulted
primarily from a decrease in the average balances of borrowed funds from $175.5
million for fiscal 1995 to $137.3 million for fiscal 1996. The Bank used
borrowed funds for loan originations and for investment and mortgage backed
securities purchases. Interest expense on borrowed funds will change in direct
correlation to interest rate changes due to the short duration of the borrowed
funds portfolio.
The Company's one-year GAP decreased from the previous year due to
increases in certificates of deposit maturing within one year and a decrease in
investment and mortgage backed securities and consumer loans maturing within one
year. These changes offset an increase in mortgage loans and a decrease in
borrowings maturing within one year. With a positive one-year GAP, the amount
of income earned on assets fluctuates more than the cost of liabilities in
response to changes in the prevailing rates of interest during the one-year
period. Accordingly, in a rising interest rate environment, financial
institutions with a positive one-year GAP will experience greater increase in
the yield on assets than in the cost of funds. Conversely, the cost of funds of
financial institutions with a positive one-year GAP will decrease less than the
yield on assets in a falling interest rate enviornment. Financial institutions
with a negative one-year GAP face the opposite situation. While management has
considerable experience in asset/liability management, future changes in the
general direction of interest rates and the overall economy could negatively
impact net interest margin. See Table 4 for further information regarding
maturity and rate sensitivity.
35
<PAGE>
TABLE 4
MATURITY AND RATE SENSITIVITY
The following table sets forth the Company's maturity and repricing
information for the periods indicated.
<TABLE>
<CAPTION>
At September 30, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Percent Within 1-5 5-10 10-20 Over
(Dollars in thousands) Amount of total 1 year years years years 20 years
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INTEREST-BEARING ASSETS
Mortgage loans
Short term and variable rate $190,736 23.55% $176,442 $ 14,294 $ -- $ -- $ --
Long term fixed rate 76,936 9.50 18,186 39,439 15,270 3,854 187
Consumer loans 136,927 16.90 94,437 39,922 95 -- 2,473
Commercial loans 90,486 11.17 71,880 9,784 3,833 1,296 3,693
Investment and mortgage
backed securities 314,984 38.88 105,709 105,016 70,970 33,166 123
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive assets $810,069 100.00% $466,654 $208,455 $ 90,168 $ 38,316 $ 6,476
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
AND NON-INTEREST-BEARING DEPOSITS
Deposits
NOW and other demand accounts $136,195 17.13% $ 29,397 $ 64,926 $ 27,867 $ 12,263 $ 1,742
Money market accounts 67,148 8.44 21,038 35,854 8,689 1,567 --
Passbook accounts 115,466 14.52 16,177 45,004 28,760 19,882 5,643
Certificate accounts 322,477 40.56 248,353 74,124 -- -- --
Borrowings
FHLB and securities sold under
agreement to repurchase 153,636 19.32 120,800 32,836 -- -- --
Capital lease obligation 273 0.03 144 129 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive liabilities $795,195 100.00% $435,909 $252,873 $ 65,316 $ 33,712 $ 7,385
- ------------------------------------------------------------------------------------------------------------------------------------
Interest sensitivity GAP $ 30,745 $(44,418) $ 24,852 $ 4,604 $ (909)
Cumulative GAP 30,745 (13,673) 11,179 15,783 14,874
as a percentage of assets 3.54% (1.57)% 1.29% 1.82% 1.71%
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, 1995
Cumulative GAP $ 46,121 $ 9,187 $ 8,131 $ 15,062 $ 9,614
as a percentage of assets 5.45% (1.09)% 0.96% 1.78% 1.14%
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, 1994(a)
Cumulative GAP $ 82,242 $(26,720) $(21,972) $ 10,394 $ 4,588
as a percentage of assets 10.04% (3.26)% (2.68)% 1.27% 0.56%
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The maturity and repricing information is derived from the OTS Thrift Financial
Report, Schedule CMR. Different prepayment rates are applied to loans and
mortgage backed securities based on their interest rate to simulate cash flows.
Annual prepayment rates range from 2.0 percent on the lowest coupon rates to
40.0 percent on the highest coupons. Attrition rates are applied to deposit
accounts that can reprice immediately or are payable on demand. These accounts
include savings accounts, NOW and DDA accounts, and money market accounts.
Attrition rates are used to estimate the cash outflows on these accounts. Rates
used were derived from estimation formulas provided by the OTS and approximate
the Bank's internally estimated rates.
(a) Data has not been restated to reflect the adoption of SFAS No. 114 due to
lack of sufficient detail to make appropriate reclassifications.
PROVISION FOR LOAN LOSSES
During fiscal 1996, the Bank made provisions to the loan loss reserve of
$895,000 compared to $1.8 million in fiscal 1995. The Bank establishes loan
loss reserves based on a systematic and detailed analysis of all loans. Among
several criteria considered in this analysis are the underlying market values of
collateral, historic loan loss experience, local economic conditions, and the
level of classified loans. The Bank analyzes its classified loans (including
nonperforming loans) on a periodic basis and provides loan loss reserves in
accordance with the level, quality, and collateral value of these loans. In
addition, historic loan loss experience, adjusted for the expected impact of
changing market values, is used to assist in determining total loan loss reserve
requirements. At September 30, 1996, the Bank had classified loans (loans rated
as "substandard," "doubtful," or "loss") totaling $14.9 million, compared to
$18.0 million at September 30, 1995. Additionally, the Bank had $2.0 million of
loans identified as "special mention," as compared with $2.9 million at
September 30, 1995. Of the $14.9 million in classified loans at September 30,
1996, $7.9 million were nonperforming (non-accruing loans
36
<PAGE>
including loans 90 days or more past due) and the balance of $7.0 million were
performing. Total nonperforming loans of $7.9 million at September 30, 1996,
represented a decrease of $3.1 million from September 30, 1995. The decrease
was primarily due to a decrease in nonperforming commercial loans which was
partially offset by an increase in nonperforming consumer loans. Management
believes that the increase in nonperforming consumer loans, primarily equity
loans and equity credit lines (ECLs), resulted from the continued economic
weakness in the Bank's lending areas and the inability of some borrowers to
maintain payments on adjustable-rate loans at higher interest rates. Continued
real estate market and economic weakness could result in increases in
nonperforming loans.
TABLE 5
NONPERFORMING ASSETS
The following table sets forth information regarding nonperforming
assets at the dates indicated.
<TABLE>
<CAPTION>
At September 30, 1996(b) 1995 1994
- ---------------------------------------------------------------------------------------------------------------
% OF % of % of
(Dollars in thousands) AMOUNT ASSETS Amount Assets Amount Assets
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Nonaccruing loans:
Commercial $3,693 0.43% $6,872 0.81% $2,509 0.31%
Consumer 2,473 0.28 1,782 0.21 1,436 0.18
Residential mortgage 1,779 0.20 2,422 0.29 1,509 0.18
- ---------------------------------------------------------------------------------------------------------------
Total nonaccruing loans 7,945 0.91 11,076 1.31 5,454 0.67
In-substance foreclosures(a) -- -- -- -- 3,610 0.44
Real estate owned, net 3,611 0.42 5,398 0.64 5,273 0.64
Other repossessed assets 448 0.05 310 0.03 232 0.03
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming assets $12,004 1.38% $16,784 1.98% $14,569 1.78%
- ---------------------------------------------------------------------------------------------------------------
Restructured troubled debt:
Performing $4,154 0.48% $4,801 0.57% $2,996 0.37%
Nonperforming (included above) -- -- 985 0.11 2,003 0.24
Impaired performing 1,819 0.21 -- -- -- --
Impaired nonperforming 952 0.11 -- -- -- --
- ---------------------------------------------------------------------------------------------------------------
Total $6,925 0.80% $5,786 0.68% $4,999 0.61%
- ---------------------------------------------------------------------------------------------------------------
Allowance for loan losses $2,858 0.33% $3,622 0.43% $3,718 0.45%
- ---------------------------------------------------------------------------------------------------------------
Allowance for loan losses to:
Nonaccruing loans(a) 35.97% 32.70% 68.17%
Total loans 0.58 0.79 0.87
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) ISF loans have been reclassified to the loan portfolio for fiscal 1996 and
1995 in accordance with SFAS No. 114. Data has not been restated to reflect
the adoption of SFAS No. 114 for fiscal 1994 due to the lack of appropriate
detail to make the required reclassifications.
(b) Impaired loans included in nonperforming loans for fiscal 1996 were
$3.5 million.
The allowance for loan losses allocated to commercial and to residential
mortgage loans decreased from September 30, 1995 to September 30, 1996, while
nonaccruing commercial and residential mortgage loans decreased. The allowance
for loan losses allocated to consumer loans decreased from September 30, 1995 to
September 30, 1996, while nonaccruing consumer loans increased. The level and
allocation of the allowance for loan losses is based upon a systematic migration
analysis. After evaluation of past due loans, management believes the allowance
allocated to such loans is adequate. For further information regarding
nonperforming loans and the allowance for loan losses, see Table 5 and note 4 of
the notes to consolidated financial statements.
In accordance with generally accepted accounting principles (GAAP), when
the Bank transfers a loan to other real estate owned (OREO), the loan transfers
at the lower of cost or fair value less selling costs. The Bank determines fair
value using current independent appraisals. Charges to the allowance for loan
losses occur for reductions in market value below the Bank's book value. As
part of its resolution efforts, the Bank charged $1.9 million to the allowance
during fiscal 1996 and $2.1 million in fiscal 1995. At September 30, 1996, the
Company's total loan loss reserves represented 36.0 percent of nonperforming
loans, compared to 32.7 percent at September 30, 1995.
37
<PAGE>
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," which was amended in October 1994 by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosure." Under SFAS No. 114, a loan is considered impaired when it is
probable that the Company will not be able to collect all amounts due according
to the contractual terms of the loan agreement. Large groups of smaller balance
homogeneous loans that are collectively evaluated for impairment, such as
residential mortgage and installment loans, are exempt from the provisions of
SFAS No. 114. The statements, which were adopted by the Company on October 1,
1995, generally require all creditors to account for impaired loans, except
those loans that are accounted for at fair value or at the lower of cost or fair
value, at the present value of the expected future cash flows discounted at the
loan's effective interest rate. In addition, the statements modify the criteria
for classification of a loan as an in-substance foreclosure such that
classification is made only when the lender is in possession of the collateral.
Adoption of SFAS Nos. 114 and 118 had no material impact on the Company's
financial condition or results of operations.
As of September 30, 1996, the Company believes its loan loss reserve is
adequate to cover potential loan losses currently in its loan portfolio.
Although the Bank has considerable experience in evaluating classified loans,
because of the impact of such factors as the overall economic conditions and the
fluctuation of interest rates on such loans, there can be no assurance that the
provisions made to the Bank's loan loss reserve will prove adequate, and, to the
extent that additional provisions to the Bank's loan loss reserve are required
in the future, the Company's results of operations would be adversely affected.
For further information, see notes 3 and 4 of the notes to the consolidated
financial statements.
NON-INTEREST INCOME
Total non-interest income was $11.3 million or 1.35 percent of average
assets, during fiscal 1996, compared to $10.0 million or 1.21 percent of average
assets during fiscal 1995. The primary reasons for the $1.3 million increase in
1996 were a $808,000 increase in the gain on sale of investment and mortgage
backed securities, and a $449,000 increase in customer service fees. See Table
6 for further information regarding non-interest income.
The FASB issued a special report on SFAS No. 115 in November 1995 that
allowed the Company a one-time reclassification from the held-to-maturity
portfolio to the available-for-sale portfolio. The Bank reclassified $43.7
million of held-to-maturity securities and subsequently sold a majority of those
securities for a net gain of $808,000.
The Company included in its stockholders' equity at September 30, 1996
$6,000 in net unrealized gains from its portfolio of investment and mortgage
backed securities available-for-sale, compared to $175,000 of net unrealized
losses at September 30, 1995. The Company had a net unrealized loss from its
portfolio of investment and mortgage backed securities held-to-maturity of $8.8
million at September 30, 1996, compared to an unrealized loss of $5.4 million at
September 30, 1995. Substantially all of these investments are securities
guaranteed by the U.S. Government or a related agency, and the increase in the
unrealized loss results primarily from the increase in interest rates during the
latter part of fiscal 1996. In order to satisfy the requirements of SFAS No.
115, management has the positive intent to hold these securities to maturity and
believes the Company has the ability to do so. For further information, see
notes 1 and 2 of the notes to consolidated financial statements.
TABLE 6
NON-INTEREST INCOME
Years ended September 30,
(As a percentage of average assets) 1996 1995 1994
- --------------------------------------------------------------------------------
Gain on sale of investment and mortgage
backed securities, net 0.10% --% 0.05%
Gain on sale of loans and servicing, net 0.22 0.23 0.10
Service fees on loans sold 0.14 0.16 0.13
Customer service fees 0.72 0.67 0.64
Miscellaneous 0.17 0.15 0.08
- --------------------------------------------------------------------------------
Total non-interest income 1.35% 1.21% 1.00%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
38
<PAGE>
Gains from the sale of loans and mortgage servicing rights were $1.9
million for both fiscal 1996 and fiscal 1995. Gains from sale of mortgage loans
are dependent on volume, price, and management's asset/liability decisions.
Loans sold or securitized and sold increased to $139.3 million in fiscal 1996
from $61.0 million in fiscal 1995. The Bank's ability to originate loans is
highly dependent on the fluctuation of interest rates. The Company expects that
if interest rates rise, the volume of refinancing activity should decrease.
Conversely, if interest rates fall, originations should increase. The fiscal
1995 results include a gain on sale of PMSR of approximately $777,000 and
$566,000 in increased gains on sales of mortgage loans due to the adoption of
SFAS No. 122, "Accounting for Mortgage Servicing Rights, an Amendment of FASB
Statement No. 65." See notes 1 and 3 of the notes to consolidated financial
statements for further information regarding SFAS No. 122.
Service fees on loans sold were $1.1 million, or .14 percent of average
assets, for fiscal 1996 and $1.3 million, or .16 percent of average assets, for
fiscal 1995. The Bank's portfolio of loans serviced for other investors
increased to $647.7 million at September 30, 1996 from $563.0 million at
September 30, 1995. The Banks sell loans without recourse primarily to the
Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage
Association (FNMA). During fiscal 1996 and 1995, the Bank purchased the rights
to service $54.1 million and $106.0 million, respectively, of residential first
mortgage loans. Premiums paid to purchase PMSR totaled $594,000 and $971,000 in
fiscal 1996 and fiscal 1995, respectively. The Bank intends to continue
purchasing mortgage servicing rights and originating mortgage loans for sale
with the servicing rights retained to increase the use of existing servicing
capacity and increase loan service fee revenue.
Customer service fees increased to $6.0 million, or .72 percent of average
assets, in fiscal 1996 from $5.6 million, or .67 percent of average assets, in
fiscal 1995. The Bank generates service fees primarily from checking and other
transaction accounts. Because of the Bank's strategy of emphasizing checking
accounts, the Bank believes this general level of fee income will continue in
future periods. The 1996 increase resulted primarily from overdraft fees on
totally free checking deposit accounts as fiscal 1996 results included, for the
first time, a full year of such deposit product in the New Hampshire branches.
Miscellaneous non-interest income increased to $1.4 million, or .17 percent
of average assets, in fiscal 1996 from $1.2 million, or .15 percent of average
assets, in fiscal 1995. The fiscal 1996 increase was primarily an increase in
ATM card fees and foreign ATM fees.
NON-INTEREST EXPENSE
Total non-interest expense increased $4.4 million during fiscal 1996 to
$34.0 million or 4.08 percent of average assets. The 1996 increase resulted
primarily from a $3.8 million non-recurring charge assessed by the FDIC to
recapitalize SAIF. Partially ofsetting these increases were decreases in OREO
expenses, restructuring and merger related expenses, and professional fees. See
Table 7 for further information regarding non-interest expense.
In connection with the legislation that was signed into law on September
30, 1996 to recapitalize SAIF, the FDIC assessed the Bank a one-time charge of
$3.8 million, that was paid on November 27, 1996. In addition, the FDIC is
proposing to lower the insurance premium rates on SAIF assessments effective
January 1, 1997 for all SAIF insured institutions. The proposal is based upon a
risk-based matrix ranging from 0 to 27 basis points. The Financing Corporation
(FICO) assessments for SAIF members will be approximately $0.0644 for every $100
of domestic deposits annually from 1997 through 1999. After 1999 the rate for
both SAIF insured and BIF insured institutions will equal $0.0243 for every $100
of domestic deposits annually.
Costs associated with office occupancy increased $951,000 to $6.1 million,
or .73 percent of average assets, for fiscal 1996. This increase was due
primarily to an increase of approximately $310,000 in equipment maintenance, an
increase of approximately $330,000 in depreciation expense primarily related to
the amortization of technology advancements, and an increase of approximately
$270,000 in general office building expense. General office building expense
increased due to branch expansions, higher than normal snow removal costs,
building maintenance, and additional administrative office space.
39
<PAGE>
TABLE 7
NON-INTEREST EXPENSE
The following table sets forth non-interest expense as a percentage of
average assets for the periods indicated.
Years ended September 30,
(As a percentage of average assets) 1996 1995 1994
- --------------------------------------------------------------------------------
Compensation and benefits 1.46% 1.37% 1.36%
Office occupancy, net 0.73 0.62 0.61
Marketing 0.20 0.18 0.14
Professional fees 0.09 0.14 0.17
Restructuring and merger related 0.05 0.12 --
Supplies 0.16 0.11 0.09
Telephone 0.10 0.07 0.07
Postage 0.11 0.10 0.09
Other 0.34 0.26 0.26
- --------------------------------------------------------------------------------
Total non-interest expense excluding
FDIC insurance, OREO, and
amortization of intangibles 3.24% 2.97% 2.79%
- --------------------------------------------------------------------------------
FDIC premium 0.63% 0.17% 0.18%
Amortization of intangibles 0.05 0.04 0.09
OREO 0.16 0.37 0.34
- --------------------------------------------------------------------------------
Total non-interest expense 4.08% 3.55% 3.40%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Compensation and benefits increased $754,000 to $12.1 million, or 1.46
percent of average assets, for fiscal 1996. Employment service fees increased
approximately $240,000 and overtime expense increase approximately $115,000
during fiscal 1996. These increases were due primarily to an increase in
temporary help hired to assist in the merger of FS into VFB. In addition,
commissions for loan origination personnel increased approximately $411,000 from
fiscal 1995, due to increased originations during fiscal 1996. Payroll expense
increased approximately $394,000 from fiscal 1995 levels and payroll tax expense
increased approximately $110,000 from fiscal 1995 levels. Somewhat offsetting
these increases was an increase in deferred origination costs of approximately
$361,000, a decrease of approximately $118,000 in the Company's discretionary
401(K) plan contributions, and a decrease of approximately $134,000 in employee
medical insurance. Total FTEs at September 30, 1996 were 412, of which 409 were
at VFB and three and a half at Eastern. This compares to 370 FTEs at the end of
fiscal 1995. During fiscal 1996, the Bank added approximately 20 FTEs at the
branch level, approximately 12 FTEs for nontraditional supermarket branches,
approximately 6 FTEs for loan originations in New Hampshire, and approximately 5
FTEs in information systems to support technology developments.
Other non-interest expense increased $610,000 to $2.8 million, or .34
percent of average assets, for fiscal 1996. The fiscal 1996 increase was due
primarily to an increase in miscellaneous operating losses of approximately
$254,000. Management reserved approximately $180,000 for old, outstanding cash
letter adjustments that may remain unresolved. Mileage expense increased
approximately $58,000, due to increased travel between Vermont and New
Hampshire. ATM expense increased approximately $42,000, due to increased
volumes and the use of an outside vendor to service New Hampshire ATMs
previously serviced by the New Hampshire branches. Bank service charges
increased approximately $38,000. Bank service charges are assessed based on the
level of available funds on deposit or through account maintenance fees. During
fiscal 1996, the Bank, due to cash flow needs, was assessed through monetary
charges as opposed to through increased compensating balances as in previous
years. Community events increased approximately $31,000 due to an increase in
branches holding customer appreciation days.
Supplies expense increased to $1.3 million, or .16 percent of average
assets, for the year ended September 30, 1996, a $459,000 increase from fiscal
1995. Costs associated with the FS-VFB Merger included a consolidation of
products and services which created the need for new brochures, forms, pamphlets
and general office supplies such as letterhead. Another consequence of the FS-
VFB Merger, was the disposal of outdated supplies which represented a $57,000
increase from fiscal 1995 levels.
40
<PAGE>
Partially offsetting these increases were decreases in OREO expenses,
restructuring and merger related expenses, and professional fees.
OREO expense decreased $1.7 million to $1.4 million, or .16 percent of
average assets, for the year ended fiscal 1996. Provisions for loss on OREO
decreased from $1.3 million for fiscal 1995 to $389,000 for fiscal 1996. In
addition, the Company experienced a decrease in carrying costs of OREO due to
sales during fiscal 1996. Management continues to focus on the reduction and
resolution of OREO.
Restructuring and FS-VFB Merger related expenses were $401,000 for
fiscal 1996 compared to $1.0 million for fiscal 1995. Fiscal 1996 results
included charges from contractual obligations to employees due to the change
of control of FS. Fiscal 1995 results includes $839,000 in restructuring
costs associated with such merger as well as $190,000 of additional related
expenses such as start-up expenses, technology updates, and miscellaneous
expenses.
Professional fees decreased $380,000 from fiscal 1995 results to $764,000,
or .09 percent of average assets, for fiscal 1996. This is due primarily to a
$212,000 decrease in consulting fees as fiscal 1995 results included expenses
incurred for specific management projects.
FEDERAL AND STATE TAXES
During fiscal 1996, the Company recognized income tax expense of $2.1
million on its income before income taxes of $5.4 million, resulting in an
effective tax rate of 38.3 percent compared to income tax expense of $2.3
million on income before taxes of $6.5 million in fiscal 1995, an effective
tax rate of 35.9 percent. Included in fiscal 1995 tax expense was a $293,000
tax credit that resulted from an IRS audit.
At September 30, 1996, the Company had a net deferred income tax asset of
approximately $1.3 million. Management believes the existing net deductible
temporary differences that give rise to the net deferred income tax asset will
reverse during periods in which the Company generates net taxable income and in
which gross taxable temporary differences are expected to reverse. For fiscal
1996, the Company generated approximately $6.5 million in taxable income.
Factors beyond management's control, such as the general state of the economy
and real estate values, can affect future levels of taxable income and no
assurance can be given that sufficient taxable income will be generated to fully
absorb gross deductible temporary differences. For further information on
income taxes, see notes 1 and 10 of the notes to consolidated financial
statements.
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED SEPTEMBER 30, 1995 AND 1994
GENERAL
The Company had net income during fiscal 1995 of $4.2 million or $1.13 per
share, compared with net income for fiscal 1994 of $3.7 million or $1.00 per
share. The improvement in fiscal 1995 net income compared to fiscal 1994 net
income came primarily from two sources. First, interest income increased $8.6
million, due primarily to higher average interest rate levels on interest-
earning assets. Second, non-interest income increased $2.0 million as a result
of additional gains on sale of loans and mortgage servicing rights and continued
growth in customer service fees. These improvements more than offset a $6.6
million increase in interest expense due to rising interest rates; a $1.0
million increase in the provision for loan losses due to an increase in
nonperforming loans; and a $2.3 million increase in non-interest expense due
primarily to restructuring and other merger-related charges, compensation and
benefits, marketing, and OREO expense.
NET INTEREST INCOME
Net interest income for fiscal 1995 was $27.9 million compared to $25.9
million in 1994, an increase of $2.0 million. A $6.6 million increase in
interest expense on deposits and borrowings partially offset the $8.6 million
increase in income on interest-earning assets. Items affecting net interest
income were interest rates, the ability of the Company's assets and liabilities
to react to changes in interest rates, and the balance and mix of the Company's
financial assets and liabilities. See Tables 1 through 4 for average balance,
rate, and repricing information.
41
<PAGE>
Interest income from loans increased $5.7 million during fiscal 1995.
Higher interest rates, during fiscal 1994 and early in fiscal 1995, resulted
in a 92 basis point increase in the average yield on the loan portfolios. The
average yield increased from 7.94 percent in fiscal 1994 to 8.86 percent in
fiscal 1995 as ARMs repriced at higher rates. Fixed-rate mortgages, priced
principally by reference to long-term interest rates, originated at interest
rates between 7.0 and 10.0 percent during fiscal 1995. ARMs, priced by
reference to short-term indices like the U.S. Treasury constant one-year
maturity indexes, increased their yields as they repriced to higher interest
rates. This matched the overall increase in their respective indexes.
Investment interest income increased $2.9 million during fiscal 1995
compared to fiscal 1994, due primarily to an increase in average balances of
$17.7 million and an increase in the weighted average yield of 55 basis points.
At September 30, 1995, the Company's mortgage backed securities included $13.5
million of CMOs. The Company considers these bonds relatively low risk
derivative securities because the Company expects them to react to changes in
interest rates in a way that is not materially different from other fixed rate
mortgage backed securities in the held-to-maturity portfolio. Also classified
as held-to-maturity at September 30, 1995, were $12.0 million in FHLB "step-up"
debentures. These structured bonds are notes with guaranteed annual interest
rate increases and are payable in full at maturity. They are callable by the
FHLB semi-annually after the first year.
Interest expense on deposits increased $3.9 million during fiscal 1995
compared to fiscal 1994. The weighted average rate on interest-bearing deposits
increased 66 basis point to 3.99 percent, correlating to the increase in market
interest rates. At September 30, 1995, non-interest bearing deposits were 7.94
percent of total deposits, and interest-bearing NOW accounts were 12.58 percent
of total deposits.
Interest expense on borrowed funds increased $2.7 million during fiscal
1995 compared to fiscal 1994. The increase results from a rise in both the
weighted average rate and the average balances of borrowed funds. The weighted
average rate increased to 6.0 percent during fiscal 1995, from 5.0 percent
during fiscal 1994.
PROVISION FOR LOAN LOSSES
During fiscal 1995, the Banks made provisions to the loan loss reserve of
$1.8 million compared to $797,000 in fiscal 1994. At September 30, 1995, the
Banks had classified loans (loans rated as "substandard," "doubtful," or "loss")
totaling $18.0 million, compared to $14.8 million at September 30, 1994.
Additionally, the Banks had $2.9 million of loans identified as "special
mention," as compared with $4.7 million at September 30, 1994. Of the $18.0
million in classified loans at September 30, 1995, $11.1 million were
nonperforming (non-accruing loans including loans 90 days or more past due) and
the balance of $6.9 million were performing. Total nonperforming loans of $11.1
million at September 30, 1995, represented an increase of $5.6 million from
September 30, 1994. Reclassification of in-substance foreclosure loans in
fiscal 1995 results account for approximately $3.6 million of the increase. The
remaining $2.0 million increase was due to the reclassification to nonperforming
status of one previously restructured loan as well as increased delinquencies in
the consumer and residential mortgage loan portfolios.
The allowance for loan losses allocated to commercial loans decreased from
September 30, 1994 to September 30, 1995, while nonaccruing commercial loans
increased. The increase in nonaccruing commercial loans resulted from one
previously restructured loan placed on nonaccrual. This loan had been
classified as substandard in prior periods with an allocated allowance.
Accordingly, classification of this loan as nonaccrual did not materially impact
the allowance allocated to commercial loans.
The allowance for loan losses allocated to residential mortgage loans
decreased from September 30, 1994 to September 30, 1995, while nonaccruing
residential mortgage loans increased. After evaluation of past due loans,
management believes the allowance allocated to such loans is adequate.
The allowance for loan losses allocated to consumer loans increased from
September 30, 1994, to September 30, 1995. Such increase relates directly to
the increase in consumer loan delinquencies, particularly mobile home loans.
For further information regarding nonperforming loans and the allowance for loan
losses, see Table 5 and note 4 of the notes to consolidated financial
statements.
42
<PAGE>
The Banks charged $2.1 million to the allowance during both fiscal 1995 and
1994. At September 30, 1995, the Company's total loan loss reserves represented
32.7 percent of nonperforming loans, compared to 68.2 percent at September 30,
1994. For further information, see notes 3 and 4 of the notes to the
consolidated financial statements.
NON-INTEREST INCOME
Total non-interest income was $10.0 million or 1.21 percent of average
assets, during fiscal 1995, compared to $8.0 million or 1.00 percent of average
assets during fiscal 1994. The primary reasons for the 1995 increase were a
$1.1 million increase in the gain on sale of loans and mortgage servicing
rights, a $577,000 increase in miscellaneous non-interest income, and a $497,000
increase in customer service fees. See Table 6 for further information
regarding non-interest income.
Gain on sale of investments and mortgage backed securities for fiscal 1995
was $0 compared to $443,000 during fiscal 1994. The Company had no sales from
its available-for-sale portfolio during fiscal 1995.
The Company included in its stockholders' equity at September 30, 1995,
$175,000 in net unrealized losses from its portfolio of investment and mortgage
backed securities available-for-sale, compared to $220,000 of net unrealized
losses at September 30, 1994. The Company had a net unrealized loss from its
portfolio of investment and mortgage backed securities held-to-maturity of $5.4
million at September 30, 1995, compared to an unrealized loss of $19.2 million
at September 30, 1994. For further information, see notes 1 and 2 of the notes
to consolidated financial statements.
Gains from the sale of loans and mortgage servicing rights were $1.9
million for fiscal 1995, compared to $783,000 for fiscal 1994. The fiscal 1995
results include a gain on sale of PMSR of approximately $777,000. In addition,
the Company recorded $566,000 in increased gains on sales of mortgage loans due
to the adoption of SFAS No. 122, "Accounting for Mortgage Servicing Rights, an
Amendment of FASB Statement No. 65." See notes 1 and 3 of the notes to
consolidated financial statements for further information regarding SFAS No.
122.
Offsetting these increases was a $259,000 decrease in gains from the sale
of mortgage loans originated for sale during fiscal 1995 compared to fiscal
1994. Gains from the sale of mortgage loans are dependent on volume, price, and
management's asset/liability decisions. Loans sold or securitized and sold
decreased to $61.0 million in fiscal 1995 from $148.8 million in fiscal 1994.
The Banks' ability to originate loans is highly dependent on the fluctuation of
interest rates.
Service fees on loans sold were $1.3 million for fiscal 1995 and $1.1
million for fiscal 1994. The Banks' portfolio of loans serviced for other
investors decreased from $666.7 million at September 30, 1994, to $563.0 million
at September 30, 1995. During fiscal 1995 and 1994, VFB purchased the rights to
service $106.0 million and $61.0 million, respectively, of residential first
mortgage loans. Premiums paid to purchase PMSR totaled $971,000 and $521,000 in
fiscal 1995 and fiscal 1994, respectively.
Customer service fees increased to $5.6 million in fiscal 1995 from $5.1
million in fiscal 1994. The Banks generate service fees primarily from checking
and other transaction accounts.
Miscellaneous non-interest income increased to $1.2 million in fiscal 1995
from $661,000 in fiscal 1994. Fiscal 1995 included a $155,000 non-recurring gain
from an asset disposition and $92,000 of interest income from an IRS refund and
the PMSR sale.
NON-INTEREST EXPENSE
Total non-interest expense increased $2.3 million during fiscal 1995 to
$29.5 million or 3.55 percent of average assets. The 1995 increase resulted
primarily from $839,000 in restructuring charges and $190,000 in other FS-VFB
Merger related expenses, a $497,000 increase in compensation and benefits
expense, a $359,000 increase in marketing expense, and a $328,000 increase in
OREO expense. See Table 7 for further information regarding non-interest
expense.
The Company provided for $839,000 in restructuring costs associated with
the October 1, 1995, FS-VFB Merger, or .10 percent of average assets. In
addition, the Company incurred other FS-VFB Merger related
43
<PAGE>
expenses of $190,000, or .02 percent of average assets, such as startup
expenses, technology updates, and miscellaneous expenses. These expenses, as
well as the restructuring charges, are non-recurring. For further information,
see note 17 of the notes to consolidated financial statements.
Total compensation and benefit expense increased $497,000 to $11.4 million
or 1.37 percent of average assets compared to fiscal 1994's 1.36 percent. The
increase of the $497,000 was due to annual merit increases and a small expansion
in staff. Total FTEs at September 30, 1995 were 370, of which three were at the
holding company, 280 were at VFB, and 87 were at FS. This represents an
increase of ten from September 30, 1994.
On October 1, 1994, the Company adopted a new accounting standard, SFAS No.
112, "Employers' Accounting for Post Employment Benefits," that requires accrual
for post employment benefits during either the employees' service periods or at
the time the Company incurs a liability. Post employment benefits include
salary continuation, supplemental employment benefits, severance benefits,
disability-related benefits, health care benefits, life insurance, and the like.
The adoption of SFAS No. 112 did not have a material impact on the Company's
results of operations and financial condition.
Marketing expense increased $359,000 during fiscal 1995 to $1.5 million or
.18 percent of average assets. The Banks primarily market their deposit
products, concentrating heavily on a direct mail marketing program, to acquire
checking accounts. The program has been very successful in attracting low-cost
checking accounts and increasing customer service fees. Also contributing to
the increase in marketing expense was the consolidation of the Banks' product
lines in advance of the FS-VFB Merger.
Other real estate operations expense increased $328,000 during fiscal 1995,
to $3.1 million from $2.7 million in fiscal 1994. The 1995 amount represented
.37 percent of average assets compared to .34 percent in fiscal 1994. Of the
fiscal 1995 total, $1.3 million came from provisions for loss on foreclosed real
estate, $1.5 million came from operating and selling costs of foreclosed real
estate, and $502,000 came from the writedown of a specific asset in recognition
of the Company's desire to target this property for early liquidation.
Partially offsetting these charges was a $288,000 net gain on sale of OREO.
Costs associated with office occupancy during fiscal 1995 was $5.1 million
or .62 percent of average assets, compared to $4.9 million or .61 percent of
average assets in fiscal 1994. Contributing to the $265,000 increase was the
addition of a new computer maintenance contract, an increase in rented space,
and an increase in general office building expense.
FDIC's insurance premium expense was $1.4 million during fiscal 1995, a
decrease of $26,000 from fiscal 1994. The decrease was due to a lower deposit
base at the time of assessment.
The amortization of excess cost over assets acquired (goodwill) during
fiscal 1995 was $382,000, a decrease of $313,000 from fiscal 1994's $695,000.
Fiscal 1994's expense included a provision to write-down the carrying value of
the PMSR due to the high prepayment speed of the PMSR mortgages during fiscal
1994.
Professional fees decreased $184,000 during fiscal 1995 to $1.1 million or
.14 percent of average assets, compared to .17 percent of average assets in
fiscal 1994. Fiscal 1994 included additional consulting fees for problem credit
resolutions, technology updates, and FDICIA implementation.
Supplies expense for fiscal 1995 was $874,000, or .11 percent of average
assets, compared to $687,000, or .09 percent of average assets, in fiscal 1994.
Postage expense for fiscal 1995 was $829,000, or .10 percent of average assets,
compared to $712,000, or .09 percent of average assets, in fiscal 1994.
FEDERAL AND STATE TAXES
During fiscal 1995, the Company recognized income tax expense of $2.3
million on its income before income taxes of $6.5 million, resulting in an
effective tax rate of 35.9 percent compared to income tax expense of $2.3
million on income before taxes of $6.0 million in fiscal 1994, an effective tax
rate of 38.7 percent. Included in fiscal 1995 tax expense was a $293,000 tax
credit that resulted from an IRS audit.
At September 30, 1995, the Company had a net deferred income tax asset of
approximately $776,000. For the year ending September 30, 1995, the Company
generated approximately $5.4 million in taxable income.
44
<PAGE>
Factors beyond management's control, such as the general state of the economy
and real estate values, can affect future levels of taxable income and that no
assurance can be given that sufficient taxable income will be generated to fully
absorb gross deductible temporary differences. For further information on
income taxes, see notes 1 and 10 of the notes to consolidated financial
statements.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The OTS requires the Bank to maintain an average daily balance of liquid
assets (cash and certain short term investments) equal to 5 percent of deposits
and short term borrowings. During fiscal 1996 the Bank was in compliance with
this requirement. The Bank uses deposit inflows, loan and mortgage backed
security repayments, and loan sales to provide funds for lending activities, its
primary use of funds. When these sources of funds are not sufficient to
maintain the Bank's loan commitments, or are not cost effective, the Bank will
borrow funds from either the FHLB or from reverse repurchase agreements using
mortgage backed securities and other qualified investments as collateral. The
FHLB requires that borrowing banks have outstanding debt no greater than 30
percent of their total assets. As of September 30, 1996, VFB had $153.9 million
of outstanding debt, or 17.72 percent of its assets.
As a holding company, the Company's primary sources of liquidity are
dividends from the Bank, and maturities and repayments of investment securities.
The Company uses its liquidity to pay cash dividends to stockholders, fund
operating expenses, pay taxes and fund the development needs of its
subsidiaries. During fiscal 1996, the Company received $2.7 million in cash
dividends from the Bank. The Company anticipates that the Bank will continue
paying dividends to the Company during fiscal 1997.
Effective August 1, 1990, the OTS adopted a regulation that establishes
uniform treatment for all capital distributions by savings associations
(including dividends, stock repurchases, and cash-out mergers). This regulation
classifies a savings association as a tier 1, a tier 2, or a tier 3 institution,
depending on its level of regulatory capital both before and after giving effect
to a proposed capital distribution. A tier 1 institution (one that both before
and after a proposed capital distribution has net capital equal to or in excess
of its fully phased-in regulatory capital requirement) would be allowed, subject
to any otherwise applicable statutory or regulatory requirements or agreements
entered into with regulating authorities, to make capital distributions in any
calendar year in an amount equal to 100 percent of its net income to date during
the calendar year plus up to 50 percent of its surplus capital ratio (the excess
of its ratio of net capital to total assets over the ratio of its fully phased-
in capital requirement to total assets) as of the beginning of the calendar
year, adjusted to reflect current earnings. No regulatory approval of the
capital distribution is required. For purposes of this regulation, at September
30, 1996, the Bank was classified as a tier 1 institution.
During fiscal 1996, the Company utilized its treasury stock to supply
shares to the Company's Stock Option Plan. The Company generated $907,000 of
additional capital by using its treasury shares for such plan during of fiscal
1996. The Company anticipates that dividends from the Bank should provide
adequate liquidity to Eastern. See note 18 of the notes to consolidated
financial statements for Eastern only financial information.
INVESTMENT AND MORTGAGE BACKED SECURITIES
Total investment and mortgage backed securities at September 30, 1996, were
$315.0 million, a decrease of $22.0 million from the portfolio of $337.0 million
at September 30, 1995. Included in the investment and mortgage backed securities
portfolio are $13.2 million of CMOs. The underlying collateral of these CMOs
consists of residential mortgages guaranteed by the FNMA. The Company considers
these bonds relatively low risk derivative securities because it expects these
bonds to react to changes in interest rates in a way that is not materially
different from other fixed rate mortgage backed securities in the portfolio.
During fiscal 1996, the Bank purchased $107.5 million in mortgage backed and
investment securities compared to $31.3 million in fiscal 1995. During the first
quarter of fiscal 1996, the Company took advantage of a provision in the FASB's
special report on SFAS No. 115 which allowed entities to make a one-time
reclassification of security classifications. The Bank reclassified $43.7
million from the held-to-maturity portfolio to the available-for-sale portfolio.
Subsequently, the Bank sold a majority of these reclassified securities and
utilized the proceeds, along with proceeds from loan and investment securities
repayments and maturities, to invest in higher yielding loans and securities.
The sources of funds for fiscal 1995 purchases were primarily loan and mortgage
backed security repayments and maturities.
45
<PAGE>
Repayments increased during fiscal 1996 due to higher prepayment rates on both
newly purchased mortgage backed securities and on previously held securities.
Proceeds from repayments and maturities of investments and mortgage backed
securities were $79.0 million during fiscal 1996 compared to $37.2 million
during fiscal 1995.
Interest rates began to rise in the second half of fiscal 1996 increasing
the net unrealized loss in the investment and mortgage backed securities held-
to-maturity portfolios to $8.8 million at September 30, 1996 compared to $5.4
million at September 30, 1995. An unrealized loss results from an interest rate
environment that is higher than the rates being earned on the investment and
mortgage backed securities portfolios. Substantially all of the Company's
securities are guaranteed by the U.S. Government or a related agency. In order
to satisfy the requirements of SFAS No. 115, management has the positive intent
to hold these securities to maturity and believes the Bank has the ability to do
so.
LOANS
The Company's net loans increased $34.8 million to $488.8 million at
September 30, 1996, from $454.0 million at September 30, 1995 due primarily to
increased originations and purchases. See Table 8 for further information
regarding loans.
Loan originations during fiscal 1996 were $215.1 million compared to $162.7
million during fiscal 1995. Falling interest rates in early fiscal 1996
increased the demand for new residential mortgage loan originations.
The Bank originates fixed and ARM loans for sale. At September 30, 1996,
the Bank had $10.5 million in mortgage loans held for sale that required no
valuation reserve to adjust their carrying value to the lower of cost or market.
At September 30, 1996, the Bank had $17.4 million in commitments to sell
mortgage loans. During the year ended September 30, 1996, the Bank sold $126.8
million and securitized and sold $12.6 million in mortgage loans; all originated
for sale.
During fiscal 1996, the Bank's commercial lending was conducted on a
limited basis. The returns realized historically had been impacted periodically
by adverse economic conditions and did not justify the amount of regulatory
capital required under the risk-based capital guidelines to support emphasis on
such assets. The Bank's business plan concentrates on retail banking,
emphasizing mortgage lending and the acquisition of demand deposits.
TABLE 8
LOAN ACTIVITY
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- --------------------------------------------------------------------------------
Originations:
Residential mortgage $163,255 $ 95,195 $177,088
Consumer 38,219 32,560 52,702
Commercial real estate
and non-real estate 13,585 34,931 16,524
- --------------------------------------------------------------------------------
Total originations $215,059 $162,686 $246,314
- --------------------------------------------------------------------------------
Loans purchased $ 53,072 $ 11,926 $ 1,619
Loans sold 126,764 60,019 129,880
Loans securitized and sold 12,575 1,002 18,887
Loans transferred to in-substance
and foreclosed real estate 2,723 1,575 3,120
Loan repayments 91,117 78,189 93,210
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
At September 30, 1996, the Bank had loan commitments of $93.5 million.
This included $16.0 million in residential mortgage loans, $17.7 million in
commercial loans (primarily unadvanced funds on lines of credit) and $59.8
million in consumer loans (primarily unadvanced funds on equity lines of
credit). While management believes it has been prudent in its lending decisions,
uncertainties regarding future events, such as changes in interest rates, the
real estate market, and the overall economy, could adversely affect the loan
portfolios and future results of operations.
46
<PAGE>
Pursuant to the Merger Agreement, the Company may not make any loans or
extensions of credit other than those which are on customary terms, conditions
and standards and are within normal business practices until the effective date
of the Merger.
OTHER REAL ESTATE OWNED
Other real estate owned totaled $3.6 million at September 30, 1996,
compared to $5.4 million at September 30, 1995. All of the fiscal 1996 and
fiscal 1995 balances consisted of assets classified as nonperforming. During
fiscal 1996, the Bank added $2.7 million into OREO, sold $4.1 million, and
reduced the carrying value of certain properties by $389,000. During fiscal
1995, the Bank transferred $5.0 million into OREO, sold $4.8 million, and
reduced the carrying value of specific properties by $1.3 million. The balance
of OREO at September 30, 1995 was restated to reflect the Company's adoption of
SFAS No. 114 that changed the criteria for classification of a loan as in-
substance foreclosure. This required a reclassification of $2.7 million from
OREO to the loan portfolio. Management continues to focus efforts on the
reduction and resolution of OREO.
TABLE 9
OTHER REAL ESTATE OWNED
<TABLE>
<CAPTION>
At September 30,
1996 1995
- -------------------------------------------------------------------------------------------------
PERCENT OF Percent of
(Dollars in thousands) AMOUNT TOTAL Amount Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
By collateral:
Residential real estate $1,463 36.41% $1,531 24.61%
Land zoned residential 189 4.70 676 10.87
Commercial real estate 941 23.42 549 8.83
Industrial parks -- -- 1,273 20.46
Investment real estate -- -- 251 4.03
Shopping centers 1,425 35.47 1,729 27.79
Other -- -- 212 3.41
- -------------------------------------------------------------------------------------------------
Total before valuation allowance $4,018 100.00% $6,221 100.00%
Valuation allowance (407) (823)
- -------------------------------------------------------------------------------------------------
Total $3,611 $5,398
- -------------------------------------------------------------------------------------------------
By state:
Vermont $2,153 53.58% $3,501 56.28%
New Hampshire 1,865 46.42 2,720 43.72
- -------------------------------------------------------------------------------------------------
Total before valuation allowance $4,018 100.00% $6,221 100.00%
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</TABLE>
TABLE 10
OTHER REAL ESTATE OWNED ACTIVITY
Years ended September 30,
(Dollars in thousands) 1996 1995
- ------------------------------------------------------------------
Balance at beginning of year $5,398 $6,545
Additions 2,723 4,960
Sales (4,121) (4,778)
Provision for loss (389) (1,329)
- ------------------------------------------------------------------
Balance at end of year $3,611 $5,398
- ------------------------------------------------------------------
- ------------------------------------------------------------------
DEPOSITS
Total deposits increased from $616.4 million at September 30, 1995, to
$641.3 million at September 30, 1996. Deposit growth in fiscal 1996 is due
primarily to the Bank offering attractive rates on time deposits, money market
accounts, and NOW accounts. Partially offsetting these increases was a decrease
in passbook accounts as the Bank experienced some disintermediation. The Bank
continued to increase demand deposit accounts for the
47
<PAGE>
purposes of attracting low cost deposits and the related fee income. These
types of accounts help establish long-term core deposit relationships with
customers to whom the Bank can sell other retail bank products and services. At
September 30, 1996, the Bank's NOW and non-interest bearing demand deposits were
$136.2 million compared to $126.5 million at September 30, 1995.
Pursuant to the Merger Agreement, the Company cannot offer an interest rate
with respect to any deposit that departs from past practices until the effective
date of the Merger.
BORROWINGS
Total borrowings of the Company decreased from $161.9 million at September
30, 1995, to $153.9 million at September 30, 1996. Deposit growth and
maturities and repayments from the loan and investment portfolios were
sufficient to meet operating activities during fiscal 1996. Therefore, the
Company was able to reduce its outstanding borrowings.
Pursuant to the Merger Agreement, the Company may not incur any additional
debt obligation except in the ordinary course of business consistent with past
practices until the effective date of the Merger.
ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities increased $2.9 million to $9.8
million at September 30,1996 from $6.8 million at September 30, 1995. Fiscal
1996's balance included an accrual of $3.8 million for a non-recurring charge by
the FDIC to recapitalize the SAIF. Somewhat offsetting this increase was a
$307,000 accrual for severance related to the FS-VFB Merger in the fiscal 1995
balance. In addition, the fiscal 1996 accounts payable balance decreased
approximately $339,000 from the fiscal 1995 accounts payable balance as the Bank
lengthened its year end accounts payable cutoff procedures.
STOCKHOLDERS' EQUITY
At September 30, 1996, stockholders' equity was $63.6 million, compared to
$61.0 million at September 30, 1995, an increase of $2.6 million. During fiscal
1996, the Company recorded earnings of $3.3 million and paid aggregate cash
dividends to stockholders of $1.8 million. The Company used approximately 78,000
treasury shares for the exercise of employee and director stock options and the
directors deferred compensation plans.
As a federally-insured savings bank, the Bank is required to maintain a
minimum level of regulatory capital in accordance with OTS regulations. Under
FIRREA, enacted August 7, 1989, the Director of the OTS must require savings
institutions to maintain (i) "core capital" in an amount of not less than 3.0
percent of total assets, (ii) "tangible capital" in an amount not less than 1.5
percent of total assets and (iii) a level of risk-based capital materially the
same as is required to be maintained by national banks. In determining
compliance with the capital standards established by FIRREA, a savings
institution must deduct from capital its entire investment in, and loans to, any
subsidiary engaged as principal in activities not permissible for a national
bank, other than subsidiaries (i) engaged in such non-permissible activities
solely as agent for their customers, (ii) engaged in mortgage banking
activities, or (iii) that are themselves savings institutions, or companies the
only investment of which is another savings institution, acquired prior to May
1, 1989.
The OTS has issued rules implementing the capital standards established by
FIRREA, requiring savings institutions to achieve and maintain the 3.0 percent
core capital to total assets ratio, a 1.5 percent tangible capital to total
assets ratio, and a minimum ratio of total capital to total risk-weighted assets
of 8.0 percent. In addition, the OTS has promulgated regulations under FDICIA
requiring savings institutions classified as adequately capitalized to have (i)
a ratio of total capital to risk-weighted assets of 8.0 percent or greater, (ii)
a ratio of core capital to risk-weighted assets of 4.0 percent or greater, and
(iii) a ratio of core capital to adjusted total assets of either (A) 4.0 percent
or greater, or (B) 3.0 percent or greater if the savings institution is rated
composite 1 under the OTS Capital Adequacy, Asset Quality, Management
Administration, Earnings, and Liquidity-Asset/Liability Management (CAMEL)
rating system in the most recent examination of the savings institution. The
OTS may impose higher regulations for individual savings institutions.
At September 30, 1996, the Bank had risk-based capital of $58.9 million
or 12.3 percent of risk-weighted assets on a fully phased-in basis. At
September 30, 1996, the Bank exceeded its current regulatory capital
48
<PAGE>
requirements. The Bank had a core capital leverage ratio (as defined in the
proposal) of 6.5 percent at September 30, 1996.
On May 23, 1996 Eastern's Board of Directors declared a three-for-two stock
split in the form of a 50 percent stock dividend. The distribution was made on
June 19, 1996 to holders of record of the Company's Common Stock as of the close
of business on June 5, 1996. All per share information herein has been adjusted
to reflect the three-for-two stock split.
49
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Eastern Bancorp, Inc. and Subsidiaries At September 30,
(Dollars in thousands, except share data) 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks (note 1) $27,766 $19,862
Short-term investments (note 1) 12,043 11,099
Investment and mortgage backed securities available-for-sale
(amortized cost of $1 at September 30, 1996,
and $4,443 at September 30, 1995, notes 2 and 8) 9 4,177
Investment securities held-to-maturity
(market value of $47,946 at September 30, 1996, and
$42,294 at September 30, 1995, notes 2 and 8) 48,793 42,259
Mortgage backed securities held-to-maturity
(market value of $236,869 at September 30, 1996, and
$264,666 at September 30, 1995, notes 2, 8, and 9) 244,856 270,133
FHLB stock (notes 2 and 8) 9,283 9,283
Loans (net of allowance for loan losses of $2,858 at
September 30, 1996, and $3,622 at September 30, 1995,
notes 3, 4, and 8) 478,306 445,780
Loans held for sale (note 3) 10,480 8,212
Accrued interest receivable:
Investment and mortgage backed securities 2,230 2,731
Loans 2,843 2,761
Other real estate owned, net (note 5) 3,611 5,398
Investment in real estate 437 447
Premises and equipment, net (note 6) 16,693 14,232
Excess of cost over net assets acquired 3,528 3,908
Deferred income tax asset, net (note 10) 1,346 776
Mortgage servicing rights (note 3) 3,061 1,675
Prepaid expense and other assets 3,393 3,352
- ----------------------------------------------------------------------------------------------------
Total assets $868,678 $846,085
- ----------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts (including non-interest-bearing deposits
of $55,986 at September 30, 1996, and $48,932 at
September 30, 1995, note 7) $641,286 $616,350
Advances from FHLB (note 8) 153,636 136,632
Securities sold under agreement to repurchase (note 9) -- 24,855
Capital lease obligation (note 6) 273 395
Accrued federal income taxes liabilities 102 17
Accrued expenses and other 9,801 6,853
- ----------------------------------------------------------------------------------------------------
Total liabilities 805,098 785,102
- ----------------------------------------------------------------------------------------------------
Commitments and contingencies (notes 3, 6, 12, 13, 15, and 16) -- --
- ----------------------------------------------------------------------------------------------------
Stockholders' equity (notes 10, 11, and 16):
Preferred stock, $0.01 par value: 1,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock, $0.01 par value: 5,000,000 shares authorized;
4,095,549 shares issued at September 30, 1996, and
4,095,549 at September 30, 1995 41 41
Additional paid-in capital 36,384 36,182
Retained income (substantially restricted) 30,138 28,629
Unrealized gain (loss) on securities available-for-sale,
net (note 2) 6 (175)
Treasury stock (at cost), 444,015 shares at September 30, 1996,
and 522,325 shares at September 30, 1995 (2,989) (3,694)
- ----------------------------------------------------------------------------------------------------
Total stockholders' equity 63,580 60,983
- ----------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $868,678 $846,085
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
50
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
Eastern Bancorp, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands, except per share data) 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Residential mortgage loans $19,226 $16,117 $13,550
Other loans 22,335 22,432 19,306
Investment and mortgage backed securities
available-for-sale 576 234 1,200
Investment securities held-to-maturity 4,219 3,300 2,496
Mortgage backed securities held-to-maturity 14,917 18,015 14,994
- ----------------------------------------------------------------------------------------------------
Total interest income 61,273 60,098 51,546
- ----------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposit accounts (note 7) 24,116 21,667 17,752
Borrowings 8,224 10,551 7,861
- ----------------------------------------------------------------------------------------------------
Total interest expense 32,340 32,218 25,613
- ----------------------------------------------------------------------------------------------------
Net interest income 28,933 27,880 25,933
Provision for loan losses (note 4) 895 1,822 797
- ----------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 28,038 26,058 25,136
- ----------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Gain on sale of investment and mortgage backed
securities, net (note 2) 808 -- 443
Gain on sale of loans and mortgage servicing rights,
net (note 3) 1,851 1,867 783
Service fees on loans sold 1,146 1,334 1,054
Customer service fees 6,027 5,578 5,081
Miscellaneous 1,441 1,238 661
- ----------------------------------------------------------------------------------------------------
Total non-interest income 11,273 10,017 8,022
- ----------------------------------------------------------------------------------------------------
Income before non-interest expense and
federal and state taxes 39,311 36,075 33,158
- ----------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Compensation and benefits (note 12) 12,122 11,368 10,871
Office occupancy, net (note 6) 6,071 5,120 4,855
Marketing 1,718 1,526 1,167
Federal deposit insurance premium 5,207 1,446 1,472
Other real estate owned operations (note 5) 1,358 3,054 2,726
Professional fees 764 1,144 1,328
Amortization of intangibles 381 382 695
Restructuring and FS-VFB merger related (note 17) 401 1,029 --
Supplies 1,333 874 687
Telephone 869 582 560
Postage 939 829 712
Other 2,789 2,179 2,119
- ----------------------------------------------------------------------------------------------------
Total non-interest expense 33,952 29,533 27,192
- ----------------------------------------------------------------------------------------------------
Income before federal and state taxes 5,359 6,542 5,966
Federal and state tax expense (notes 1 and 10) 2,055 2,347 2,307
- ----------------------------------------------------------------------------------------------------
Net Income $3,304 $4,195 $3,659
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
Earnings per common and common equivalent shares
outstanding $ 0.87 $ 1.13 $ 1.00
Cash dividends paid per common share 0.49 0.24 0.10
Weighted average number of common and common equivalent
shares outstanding 3,807,724 3,721,573 3,658,510
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
51
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Eastern Bancorp, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Unrealized gain
(loss) on
Number Additional securities Total
of common Common paid-in Retained available- Treasury stockholders'
(Dollars in thousands) shares stock capital income for-sale, net stock equity
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT SEPTEMBER 30, 1993 3,492 $ 41 $ 36,092 $ 21,991 $ 997 $ (4,438) $ 54,683
Net income -- -- -- 3,659 -- -- 3,659
Cash dividends paid
($0.10 per share) -- -- -- (353) -- -- (353)
Stock options exercised,
net (note 16) 24 -- (137) -- -- 244 107
Sale of treasury stock 25 -- 91 -- -- 233 324
Increase in unrealized (loss) on
securities available-for-sale,
net (note 2) -- -- -- -- (1,217) -- (1,217)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1994 3,541 41 36,046 25,297 (220) (3,961) 57,203
Net income -- -- -- 4,195 -- -- 4,195
Cash dividends paid ($0.24
per share) -- -- -- (863) -- -- (863)
Stock options exercised, net
(note 16) 3 -- -- -- -- 37 37
Sale of treasury stock 29 -- 136 -- -- 230 366
Decrease in unrealized (loss) on
securities available-for-sale,
net (note 2) -- -- -- -- 45 -- 45
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1995 3,573 41 36,182 28,629 (175) (3,694) 60,983
Net income -- -- -- 3,304 -- -- 3,304
Cash dividends paid ($0.49
per share) -- -- -- (1,795) -- -- (1,795)
Stock options exercised, net
(note 16) 77 -- 194 -- -- 695 889
Sale of treasury stock 1 -- 8 -- -- 10 18
Decrease in unrealized (loss) on
securities available-for-sale,
net (note 2) -- -- -- -- 181 -- 181
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1996 3,651 $41 $36,384 $30,138 $6 $(2,989) $63,580
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
52
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Eastern Bancorp, Inc. and Subsidiaries Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $3,304 $4,195 $3,659
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation, amortization, and accretion 4,101 3,622 5,215
Provision for loan losses 895 1,822 797
(Gain) on sale of investment and mortage
backed securities (808) -- (443)
(Gain) on sale of loans and mortgage servicing
rights (1,851) (1,867) (783)
(Gain) on sale of real estate owned (521) (288) (156)
Provision for loss on other real estate owned 389 1,329 1,282
Loans originated for sale (133,569) (64,073) (132,191)
Proceeds from sales of loans originated for sale 133,062 61,021 140,954
(Increase) decrease in accrued interest receivable 419 (613) (114)
Decrease in income taxes receivable -- -- 319
Capitalization of mortgage servicing rights (1,549) (629) --
(Increase) decrease in prepaid expenses and
other assets 842 (480) 805
(Increase) decrease in deferred income tax asset (663) 372 (55)
Increase (decrease) in accrued expenses and
other liabilities 2,948 1,704 (1,844)
Increase (decrease) in accrued federal income taxes 85 (490) 507
Total adjustments 3,780 1,430 14,293
- ----------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 7,084 5,625 17,952
- ----------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net (increase) decrease in short-term investments (944) (4,390) 16,472
Net (increase) in FHLB stock -- (360) (1,409)
Portfolio loans:
Proceeds from sales 6,277 -- 7,813
Purchases (53,072) (11,926) (1,619)
Originations net of repayments 9,627 (20,423) (20,913)
Recoveries on loans previously charged off 231 136 313
Investment and mortgage backed securities
available-for-sale:
Purchases (4,995) (231) (196)
Proceeds from sales 51,909 -- 146,120
Proceeds from maturities and returns of
principal 1,980 -- 11,211
Investments held-to-maturity:
Purchases (61,207) (18,712) (27,216)
Proceeds from sales -- -- 165
Proceeds from maturities and returns of
principal 42,751 8,900 11,855
Mortgage backed securities held-to-maturity:
Purchases (41,340) (12,350) (244,377)
Proceeds from sales -- -- --
Proceeds from maturities and returns of
principal 34,260 28,339 39,171
Purchases of premises and equipment, net of
sales proceeds (4,790) (2,902) (1,287)
Proceeds from sales of real estate, net 4,642 5,066 8,005
Purchase of mortgage servicing rights (594) (971) (521)
Proceeds from sale of servicing rights -- 2,023 --
(Increase) decrease in investment in real estate 10 702 (548)
- ----------------------------------------------------------------------------------------------------
Net cash (used) by investing activities $(15,255) $(27,099) $(56,961)
- ----------------------------------------------------------------------------------------------------
</TABLE>
CONTINUED
53
<PAGE>
<TABLE>
<CAPTION>
CONTINUED Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in deposits $24,936 $31,961 $12,435
Advances from FHLB:
Proceeds 87,023 199,456 171,479
Repayments (70,019) (234,303) (131,260)
Securities sold under agreement
to repurchase:
Proceeds 11,855 37,855 4,500
Repayments (36,710) (13,000) (15,500)
Reduction in capital lease obligation (122) (114) (105)
Net proceeds from exercise of stock
options and/or sale of treasury stock 907 403 431
Dividends paid (1,795) (863) (353)
- ------------------------------------------------------------------------------------------
Net cash provided by financing activities 16,075 21,395 41,627
- ------------------------------------------------------------------------------------------
Net increase (decrease) in cash 7,904 (79) 2,618
Cash and cash equivalents at beginning
of year 19,862 19,941 17,323
Cash and cash equivalents at end of year $27,766 $19,862 $19,941
- ------------------------------------------------------------------------------------------
Cash paid for:
Interest $32,511 $31,984 $25,546
Federal and state taxes 2,200 2,249 1,910
Supplemental disclosure of non-cash activities:
Change in unrealized gain (loss) on
investment and mortgage backed securities
available-for-sale, net 181 45 (1,217)
Investment and mortgage backed securities
held-to-maturity transferred to investment
and mortgage backed securities
available-for-sale 43,664 -- --
Loans charged off 1,890 2,054 2,114
Loans securitized and sold 12,575 1,002 18,887
Loans foreclosed or transferred to
in-substance foreclosure 2,723 1,575 3,120
- ------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
54
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Eastern Bancorp, Inc. and Subsidiaries
September 30, 1996, 1995, and 1994
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform to generally
accepted accounting principles and to general practices within the banking
industry.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the balance sheets, and income and expense for
the periods. Actual results could differ materially from those estimates.
Among the material estimates that are particularly susceptible of change
are those that relate to the determination of the allowance for loan losses and
valuation of other real estate owned. In connection with the determination of
the allowance for loan losses and the carrying value of OREO, management obtains
independent appraisals for significant properties.
A substantial portion of the Company's loans are secured by real estate in
depressed markets in Vermont and New Hampshire. In addition, a majority of OREO
is located in those same markets. Accordingly, the ultimate collectibility of a
substantial portion of the Company's loan portfolio and the recovery of all the
OREO is susceptible of changing conditions in these markets.
Certain fiscal 1995 and fiscal 1994 information has been reclassified to
conform with the 1996 presentation. The following is a description of the
significant accounting policies.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Eastern Bancorp, Inc. and its wholly-owned subsidiary VFB. The Company also
owns VSC, a real estate development company it purchased from VFB in December
1991. VFB's wholly-owned subsidiaries are Eastern Real Estate Corporation,
Investment Alternative Financial Services Corporation, and Long Bay II
(liquidated as of September 30, 1996). All significant intercompany balances
and transactions have been eliminated in consolidation.
CASH AND DUE FROM BANKS
The Bank is required to maintain cash and reserve balances with the Federal
Reserve Bank. The reserve calculation is 3.0 percent of the first $52.0 million
of checking deposits and 10.0 percent of total checking deposits over $52.0
million. At September 30, 1996, the Bank was required to maintain a reserve
balance of $10.3 million.
SHORT-TERM INVESTMENTS
Short-term investments are carried at cost, which approximates market
value, and consist of federal funds and certificates of deposit with original
maturities of ninety days or less.
INVESTMENT AND MORTGAGE BACKED SECURITIES
Debt securities that the Company has the positive intent and ability to
hold to maturity are classified as held-to-maturity and reported at amortized
cost; debt and equity securities that are bought and held principally for the
purpose of selling are classified as trading and reported at fair value, with
unrealized gains and losses included in earnings; and debt and equity securities
not classified as either held-to-maturity or trading are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity, net of estimated income taxes. Originated mortgage loans converted to
mortgage backed securities to be sold are classified as trading.
Premiums and discounts on investment and mortgage backed securities are
amortized or accreted into income by use of the level-yield method. If a
decline in fair value below the amortized cost basis of an investment or
mortgage backed security is judged to be other than temporary, the cost basis of
the investment is written down to fair value. The amount of the writedown is
included as a charge against gain on sale of investment and mortgage backed
securities. Gains and losses on the sale of investment and mortgage backed
securities are recognized at the time of sale on a specific identification
basis.
55
<PAGE>
LOANS
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," that was amended in October 1994 by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosure." Under SFAS No. 114, a loan is impaired when it is probable that
the Company will not be able to collect all amounts due according to the
contractual terms of the loan agreement. Large groups of smaller balance
homogeneous loans that are collectively evaluated for impairment, such as
residential mortgage and installment loans, are exempt from the provisions of
SFAS No. 114. The statements, which were adopted by the Company on October 1,
1995, require changes in both the disclosure and impairment measurement of
certain loans. In addition, criteria for classification of a loan as an in-
substance foreclosure were modified in such a way that such classification need
be made only when the lender is in possession of the collateral. At adoption,
the Company reclassified $2.6 million of in-substance foreclosure loans from
OREO to loans. Adoption of these statements had no material impact on the
Company's financial position or results of operations. Fiscal 1996 and 1995
amounts reflect the reclassification of ISF loans to the loan portfolio. Fiscal
1994 amounts have not been reclassified due to the lack of appropriate detail to
make the required reclassifications.
Impaired loans are commercial, commercial real estate, and individually
significant mortgage and consumer loans for which it is probable that the
Company will not be able to collect all amounts due according to the contractual
terms of the loan agreement. The definition of "impaired loans" is not the same
as the definition of "nonaccrual loans," although the two categories overlap;
nonaccrual loans include impaired loans. The Company may choose to place a loan
on nonaccrual status, while not classifying the loan as impaired, if (i) it is
not probable that the Company will not collect all amounts due in accordance
with the contractual terms of the loan or (ii) the loan is not a commercial,
commercial real estate or an individually significant mortgage or consumer loan.
Factors considered by management in determining impairment include payment
status and collateral value. The amount of impairment is determined by the
difference between the present value of the expected cash flows related to the
loan, using the original contractual interest rate, and its recorded value. The
Company, as a practical expedient in the case of collateralized loans determines
the amount of impairment as the difference between the fair value of the
collateral and the recorded amount of the loan, which does not materially differ
from that which would be recognized by the use of the present value of the
expected cash flows related to the loan. When foreclosure is probable,
impairment is measured based on the fair value of the collateral. Mortgage and
consumer loans which are not individually significant are measured for
impairment collectively. Loans that experience insignificant payment delays and
insignificant shortfalls in payment amounts generally are not classified as
impaired. Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed.
Restructured, accruing loans entered into prior to the adoption of these
statements are not required to be reported as impaired unless such loans are not
performing according to the restructured terms at adoption of SFAS No. 114.
Loan restructurings entered into after adoption of SFAS No. 114 are reported as
impaired loans, and impairment is measured as described above using the loan's
pre-modification rate of interest.
Interest income on loans is recognized on the accrual method. Loans on
which the accrual of interest has been discontinued are designated nonaccrual
loans. Accrual of interest income on loans is discontinued when loan payments
are ninety days or more in arrears or when concern exists as to the
collectibility of principal or interest. When a loan is placed on nonaccrual
status, all interest previously accrued but not collected is reversed against
current period income. Loans are removed from nonaccrual when they become less
than ninety days past due and when concern no longer exists as to the
collectibility of principal or interest. Interest received on nonaccruing loans
is either applied against principal or reported as income according to
management's judgment as to the collectibility of principal. Income received on
impaired loans is recognized in income similar to nonaccrual loans.
Discounts and premiums on loans are accreted over the remaining estimated
lives of the related loans using the level-yield method. Loan origination and
commitment fees and certain incremental loan origination costs are deferred and
are amortized over the contractual lives of the related loans, using the level-
yield method.
LOAN SALES AND SERVICING
Additional funds for lending are provided by selling loans and
participating interests in loans. Mortgage loans designated as held for sale are
carried at the lower of cost or market value. Net unrealized losses, if any,
are provided for in a valuation allowance by charges to operations.
When loans are sold, gains and losses on sales of these loans are
determined using the specific identification method.
56
<PAGE>
Gains and losses resulting from the sales of loans with servicing retained
are adjusted to recognize the present value of the differences between the loan
yield to the investor, reduced by normal servicing fees, and the interest rate
on the loan over the estimated lives of the related loans. The resulting
premium is amortized as a reduction of servicing fee income, using the level
yield method over the estimated remaining lives of the loans.
In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage
Servicing Rights , an Amendment of FASB Statement No. 65." The Company elected
to adopt this standard effective October 1, 1994. Accordingly, the Company's
financial statement reporting for fiscal 1994 was accounted for under the
original FASB Statement No. 65. As a result of adopting SFAS No. 122, gain on
sale of loans and mortgage servicing rights increased $566,000 for the year
ended September 30, 1995.
This statement requires the Company to recognize as separate assets rights
to service mortgage loans for others, however those servicing rights are
acquired. When the Company acquires mortgage servicing rights either through
the purchase or origination of mortgage loans (originated mortgage loan
servicing rights) and sells or securitizes those loans with servicing rights
retained, it allocates the total cost of the mortgage loans to the mortgage
servicing rights and the loans (without the mortgage servicing rights) based on
their relative fair values. To determine the fair value of the servicing rights
created, the Company uses the market prices under comparable servicing sales
contracts, when available, or alternatively uses a valuation model that
calculates the present value of future cash flows to determine the fair value of
the servicing rights. In using this valuation method, the Company incorporates
assumptions that market participants would use in estimating future net
servicing income, which includes estimates of the cost of servicing loans, the
discount rate, the float value, an inflation rate, ancillary income, prepayment
speeds and default rates. When the Company purchases mortgage loan servicing
rights separately, the initial purchase cost is recognized as an asset.
Originated and purchased mortgage loan servicing rights are amortized as a
reduction of service income in proportion to, and over the period of, estimated
net servicing income by use of the level-yield method.
On a quarterly basis, the carrying values of originated and purchased
mortgage loan servicing rights are assessed for impairment based on the fair
value of such rights. The fair value is estimated using market prices when
available or, alternatively, using the valuation model referred to above with
current assumptions. Any impairment is recognized as a charge to earnings
through a valuation allowance. The risk characteristics of the underlying loans
used to measure impairment of originated and purchased mortgage loan servicing
rights include loan type, interest rate, loan origination date, term to
maturity, and geographic location.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that management
considers adequate to provide for potential losses based upon an evaluation of
inherent risk in the loan portfolio. Such evaluation includes a review of
overall portfolio size, quality, and composition, and an assessment of existing
economic conditions that may affect the borrower's ability to pay, specific
problem loans, and trends in delinquencies and charge offs.
While management uses available information in establishing the allowance
for loan losses, future adjustments to the allowance may be necessary if
economic conditions differ substantially from the assumptions used in making the
evaluations. Additions to the allowance are charged to operations; realized
losses, net of recoveries, are charged to the allowance. Loans are charged off
in whole or in part when, in management's opinion, collectibility is not
probable. Management believes that the allowance for loan losses is adequate. In
addition, various regulatory agencies, as part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
OTHER REAL ESTATE OWNED
OREO includes foreclosed properties of which the Bank has actually received
title. Real estate formally acquired in settlement of loans are recorded at
the lower of the carrying value of the loan or the fair value of the property
actually received, less selling costs. Losses arising from the acquisition of
real estate are charged against the allowance for loan losses. Operating
expenses and any subsequent provisions to reduce the carrying value to fair
value minus costs to sell are charged to current period earnings. Gains upon
disposition are reflected in earnings as realized; realized losses are charged
to the related allowance.
An allowance for losses is maintained for OREO which management believes to
be adequate to provide for potential losses. Additions to the allowance are
charged to operations.
57
<PAGE>
INVESTMENT IN REAL ESTATE
Real estate investments are carried at the lower of cost or net realizable
value. The acquisition, construction and holding costs incurred during the
development period are capitalized. After each project is completed and the unit
sales are consummated, revenue is recognized when a sufficient down payment is
received from the buyer.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation
and amortization. Depreciation is accumulated over the estimated useful lives of
the related assets using the straight-line method for buildings and the
declining balance or straight-line method for other assets. Amortization of
leasehold improvements is accumulated on a straight-line basis over the lesser
of the term of the respective lease or the asset's useful life.
It is general practice to charge the cost of maintenance and repairs to
operations when incurred; major expenditures for improvements are capitalized
and depreciated.
EXCESS OF COST OVER NET ASSETS ACQUIRED
The excess of cost over net assets acquired is amortized to expense using
the straight-line method over periods of fifteen and twenty-five years. On an
ongoing basis, management reviews the valuation and amortization of its
intangible assets. During this review, management estimates the value of the
Company's intangible assets, taking into consideration any events and
circumstances which might have diminished fair value.
FEDERAL INCOME TAXES
Income taxes are accounted for using the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and the respective tax bases and operating loss
and tax credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
PER SHARE DATA
Earnings per share have been calculated based on the weighted average
number of common and common equivalent shares outstanding for each of the
periods presented. Employee Stock Ownership plan (ESOP) shares that are not
committed to be released are not considered outstanding for purposes of
calculating earnings per share.
STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, cash and due from banks includes cash
on hand, cash items in the process of collection, and amounts due from banks.
RECENT ACCOUNTING DEVELOPMENTS
SFAS No. 123, "Accounting for Stock-Based Compensation," is effective for
years beginning on October 1, 1996. This statement establishes a fair-value-
based method of accounting for stock-based compensation plans under which
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period. However, the statement allows a
company to continue to measure compensation cost for such plans under Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," under APB Opinion No. 25, no compensation cost is recorded if, at
the grant date, the exercise price of options granted is equal to the fair
market value of the Company's common stock. The Company has elected to continue
to follow the accounting method under APB No. 25. SFAS No. 123 requires
companies that elect to continue to follow the accounting in APB Opinion No. 25
to disclose in the notes to their financial statements pro forma net income and
earnings per share as if the fair-value-based method of accounting had been
applied.
In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. Under the financial-components approach,
after a transfer of financial assets,
58
<PAGE>
an entity recognizes all financial and servicing assets it controls and
liabilities it has incurred and derecognizes financial assets it no longer
controls and liabilities that have been extinguished. The financial-components
approach focuses on the assets and liabilities that exist after the transfer.
Many of these assets and liabilities are components of financial assets that
existed prior to the transfer. If a transfer does not meet the criteria for a
sale, the transfer is accounted for as a secured borrowing with a pledge of
collateral.
The statement is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after December 31, 1996, and will
be applied prospectively. Earlier or retroactive application of this statement
is not permitted. The Company has determined that the adoption of this
statement will not have a material impact on its consolidated financial
statements.
(2) INVESTMENT AND MORTGAGE BACKED SECURITIES
A summary of investment and mortgage backed securities classified as
available-for-sale and held-to-maturity at September 30, 1996 and 1995 follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE Quoted
(Dollars in thousands) Amortized Unrealized Unrealized market
AT SEPTEMBER 30, 1996 cost gains losses value
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment securities:
Marketable equity securities $0 $3 $-- $3
- -----------------------------------------------------------------------------------------------------------
Total investment securities $0 $3 $-- $3
- -----------------------------------------------------------------------------------------------------------
Mortgage backed securities, by issuer:
Other $1 $5 $-- $6
- -----------------------------------------------------------------------------------------------------------
Total mortgage backed securities $1 $5 $-- $6
- -----------------------------------------------------------------------------------------------------------
Total available-for-sale $1 $8 $-- $9
- -----------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY Quoted
(Dollars in thousands) Amortized Unrealized Unrealized market
AT SEPTEMBER 30, 1996 cost gains losses value
- -----------------------------------------------------------------------------------------------------------
Investment securities:
United States Government and related
obligations $27,075 $3 $234 $26,844
Municipal bonds 247 2 1 248
Corporate debentures 1,002 1 1 1,002
FHLB debentures 20,469 -- 617 19,852
- -----------------------------------------------------------------------------------------------------------
Total investment securities
held-to-maturity $48,793 $6 $853 $47,946
- -----------------------------------------------------------------------------------------------------------
Mortgage backed securities, by issuer:
Fixed rate:
FHLMC $ 26,679 $ 148 $ 581 $ 26,246
FNMA 165,116 109 7,433 157,792
GNMA 99 1 1 99
Adjustable rate:
FHLMC 3,788 -- 168 3,620
FNMA 11,415 -- 299 11,116
GNMA 37,759 237 -- 37,996
- -----------------------------------------------------------------------------------------------------------
Total mortgage backed securities
held-to-maturity $244,856 $495 $8,482 $236,869
- -----------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE Quoted
(Dollars in thousands) Amortized Unrealized Unrealized market
AT SEPTEMBER 30, 1995 cost gains losses value
- -----------------------------------------------------------------------------------------------------------
Investment securities:
Mutual fund $4,440 $-- $301 $4,139
Marketable equity securities 2 29 -- 31
- -----------------------------------------------------------------------------------------------------------
Total investment securities $4,442 $29 $301 $4,170
- -----------------------------------------------------------------------------------------------------------
Mortgage backed securities, by issuer:
FNMA $ 1 $ 6 $ -- $ 7
- -----------------------------------------------------------------------------------------------------------
Total mortgage backed securities $ 1 $ 6 $ -- $ 7
- -----------------------------------------------------------------------------------------------------------
Total available-for-sale $4,443 $35 $301 $4,177
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
HELD-TO-MATURITY Quoted
(Dollars in thousands) Amortized Unrealized Unrealized market
AT SEPTEMBER 30, 1995 cost gains losses value
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment securities:
United States Government and related
obligations $20,997 $17 $26 $20,988
Municipal bonds 1,251 1 5 1,247
Corporate debentures 1,011 2 5 1,008
FHLB debentures 19,000 66 15 19,051
- ---------------------------------------------------------------------------------------------------------
Total investment securities
held-to-maturity $42,259 $86 $51 $42,294
- ---------------------------------------------------------------------------------------------------------
Mortgage backed securities, by issuer:
Fixed rate:
FHLMC $ 36,832 $ 294 $ 585 $ 36,541
FNMA 195,644 275 5,510 190,409
GNMA 128 3 -- 131
Adjustable rate:
FHLMC 19,039 304 174 19,169
FNMA 12,348 -- 371 11,977
GNMA 6,142 297 -- 6,439
- ---------------------------------------------------------------------------------------------------------
Total mortgage backed securities
held-to-maturity $270,133 $1,173 $6,640 $264,666
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
The Company had $51,909,000, $0, and $146,120,000 in proceeds from sales of
investment and mortgage backed securities available-for-sale in 1996, 1995 and
1994, respectively. Realized gains from sales of investment and mortgage backed
securities available-for-sale during 1996 were $121,000 and $990,000, compared
to realized gains of $0 and $0, respectively, in 1995, and realized gains of
$265,000 and $1,037,000, respectively, in 1994. Realized losses from sales of
investment and mortgage backed securities available-for-sale during 1996 were
$241,000 and $62,000, respectively compared to realized losses of $0 and $0,
respectively, in 1995, and $0 and $859,000, respectively, in 1994.
The following table sets forth the contractual maturities of the Company's
investment and mortgage backed securities held-to-maturity. Maturities of
mortgage backed securities are presented based on the last contractual payment
date which is not representative of anticipated cash receipts. Actual
principal paydowns of mortgage backed securities will occur throughout the life
of the securities. Expected maturities of certain securities may differ from
contractual maturities because borrowers have the right to call or prepay.
<TABLE>
<CAPTION>
HELD-TO-MATURITY
(Dollars in thousands) At September 30, 1996
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
After 1 After 5
Within through through After
AMORTIZED COST 1 year 5 years 10 years 10 years Total
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
United States Government and related obligations $5,075 $12,000 $10,000 $ -- $ 27,075
Mortgage backed securities -- 8,678 27,363 208,815 244,856
Municipal bonds 125 -- -- 122 247
Corporate debentures 502 500 -- -- 1,002
FHLB debentures 699 5,000 4,770 10,000 20,469
- --------------------------------------------------------------------------------------------------------------------------
Total $6,401 $26,178 $42,133 $218,937 $293,649
- --------------------------------------------------------------------------------------------------------------------------
Weighted average interest rate 5.35% 6.49% 6.66% 6.79% 6.71%
MARKET VALUE
- --------------------------------------------------------------------------------------------------------------------------
United States Government and related obligations $5,077 $ 11,916 $ 9,851 $ -- $ 26,844
Mortgage backed securities -- 8,536 26,886 201,447 236,869
Municipal bonds 125 -- -- 123 248
Corporate debentures 501 501 -- -- 1,002
FHLB debentures 699 4,903 4,600 9,650 19,852
- --------------------------------------------------------------------------------------------------------------------------
Total $6,402 $25,856 $41,337 $211,220 $284,815
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1996, the Company had mortgage backed securities
available-for-sale maturing on November 1, 2008, with an amortized cost of $500
and a market value of $6,000.
60
<PAGE>
At September 30, 1996, the Company owned $13.2 million of CMOs classified
as mortgage backed securities held-to-maturity. The underlying collateral of
these derivative securities consists of residential mortgages guaranteed by the
FNMA.
As a member of the FHLB, the Bank is required to invest in $100 par value
stock of the FHLB in the amount of 1.0 percent of its outstanding loans secured
by residential housing, or 1.0 percent of 30 percent of total assets, or 5.0
percent of their outstanding advances from the FHLB, whichever is highest. As
and when such stock is redeemed, the Bank would receive from the FHLB an amount
equal to the par value of the stock. As of September 30, 1996, the Bank was
required to have an investment of at least $7,681,000.
During the first quarter of fiscal 1996, the Company took advantage of a
provision in the FASB's special report on SFAS no. 115 which allowed entities to
make a one-time reclassification of security classifications. The Bank
reclassified $43.7 million from the held-to-maturity portfolio to the available-
for-sale portfolio. Subsequently, the Bank sold a majority of these
reclassified securities.
(3) LOANS
The Company's lending activities are conducted principally in Vermont and
southeastern and central New Hampshire. The Bank grants single family
residential loans, condominium loans, commercial real estate loans, commercial
loans, and a variety of consumer loans. In addition, the Bank grants loans for
the construction of residential homes, for the construction of commercial real
estate properties, and for land development. Substantially all loans granted by
the Bank are secured by real estate collateral. The ability and willingness of
residential mortgage and consumer loan borrowers to honor their repayment
commitments is impacted by the health of the real estate market in the
borrowers' geographic areas and the general economy. The Bank is prohibited by
statute and OTS regulations from lending to any one borrower aggregate amounts
in excess of 15.0 percent of the institution's unimpaired capital and unimpaired
surplus for loans and extensions of credit that are not fully secured and an
additional 10.0 percent of unimpaired capital and unimpaired surplus for loans
and extensions of credit that are fully secured by readily marketable
collateral. This lending limit may not apply to loans and extensions of credit
that are less than $500,000 in the aggregate. The Company had no such lending
relationships with borrowers at September 30, 1996.
Loans totaling $7,945,000, $11,076,000, and $5,454,000 were nonaccruing at
September 30, 1996, 1995 and 1994, respectively. However, fiscal 1994 does not
include in-substance foreclosures. Total restructured loans were $6,925,000,
$5,786,000, and $4,999,000 at September 30, 1996, 1995, and 1994, respectively.
The Bank has no additional funding commitments to these borrowers. The
reduction in interest income for the years ended September 30 associated with
nonaccrual and restructured loans held at the end of each year is as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income in accordance
with original terms $904 $1,225 $575
Interest income recognized 132 332 303
- ------------------------------------------------------------------------------------------
Interest income not recognized $772 $893 $272
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1996, the recorded investment in loans that are considered
to be impaired under SFAS No. 114 was $5,348,572 (of which $3,529,559 was on a
nonaccrual basis). Included in total impaired loans are $3,336,575 of impaired
loans with specific valuation allowances aggregating to $408,630. All impaired
loan relationships in excess of $100,000 were measured using the difference
between the fair value of collateral and the recorded amount of the loan.
Impaired loan relationships less than $100,000 totaled $211,448. The average
recorded investment in impaired loans during the twelve months ended September
30, 1996 was approximately $6,437,640. For the twelve months ended September 30,
1996, the Bank recognized interest income on impaired loans of $451,469.
61
<PAGE>
In the ordinary course of business, the Bank makes loans to its directors,
officers, principal stockholders, and related interests of such individuals or
entities ("affiliates") on substantially the same terms as those prevailing at
the time of origination for comparable transactions with other borrowers and
subject to certain other limitations as provided in OTS regulations. An analysis
of loans to affiliates that exceed $60,000 in aggregate outstanding amount to
any related parties during the years ended September 30, 1996 and 1995 is as
follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1996 1995
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $2,317 $2,465
Additions 261 71
Repayments (454) (219)
Employment changes (1,245) --
- -------------------------------------------------------------------------------------
Balance at end of year $ 879 $2,317
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</TABLE>
Loans are summarized as follows:
<TABLE>
<CAPTION>
At September 30,
(Dollars in thousands) 1996 1995
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
<S> <C> <C>
Residential mortgage loans:
Conventional -- fixed rate $ 60,218 $ 29,859
Conventional -- variable rate 186,049 179,118
Construction 9,939 5,386
Partially guaranteed by VA or insured by FHA 986 1,467
Mortgage loans held for sale 10,480 8,212
- -------------------------------------------------------------------------------------
Total residential mortgage loans 267,672 224,042
- -------------------------------------------------------------------------------------
Consumer loans:
Home equity 76,917 79,878
Mobile home 40,109 44,690
Auto and personal 15,866 11,522
Secured by deposit accounts 2,018 2,062
Other 2,017 4,176
- -------------------------------------------------------------------------------------
Total consumer loans 136,927 142,328
- -------------------------------------------------------------------------------------
Commercial loans:
Commercial real estate 83,171 82,962
Other secured 7,315 10,174
- -------------------------------------------------------------------------------------
Total commercial loans 90,486 93,136
- -------------------------------------------------------------------------------------
Total loans receivable 495,085 459,506
- -------------------------------------------------------------------------------------
Deductions:
Deferred loan (fees) costs (151) 245
Unamortized premiums, net (488) (252)
Undisbursed proceeds on loans in process 4,080 1,899
Allowance for loan losses (note 4) 2,858 3,622
- -------------------------------------------------------------------------------------
Total 6,299 5,514
- -------------------------------------------------------------------------------------
Net loans receivable $488,786 $453,992
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</TABLE>
Mortgage and commercial loans serviced for other investors were
approximately $647,653,000, $563,021,000, and $666,732,000 at September 30,
1996, 1995, and 1994, respectively. Loans serviced for others include
approximately $95.0 million and $59.0 million at September 30, 1996 and 1995,
respectively, the servicing rights to which were purchased by VFB during 1996
and 1995. During 1995, the rights to service $162.6 million of mortgage loans
were sold without recourse to an unrelated party for a price of $2.0 million.
This sale resulted in a gain of $777,000. The following table shows fiscal 1996
and fiscal 1995 activity for all loan servicing rights.
62
<PAGE>
<TABLE>
<CAPTION>
(Dollars in thousands) Purchased Originated Excess Total
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of fiscal 1995 $1,524 $ -- $ 463 $1,987
Purchases and capitalization 971 566 63 1,600
Sales, net (1,246) -- -- (1,246)
Amortization (457) (62) (147) (666)
- -----------------------------------------------------------------------------------------------
Balance at end of fiscal 1995 $ 792 $ 504 $ 379 $1,675
- -----------------------------------------------------------------------------------------------
Purchases and capitalization 594 1,350 199 2,143
Sales, net -- -- -- --
Amortization (269) (309) (179) (757)
- -----------------------------------------------------------------------------------------------
BALANCE AT END OF FISCAL 1996 $1,117 $1,545 $ 399 $3,061
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
</TABLE>
(4) ALLOWANCE FOR LOAN LOSSES
The following summarizes transactions in the allowance for loan losses:
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $3,622 $3,718 $4,722
Provision for loan losses 895 1,822 797
Recoveries on loans previously charged off 231 136 313
Loans charged off (1,890) (2,054) (2,114)
- ------------------------------------------------------------------------------------------
Balance at end of year $2,858 $3,622 $3,718
- ------------------------------------------------------------------------------------------
Allocation of ending balance:
Commercial $1,352 $1,817 $2,460
Residential mortgage 428 519 648
Consumer 1,078 1,286 610
- ------------------------------------------------------------------------------------------
Total $2,858 $3,622 $3,718
- ------------------------------------------------------------------------------------------
Allocation of charge offs:
Commercial $1,246 $1,014 $1,221
Residential mortgage 168 482 356
Consumer 476 558 537
- ------------------------------------------------------------------------------------------
Total $1,890 $2,054 $2,114
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
(5) OTHER REAL ESTATE OWNED
The components of OREO are as follows:
<TABLE>
<CAPTION>
At September 30,
(Dollars in thousands) 1996 1995
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Residential real estate $1,463 $1,531
Land zoned residential 189 676
Commercial real estate 941 549
Industrial parks -- 1,273
Investment real estate -- 251
Shopping centers 1,425 1,729
Other -- 212
Less valuation allowance (407) (823)
- ------------------------------------------------------------------------------------------
Total $3,611 $5,398
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
Real estate foreclosed but subject to a redemption waiting period was
$337,946 and $145,000 on September 30, 1996 and 1995, respectively.
63
<PAGE>
Changes in the allowance for other real estate owned are as follows:
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 823 $ 226 $ 116
Provision charged to expense 389 1,329 1,282
Charge offs (805) (732) (1,172)
- ------------------------------------------------------------------------------------------
Balance at end of year $ 407 $ 823 $ 226
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
The components of other real estate owned operations expense are as
follows:
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net (gain) on sales of real estate owned $ (521) $ (288) $ (156)
Provision for loss 389 1,329 1,282
Investment in real estate expense 69 44 45
Provision for loss on investement in real estate -- 502 --
Other operating expense, net of income 1,421 1,467 1,555
- ------------------------------------------------------------------------------------------
Total $1,358 $3,054 $2,726
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
(6) PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
<TABLE>
<CAPTION>
At September 30,
(Dollars in thousands) 1996 1995
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Land $ 2,041 $ 2,025
Office buildings and improvements 8,251 7,299
Furniture, fixtures, and equipment 14,165 10,410
Computer equipment 2,760 3,127
Leasehold improvements 1,860 1,673
- ------------------------------------------------------------------------------------------
Total 29,077 24,534
- ------------------------------------------------------------------------------------------
Less accumulated depreciation and amortization 12,384 10,302
- ------------------------------------------------------------------------------------------
Total premises and equipment $16,693 $14,232
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
The Bank occupies leased quarters at various locations. These leases expire
on various dates through 2003 with options to renew. In September 1991, the Bank
leased $807,000 of certain data processing equipment under a capital lease. The
commitments for minimum annual lease payments for operating and capital leases
are as follows:
<TABLE>
<CAPTION>
Years ending September 30,
Imputed Net Present
(Dollars in thousands) 1997 1998 1999 2000 2001 Thereafter Total Interest Value
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Operating $901 $868 $800 $734 $155 $331 $3,789
Capital 147 148 -- -- -- -- 295 $22 $273
- ----------------------------------------------------------------------------------------------------------------------------------
Total $1,048 $1,016 $800 $734 $155 $331 $4,084
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Rental expense was approximately $936,000, $835,000, and $767,000 for the
years ended September 30, 1996, 1995, and 1994, respectively.
64
<PAGE>
(7) DEPOSIT ACCOUNTS
Deposit accounts are summarized as follows:
<TABLE>
<CAPTION>
At September 30,
1996 1995 1994
Weighted Weighted Weighted
average average average
(Dollars in thousands) Amount interest rate Amount interest rate Amount interest rate
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Non-interest-bearing:
Commercial demand deposits $18,878 -- % $17,569 -- % $15,908 -- %
Retail demand deposits 37,108 -- 31,363 -- 29,845 --
NOW accounts 80,209 1.15 77,518 1.43 74,980 1.51
Passbook accounts 115,466 2.66 119,383 2.65 140,668 2.62
Money market deposit accounts 67,148 3.53 59,862 4.54 56,745 3.86
Certificate accounts:
Less than $100,000 294,631 5.35 284,515 5.73 244,895 4.44
$100,000 or greater 27,846 5.50 26,139 5.84 21,347 4.72
- -----------------------------------------------------------------------------------------------------------------------------
641,286 3.69% 616,349 4.03% 584,388 3.23%
Unamortized premium -- 1 1
- -----------------------------------------------------------------------------------------------------------------------------
Total $641,286 $616,350 $584,389
- -----------------------------------------------------------------------------------------------------------------------------
Maturity of certificate accounts:
Within one year $248,353 $228,397 $180,716
From one to within two years 35,948 37,931 48,424
From two to within three years 20,349 15,914 10,003
Balance thereafter 17,827 28,412 27,099
- -----------------------------------------------------------------------------------------------------------------------------
Total $322,477 $310,654 $266,242
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
During fiscal 1996 the Bank offered a range of rates from 1.02 percent to
2.83 percent on now accounts, from 2.41 percent to 3.05 percent on passbook
acoounts, from 2.46 percent to 5.35 percent on money market accounts, and from
3.20 percent to 6.63 percent on certificate accounts
A summary of interest expense on deposits follows:
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Certificate accounts $17,525 $14,798 $11,097
NOW accounts 919 1,083 1,094
Money market deposit accounts 2,608 2,402 1,825
Passbook accounts 3,064 3,384 3,736
- ------------------------------------------------------------------------------------------
Total $24,116 $21,667 $17,752
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
65
<PAGE>
(8) ADVANCES FROM FHLB
Advances from FHLB consisted of the following:
<TABLE>
<CAPTION>
At September 30,
(Dollars in thousands) 1996 1995
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
Due in fiscal years Weighted average Weighted average
ended September 30, Amount interest rate Amount interest rate
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996 $ -- --% $ 96,277 6.04%
1997 120,800 5.71 21,000 6.20
1998 6,700 5.70 4,000 5.57
1999 18,500 5.48 9,500 5.26
2001 5,000 5.88 5,000 5.88
Thereafter 2,636 4.84 855 7.68
- ---------------------------------------------------------------------------------------------
Total $153,636 5.67% $136,632 6.00%
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
</TABLE>
FHLB stock, mortgage loans on residential properties, and other eligible
investments not sold under agreement to repurchase are pledged as collateral to
secure such advances. The total unused line of credit with FHLB at September
30, 1996, was $8,257,000. Three advances totaling $2,636,000 have scheduled
monthly repayments with maturity dates after September 2007.
(9) SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The collateral for securities sold under agreement to repurchase consisted
of mortgage backed securities with a book value of approximately $30,386,000 and
a market value of approximately $29,984,000 at September 30, 1995. The Company
had no outstanding repurchase agreements at September 30, 1996 or 1994.
<TABLE>
<CAPTION>
(Dollars in thousands) At September 30, 1995
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
Matured Interest
in Amount rate
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Securities sold under agreement
to repurchase matured in
10/95 $ 7,000 5.85%
11/95 7,000 5.85
12/95 6,000 5.84
5/96 4,855 6.08
- ------------------------------------------------------------------------------------------
Total $24,855 5.89%
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
The mortgage backed securities underlying the agreements were delivered to
one primary dealer who arranged the transactions. The dealer may have sold,
loaned, or otherwise disposed of such securities to other parties in the normal
course of operations and have resold to the Company substantially identical
securities at the maturities of the agreements.
Securities sold under agreement to repurchase averaged $5,606,000,
$19,977,000, and $2,516,000 during 1996, 1995, and 1994, respectively. Maximum
amounts outstanding at any month end during 1996, 1995, and 1994 were
$17,855,000, $32,855,000, and $10,500,000, respectively. The average costs of
repurchase agreements was 6.43 percent, 6.13 percent, and 3.50 percent during
fiscal 1996, 1995, and 1994, respectively.
66
<PAGE>
(10) FEDERAL AND STATE TAXES
The components of income tax expense for the years ended September 30 were
as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal and state tax expense:
Current $2,718 $1,975 $2,362
Deferred (645) 368 (3)
Change in valuation reserve (18) 4 (52)
- ------------------------------------------------------------------------------------------
Total $2,055 $2,347 $2,307
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences (the difference between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases) that give rise to significant portions of the deferred tax
asset and deferred tax liability are as follows:
<TABLE>
<CAPTION>
At September 30,
(Dollars in thousands) 1996 1995
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax asset:
Allowance for loan losses $956 $1,436
Deposit insurance assessment 1,330 --
Deferred loan fees -- 136
Purchase accounting adjustments 85 107
Deferred compensation 254 192
Pension 183 180
Early retirement contribution 26 35
Purchased mortgage servicing rights 66 25
Unrealized loss on investment securities
available-for-sale -- 90
Other 239 225
- ------------------------------------------------------------------------------------------
Total 3,139 2,426
Valuation reserve -- (18)
- ------------------------------------------------------------------------------------------
Gross deferred tax asset $3,139 $2,408
- ------------------------------------------------------------------------------------------
Deferred tax liability:
Pension $167 $134
Depreciation 491 677
Originated mortgage servicing rights 544 164
Purchase accounting adjustments 168 233
Excess servicing rights 20 34
Deferred loan origination expense 401 330
Unrealized gain on investment securities
available-for-sale 2 --
Other -- 60
- ------------------------------------------------------------------------------------------
Gross deferred tax liability 1,793 1,632
- ------------------------------------------------------------------------------------------
Deferred income tax asset, net $1,346 $ 776
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
On August 20, 1996, President Clinton signed into law the Small Business
Job Protection Act of 1996 which included the repeal of the special thrift bad
debt provisions. Although the percentage of taxable income method bad debt
deduction will no longer be available to the Bank, the tax requirement to invest
in certain qualifying types of investments and loans has been eliminated, thus
providing greater freedom to the Bank in structuring its balance sheet to
maximize return.
The Company has not provided deferred income taxes for the Bank's tax
return reserve for bad debts that arose in tax years beginning before September
30, 1988 because it is not expected that this difference will reverse in the
foreseeable future. The cumulative net amount of temporary differences related
to the reserve for bad debts for which deferred taxes have not been provided was
approximately $10.3 million at September 30, 1996. If the Company does not meet
the remaining income tax requirements of Internal Revenue Code section
67
<PAGE>
593, as amended by the Small Business Job Protection Act of 1996, the Bank could
incur a tax liability for the previously deducted tax return loan losses in the
year in which such requirements are not met. This potential liability for which
no deferred income taxes have been provided was approximately $3.6 million as of
September 30, 1996.
Realization of the net deferred tax asset is supported by the Company's tax
history. Management believes that the existing net deductible temporary
differences that give rise to the net deferred income tax asset will reverse
during periods in which the Company generates net taxable income. For the year
ending September 30, 1996 the Company generated taxable income of approximately
$6.5 million. In addition, gross deductible temporary differences are expected
to reverse in periods during which offsetting gross taxable temporary
differences are expected to reverse. It should be noted, however, that factors
beyond management's control, such as the general state of the economy and real
estate values, can affect future levels of taxable income and that no assurance
can be given that sufficient taxable income will be generated to fully absorb
gross deductible temporary differences.
The Company's effective tax rates differ from the statutory federal income
tax rate for the following principal reasons:
<TABLE>
<CAPTION>
Years ended
September 30,
1996 1995 1994
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal income tax rate 34.0% 34.0% 34.0%
Items affecting federal income tax rate:
State tax expense 4.2 4.2 3.7
Internal Revenue Service settlement -- (4.5) --
Amortization of excess of cost over
net assets acquired 2.0 1.6 1.8
Low income housing tax credit (1.7) -- --
Change in valuation reserve (0.3) 0.1 (0.9)
Other, net 0.1 0.5 0.1
- ------------------------------------------------------------------------------------------
Effective federal income tax rate 38.3% 35.9% 38.7%
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
(11) STOCKHOLDERS' EQUITY
In connection with the Bank's conversion to a federal stock savings bank
and FS's conversion to a stock savings association, a liquidation account was
established for the benefit of eligible deposit account holders in the event of
a complete liquidation. At September 30, 1996, the amount of the combined
liquidation account was approximately $1.2 million (unaudited).
On May 23, 1996, Eastern's Board of Directors declared a three-for-two
stock split in the form of a 50 percent stock dividend. The distribution was
made on June 19, 1996 to holders of record of the Company's Common Stock as of
the close of business on June 5, 1996. All earnings per share, dividends, and
share information has been adjusted to reflect this stock split.
The OTS prohibits the Bank from paying dividends if the effect thereof
would cause decline in regulatory capital to a level below required minimums,
reduction of net worth below the amount required for the liquidation account, or
violation of other regulatory requirements. The Bank was in compliance with all
regulatory capital requirements at September 30, 1996.
The Bank is subject to various regulatory capital requirements administered
by 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. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
68
<PAGE>
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk
weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of September 30, 1996, that the
Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 1996, the most recent notification from the OTS
categorized the Bank as well capitalized under the framework for prompt
corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes would cause a change in the Bank's
categorization.
The Bank's actual capital amounts and ratios are presented in the following
table.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Action Provisions
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1996:
Total Capital
(to risk weighted assets) $59,952 12.5% $38,276 > 8.0% $47,845 > 10.0%
Tier I capital - -
(to risk weighted assets) 56,152 11.7 19,134 > 4.0 28,707 > 6.0
Tier I capital - -
(to average assets) 56,152 6.8 33,221 > 4.0 23,922 > 5.0
- -
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
(12) EMPLOYEE BENEFIT PLANS
The Company has a defined contribution plan and an employee stock ownership
plan, the Eastern Bancorp, Inc. 401(k) and ESOP Plan, for substantially all of
the Bank's employees. Company contributions to the plan are discretionary and
are based on annual profitability. Participants may make voluntary contributions
within limits prescribed by the plan's 401(k) and by regulations under Section
401(k) of the Internal Revenue Code and the Company will match half of the first
six percent of compensation contributed. During fiscal 1996, the Company made
$231,000 and $147,000 in discretionary plan contributions to the 401(k) and
ESOP, respectively, compared to $311,000 and $185,000 in fiscal 1995 and
$279,000 and $166,000 in fiscal 1994. The Company also made matching
contributions to the participant's 401(k) accounts of approximately $167,000,
$107,000, and $108,000 during fiscal years 1996, 1995, and 1994, respectively.
Contributions to the ESOP are used to purchase Company shares that are then
allocated to eligible employees. Dividends on allocated shares are used to
purchase additional shares that are then allocated to eligible participants. At
September 30, 1996, the shares held by the ESOP amounted to 89,286, all of which
were allocated to ESOP participants.
In 1986, VFB established a supplemental deferred compensation plan for
directors and certain former officers of VFB. Under the plan, a participant or,
in the event of his or her death, his or her designated beneficiary, would
receive fixed annual payments for fifteen years following the participant's
retirement or death, as the case might be. The plan was established pursuant to
a recommendation by a life insurance company and insurance agents who
represented to VFB that the purchase of life insurance on the lives of
participants in the program would result in life insurance proceeds to VFB
sufficient to fund VFB's obligations under the plan at no cost to VFB. During
fiscal 1989, VFB discovered that the program presented by the insurance agents
was based on assumptions that were unjustified and unlikely to occur, as a
result of which the return on the policies was insufficient to fully fund VFB's
obligations under the plan. In December 1989, VFB instituted suit against the
insurance company and the insurance agents who made the above-referenced
representations to VFB. The Bank and the defendants have settled the lawsuit. In
December 1992, VFB reached a resolution with certain director participants in
this plan. Under the resolution, VFB returned to director participants their
original
69
<PAGE>
amounts deferred over a three-year period, beginning in January 1993. In return,
the director participants released VFB from any liability from the plan. As of
September 30, 1993, all but three director participants of the original twelve
accepted this resolution. Under the resolution, VFB retains the option of
keeping in force life insurance policies on the participants. The net present
value of these policies currently exceeds the cost of this resolution. All
director participants have since reached an agreement with VFB.
All eligible officers and employees of the Company, if they so choose, are
covered by a self-insured health and dental plan. The cost of this program was
$354,000 during fiscal 1996, $427,000 during fiscal 1995, and $489,000 during
fiscal 1994.
Prior to the FS-VFB Merger, all eligible officers and employees of FS were
included in a non-contributory pension plan provided by FS as a participating
employer of the Financial Institutions Retirement Fund (FIRF). The FIRF does not
segregate the assets or liabilities by participating employer and, accordingly,
disclosure of accumulated vested and non-vested benefits and net assets
available for benefits required by SFAS No. 87 is not possible. Pension expense
amounted to approximately $121,000 and $216,000 for each of the years ended
September 30, 1995 and 1994, respectively. FS instituted an executive
supplemental insurance and retirement plan in 1988 under which an executive
officer receives a retirement benefit based upon compensation and length of
service. Life insurance policies were purchased of which the Bank is the owner.
(13) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of their customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, standby letters of credit,
credit lines, loans sold with recourse and commitments to sell loans. Such
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the statement of financial condition.
The contract or notional amounts of these instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit, and loans sold with recourse is represented by the
contractual notional amount of those instruments. The Bank uses the same credit
policies in making commitments and conditional obligations as they do for on-
balance-sheet instruments.
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with credit risk.
<TABLE>
<CAPTION>
September 30,
(Dollars in thousands) 1996 1995
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
<S> <C> <C>
Financial instruments with off-balance-sheet risk:
Commitments to extend credit:
Residential mortgage - fixed rate $12,747 $12,499
Residential mortgage - variable rate 3,295 2,736
Consumer - fixed rate 855 517
Consumer - variable rate 1,044 1,814
Commercial - fixed rate 974 523
Commercial - variable rate 5,643 4,719
Standby letters of credit 1,257 2,328
Unused credit lines, including unused
portions of equity lines of credit 67,653 63,969
Loans sold with recourse -- --
Commitments to sell loans 17,437 10,112
Commitments to buy loans -- 1
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee by the customer. Since many of the commitments
are expected to
70
<PAGE>
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates customers' credit-
worthiness on a case-by-case basis. The amount of collateral obtained if deemed
necessary by the Bank upon extension of credit is based on management's credit
evaluation of the counter-party. Collateral held varies but may include real
estate; accounts receivable; inventory; property, plant, and equipment; and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those instruments are
primarily issued to support private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loans to customers.
The Bank originates a variety of adjustable-rate loans with interest rate
caps and floors. Interest rate caps and floors on loans written by the Bank
enable customers to transfer, modify, or reduce their interest rate risk.
Forward commitments to sell mortgage loans are contracts the Company enters
into for the purpose of reducing the interest rate risk associated with
originating loans held for sale. Risks may arise from the possible inability of
the Company to originate loans to fulfill the contracts.
Most of the Bank's business activity is with customers located within
Vermont and New Hampshire. A significant amount of the Bank's assets are
secured by real estate with no industry concentrations.
(14) FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments."
The following methods and assumptions were used by the Company in
estimating fair values of its financial instruments:
The respective carrying values of certain financial instruments
approximated their fair value as they were short-term in nature or they were
payable on demand. These include, "Cash and due from banks," "short-term
investments," and non-certificate deposit accounts.
Investment and mortgage backed securities: Fair values for investment and
mortgage backed securities were based on quoted market prices, where available.
If quoted market prices were not available, fair values were based on quoted
market prices of comparable instruments.
FHLB stock: The carrying amount reported in the statement of condition
approximates fair value. If the stock is redeemed, the Company will receive an
amount equal to the par value of the stock.
Loans: The fair value of loans including loans sold with recourse was
determined using discounted cash flow analysis, using interest rates currently
being offered by the Company to discount future cash flows to present value. The
fair value of non-accrual loans was estimated using a discount rate
substantially higher than the rates used for performing loans to reflect the
increased credit risk.
Off-balance-sheet instruments: The fair value of mortgage servicing rights
was estimated using discounted cash flow analysis. The fair value of commitments
to extend credit or sell loans was based on quoted market prices for comparable
instruments.
The fair values of the unused portion of lines of credit and letters of
credit are based on fees currently charged to enter into similar agreements and
were estimated to be the fee charged. Commitments to originate non-mortgage
loans were short-term and were at current market rates and estimated to have no
fair value.
Financial Liabilities: The fair value of certificates of deposit, FHLB term
advances, and repurchase agreements were estimated using discounted cash flow
analysis using rates currently being offered by the Company and the FHLB for
comparable instruments.
71
<PAGE>
Limitations: The estimates of fair value of financial instruments were
based on information available at September 30, 1996 and 1995, and are not
indicative of the fair market value of those instruments at the date this report
is published. These estimates do not reflect any premium or discount that could
result from offering for sale at one time the Company's entire holdings of a
particular financial instrument. Because no market exists for a portion of the
Company's financial instruments, fair value estimates were based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance-sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Significant assets and liabilities that are not
considered financial instruments include real estate acquired by foreclosure,
the deferred income tax asset, office properties and equipment, and core deposit
and other intangibles. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant effect on
fair value estimates and have not been considered.
The estimation methodologies used, book values and estimated fair values
for the Bank's financial instruments follows.
<TABLE>
<CAPTION>
At September 30,
1996 1995
- ----------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) amount fair value amount fair value
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $27,766 $27,766 $19,862 $19,862
Short-term investments 12,043 12,043 11,099 11,099
Investment and mortgage backed securities 293,658 284,824 316,569 311,137
FHLB stock 9,283 9,283 9,283 9,283
Loans, net 488,786 483,161 453,992 454,890
Accrued interest receivable 5,073 5,073 5,492 5,492
Mortgage servicing rights 3,061 5,249 1,675 4,923F
Financial liabilities:
Deposits $641,286 $642,779 $616,350 $616,514
Advances from FHLB 153,636 153,303 136,632 136,042
Securities sold under areement to repurchase -- -- 24,855 24,750
Capital lease obligation 273 270 395 388
- ----------------------------------------------------------------------------------------------------------
Off-balance-sheet instruments:
Commitments to extend credit $-- $15 $-- $(19)
Commitments to sell loans -- 14 -- 3
- ----------------------------------------------------------------------------------------------------------
</TABLE>
(15) LITIGATION
At September 30, 1996, the Company was involved in various claims and legal
actions arising in the normal course of its business. The outcomes of these
claims and actions are not presently determinable; however, in the opinion of
the Company's management, after consulting with the Company's legal counsel, the
ultimate disposition of these matters is not expected to have a material adverse
effect on the Company's financial condition or results of operations.
(16) STOCK OPTION PLANS
The Board of Directors of the Company adopted the 1984 Stock Option Plan
effective simultaneously with the Bank's conversion to a stock charter in
November 1983. Upon formation of the Company, all outstanding options of the
Bank were automatically converted to options of the Company. A total of 189,015
shares of authorized but unissued common stock has been reserved under the 1984
Stock Option Plan. This plan is no longer available for grant.
In April 1987, the Board of Directors of the Company adopted a second stock
option plan, in addition to and separate from the 1984 Stock Option Plan, which
was approved by stockholders at the 1988 annual meeting
72
<PAGE>
of stockholders. A total of 532,500 authorized but unissued shares of Company
common stock is reserved for issuance under the 1987 Stock Option Plan all of
which remain eligible for future grant under such plan.
Under the terms of the plans, options are granted at not less than the fair
market value of the shares at the date of grant and may not have a term of more
than ten years. Options may generally be exercised at such time during the term
as is deemed appropriate by the Compensation and Option Committee of the Board
of Directors.
Options exercisable at September 30, 1996 totaled 394,425 with a weighted
average option price per share of $10.34.
Information with regard to the stock option plans follows:
Number of Weighted average option
option shares price per share
- --------------------------------------------------------------------------------
Outstanding at September 30, 1993 441,939 $ 9.04
Granted 38,250 12.04
Exercised (26,514) 5.69
Cancelled (21,000) 9.67
- --------------------------------------------------------------------------------
Outstanding at September 30, 1994 432,675 9.50
Granted 10,500 14.09
Exercised (4,050) 9.17
- --------------------------------------------------------------------------------
Outstanding at September 30, 1995 439,125 9.61
Granted 34,125 16.13
Exercised (77,100) 8.76
Cancelled (1,725) 10.54
- --------------------------------------------------------------------------------
Outstanding at September 30, 1996 394,425 $ 10.34
- --------------------------------------------------------------------------------
A summary of the options by maturity follows:
Expiring during the Number of Weighted average option
year ended September 30, option shares price per share
- --------------------------------------------------------------------------------
1997 30,600 $16.05
1998 7,500 9.50
1999 32,400 9.17
2000 31,500 5.83
2001 -- --
2002 18,000 3.72
2003 191,925 9.46
2004 38,250 12.04
2005 32,250 15.26
2006 12,000 16.67
- --------------------------------------------------------------------------------
394,425 $10.34
- --------------------------------------------------------------------------------
(17) RESTRUCTURING AND FS-VFB MERGER-RELATED CHARGES
In May 1995, the Company announced plans to merge its subsidiary banks,
Vermont Federal Bank, FSB, and First Savings of New Hampshire. The two banks
operated as separate legal entities during fiscal 1995, and began operating as
one bank on October 1, 1995. The Company's restructuring plan included
consolidation of operational support functions that were completed during fiscal
1996.
73
<PAGE>
During fiscal 1995, the Company provided for $839,000 in restructuring
charges associated with the FS-VFB Merger. A summary of the charges is as
follows:
(Dollars in thousands)
- -------------------------------------------
Separation and benefits $351
Obsolete supplies and equipment 334
Consulting 71
Legal 28
Contract termination penalties 23
Accounting 19
OTS filing fee 8
Miscellaneous 5
- -------------------------------------------
Total $839
- -------------------------------------------
At September 30, 1995, the remaining restructuring liability was $330,000.
This balance consisted of $307,000 of accrued separation and benefits expense
and $23,000 of accrued contract termination penalties. At September 30, 1996,
the restructuring liability no longer existed.
During fiscal 1995, the Company also incurred other FS-VFB Merger-related
expenses of $190,000 such as startup expenses, technology updates, and
miscellaneous expenses.
During fiscal 1996's first quarter, the Company incurred other FS-VFB
Merger-related expenses of $401,000 due to contractual obligations from the
change in control of FS.
(18) EASTERN BANCORP, INC. (PARENT COMPANY ONLY)
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
STATEMENTS OF FINANCIAL CONDITION At September 30,
(Dollars in thousands, except per share data) 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 52 $ 60
Short-term investments 665 584
Investment in subsidiaries 60,279 58,657
Investment securities 2,777 1,525
Accrued interest receivable 414 227
Other assets 563 634
- ------------------------------------------------------------------------------------------------------
Total assets $64,750 $61,687
- ------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accrued federal income taxes $ 102 $ 17
Other liabilities 701 506
Accounts payable to subsidiaries 367 181
- ------------------------------------------------------------------------------------------------------
Total liabilities 1,170 704
- ------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $0.01 par value: 1,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $0.0067 par value: 5,000,000 shares authorized;
4,095,549 shares issued at September 30, 1996 and
4,095,549 shares issued at September 30, 1995 27 27
Additional paid-in capital 36,398 36,196
Retained income (substantially restricted) 30,138 28,629
Unrealized gain (loss) on securities available-for-sale, net 6 (175)
Treasury stock (at cost), 444,015 shares at September 30, 1996,
and 522,325 shares at September 30, 1995 (2,989) (3,694)
- ------------------------------------------------------------------------------------------------------
Total stockholders' equity 63,580 60,983
- ------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $64,750 $61,687
- ------------------------------------------------------------------------------------------------------
</TABLE>
74
<PAGE>
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS
Interest on investment and mortgage backed securities $ 334 $ 282 $ 170
- --------------------------------------------------------------------------------------------------------------------
Total interest income 334 282 170
Net operating expenses 1,623 1,476 1,290
- --------------------------------------------------------------------------------------------------------------------
Loss before federal and state taxes, dividends, and equity in
undistributed earnings of subsidiaries (1,289) (1,194) (1,120)
Federal and state tax benefit 571 671 508
- --------------------------------------------------------------------------------------------------------------------
Loss before dividends and equity in undistributed
earnings of subsidiaries (718) (523) (612)
Dividends from subsidiaries 2,729 1,501 1,160
Equity in undistributed net income of subsidiaries 1,293 3,217 3,111
- --------------------------------------------------------------------------------------------------------------------
Net income $3,304 $4,195 $3,659
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net income $3,304 $4,195 $3,659
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed (earnings) of subsidiaries:
VSC 296 777 228
VFB (1,589) (3,606) (2,765)
Rockingham -- (388) (574)
Amortization of fees, discounts, and premiums (10) (83) (23)
(Increase) decrease in other assets 71 (215) 283
(Increase) in accrued interest receivable (187) (164) (56)
(Increase) decrease in net accounts receivable to subsidiaries 186 245 (170)
Increase in other liabilities 195 96 6
(Decrease) in deferred federal income taxes (11) (183) --
Increase (decrease) in accrued federal income taxes 85 (490) 507
- --------------------------------------------------------------------------------------------------------------------
Total adjustments (964) (4,011) (2,564)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 2,340 184 1,095
- --------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Investment in subsidiary -- (200) --
Loans to subsidiary, net of repayments (145) 80 (763)
(Increase) decrease in short-term investments (81) (38) 557
Investment and mortgage backed securities purchases (4,484) (4,418) (3,265)
Proceeds from maturities and returns of principal 3,250 4,706 1,949
- --------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities (1,460) 130 (1,522)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net proceeds from exercise of stock options and sale of
treasury stock 907 403 431
Dividends paid (1,795) (863) (353)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (888) (460) 78
- --------------------------------------------------------------------------------------------------------------------
Net (decrease) in cash (8) (146) (349)
Cash at beginning of year 60 206 555
- --------------------------------------------------------------------------------------------------------------------
Cash at end of year $52 $60 $206
- --------------------------------------------------------------------------------------------------------------------
Cash paid:
Federal and state taxes $2,200 $2,023 $1,100
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The parent only statements of stockholders' equity are identical to the
consolidated statements of stockholders' equity and, therefore, are not
reprinted here.
75
<PAGE>
(19) UNAUDITED QUARTERLY INFORMATION
<TABLE>
<CAPTION>
Year ended September 30, 1996
(Dollars in thousands, except per share data) First quarter Second quarter Third quarter Fourth quarter
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income $15,476 $15,177 $15,007 $15,613
Net interest income 6,902 7,175 7,244 7,612
Provision for loan losses 435 300 100 60
Non-interest income 3,069 2,534 2,475 3,195
Non-interest expense(a) 7,193 7,032 7,483 12,170
Net income 1,487 1,506 1,309 (998)
Earnings per share 0.39 0.40 0.34 ( 0.27)
- --------------------------------------------------------------------------------------------------------------------------
Year ended September 30, 1995
(Dollars in thousands, except per share data) First quarter Second quarter Third quarter Fourth quarter
- --------------------------------------------------------------------------------------------------------------------------
Total interest income $14,322 $14,795 $15,272 $15,709
Net interest income 7,008 6,981 6,907 6,984
Provision for loan losses 260 699 566 297
Non-interest income 2,256 2,463 2,366 2,932
Non-interest expense(b) 7,015 7,387 8,243 6,888
Net income 1,200 1,083 207 1,705
EARNINGS PER SHARE 0.33 0.29 0.06 0.45
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(A) Fourth quarter results include a $3.8 million non-recurring charge to
recapitalize SAIF.
(B) Third quarter non-interest expense increased due primarily to $839,000 in
restructuring charges and $190,000 in other merger-related expenses. See note
17 of the notes to consolidated financial statements for further information
regarding restructuring charges.
(20) SUBSEQUENT EVENT
On November 13, 1996, the Company entered into an Agreement and Plan of
Reorganization (the Merger Agreement) by and among the Company, the Bank, and
Vermont Financial Services Corp., a Delaware corporation (VFSC). Pursuant to
the Merger Agreement, the Company will merge with and into VFSC and the Bank
will become a wholly-owned subsidiary of VFSC (the Merger). Subject to certain
price adjustment provisions, under the terms of the Merger Agreement, the
Company's shareholders will receive stock and/or cash equal to the sum of $7.25
plus the product of 0.49 times the average closing bid price of VFSC common
stock for a twenty-day period ending shortly before the effective time of the
Merger. Based on a twenty-day average closing bid price of VFSC common stock at
the November 13, 1996 of $34.66, the Company's shareholders would be entitled to
receive stock and /or cash equal to approximately $24.23 for each share of the
of the Company's common stock. The Merger is expected to be completed in mid
1997. Consummation of the Merger is conditioned, among other things, upon
stockholder approval and regulatory approval.
76
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Eastern Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Eastern Bancorp, Inc. and subsidiaries as of September 30, 1996 and 1995, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the years in the three-year period ended September 30,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eastern Bancorp,
Inc. and subsidiaries as of September 30, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended September 30, 1996, in conformity with generally accepted
accounting principles.
As discussed in note 1 of the notes to the consolidated financial statements,
during 1995 the Company adopted Statement of Financial Accounting Standards No.
122, "Accounting for Mortgage Servicing Rights, an Amendment of FASB Statement
No. 65."
KPMG Peat Marwick LLP
Boston, Massachusetts
November 8, 1996, except as to note 20,
which is as of November 13, 1996
77
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
78
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information regarding the Board of Directors of
Eastern Bancorp.
<TABLE>
<CAPTION>
DIRECTOR FOR TERM POSITION(S) HELD
CONTINUING DIRECTORS: AGE (a) SINCE (b) EXPIRING WITH THE COMPANY
- -------------------- ------- --------- -------- ----------------
<S> <C> <C> <C> <C>
John A. Cobb 52 1988 1999 Director, President and
Chief Executive Officer
of Eastern Bancorp
Vice Chair and Chief
Executive Officer of
Vermont Federal Bank
E. David Humphrey 54 1992 1997 Director and Executive
Vice President of
Eastern Bancorp
President and Chief
Operating Officer of
Vermont Federal Bank
W. Stevens Sheppard 66 1989 1998 Chair of the Board
John K. Dwight 52 1989 1998 Director
Michael D. Flynn 57 1991 1997 Director
John S. Kimbell 50 1993 1997 Director
Garry T. Melia 54 1987 1997 Director
Mary Alice McKenzie 39 1991 1999 Director
Ernest A. Pomerleau 49 1990 1999 Director
James M. Sutton 55 1995 1998 Director
- ------------------------------------------
</TABLE>
(a) At December 31, 1996.
(b) The dates shown include service as directors of the Company's subsidiary,
Vermont Federal Bank, FSB, in the case of Ms. McKenzie and Messrs. Cobb,
Humphrey and Pomerleau.
The business background of each member of the Board of Directors for the
past five years follows.
MICHAEL D. FLYNN, C.P.A. is Managing Partner of the Burlington, Vermont
Certified Public Accounting firm of Gallagher, Flynn & Company and has been
associated with the largest independent CPA firm in Vermont since 1972. He is
treasurer and a director of the Vermont Business Roundtable and chair of the
Board of Advisors for the School of Business Administration of the University of
Vermont. Mr. Flynn has served as Chair of the Vermont Chamber of Commerce,
President of the Lake Champlain Chamber of Commerce, and is a member of the
Board of Trustees of Champlain College. Mr. Flynn holds a B.A. from Colby
College and an M.B.A. from Harvard Business School.
E. DAVID HUMPHREY joined the Bank on November 30, 1991 and began serving as
its president during fiscal 1992 and serves on its board of directors. Before
joining the Bank, he served as president, chief executive officer, and a
director of Eureka Savings Bank in Overland Park, Kansas from 1988 through 1991.
He holds a B.S. in Business Administration from West Virginia University.
79
<PAGE>
JOHN S. KIMBELL is the President and Chief Executive Officer of Vermont Gas
Systems, Inc. Prior to joining Vermont Gas in 1989, he served as Assistant Vice
President and subsequently as Vice President of Elizabethtown Gas Company in New
Jersey. He is currently Chair and Director of the Vermont Business Roundtable,
and Vice Chair of the New England Gas Association. Mr. Kimbell holds a B.A. in
Human Relations from Salem College in Salem, West Virginia and an M.B.A. from
Fairleigh Dickinson University in New Jersey.
GARRY T. MELIA is the managing partner of Melia & Osol, a law firm in
Worcester, Massachusetts. Mr. Melia is a member of both the Massachusetts and
Florida Bar Associations. He is also President and Director of several
Massachusetts business corporations. From December 1987 through September 1995,
Mr. Melia served on the Board of Directors of each of First Savings and
Rockingham. Mr. Melia holds a Bachelors degree from Salem State College in
Salem, Massachusetts and a J.D. from the University of Miami in Miami, Florida.
JOHN A. COBB was elected president, chief operating officer, and a director
of the Company in August 1988, and in February 1989 Mr. Cobb became the
Company's chief executive officer. He also currently serves as chief executive
officer and as a director of the Bank. He has a Bachelors degree from West
Virginia University and is a Certified Public Accountant.
MARY ALICE MCKENZIE is the President of McKenzie's L.L.C., a meat company
located in Burlington, Vermont. She is a Director of the Bank and the Central
Vermont Public Service Company. Ms. McKenzie is also Director of, and on the
Executive Committee of, the Associated Industries of Vermont. She is currently
the Chair of the Board of the American Meat Institute. She is a member of the
Governor's Council of Economic Advisors and the Vermont Technology Council. Ms.
McKenzie holds a Bachelors of Business Administration from St. Mary's College in
Notre Dame, Indiana and a J.D. from Valparaiso University in Valparaiso,
Indiana.
ERNEST A. POMERLEAU is President of Pomerleau Real Estate in Burlington,
Vermont. He currently serves as Chair of the Board of Vermont Federal, is a
member of the Executive Committee of Eastern Bancorp, and Chair of its
Compensation Committee. Mr. Pomerleau currently serves as a director for Greater
Burlington Industrial Corporation. Mr. Pomerleau graduated from St. Michael's
College in Colchester, Vermont.
JOHN K. DWIGHT is currently President, Chief Executive Officer, and a
director of Dwight Asset Management Company, Inc. located in Burlington,
Vermont, a subsidiary of United Asset Management Company, in Boston,
Massachusetts. Upon graduation from the University of North Carolina in Chapel
Hill in 1967 with a B.A. in English, Mr. Dwight joined Fidelity Mutual Life
Insurance Company in Cincinnati, Ohio, as a sales and pension consultant. Upon
moving to Vermont in 1975, Mr. Dwight became a partner in Brown Bridgman &
Company, offering preferred investment vehicles for pension plans, and later
owned and operated John K. Dwight, Inc. and John K. Dwight Asset Management
Company from 1985 through 1994 when such companies were acquired by United Asset
Management Company.
W. STEVENS SHEPPARD was elected to the Board in 1989 and currently serves
as Chairman. He is an Administrator of Pequot Investment Advisors, Inc., and an
Advisory Director of Berkshire Capital Corporation. Mr. Sheppard was a Managing
Director of Berkshire Capital Corporation from March 1988 to June 1995 and,
prior to that, a Managing Director of Financial Institutions Group in Corporate
Finance, specializing in the thrift and mortgage banking industries with Paine
Webber. Prior thereto, he served as President and Director of Paine Webber Real
Estate Securities Inc., as well as a board member of a number of Paine Webber
subsidiaries. Mr. Sheppard is a graduate of the University of Virginia with a
B.A. in Economics, and is a retired Naval Officer.
JAMES M. SUTTON was elected to the Board of Directors effective November 1,
1995. Mr. Sutton is the general partner of James M. Sutton Investors Limited of
Englewood, Colorado, President and Chief Executive Officer of Maxwell
Corporation, an investment company headquartered in Welch, West Virginia, and
President of Monogram Homes, Inc. of Englewood, Colorado, a residential
construction firm. He currently serves as President of Ameribank in Northfork,
West Virginia, and Chair of American Bankshares, Inc., a bank holding company
in Welch, West Virginia. Mr. Sutton is a graduate of West Virginia University
with a B.S./B.A. in Accounting. He has completed the Graduate School of Banking
at the University of
80
<PAGE>
Wisconsin in Madison, Wisconsin and the Small Company Management Program
conducted by the Harvard Business School.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY
The following table sets forth certain information concerning the annual
and long-term compensation paid or accrued to or for the benefit of (i) the
Company's Chief Executive Officer and (ii) the other two most highly paid
executive officers of the Company whose annual salary and bonuses exceeded
$100,000 for services rendered during fiscal 1996 together with the annual and
long-term compensation paid or accrued to or for the benefit of the same
individuals (the "Named Executive Officers") for services rendered during the
years ended September 30, 1994 and 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Annual Compensation (1)
--------------------------------------
Other
Annual All Other
Name and Principal Compen- Compensation
Position Year Salary $ Bonus sation $ (2) (3)
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
John A. Cobb, President 1996 $243,096 $63,662 $-- $210,477 (4)
- -------------------------------------------------------------------------------------------------------
and Chief Executive 1995 $224,977 $70,394 $-- $18,300 (5)
- -------------------------------------------------------------------------------------------------------
Officer of the Company 1994 $217,673 $62,027 $-- $22,530 (6)
- -------------------------------------------------------------------------------------------------------
E. David Humphrey, Executive 1996 $216,539 $56,137 $-- $9,000 (7)
- -------------------------------------------------------------------------------------------------------
Vice President of the Company, 1995 $184,504 $65,851 $-- $18,300 (8)
- -------------------------------------------------------------------------------------------------------
President of the Bank 1994 $176,287 $55,000 $-- $21,307 (9)
- -------------------------------------------------------------------------------------------------------
Steven F. Shea, Executive (10) 1996 $64,777 $-- $-- $447,625 (11)
- -------------------------------------------------------------------------------------------------------
Vice President of the Company 1995 $161,953 $43,072 $-- $10,016 (12)
- -------------------------------------------------------------------------------------------------------
President of First Savings 1994 $154,936 $18,271 $-- $10,016 (12)
- -------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes amounts that would have been paid in cash to such persons during
such fiscal years but for the deferral of such payments.
(2) Other compensation to any executive officer in the form of personal
benefits, including the use of a company car and the payment of club dues,
has been omitted pursuant to applicable regulations of the Securities and
Exchange Commission, since such compensation constituted less than 10
percent of such officer's salary and bonuses for the year.
(3) Amounts for 1994 and 1995 are adjusted in accordance with Section 415 of
the Internal Revenue Code and reflect amounts earned during the fiscal
year indicated.
(4) Comprised of $13,230 Company contribution to Mr. Cobb's 401(k) account and
$4,500 Company contribution to Mr. Cobb's Employee Stock Ownership Plan
("ESOP") account, $192,747 to cover the loss on sale of Mr. Cobb's Vermont
residence after the Company moved its corporate headquarters to New
Hampshire; and the amount of Company contribution to Mr. Cobb's
Supplemental Deferred Compensation Plan account has not yet been
determined.
(5) Comprised of $12,120 Company contribution to Mr. Cobb's 401(k) account and
$4,500 Company contribution to Mr. Cobb's Employee Stock Ownership Plan
("ESOP") account and a $1060.86 Company contribution to Mr. Cobb's
Supplemental Deferred Compensation Plan account.
(6) Comprised of $14,376 Company contribution to Mr. Cobb's 401(k) account and
$5,366 Company contribution to Mr. Cobb's ESOP account and a $2,788
Company contribution to Mr. Cobb's Supplemental Deferred Compensation Plan
account.
(7) Comprised of $4,500 Company contribution to Mr. Humphrey's 401(k) account
and $4,500 Company contribution to Mr. Humphrey's ESOP account; amount of
Company contribution to Mr. Humphrey's Supplemental Deferred Compensation
Plan account has not yet been determined.
(8) Comprised of $12,120 Company contribution to Mr. Humphrey's 401(k) account
and $4,500 Company contribution to Mr. Humphrey's ESOP account, and a
$1,060.88 Company contribution to Mr. Humphrey's Supplemental Deferred
Compensation Plan account.
(9) Comprised of $11,906 Company contribution to Mr. Humphrey's 401(k) account
and $6,601 Company contribution to Mr. Humphrey's ESOP account and a
$2,800 Company contribution to Mr. Humphrey's Supplemental Deferred
Compensation account.
81
<PAGE>
(10) Comprised of a Severance payment in the amount of $434,562 and
(11) Supplemental Retirement Annual Compensation of $13,062,which will be paid
out for a 15-year period.
(12) Represents the cost to the Company of life insurance benefits obtained for
such Named Executive Officer.
OPTION GRANTS
No options were awarded to any of the Company's Named Executive Officers
during Fiscal Year 1996.
YEAR-END OPTION TABLE
The following table sets forth certain information concerning exercises
of stock options by the Named Executive Officers during the fiscal 1996 and
the number and value of unexercised options held by each such Named Executive
Officers on September 30, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUE
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Number of Value of Unexercised
Shares Unexercised Options at In-The-Money Options
Acquired Value Fiscal Year-End at Fiscal Year-End (1)
on ---------------------------------------------------------
Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
John A. Cobb -- $-- 157,500 -- $1,884,450 --
- ----------------------------------------------------------------------------------------------------------------
E. David Humphrey -- $-- 75,000 -- $936,300 --
- ----------------------------------------------------------------------------------------------------------------
Steven F. Shea 48,000 $556,250 -- -- -- --
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Represents the difference between the exercise price and the closing sale
price of Eastern's common stock on the Nasdaq National Market on the final
trading day of the fiscal year which was $20.75.
SUPPLEMENTAL DEFERRED COMPENSATION PLAN
Executive officers of the Company including the Named Executive Officers
are eligible to participate in the deferred compensation plan described under
"Compensation of Directors." Under a separate supplemental plan (the
"Supplemental Plan"), the Company matches amounts deferred by officers and
employees of the Company (but not directors) up to specified maximum amounts
equal to the difference between the maximum Company match permitted under the
401(k)/ESOP Plan pursuant to federal income tax law prior to 1993 and the
maximum Company match permitted under current law. Pursuant to the Supplemental
Plan, a Company match, which has not yet been determined, will be credited to
the accounts of Messrs. Cobb and Humphrey for the fiscal year ended September
30, 1996. The amounts credited for the fiscal year ended September 30, 1995 for
Messrs. Cobb and Humphrey were $1,060.86 and $1,060.88, respectively. If they
elect to defer the maximum amount of compensation which qualifies for matching
pursuant to the Supplemental Plan, the Supplemental Plan will provide a maximum
Company match of $4,500 for Mr. Cobb ($0.50 for every one dollar Mr. Cobb
contributes, provided that the total Company match under the 401(k) Plan and the
Supplemental Plan shall not exceed 3 percent of Mr. Cobb's total compensation),
and $4,500 for Mr. Humphrey ($0.50 for every one dollar Mr. Humphrey
contributes, provided that the total Company match under the 401(k) Plan and the
Supplemental Plan shall not exceed 3 percent of Mr. Humphrey's total
compensation). Each Company match is to be fully vested for participants having
two or more years of service with the Company.
82
<PAGE>
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
Mr. Cobb has entered into a written employment contract with the Company
and Mr. Humphrey has entered into a written employment contract with each of
Vermont Federal and the Company. These contracts are uniform except with
respect to title and capacity, responsibilities and duties, salary level and
location of employment.
Each executive has a contract that provides for his participation on an
equitable basis in all of the Company's bonus and fringe benefit plans, subject
to applicable eligibility requirements. Each contract prohibits base salary
reductions except as part of a general reduction in the compensation of all
executive officers. The Company may not materially increase or decrease the
executive's duties except in connection with the FS-VFB Merger.
The contracts currently provide for a term ending December 31, 1996. Prior
to December 31, 1995, the Company and the executive may mutually agree to extend
the term to two years. Further annual extensions are permitted, provided that
the term of the contract never exceeds two years. The executive is prohibited
from resigning as an employee during the term of the contract except in some
circumstances following a change in control, as described below. Following any
breach of this provision, the Company is entitled to have the executive enjoined
from working for another bank or thrift institution in Vermont or New Hampshire
or certain other states during the remaining term. Termination for cause or
voluntary resignation also requires the employee to forfeit any bonus accruing
for the year of termination or resignation and to repay to the Company six
months' base salary. The Company is entitled to terminate the executive at any
time with or without cause (which is defined to include willful misconduct,
willful violation of any law or regulation, incompetence measured against
standards generally prevailing in the banking industry, and in various
circumstances required by applicable banking regulations). Termination without
cause requires the payment of severance pay in a lump sum equal to the
executive's base salary over the remaining term of the contract (or, in Mr.
Cobb's case, a minimum of 18 months), plus continuation of employee benefits
during such period. Such payment is not to be reduced by any compensation which
the executive may subsequently earn from other sources.
Special rules apply if there is a change in control (as defined in the
contract) of the Company or the Bank during the term of the employment
agreement. If the executive were to be terminated by the Company or Bank other
than for cause in connection with or within one year after such a change in
control, he would be entitled to receive a lump sum cash payment (in lieu of his
regular severance pay) equal to three times his average annual compensation
includible in his gross income for federal income tax purposes with respect to
the five most recent taxable years ending prior to such change in control (or
such portion thereof as he was a full-time employee of the Company or Bank),
less one dollar and less any special bonus paid in connection with the change in
control. If for good reason, as defined, in connection with or within one year
after a change in control, the executive were to terminate his employment
voluntarily he would be entitled to receive a lump sum cash payment equal to two
times his then current salary (but not less than his salary for the fiscal year
preceding the change in control). "Good reason" includes a reduction in
compensation, a forced relocation, a material increase in the executive's
duties, or a material decrease in the executive's position. The executive is not
entitled to receive any of the foregoing payments to the extent that such
payments would be considered "excess parachute payments" under the Internal
Revenue Code of 1986, as amended. In addition, federal legislation authorizes
the FDIC under certain circumstances to prohibit or limit payments that are
contingent on the termination of a person's employment with an insured
depository institution or holding company such as Vermont Federal or the
Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the Company's Compensation Committee (which consists
of Mr. Pomerleau (Chair), Ms. McKenzie and Messrs. Dwight, and Melia) has ever
been an officer or employee of the Company or any of its subsidiaries. No
executive officer of the Company has served as a director or member of the
Compensation Committee (or other committee serving an equivalent function) of
any other entity any of whose executive officers served as a director of the
Company or member of the Company's Compensation Committee.
83
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of September 30, 1996 with
respect to the amount of the Company's common stock beneficially owned by (i)
each director, (ii) each of the Named Executive Officers and (iii) all current
directors and executive officers of the Company as a group.
<TABLE>
<CAPTION>
Amount and Percentage of
Nature of Common
Name and Positions with the Company Beneficial Ownership (a) Stock Outstanding
- ----------------------------------- ------------------------ -----------------
<S> <C> <C>
W. Stevens Sheppard 43,800 (b) (c) 1.2%
Chair of the Board
John A. Cobb 195,888 (d) 5.1%
President, Chief Executive
Officer and Director
John K. Dwight 13,200 (b) (c) *
Director
Michael D. Flynn 6,900 *
Director
E. David Humphrey 94,441 (d) 2.5%
Executive Vice President
and Director
John S. Kimbell 7,590 (b) *
Director
Mary Alice McKenzie 7,571 (b) *
Director
Garry T. Melia 7,650 (b) *
Director
Ernest A. Pomerleau 14,500 (b) *
Director
James M. Sutton 361,500 (b) (e) 9.8%
Director
All directors and executive officers as a group (12 persons) 753,040 19.0%
</TABLE>
* Less than 1 percent.
(a) In accordance with Rule 13d-3 under the 1934 Act, a person is deemed to be
the beneficial owner of a security for purposes of the Rule if he or she
has or shares voting power or investment power with respect to such
security or has the right to acquire such ownership within 60 days. All
persons shown in the table have sole investment and voting power except as
otherwise indicated. The table includes 283,500 shares of Eastern Bancorp
common stock subject to outstanding stock options which are exercisable by
directors and officers of the Company within 60 days after September 30,
1996. Of such shares, the beneficial ownership interests of the named
persons are as follows: Mr. Cobb - 157,500 shares; Mr. Dwight - 6,750
shares; Mr. Flynn - 6,750 shares; Mr. Humphrey - 75,000 shares; Mr. Kimbell
- 6,750 shares; Ms. McKenzie - 6,750 shares; Mr. Melia - 6,750 shares; Mr.
Pomerleau - 6,750 shares; Mr. Sheppard - 6,750 shares; and Mr. Sutton -
3,750 shares.
(b) Excludes 12,493, 3,877, 3,877, 7,749, 1,203, 226, 3,877 shares purchased by
the Company through the Eastern Bancorp Director's Deferred Compensation
Trust to cover obligations of the Company to Messrs. Sheppard, Dwight,
Melia, Pomerleau, Kimbell, Sutton, and Ms. McKenzie, respectively. Such
directors do not have power to vote or dispose of such shares.
84
<PAGE>
(c) Mr. Sheppard's share amount includes 4,500 shares individually owned by
his wife as to which Mr. Sheppard disclaims beneficial ownership. Mr.
Dwight's share amount includes 1,800 shares held in trust for his two
children.
(d) Includes amounts purchased through the 401(k)/ESOP and SERP.
(e) Includes 267,750 shares owned by JMS Investors, Ltd., 11,400 shares owned
through an IRA, 4,500 shares owned by Mr. Sutton as custodian for his
children, 4,950 shares owned by Mr. Sutton's wife, and 63,900 shares owned
by Mr. Sutton's wife as custodian for their children.
PRINCIPAL HOLDERS OF VOTING SECURITIES
The following table sets forth information as of September 30, 1996 with
respect to the ownership of shares of common stock of the Company by each person
believed by management to be the beneficial owner of more than five percent of
the Company's outstanding common stock. The information is based on the most
recent Schedule 13D or 13G filed on behalf of such person or other information
made available to the Company.
Name and Address Amount and Nature of Percentage of Common
Of Beneficial Owner Beneficial Ownership Stock Outstanding
------------------- -------------------- -----------------
Kramer Spellman, L.P. 331,450 (a) 9.0%
2050 Center Avenue, Ste. 300
Fort Lee, NJ 07024
James M. Sutton 361,500 (b) 9.8%
6402 South Troy Circle
Englewood, CO 80111-6424
Wellington Management Company 353,700 9.6%
75 State Street
Boston, MA 02109
(a) The two general partners of Kramer Spellman, L.P., (Orin S. Kramer and Jay
Spellman) share voting and dispositive power over these shares.
(b) Includes 267,750 shares owned by JMS Investors, Ltd., 11,400 shares owned
through an IRA, 4,500 shares owned by Mr. Sutton as custodian for his
children, 4,950 shares owned by Mr. Sutton's wife, and 63,900 shares owned
by Mr. Sutton's wife as custodian for their children.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Vermont Federal offers home and other loans to its directors, officers
and other employees. These loans are made in the ordinary course of business and
in the judgment of management do not involve more than the normal risk of
collectibility. Such loans are made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with non-affiliated persons, except that prior to enactment of the
FIRREA, loan origination fees that would otherwise be payable on certain types
of such loans were reduced or not charged. Loans to directors and executive
officers are in an aggregate amount which equals less than 1 percent of
stockholders' equity at September 30, 1996.
85
<PAGE>
The following table sets forth information, as of September 30, 1996, with
regard to loans made by Vermont Federal to directors and executive officers of
the Company in aggregate amounts greater than $60,000.
Highest Amount
Outstanding Unpaid Balance Interest Rate
Name and Since as of as of
Type of Loan October 1, 1995 September 30, 1996 September 30, 1996
- ------------ --------------- ------------------ ------------------
John A. Cobb
First Mortgage Loan $337,495 $261,000 8.875%
John K. Dwight $104,605 0 10.8%
Under FIRREA, all loans and extensions of credit by an insured institution
to its executive officers and directors, or executive officers and directors of
its parent company, must be on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with the general public and must not involve more than the normal
risk of repayment or present other unfavorable features. Loan programs
providing for lower interest rates on loans to directors and executive officers
or the waiver of loan origination fees normally charged to unaffiliated
borrowers are no longer permitted. In addition, a loan made to a director or
executive officer in excess of the greater of $25,000 or 5 percent of the Bank's
capital and surplus (up to a maximum of $500,000) must be approved in advance by
a majority of the disinterested members of the Board of Directors.
The OTS adopted additional regulations in 1992, governing loans and other
extensions of credit made by OTS-regulated institutions, such as Vemont Federal
to their executive officers, directors, principal shareholders and all related
interests of such individuals or entities (collectively, Affiliates). The
restrictions contained in these regulations are in addition to those summarized
in the paragraph immediately above and limit the aggregate dollar amount of such
loans or extensions of credit made (i) to any Affiliate and (ii) to all
Affiliates as a group. The regulations also require prior approval of Vermont
Federal's Board of Directors and certain other procedural standards for loans
and other extensions of credit made to any Affiliate which (when added to the
amount of all loans made to all related interests of such Affiliate) exceed the
higher of $25,000 or 5 percent of the Bank's unimpaired capital and unimpaired
surplus. The regulations further restrict loans to executive officers (other
than loans made to finance the education of such officer's children, or to
finance the purchase, construction, or improvement of a residence of the
executive officer) so as not to exceed 2.5 percent of capital and unimpaired
surplus of the Banks up to a maximum of $100,000. Vermont Federal's policy
regarding loans to its directors and executive officers complies with the
requirements of FIRREA and the 1992 regulations.
86
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (l) The following consolidated financial statements of Registrant and
its subsidiaries are included in this Annual Report on Form 10-K for
the year ended September 30, 1996.
Consolidated Statements of Financial Condition as of September 30,
1996 and 1995.
Consolidated Statements of Operations - Years Ended September 30,
1996, 1995 and 1994.
Consolidated Statements of Stockholders' Equity - Years Ended
September 30, 1996, 1995 and 1994.
Consolidated Statements of Cash Flows - Years Ended September 30,
1996, 1995, and 1994.
Notes to consolidated financial statements.
Independent Auditors' Report.
(2) All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions, are inapplicable and
therefore have been omitted, or are included in the Notes to
consolidated financial statements.
(b) Reports on Form 8-K.
None.
(c) The Exhibits listed in the Exhibit Index hereto are filed as part of
this Annual Report on Form 10-K.
87
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
EASTERN BANCORP, INC.
By:/s/John A. Cobb, CPA
-------------------------
John A. Cobb, CPA
President/Chief Executive Officer
Date December 23, 1996
----------------------------
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.
By: /s/ John A. Cobb, CPA Date December 23, 1996
------------------------------ -----------------------------------
John A. Cobb, CPA
CPA, Director, President,
Chief Executive Officer
By: /s/Janine K. Pinel, CPA Date December 23, 1996
------------------------------ -----------------------------------
Janine K. Pinel, CPA
Chief Financial Officer and
Principal Financial and Accounting Officer
By: /s/W. Stevens Sheppard Date December 23, 1996
------------------------------ -----------------------------------
W. Stevens Sheppard
Chair of the Board
By:/s/John K. Dwight Date December 23, 1996
------------------------------ -----------------------------------
John K. Dwight
Director
By:/s/ Michael D. Flynn, CPA Date December 23, 1996
------------------------------ -----------------------------------
Michael D. Flynn, CPA
Director
By: /s/E. David Humphrey Date December 23, 1996
------------------------------ -----------------------------------
E. David Humphrey
Director,
Executive Vice President
By: /s/John S. Kimbell Date December 23, 1996
------------------------------ -----------------------------------
John S. Kimbell
Director
By:/s/Mary Alice McKenzie Date December 23, 1996
------------------------------ -----------------------------------
Mary Alice McKenzie
Director
88
<PAGE>
By: /s/Garry T. Melia Date December 23, 1996
------------------------------ -----------------------------------
Garry T. Melia
Director
By: /s/Ernest A. Pomerleau Date December 23, 1996
------------------------------ -----------------------------------
Ernest A. Pomerleau
Director
By:/s/James M. Sutton Date December 23, 1996
------------------------------ -----------------------------------
James M. Sutton
Director
89
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Identity of Exhibit
- -------- --------------------------------------------------
3 (a) Restated Certificate of Incorporation of the Company.
3 (b) Amended Bylaws of the Company, filed as Exhibit 3(b) to the
Company's 1993 Form 10-K, is incorporated herein by reference.
4 Specimen certificate for shares of the Registrant's common stock,
filed as Exhibit 4 to the Company's Statement on Form S-4
(Registration No. 33-5502), is incorporated herein by reference.
10 (a) # Stock Option Plan, filed on May 7, 1986 as Exhibit 10 to the
Company's Registration Statement on Form S-4 (Registration No.
33-5502), is incorporated herein by reference.
10 (b) # 1987 Stock Option Plan, as amended filed as Exhibit 10(b) to the
Company's 1993 Form 10-K, is incorporated herein by reference.
10 (c) # Amendment to the 1987 Stock Option Plan, filed as Exhibit 10(c)
to the Company's 1994 Form 10-K, is incorporated herein by
reference.
10 (d) # Amended and restated Deferred Compensation Plan of Eastern
Bancorp, Inc., filed as Exhibit 10(d) to the Company's 1994 Form
10-K, is incorporated herein by reference.
10 (e) # Amended and restated Deferred Compensation Plan of Vermont
Federal Bank, FSB, filed as Exhibit 10(e) to the Company's 1994
Form 10-K is incorporated herein by reference.
10 (f) # Supplemental Executive Retirement Plan of Eastern Bancorp, Inc.,
filed as Exhibit 10(f) to the Company's 1994 Form 10-K, is
incorporated herein by reference.
10 (g) # Supplemental Executive Retirement Plan of Vermont Federal Bank,
FSB filed as Exhibit 10(g) to the Company's 1994 Form 10-K, is
incorporated herein by reference.
10 (h) # Employment Agreement between John A. Cobb and Eastern Bancorp,
Inc., filed as Exhibit 10(f) to the Company's 1993 Form 10-K, is
incorporated herein by reference.
10 (i) # Employment Agreement between E. David Humphrey and Eastern
Bancorp, Inc., filed as Exhibit 10(m) to the Company's 1993 Form
10-K, is incorporated herein by reference.
10 (j) # Employment Agreement between E. David Humphrey and Vermont
Federal Bank, FSB filed as Exhibit 10(n) to the Company's 1993
Form 10-K, is incorporated herein by reference.
10 (k) Agreement relating to the acquisitions of Seacoast Savings Bank
and Iona Savings Bank, filed on September 11, 1992 as an Exhibit
to the Company's current report on form 8-K, is incorporated
herein by reference.
10 (l) Synopsis of Incentive Compensation Plan, filed as Exhibit 10(q)
to the Company's 1993 Form 10-K, is incorporated herein by
reference.
90
<PAGE>
Exhibit
Number Identity of Exhibit
- ------- ----------------------------------------------------------
11 * Computation of Primary and Fully Diluted Earnings Per Share.
21 * Subsidiaries of Registrant.
23 * Accountants' consent (Registration Statements
No. 33-5502, 33-19280, 33-31021, 33-66754, and 333-02478).
27 * Financial Data Schedule
- -------------------------
* Filed herewith.
# Management contract or compensatory plan or arrangement filed as an exhibit
to this Form 10-K pursuant to Items 14(a) and 14(c) of Form 10-K.
91
<PAGE>
Exhibit 11
EASTERN BANCORP, INC.
Computation of Primary and Fully diluted Earnings Per Share
<TABLE>
<CAPTION>
For the Years Ended September 30,
---------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NET INCOME $3,304 $4,195 $3,659
------ ------ ------
------ ------ ------
PRIMARY
Shares:
Weighted-average number
of common shares outstanding 3,634,577 3,588,481 3,534,208
Dilutive effect of outstanding
stock options 173,147 133,092 124,302
--------- --------- ---------
Weighted-average number of
common shares and common
stock equivalents 3,807,724 3,721,573 3,658,510
--------- --------- ---------
--------- --------- ---------
Earnings per share $0.87 $1.13 $1.00
----- ----- -----
----- ----- -----
ASSUMING FULL DILUTION:
Shares:
Weighted-average number
of common shares outstanding 3,634,577 3,588,481 3,534,208
Fully diluted effect of outstanding
stock options 220,391 141,576 133,884
--------- --------- ---------
Weighted-average number of
common shares and common
stock equivalents 3,854,968 3,730,057 3,668,092
--------- --------- ---------
--------- --------- ---------
Earnings per share $0.86 $1.12 $1.00
----- ----- -----
----- ----- -----
</TABLE>
<PAGE>
Exhibit 21
Subsidiaries
Jurisdiction of
Name of Subsidiary Incorporation
------------------ -------------
Vermont Federal Bank, FSB United States
Vermont Service Corporation Vermont
Vermont East Coast Corporation Vermont
Eastern Real Estate Company Vermont
Investment Alternative Financial Services Corporation Vermont
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<CIK> 0000793169
<NAME> EASTERN BANCORP, INC.
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-END> SEP-30-1996
<CASH> 27,766
<INT-BEARING-DEPOSITS> 55,986
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 9
<INVESTMENTS-CARRYING> 293,649
<INVESTMENTS-MARKET> 284,815
<LOANS> 488,786
<ALLOWANCE> 2,858
<TOTAL-ASSETS> 868,678
<DEPOSITS> 641,286
<SHORT-TERM> 120,800
<LIABILITIES-OTHER> 9,903
<LONG-TERM> 32,836
0
0
<COMMON> 41
<OTHER-SE> 63,539
<TOTAL-LIABILITIES-AND-EQUITY> 868,678
<INTEREST-LOAN> 41,561
<INTEREST-INVEST> 19,712
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 61,273
<INTEREST-DEPOSIT> 24,116
<INTEREST-EXPENSE> 32,340
<INTEREST-INCOME-NET> 28,933
<LOAN-LOSSES> 895
<SECURITIES-GAINS> 808
<EXPENSE-OTHER> 33,952
<INCOME-PRETAX> 5,359
<INCOME-PRE-EXTRAORDINARY> 5,359
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,304
<EPS-PRIMARY> 0.87
<EPS-DILUTED> 0.86
<YIELD-ACTUAL> 7.94
<LOANS-NON> 7,945
<LOANS-PAST> 0
<LOANS-TROUBLED> 6,925
<LOANS-PROBLEM> 5,349
<ALLOWANCE-OPEN> 3,622
<CHARGE-OFFS> 1,890
<RECOVERIES> 231
<ALLOWANCE-CLOSE> 2,858
<ALLOWANCE-DOMESTIC> 2,858
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
