SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended 9/30/98
-------
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 0-16143
-------
FIRST ESSEX BANCORP, INC.
-------------------------
(Exact name of registrant as specified in its charter)
Delaware 04-2943217
- -------------------- ------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
71 Main Street, Andover, MA 01810
- ------------------------------------ -------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 681-7500
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
The number of shares outstanding of each of the registrant's classes of common
stock as of September 30, 1998:
Title of Class Shares Outstanding
------------------ ------------------
Common Stock, $.10 par value 7,563,669
<PAGE>
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
------------------------------------------------
The Company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This Report contains certain
"forward-looking statements" including statements concerning plans, objectives,
future events or performance, assumptions, Year 2000 evaluations, and other
statements which are other than statements of historical fact. The Company
wishes to caution readers that the following important factors, among others,
may have affected, and could in the future affect, the Company's actual results
and could cause the Company's actual results for subsequent periods to differ
materially from those expressed in any forward-looking statement made by, or on
behalf of, the Company herein: (i) the effect of changes in laws and
regulations, including federal and state banking laws and regulations, with
which the Company and its wholly owned banking subsidiary, First Essex Bank,
FSB, must comply, and the associated costs of compliance with such laws and
regulations, either currently or in the future as applicable; (ii) the effect of
changes in accounting policies and practices, as may be adopted by the
regulatory agencies as well as by the Financial Accounting Standards Board, or
of changes in the Company's organization, compensation and benefit plans; (iii)
the effect on the Company's competitive position within its market area of the
increasing consolidation within the banking and financial services industries,
including increased competition from larger regional and out-of-state banking
organizations as well as nonbank providers of various financial services; (iv)
the effect of unforeseen changes in interest rates; (v) the effect of changes in
the business cycle and downturns in the local, regional and national economies;
and, (vi) Year 2000 risks.
2
<PAGE>
FIRST ESSEX BANCORP, INC.
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
<S> <C> <C>
ITEM 1. Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30,1998
and December 31, 1997 4
Consolidated Statements of Operations for the
three months ended September 30, 1998 and 1997 5
Consolidated Statements of Operations for the
nine months ended September 30, 1998 and 1997 6
Consolidated Statements of Stockholders' Equity
for the three months ended September 30, 1997 and 1998 7
Consolidated Statements of Stockholders' Equity
for the nine months ended September 30, 1997 and 1998 8
Consolidated Statements of Cash Flows for the
nine months ended September 30, 1998 and 1997 9
Notes to the Consolidated Financial Statements 10-11
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-23
ITEM 3. Quantitative and Qualitative Disclosure
About Market Risk 24
PART II - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 25-26
</TABLE>
3
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FIRST ESSEX BANCORP, INC.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
(Dollars in thousands)
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $79,071 $22,542
Investment securities available-for-sale 326,027 211,903
Investment securities held-to-maturity
(fair value of $180,743 at December 31, 1997, Note 4) ----- 178,999
Stock in Savings Bank Life Insurance Company 1,194 1,194
Stock in Federal Home Loan Bank of Boston 19,985 19,803
Mortgage loans held-for-sale 3,795 11,807
Loans receivable, less allowance for possible loan losses of
$11,357 and $10,570 744,350 696,338
Foreclosed property 582 891
Bank premises and equipment 12,138 10,545
Accrued interest receivable 7,339 8,084
Goodwill and core deposit intangibles 25,081 10,991
Other assets 21,870 24,362
------ ------
Total assets $1,241,432 $1,197,459
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Depositors' accounts $922,267 $744,322
Borrowed funds 206,130 343,557
Mortgagors' escrow accounts 1,634 561
Other liabilities 15,520 17,954
------ ------
Total liabilities 1,145,551 1,106,394
--------- ---------
STOCKHOLDERS' EQUITY
Serial preferred stock: $.10 par value per share; 5,000,000 shares
authorized, no shares issued or outstanding
Common stock, $.10 par value per share; 25,000,000 shares
authorized, 9,658,836 and 9,522,424 shares issued 967 952
Additional paid-in capital 76,797 75,303
Retained earnings 34,757 29,685
Treasury stock, at cost, 2,096,500 shares and 1,986,000 shares (18,335) (15,842)
Accumulated other comprehensive income 1,695 967
----- ---
Total stockholders' equity 95,881 91,065
------ ------
Total liabilities and stockholders' equity $1,241,432 $1,197,459
========== ==========
</TABLE>
4
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
<TABLE>
<CAPTION>
Three Months Ended September 30,
1998 1997
---- ----
(Dollars in thousands,
except per share amounts)
(Unaudited)
<S> <C> <C>
Interest and dividend income:
Interest on mortgage loans $9,320 $9,750
Interest on other loans 7,685 6,043
Interest and dividends on investment securities available-for-sale 4,680 3,610
Interest and dividends on investment securities held-to-maturity (Note 4) 359 3,399
Interest on short-term investments 1,100 204
Interest on other earning assets 261 259
--- ---
Total interest and dividend income 23,405 23,265
------ ------
Interest expense
Interest on depositors' accounts 9,712 8,063
Interest on borrowed funds 3,230 5,842
----- -----
Total interest expense 12,942 13,905
------ ------
Net interest income 10,463 9,360
Provision for possible loan losses 290 510
--- ---
Net interest income after provision for possibe loan losses 10,173 8,850
Non-interest income
Net gain on sales of mortgage loans and mortgage servicing rights 294 363
Net gain on sale of investment securities 83 178
Loan fees 209 110
Other fee income 800 599
Miscellaneous income 346 ----
--- ----
Total non-interest income 1,732 1,250
----- -----
Non-interest expense
Salaries and employee benefits 3,554 2,760
Buildings and equipment 1,079 963
Professional services 276 239
Information processing 612 388
Insurance 64 92
Expenses, gains and losses on
and write-downs of, foreclosed property 60 (11)
Other 1,099 901
Amortization of goodwill and core deposit intangible 665 197
--- ---
Total non-interest expenses 7,409 5,529
----- -----
Income before provision for income taxes 4,496 4,571
Provision for income taxes 1,698 1,921
----- -----
Net income $2,798 $2,650
====== ======
Earnings per share - Basic $0.37 $0.35
===== =====
Earnings per share - Diluted $0.36 $0.34
===== =====
Dividends declared per share $0.14 $0.12
===== =====
Weighted average number of shares - basic 7,562,568 7,516,547
========= =========
Weighted average number of shares - diluted 7,825,132 7,825,265
========= =========
</TABLE>
5
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
---- ----
(Dollars in thousands,
except per share amounts)
(Unaudited)
<S> <C> <C>
Interest and dividend income:
Interest on mortgage loans $27,725 $29,088
Interest on other loans 20,754 17,512
Interest and dividends on investment securities available-for-sale 13,401 10,886
Interest and dividends on investment securities held-to-maturity (Note 4) 5,879 8,888
Interest on federal funds sold 1,558 467
Interest on other earning assets 782 259
--- ---
Total interest and dividend income 70,099 67,100
------ ------
Interest expense
Interest on depositors' accounts 26,208 23,040
Interest on borrowed funds 14,256 15,948
------ ------
Total interest expense 40,464 38,988
------ ------
Net interest income 29,635 28,112
Provision for possible loan losses 1,160 1,530
----- -----
Net interest income after provision
for possible loan losses 28,475 26,582
Non-interest income
Net gain on sales of mortgage loans and mortgage servicing rights 976 1,281
Net gain on sale of investment securities 1,049 227
Loan fees 516 414
Other fee income 2,107 1,787
Miscellaneous income 346 ----
--- ---
Total non-interest income 4,994 3,709
----- -----
Non-interest expense
Salaries and employee benefits 9,662 8,458
Buildings and equipment 3,091 3,098
Professional services 894 1,030
Information processing 1,691 1,154
Insurance 192 246
Expenses, gains and losses on
and write-downs of, foreclosed property 166 352
Other 3,138 2,768
Amortization of goodwill and core deposit intangible 1,058 590
----- ---
Total non-interest expenses 19,892 17,696
------ ------
Income before provision for income taxes 13,577 12,595
Provision for income taxes 5,332 5,272
----- -----
Net income $8,245 $7,323
====== ======
Earnings per share - basic $1.09 $0.98
===== =====
Earnings per share - diluted $1.05 $0.94
===== =====
Dividends declared per share $0.42 $0.36
===== =====
Weighted average number of shares - basic 7,554,655 7,487,241
========= =========
Weighted average number of shares - diluted 7,857,924 7,767,057
========= =========
</TABLE>
6
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statements of Stockholders' Equity
Three Months Ended September 30, 1997 and 1998
<TABLE>
<CAPTION>
Components of Stockholders' Equity
Unrealized Gains (Losses)
on Investment
Comprehensive Common Paid in Retained Treasury Securities Available-
Income Stock Capital Earnings Stock For - Sale, Net Total
------------- ------ ------- -------- -------- --------------- --------
(Dollars in thousands)
(Unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1997 $949 $75,014 $26,596 ($15,842) $128 $86,845
Comprehensive income:
Net income $2,650 2,650 2,650
Other comprehensive income:
-Unrealized securities gains,
net of $576 of tax expense,
arising during the period 839
-Less: reclassifcation adjustment
for security losses included in
net income, net of $72 tax expense 106
---
Total other comprehensive income 733 733 733
---
Total Comprehensive income $3,383 0
Cash dividends declared ---- ---- (896) ---- ---- (896)
Stock options exercised 2 208 ----- ----- ----- 210
- --- ----- ----- ----- ---
Balance at September 30,1997 $951 $75,222 $28,350 ($15,842) $861 $89,542
==== ======= ======= ======== ==== =======
Balance at June 30, 1998 $966 $76,791 $33,018 ($18,335) $1,376 $93,816
Compehensive income:
Net income $2,798 ---- ---- 2,798 ---- ---- 2,798
Other comprehensive income:
-Unrealized securities gains,
net of $246 tax expense,
arising during the period 369
-Less: reclassifcation adjustment
for security gains included in
net income, net of $33 tax expense 50
--
Total other comprehensive income 319 319 319
---
Total Comprehensive income 3,117
Cash dividends declared ===== ---- ---- (1,059) ---- ---- (1,059)
Stock options exercised 1 6 ----- ----- ----- 7
- - ----- ----- ----- -
Balance at September 30, 1998 $967 $76,797 $34,757 ($18,335) $1,695 $95,881
==== ======= ======= ======== ====== =======
</TABLE>
7
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statements of Stockholders' Equity
Nine Months Ended September 30, 1997 and 1998
<TABLE>
<CAPTION>
Components of Stockholders' Equity
Unrealized Gains (Losses)
on Investment
Comprehensive Common Paid in Retained Treasury Securities Available-
Income Stock Capital Earnings Stock For - Sale, Net Total
------------- ------ ------- -------- -------- --------------- --------
(Dollars in thousands)
(Unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $941 $74,408 $23,727 ($15,842) ($93) $83,141
Comprehensive income:
Net income $7,323 7,323 $7,323
Other comprehensive income:
-Unrealized securities gains,
net of $748 of tax expense,
arising during the period 1,089
-Less: reclassifcation adjustment
for security gains included in
net income, net of $92 tax expense 135
---
Total other comprehensive income 954 954 954
---
Total Comprehensive income $8,277
======
Cash dividends declared ---- ---- (2,700) ---- ---- (2,700)
Stock options exercised 10 814 ----- ----- ----- 824
-- --- ----- ----- ----- ---
Balance at September 30,1997 $951 $75,222 $28,350 ($15,842) $861 $89,542
==== ======= ======= ======== ==== =======
Balance at December 31, 1997 $952 $75,303 $29,685 ($15,842) $967 $91,065
Compehensive income:
Net income $8,245 ---- ---- 8,245 ---- ---- 8,245
Other comprehensive income:
-Unrealized securities gains,
net of $905 tax expense,
arising during the period 1,357
-Less: reclassifcation adjustment
for security gains included in
net income, net of $420 tax expense 629
---
Total other comprehensive income 728 728 728
---
Total Comprehensive income $8,973
Cash dividends declared ====== ---- ---- (3,173) ---- ---- (3,173)
Stock options exercised 15 1,494 1,509
Acquisition of treasury stock ----- ----- ----- (2,493) ---- (2,493)
----- ----- ----- ------ ---- ------
Balance at September 30, 1998 $967 $76,797 $34,757 ($18,335) $1,695 $95,881
==== ======= ======= ======== ====== =======
</TABLE>
8
<PAGE>
FIRST ESSEX BANCORP, INC
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
(Dollars in thousands)
(Unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income $8,245 $7,323
Adjustments to reconcile net income to net cash provided by operating activities
Provision for possible loan losses 1,160 1,530
Provision for depreciation and amortization 1,450 1,408
Gain on sales of foreclosed property (277) (451)
Write-down of foreclosed property 16 35
Amortization of goodwill and core deposit intangible 1,058 590
Amortization of investment securities discounts and premiums, net 1,228 437
Proceeds from sales of mortgage loans and mortgage servicing rights 84,321 64,597
Mortgage loans originated for sale (75,333) (65,317)
Realized gains on the sale of investment securities (1,049) (227)
Realized gains on the sale of mortgage loans and mortgage servicing rights, net (976) (1,281)
(Increase) decrease in accrued interest receivable 745 (1,662)
(Increase) decrease in other assets 3,960 (17,508)
Increase (decrease) in other liabilities (2,821) 5,938
------- -------
Net cash provided by (used in) operating activities 21,727 (4,588)
Cash flows from investing activities
Acquisition of branch assets and assumed deposit liabilities, net of cash received 65,033 ----
Proceeds from sales of available-for-sale securities 167,614 58,819
Proceeds from maturities and principal payments of available-for-sale securities 50,982 28,753
Proceeds from maturities and principal payments of held-to-maturity securities 37,456 15,069
Purchases of available-for-sale securities (169,179) (113,317)
Purchases of held-to-maturity securities (21,892) (96,124)
Purchases of Federal Home Loan Bank stock (182) (4,286)
Loans originated and purchased, net of principal collected 8,312 (26,139)
Proceeds from sales of foreclosed property 2,891 3,949
Purchases of bank premises and equipment (821) (779)
-------- --------
Net cash provided by (used in) investing activities 140,214 (134,055)
Cash flows from financing activities
Net increase in demand deposits, NOW accounts and savings accounts 41,446 44,684
Net increase (decrease) in term deposits (3,800) 5,026
Net decrease in borrowed funds with maturities of three months or less (68,811) (30,351)
Proceeds from borrowed funds with maturities in excess of three months 72,000 221,000
Repayments of borrowed funds with maturities in excess of three months (143,017) (110,895)
Increase in mortgagors' escrow accounts 923 720
Dividends paid (3,169) (2,689)
Stock options exercised 1,509 824
Common stock repurchases (2,493) ----
-------- --------
Net cash provided by (used in) financing activities (105,412) 128,319
-------- --------
Net increase (decrease) in cash and cash equivalents 56,529 (10,324)
Cash and cash equivalents at beginning of period 22,542 38,078
-------- --------
Cash and cash equivalents at end of period $79,071 $27,754
======== ========
Supplemental disclosure of cash flow information:
Interest paid during the year $41,077 $37,675
Income taxes paid during the year 5,565 5,231
Cost incurred in early repayment of Federal Home Loan Bank advances 150 ----
Supplemental schedule of noncash financing and investing activities:
Real estate acquired through foreclosure 661 2,414
</TABLE>
9
<PAGE>
FIRST ESSEX BANCORP, INC.
Notes to Consolidated Financial Statements
1. Basis of Presentation
The accompanying consolidated financial statements are unaudited and include
the accounts of First Essex Bancorp, Inc. (the "Company") and its subsidiary,
First Essex Bank, FSB. These financial statements reflect, in management's
opinion, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the Company's financial position and the
results of its operations and cash flows for the periods presented. These
financial statements should be read in conjunction with the financial
statements and notes thereto included in the Company's 1997 annual report.
2. Earnings Per Share
In 1997, the Company adopted the provisions of SFAS No. 128, "Earnings per
Share" ("SFAS No. 128"). This statement was issued by the FASB in February
1997 and establishes new standards for computing and presenting earnings per
share (EPS) and makes them comparable to international EPS calculations and
standards. This statement replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the statement of operations and requires a
reconciliation of the numerators and denominators of the basic and diluted
EPS computations. The statement also requires a restatement of all
prior-period EPS data presented.
Basic EPS amounts have been computed by dividing reported earnings available
to common shareholders by the weighted average number of common equivalent
shares outstanding during each year. Diluted EPS amounts have been computed
using the weighted average number of common and common equivalent shares and
the dilutive potential common shares outstanding during each year.
A reconciliation between basic and diluted EPS is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income available to common shareholders $2,798 $2,650 $8,245 $7,323
====== ====== ====== ======
Basic EPS:
Basic Common Stock outstanding 7,563 7,517 7,555 7,487
===== ===== ===== =====
Basic EPS $0.37 $0.35 $1.09 $0.98
===== ===== ===== =====
Diluted EPS:
Basic Common Stock outstanding 7,563 7,517 7,555 7,487
Plus: Common Stock from options 262 308 303 280
--- --- --- ---
Dilutive common stock outstanding 7,825 7,825 7,858 7,767
===== ===== ===== =====
Diluted EPS: $0.36 $0.34 $1.05 $0.94
===== ===== ===== =====
</TABLE>
10
<PAGE>
3. Acquisition of Branch Assets and Assumption of Deposit Liabilities
Pursuant to a Purchase and Assumption Agreement, the Company purchased
certain assets from and assumed certain deposit liabilities of another
financial institution on June 19 and June 26, 1998. The assets acquired
consisted of approximately $63.9 million of loans, fixed and other assets,
real property related to the owned branches and cash at the branches. The
Company also paid a premium of approximately $15.1 million of which
approximately $10.5 million was allocated to the deposit liabilities and
repurchase agreements assumed and approximately $4.6 million was allocated to
goodwill. The core deposit premium (CDI) will be amortized over eight years
on a 125% declining balance method while the goodwill will amortized over a
twenty year life on a straight line basis.
Because the acquisition of the branches represents the acquisition of assets
and does not represent the acquisition of a business, separate entity or a
subsidiary, no historical financial statements or pro forma financial
statements are required. Because the deposit liabilities assumed exceed the
assets acquired, there was a cash payment made to the Company as a result of
this transaction. The following is a summarization of the components of the
transaction based on estimates of fair value at the date of acquisition (in
thousands):
<TABLE>
<S> <C>
Loans net $ 60,425
Bank premises and equipment 2,222
Core deposit intangible 10,544
Goodwill 4,580
Prepaid expenses and other assets 434
Deposit and repurchase agreement liabilities assumed (142,701)
Accrued expenses and other liabilities (537)
-----------
Net cash received $ 65,033
===========
</TABLE>
4. Investment Securities
During the second quarter of 1998, all securities previously classified as
"Held-to-Maturity" in accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" were reclassified to
"Available-for-Sale". This reclassification was the result of an analysis of
the strategic alternatives for the securities portfolio and had no impact on
the reported earnings for the period. On a prospective basis, the Company is
no longer classifying investment securities as held-to-maturity.
11
<PAGE>
ITEM 2. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FIRST ESSEX BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
September 30, 1998
General
-------
First Essex Bancorp, Inc., (the "Company"), is a Delaware corporation whose
primary activity is to act as the parent holding company for First Essex Bank,
FSB (the "Bank").
The Company's net earnings depend to a large extent upon its net interest
income, which is the difference between interest and dividend income earned on
its loans and investments and interest expense paid on its deposits and borrowed
funds. The Company's net earnings also depend upon its provision for possible
loan losses, non-interest income, non-interest expense and income tax expense.
Interest and dividend income and interest expense are significantly affected by
general economic conditions. These economic conditions, together with conditions
in the local real estate markets, affect the levels of non-performing assets and
provision for possible loan losses.
Results of Operations
---------------------
General
- -------
The three months ended September 30, 1998 was the first full quarter of
operations for the four branches acquired at the end of the second quarter. The
activity associated with the new loans, deposits, personnel and facilities
acquired in this acquisition account for the majority of the fluctuations in the
comparative data between the third quarter of 1998 and 1997.
Net income for the three months ended September 30, 1998 was $2.8 million
compared to $2.7 million for same period in 1997, or a 6% increase. Net interest
income totaled $10.5 million for the quarter compared to $9.4 million for the
same period in 1997. Net interest income was higher by $1.1 million compared to
the prior comparable period due mainly to lower cost funding sources resulting
from increased levels of core deposits. Non-interest income for the quarter
increased $482 thousand due primarily to receipt of a special one-time payment
from the Depositors Insurance Fund of Massachusetts, the entity that insures the
Bank's deposits in excess of FDIC insurance coverages. Non-interest expense for
this same three-month period increased by $1.9 million which is primarily
attributable to the salaries, information processing and other volume-related
expenditures related to the June branch acquisition, as well as amortization of
premium paid in this acquisition.
Net income for the nine months ended September 30, 1998 was $8.2 million
compared to $7.3 million for the same period in 1997, or a 13% increase. The
increase in net income over the comparative nine months in 1997 was comprised of
higher net interest income of $1.5 million and higher non-interest income of
$1.3 million and a decrease in the provision for loan losses of $370 thousand,
offset by increases in non-interest expense and income tax expense of $2.2
million and $60 thousand, respectively.
12
<PAGE>
The following table presents an analysis of average yields earned and rates paid
for the periods indicated:
<TABLE>
<CAPTION>
For the Three Months Ended September 30,
1998 1997
---- ----
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
---------- -------- ------- ---------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets
Earning assets
Short-term investments $85,320 $1,100 5.16% $22,857 $204 3.57%
Investment securities 364,031 5,039 5.54 431,707 7,009 6.50
Total loans (1) 764,114 17,005 8.90 704,720 15,793 8.96
Other earning assets 17,348 261 6.00 17,266 259 6.00
------ --- ------ ---
Total earning assets 1,230,813 23,405 7.61 1,176,550 23,265 7.91
Allowance for possible loan losses (11,536) (10,289)
------- -------
Total earning assets less allowance
for possible loan losses 1,219,277 1,166,261
Other assets 41,969 71,536
------ ------
Total assets $1,261,246 $1,237,797
========== ==========
Liabilities and Stockholders' Equity
Deposits
NOW accounts $50,757 $160 1.26% $40,218 $132 1.31%
Money market accounts 83,835 761 3.63 69,694 416 2.39
Savings accounts 212,157 1,927 3.63 133,925 1,170 3.49
Time deposits 492,180 6,864 5.58 432,778 6,345 5.86
------- ----- ------- -----
Total interest bearing deposits 838,929 9,712 4.63 676,615 8,063 4.77
Borrowed funds 218,343 3,230 5.92 390,882 5,842 5.98
------- ----- ------- -----
Total interest bearing deposits and
borrowed funds 1,057,272 12,942 4.90 1,067,497 13,905 5.21
--------- ------ --------- ------
Demand deposits 90,412 64,192
Other liabilities 18,363 17,953
------ ------
Total liabilities 1,166,047 1,149,642
Stockholders' equity 95,199 88,155
------ ------
Total liabilities and
stockholders' equity $1,261,246 $1,237,797
========== ==========
Net interest income $10,463 $9,360
======= ======
Weighted average interest
rate spread 2.71% 2.70%
==== ====
Net yield on average
arning assets (2) 3.40% 3.18%
==== ====
Return on average assets 0.89% 0.86%
==== ====
Return on average equity 11.76% 12.02%
===== =====
</TABLE>
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for possible loan losses divided by
average earning assets
13
<PAGE>
The following table presents an analysis of average yields earned and rates paid
for the periods indicated:
<TABLE>
<CAPTION>
For the Nine Months Ended September 30,
1998 1997
---- ----
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
---------- -------- ------- ---------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets
Earning assets
Short-term investments $39,714 $1,558 5.24% $17,535 $467 3.55%
Investment securities 402,158 19,280 6.39 406,747 19,774 6.48
Total loans (1) 734,066 48,479 8.81 707,391 46,600 8.78
Other earning assets 17,324 782 6.00 5,755 259 6.00
------ --- ----- ---
Total earning assets 1,193,262 70,099 7.83 1,137,428 67,100 7.87
Allowance for possible loan losses (10,879) (10,128)
------- -------
Total earning assets less allowance
for possible loan losses 1,182,383 1,127,300
Other assets 67,570 61,953
------ ------
Total assets $1,249,953 $1,189,253
========== ==========
Liabilities and Stockholders' Equity
Deposits
NOW accounts $46,041 $458 1.33% $40,594 $390 1.28%
Money market accounts 72,755 1,574 2.88 76,059 1,292 2.26
Savings accounts 185,969 5,230 3.75 113,572 2,717 3.19
Time deposits 442,718 18,946 5.71 430,468 18,641 5.77
------- ------ ------- ------
Total interest bearing deposits 747,483 26,208 4.67 660,693 23,040 4.65
Borrowed funds 318,753 14,256 5.96 364,129 15,948 5.07
------- ------ ------- ------
Total interest bearing deposits and
borrowed funds 1,066,236 40,464 5.06 1,024,822 38,988 5.11
--------- ------ --------- ------
Demand deposits 72,180 62,547
Other liabilities 18,313 16,326
------ ------
Total liabilities 1,156,729 1,103,695
Stockholders' equity 93,224 85,558
------ ------
Total liabilities and
stockholders' equity $1,249,953 $1,189,253
========== ==========
Net interest income $29,635 $28,112
======= =======
Weighted average interest
rate spread 2.77% 2.80%
==== ====
Net yield on average
earning assets (2) 3.31% 3.29%
==== ====
Return on average assets 0.88% 0.82%
==== ====
Return on average equity 11.79% 11.44%
===== =====
</TABLE>
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for possible loan losses divided by
average earning assets.
14
<PAGE>
Net Interest Income
- -------------------
Net interest income increased by $1.1 million to $10.5 million for the three
months ended September 30, 1998, and increased by $1.5 million to $29.6 million
for the nine months ended September 30, 1998. The increase in net interest
income for the quarter is primarily related to the lower cost funding sources
which resulted from increased levels of core deposits.
Interest and Dividend Income
- ----------------------------
Interest and dividend income increased by $140 thousand to $23.4 million, and by
$3.0 million to $70.1 million for the three and nine month periods ended
September 30, 1998, respectively, from $23.3 million and $67.1 million recorded
in the same periods in 1997. The changes relate to volume increases in earning
assets primarily related to increased levels of loans.
Interest Expense
- ----------------
Interest expense decreased by $963 thousand to $12.9 million, and increased by
$1.5 million to $40.5 million, for the three and nine month periods ended
September 30, 1998 when compared to the same periods in 1997. These changes were
attributable to volume increases associated with the additional borrowings to
fund the growth in the Company's investment portfolio during the first six
months of 1998 with a shift to lower cost core deposit funding sources during
the third quarter of 1998.
Provision for Possible Loan Losses
- ----------------------------------
Possible losses on loans are provided for under the accrual method of
accounting. Assessing the adequacy of the allowance for possible loan losses
involves substantial uncertainties and is based upon management's evaluation of
the amount required to meet estimated losses inherent in the loan portfolio
after weighing various factors. Among the factors management may consider are
the quality of specific loans, risk characteristics of the loan portfolio
generally, the level of non-accruing loans, current economic conditions, trends
in delinquencies and charge-offs and collateral values of the underlying
security. Ultimate losses may vary significantly from the current estimates.
Losses on loans, including impaired loans, are charged against the allowance
when management believes the collectability of principal is doubtful.
The provisions for possible loan losses totaled $290 thousand and $1.2 million
for the three and nine months ended September 30, 1998. The provision for
possible loan losses totaled $510 thousand and $1.5 million for the comparable
three and nine month periods in 1997. The entire provision for the third quarter
of 1998 related to impaired loans as defined in SFAS No. 114,"Accounting by
Creditors for Impairment of a Loan", as amended by SFAS No. 118 compared to $411
thousand in the third quarter of 1997. There was no impaired provision in the
first two quarters of 1998 or the second quarter of 1997. The entire first
quarter provision for the first quarter of 1997 related to impaired loans.
Provisions result from management's continuing internal review of the loan
portfolio as well as its judgment as to the adequacy of the reserves in light of
the condition of the regional real estate and other markets, and the economy in
general. As a result of increased loans, there is an expectation that the Bank
will continue to find it necessary to make provisions for possible loan losses
in the future. See "Financial Condition - Non-Performing Assets."
Non-Interest Income
- -------------------
Non-interest income consists of net gains from the sales of mortgage loans and
mortgage loan servicing rights and gains on the sale of investment securities,
together with fee and other non-interest income.
Non-interest income increased by $482 thousand to $1.7 million and by $1.3
million to $5.0 million for the three and nine months ended September 30, 1998,
respectively, compared to $1.2 million and $3.7 million for the same periods in
1997. The year-to-date increase in non-interest income is due mainly to the
second quarter gain on the sale of investment securities of $949 thousand that
resulted from the balance sheet realignment while the third quarter increase is
due to higher amounts of fee income and a special payment of $346 thousand from
the Depositors Insurance Fund of Massachusetts, partially offset by reduced
levels of gains on the sales of investment securities and mortgage loans.
Non-Interest Expense
- --------------------
Non-interest expense increased by $1.9 million to $7.4 million for the three
months ended September 30, 1998, and by $2.2 million to $19.9 million for the
nine months ended September 30, 1998, compared to $5.5 million and $17.7 million
for the same periods in 1997. The increase in the third quarter of 1998 is
primarily due to the salaries, information processing and other volume related
expenditures related to the branch acquisition in June. Additionally,
approximately $200 thousand of one-time costs related to the acquisition were
incurred in the third quarter of 1998.
15
<PAGE>
Income Tax Expense
- ------------------
The provision for income taxes for the three and nine month periods ended
September 30, 1998 reflects an effective tax rate that is consistent with the
comparable periods in 1997. The effective tax rate in 1998 is lower due to
favorable tax rates on certain investment income.
Financial Condition
-------------------
Total assets amounted to $1,241.4 million at September 30, 1998, an increase of
$44.0 million or 3.7% from $1,197.5 million at December 31, 1997
Loans
- -----
At September 30, 1998, the loan portfolio, including mortgage loans held for
sale, and before consideration of the allowance for possible loan losses, was
$759.5 million, representing 61.2% of total assets, compared to $718.7 million
or 60.0% of total assets at December 31, 1997.
The following table sets forth information concerning the Company's loan
portfolio at the dates indicated. The balances shown in the table are net of
unadvanced funds and unearned discounts and fees
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
September 30, 1998 December 31, 1997
------------------ -----------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real Estate:
Residential $208,702 27.5% $274,865 38.2%
Commercial 82,223 10.8 83,077 11.6
Construction 55,256 7.3 31,851 4.4
------ --- ------ ---
Total Real Estate Loans 346,181 45.6 389,793 54.2
------- ---- ------- ----
Owner occupied Commercial Real Estate 67,194 8.8 52,335 7.3
Commercial loans 91,887 12.1 67,018 9.3
Aircraft loans 53,531 7.1 41,220 5.8
Consumer loans
Home Equity, Home Improvement
& Second Mortgage 61,467 8.1 59,897 8.3
Automobile 132,049 17.4 103,551 14.4
Other 7,193 0.9 4,901 0.7
----- --- ----- ---
Total consumer loans 200,709 26.4 168,349 23.4
------- ---- ------- ----
Total loans $759,502 100.0% $718,715 100.0%
======== ===== ======== =====
- ----------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
Allowance for Possible Loan Losses
- ----------------------------------
Possible losses on loans are provided for under the accrual method of
accounting. Assessing the adequacy of the allowance for possible loan losses
involves substantial uncertainties and is based upon management's evaluation of
the amount required to meet estimated losses inherent in the loan portfolio
after weighing various factors. Among the factors management may consider are
the quality of specific loans, risk characteristics of the loan portfolio
generally, the level of non-accruing loans, current economic conditions, trends
in delinquencies and charge-offs and collateral values of the underlying
security. Ultimate losses may vary significantly from the current estimates.
Losses on loans, including impaired loans, are charged against the allowance
when management believes the collectability of principal is doubtful. (See
"Non-Performing Assets" for a discussion of the Company's impaired loans.)
The following table summarizes the activity in the allowance for possible loan
losses (including amounts established for impaired loans) for the nine months
ended September 30, 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C>
Balance at December 31, 1997 $10,570
Acquired Allowance - Branch Acquisition 765
Provision for possible loan losses 1,160
Charge-offs
Mortgage 347
Owner occupied commercial real estate ---
Construction ---
Commercial 206
Consumer 1,496
-----
Total charge-offs 2,049
-----
Recoveries
Mortgage 547
Owner occupied commercial real estate ---
Construction 10
Commercial 209
Consumer 145
---
Total recoveries 911
---
Net charge-offs 1,138
-----
Balance at September 30, 1998 $11,357
=======
Total loans at end of period $759,502
========
Average loans for the period 734,066
=======
Allowance to loans ratio 1.50%
====
Net charge-offs to average loans ratio 0.15%
====
- --------------------------------------------------------------------------------
</TABLE>
17
<PAGE>
Non-Performing Assets
- ---------------------
Non-performing assets consist of non-accruing loans (including loans impaired
under SFAS No. 114), and foreclosed property. Non-performing assets totaled $6.5
million at September 30, 1998 and $6.4 million at December 31, 1997.
The Bank's policy is to discontinue the accrual of interest on all loans
(including loans impaired under SFAS No. 114), for which payment of interest or
principal is 90 days or more past due or for such other loans as considered
necessary by management if collection of interest and principal is doubtful.
When a loan is placed on non-accrual status, all previously accrued but
uncollected interest is reversed against the current period interest income.
Restructured loans are loans (1) on which concessions have been made in light of
the debtor's financial difficulty with the objective of maximizing recovery and
(2) with respect to which the renegotiated payment terms continue to be met.
Interest income recognized on impaired loans (including restructured loans),
using the cash basis of income recognition, amounted to approximately $234 and
$402 thousand for the three and nine months ended September 30, 1998, compared
to $38 and $186 thousand for the same periods in 1997. The average recorded
investment of impaired loans for the three and nine months ended September 30,
1998 was $3.2 and $2.9 compared to $2.8 and $2.8 million for the same periods in
1997, and $2.6 million for the twelve month period ended December 31, 1997.
Foreclosed property consists mainly of real estate collateral from loans which
were foreclosed.
The following table indicates the recorded investment of non-performing assets
and the related valuation allowance for impaired loans.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
September 30, 1998 December 31, 1997
Impaired Loan Impaired Loan
Recorded Valuation Recorded Valuation
Investment Allowance (1) Investment Allowance (1)
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Non-accruing Loans
Impaired Loans
Requiring a valuation allowance $1,977 $888 $1,577 $ 590
Not requiring a valuation allowance 1,133 --- 309 ---
----- --- --- ---
$3,110 888 1,886 590
Restructured Loans 337 172 905 420
--- --- --- ---
Total impaired 3,447 $1,060 2,791 $1,010
====== ======
Residential Mortgage 1,423 1,525
Other 1,087 1,228
----- -----
Total non-accruing 5,957 5,544
Foreclosed property, net 582 891
--- ---
Total non-performing assets $6,539 $6,435
====== ======
Percentage of non-performing assets
to total assets 0.53% 0.54%
Percentage of allowance for possible
loan losses to non-accruing loans 190.6% 190.7%
(1) The valuation allowance for impaired loans is included in the allowance for
possible loan losses on the balance sheet
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<PAGE>
Investments
- -----------
At September 30, 1998, the investment portfolio, consisting of short-term
investments, investment securities, mortgage-backed securities, Federal Home
Loan Bank ("FHLB") stock and stock in the Savings Bank Life Insurance Company of
Massachusetts, totaled $347.2 million or 28.0% of total assets, compared to
$411.9 million or 34.4% of total assets at December 31, 1997.
To identify and control market risks associated with the investment portfolio,
the Company has established policies and procedures, which include stop loss
limits and stress testing on a periodic basis.
Deposits
- --------
Deposits are the primary source of funds for lending and investment activities.
Deposit flows vary significantly and are influenced by prevailing interest
rates, market conditions, economic conditions and competition. At September 30,
1998 the Bank had total deposits of $922.3 million representing a net increase
of $177.9 million compared to total deposits of $744.3 million at December 31,
1997. Approximately $121.0 million of the deposit increase is attributed to the
deposit liabilities assumed in the branch acquisition.
While deposit flows are by nature unpredictable, the Bank attempts to manage its
deposits through selective pricing. Due to the uncertainty of market conditions,
it is not possible for the Bank to predict how aggressively it will compete for
deposits in future quarters or the likely effect of any such decision on deposit
levels, interest expense and net interest income. Strategies are currently in
place to aggressively market more stable deposit sources in such accounts as NOW
and Demand Deposits.
Borrowed Funds
- --------------
The Bank is a member of the FHLB and is entitled to borrow from the FHLB by
pledging certain assets. The Bank also utilizes short-term repurchase
agreements with maturities less than three months, as an additional source of
funds. Repurchase agreements are secured by U.S. government and agency
securities. These borrowings are an alternative source of funds compared to
deposits and decreased from $343.6 million at December 31, 1997 to $206.1
million at September 30, 1998 as the Bank was able to replace them with lower
cost core deposits.
Regulatory Capital Requirements
- -------------------------------
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken,
19
<PAGE>
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.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of 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, 1998, that the
Bank meets all capital adequacy requirements to which it is subject.
The most recent notification from the Office of Thrift Supervision ("OTS")
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as
set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table. As
of September 30, 1998, the OTS did not deem it necessary for an interest-rate
risk component to be deducted from capital in determining risk-based capital
requirements.
The Bank may not declare or pay cash dividends on its shares of common stock if
the effect thereof would cause stockholders' equity to be reduced below
applicable capital maintenance requirements or if such declaration and payment
would otherwise violate regulatory requirements.
The following table displays the Bank's capital calculations as defined under
prompt corrective action for the periods indicated:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
To Be Well
First Essex Bank, FSB For Capital Capitalized Under Prompt
Actual Actual Adequacy Purposes Corrective Action Provision:
Amount Ratio Amount Ratio Amount Ratio
------ ----- -------- -------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998 (unaudited)
Tangible Capital (to Adjusted Assets) $68,801 5.63% $18,333 > 1.50% n/a
-
Tier 1 (Core) Capital (to Adjusted Assets) 68,801 5.63 36,666 3.00 $61,110 > 5.00%
-
Tier 1 (Core) (to Risk Weighted Assets) 68,801 9.08 30,308 4.00 45,462 6.00
Total Risk Based Capital
(to Risk Weighted Assets) 78,282 10.33 60,615 8.00 75,769 10.00
December 31, 1997
Tangible Capital (to Adjusted Assets) $72,319 5.91% $17,822 > 1.50% n/a
-
Tier 1 (Core) Capital (to Adjusted Assets) 72,319 5.91 35,644 3.00 $59,408 > 5.00%
-
Tier 1 Capital (to Risk Weighted Assets) 72,319 9.67 28,372 4.00 42,559 6.00
Total Risk Based Capital
(to Risk Weighted Assets) 81,194 10.92 56,744 8.00 70,931 10.00
</TABLE>
Year 2000
The Company has addressed the issues inherent in the impending change of
century, otherwise known as "Year 2000", or "Y2K". The potential problem with
year 2000 concerns the inability of information systems, primarily software
programs, to properly recognize and process date sensitive information for the
year 2000 and beyond. A bank-wide project team has been organized to
20
<PAGE>
address and resolve Y2K issues. In addition, the Board has established a Year
2000 Compliance Oversight Committee to oversee activities of management and
others in dealing with Y2K issues.
A principal issue with which the Company is faced is the Y2K preparedness of its
third party vendor who supplies the Company's primary application systems. These
systems are the loan and deposits systems, and the general ledger application.
This vendor has developed plans to deal with the Y2K problem and the Company is
closely monitoring the remediation progress of this plan. The Company is also
involved in the testing of all applicable changes that have occurred in the
vendor's software, together with addressing other mission critical systems.
A. The Company's State of Readiness
In preparing for the change of century, the Company has reviewed and assessed
both information technology (IT) and non-IT systems. IT systems include all
significant operating systems (e.g., the deposit system, platform teller system,
financial reporting system, payroll system, loan systems, etc.). The non-IT
systems (otherwise known as "embedded technology") include items such as vault
doors, elevators, and security systems. Monitoring the state of readiness is
accomplished by reviewing the various phases of the Company's project plan.
These phases are defined as follows:
1. Awareness - defining the Y2K problem, informing employees and customers,
developing a strategy, project team and plan to resolve issues and risks
attendant to the problem.
2. Assessment - determining the size and complexity of the Y2K problem together
with the magnitude of the effort needed to correct the issues. It includes
establishing an inventory of IT and non-IT systems, identification of the
"mission critical" items, and a determination of the resources necessary to
address the mission critical items.
3. Analysis, renovation (or remediation) and implementation analyzing and
replacing hardware and software (e.g., personal computers, e-mail, voice
response units, etc.), software reprogramming, third-party vendor
certifications, and other associated changes necessary to correct the items
determined to be mission critical.
4. Validation (or testing) and contingency planning - post-renovation
incremental testing of new, existing and renovated hardware and software,
together with testing the connectivity of new, existing and renovated
systems to each other. The major validation for the Company relates to the
renovation efforts of its third party provider of the Company's major
application systems. Contingency planning accounts for the possibility that,
even with renovation, Y2K issues may still arise.
The following table reflects the Company's progress to date, and expected
completion date, with respect to these phases:
<TABLE>
<CAPTION>
----------------------------------------------------
Estimated Estimated
Phase Description Completion Completion
% (*) Date
----------------------------------------------------
<S> <C> <C>
Awareness 100% August 1998
----------------------------------------------------
Assessment 100 August 1998
----------------------------------------------------
Analysis, renovation
and implementation 80 March 1999
----------------------------------------------------
Validation and
contingency planning 10 June 1999
----------------------------------------------------
(*) Percentages are rounded to the nearest 10%.
</TABLE>
B. Costs To Address The Company's Year 2000 Issues
The following table details the expenditures (period and capital) incurred to
date by the Company, together with the estimated expenditures that will be
incurred to bring the Y2K project to closure. Period expenditures have been or
will be expensed in the period incurred. Capital expenditures have been or will
be capitalized and amortized over the estimated useful life of the item.
21
<PAGE>
<TABLE>
<CAPTION>
($000's)
- -------------------------------------------------------------------------------------
Description Incurred Additional Additional Total %
to date 1998 1999 Expenditures Complete
Expenditures Expenditures (*)
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Period expenditures:
- -------------------------------------------------------------------------------------
Management and staff
salaries, and Board
fees $ 90 $ 40 $130 $260 30%
- -------------------------------------------------------------------------------------
Y2K consulting fees 30 25 80 135 20
- -------------------------------------------------------------------------------------
Third party vendor
expense and system
testing 30 10 20 60 50
- -------------------------------------------------------------------------------------
Capital expenditures:
- -------------------------------------------------------------------------------------
Replacement of
noncompliant
IT and non-IT systems 140 60 200 400 35
- -------------------------------------------------------------------------------------
(*) Percentages are rounded to the nearest 10%.
</TABLE>
C. The Risks of the Company's Year 2000 Issues
The worst case scenario for the Company would be major and prolonged disruptions
in electrical power and telephone communications. Due to the branch network's
dependence on computer and telephone links for data retrieval and security
mechanisms, it would be difficult to operate in either or both of these
situations. The Company has been and will continue to interact with these
suppliers, and review the results of their testing, to confirm their readiness
for the Year 2000. Another risk scenario for the Company would be temporary
business disruptions of its large commercial borrowers due to their failure(s)
to be prepared for Y2K. The financial impact of this contingency on borrowers
could cause income and cash flow shortfalls for the Company. The Company has
begun a process of surveying and evaluating its commercial customers with
respect to their readiness for the change of century by means of a
questionnaire. This process allows the Company to be more proactive in planning
for this contingency. If warranted, the Company's Reserve for Possible Loan
Losses would be increased and an appropriate charge-off would be recorded for
the estimated impact of the customer's failure to be compliant. New loans and
loan renewals have clauses inserted in the loan documents to address the
borrowers' Y2K readiness.
Because the more probable risk scenarios of the Company would be intermittent,
minor and short-term IT systems failures that were not previously anticipated,
the Company is addressing these risks by means of formulating "contingency
plans".
D. The Company's Contingency Plans
The Company intends to develop contingency plans for its core business
operations. Core business operations are those processes that are required to
maintain the ongoing business of the Company. To date, there have been nine (9)
core operations identified. Initially, a template for contingency plan design
will be developed for one of these operations. This template will then be used
in the design of contingency plans for the other eight identified operations.
The initial plan should be finalized by the end of November, 1998 and will
include the possible contingencies along with other courses of action to be
availed of in the event this contingency occurs. The final product of this phase
will be the development and scenario testing of a "core business resumption
plan" (CBRP) for the selected test case. Development and scenario testing of
CBRP's for the other identified core business functions will follow.
Comprehensive Income
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" which requires the
display of comprehensive income and its components. The Company has chosen, as
permitted by SFAS No. 130, to disclose comprehensive income, which is comprised
of net income and unrealized gains or losses on securities classified as
available-for-sale, in the Consolidated Statements of Stockholders' Equity. All
prior year data has been restated to conform to the
22
<PAGE>
SFAS No. 130 requirements.
Recent Accounting Developments
- ------------------------------
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information". This pronouncement is effective for the
Company's 1998 financial statements. SFAS No. 131 requires additional
disclosures regarding segments of an enterprise, if any, that are used by the
enterprise for making operating decisions and assessing performance. Management
continues to evaluate the applicability of this statement to the Company.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities. The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded on the
balance sheet as either an asset or liability measured at its fair value. The
Statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998).
The Company has not yet quantified the impact of adopting SFAS No. 133 on the
financial statements, and has not determined the timing of or method of the
adoption of the Statement. The adoption of SFAS No. 133 could have the effect of
increasing the volatility in reported earnings and other comprehensive income.
23
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- ------- ---------------------------------------------------------
Market Risk
- -----------
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices such as interest rates, foreign currency exchange
rates, commodity prices, and equity prices. The Company's primary market risk
exposure is interest rate risk. The ongoing monitoring and management of this
risk is an important component of the Company's asset/liability management
process which is governed by policies established by the Board of Directors that
are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee (ALCO). In this capacity, ALCO develops guidelines and
strategies impacting the Company's asset/liability related activities based upon
estimated market risk sensitivity, policy limits and overall market interest
rate levels/trends.
Interest Rate Risk
- ------------------
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change the interest income and expense streams
associated with the Company's financial instruments also changes thereby
impacting net interest income (NII), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling two-year
horizon, it also utilizes additional tools to monitor potential longer-term
interest rate risk. There have been no material changes in the interest rate
risk reported at the conclusion of the Company's December 31, 1997 year end.
Liquidity and Capital Resources
- -------------------------------
The Bank's principal sources of liquidity are customer deposits, borrowings from
the FHLB, scheduled amortization and prepayments of loan principal, cash flow
from operations, maturities of various investments and loan sales.
Management believes it is prudent to maintain an investment portfolio that not
only provides a source of income, but also provides a potential source of
liquidity to meet lending demand and deposit flows. The Bank adjusts the level
of its liquid assets and the mix of its loans and investments based upon
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
Net cash provided from operating activities totaled $21.7 million for the nine
months ended September 30, 1998 compared to $4.6 million that was used in
operating activities for the same period in 1997. The change is primarily
related to the decrease in other assets and the growth in other liabilities
together with the increased sales of mortgage loans experienced during the first
nine months of 1998 compared to the prior period.
Net cash provided by investing activities totaled $140.2 million for the six
months ended September 30, 1998 compared to cash used of $134.1 million for the
comparable period in 1997. The change is due primarily to the sale of investment
securities, and the cash received as part of the assumption of deposit
liabilities connected with the branch acquisition in the second quarter of 1998.
Net cash used in financing activities totaled $105.4 million for the nine months
ended September 30, 1998, compared to net cash provided of $128.3 million for
the comparable period in 1997. The period to period change in the amount of cash
provided from this funding source is primarily related to the repayment of
borrowed funds incident to the sale of investment securities in the second
quarter of 1998.
Impact of Inflation
- -------------------
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles which require
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation.
An important concept in understanding the effect of inflation on financial
institutions is the distinction between monetary and non-monetary items. In a
stable environment, monetary items are those assets and liabilities which are or
will be converted into a fixed amount of dollars regardless of changes in
prices. Examples of monetary items include cash, investment securities, loans,
deposits and borrowings. Non-monetary items are those assets and liabilities
which gain or lose general purchasing power as a result of the relationships
between specific prices for the items and price change levels. Examples of
non-monetary items include equipment and real estate. Additionally, interest
rates do not necessarily move in the same direction, or in the same magnitude,
as the prices of goods and services as measured by the consumer price index.
24
<PAGE>
FIRST ESSEX BANCORP, INC.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(3) Articles of Incorporation and By-laws:
3.1 The Restated Certificate of Incorporation of the Company is incorporated
herein by reference to Exhibit 3.1 to Amendment No. 1 to the Company's
Registration Statement on Form S-1, Registration No. 33-10966, filed
with the Securities and Exchange commission on April 17, 1987
("Amendment No. 1 to Form S-1").
3.2 The Amended and Restated By-laws of the Company are incorporated herein
by reference to Exhibit 4.1 of the Company's current report on Form 8-K
filed on December 28, 1992.
(10) Material Contracts
*10.1- The First Essex Bancorp, Inc. 1987 Stock Option Plan incorporated
herein by reference to Appendix B to the prospectus included in the
Company's Registration Statement on Form S-8, Registration No. 33-21292,
filed on April 15, 1988.
10.2- The Shareholder Rights Agreement incorporated herein by reference to the
exhibit to the company's Current Report on Form 8-K filed on October 12,
1989, as amended by the Amendment to the Shareholder Rights Plan,
incorporated herein by reference to Exhibit 28.2 to the company's
Current Report on Form 8-K filed on February 12, 1990.
*10.3- Executive Salary Continuation Agreement between First Essex Bancorp,
Inc., First Essex Bank, FSB and Leonard A. Wilson incorporated herein by
reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K
for fiscal year ended December 31, 1988.
*10.4- Amended and Restated Employment Agreement dated as of October 9, 1997
between Leonard A. Wilson and First Essex Bancorp, Inc., incorporated
herein by reference to Exhibit 10.4 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
*10.5- Amended and Restated Employment Agreement dated as of October 9, 1997
between Leonard A. Wilson and First Essex Bank, FSB, incorporated herein
by reference to Exhibit 10.5 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997.
*10.6- Amended and Restated Employment Agreement dated as of October 9, 1997
between David W. Dailey and First Essex Bancorp, Inc., incorporated
herein by reference to Exhibit 10.6 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
*10.7- Amended and Restated Employment Agreement dated as of October 9, 1997
between David W. Dailey and First Essex Bank, FSB, incorporated herein
by reference to Exhibit 10.7 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997.
*10.8- Amended and Restated Employment Agreement dated as of October 9, 1997
between Brian W. Thompson and First Essex Bancorp, Inc., incorporated
herein by reference to Exhibit 10.8 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
*10.9- Amended and Restated Employment Agreement dated as of October 9, 1997
between Brian W. Thompson and First Essex Bank, FSB, incorporated herein
by reference to Exhibit 10.9 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997.
*10.10- Special Termination Agreement dated January 1, 1994 and restated as
of October 9, 1997 between Leonard A. Wilson and First Essex Bancorp,
Inc. incorporated by reference to Exhibit 10.10 to the Company's
Quarterly report on Form 10-Q for the quarter ended September 30, 1997.
*10.11- Special Termination Agreement dated January 1, 1994 and restated as of
October 9, 1997 between David W. Dailey and First Essex Bancorp, Inc.
incorporated by reference to Exhibit 10.11 to the Company's Quarterly
report on Form 10-Q for the quarter ended September 30, 1997.
*10.12- Special Termination Agreement dated January 1, 1994 and restated as of
October 9, 1997 between Brian W. Thompson and First Essex Bancorp, Inc.
incorporated by reference to Exhibit 10.12 to the Company's Quarterly
report on Form 10-Q for the quarter ended September 30, 1997.
*10.13- Form of Special Termination Agreement between First Essex Bancorp, Inc.,
First Essex Bank, FSB, and each of John M. DiGaetano, Wayne C. Golon,
David L. Savoie and William F. Burke incorporated herein by reference to
Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997.
*10.14- First Essex Bancorp, Inc. Senior Management Incentive Compensation
Plan incorporated herein by reference to Exhibit 10.9 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1994.
*10.15- Common Stock Option Plan for Brian W. Thompson incorporated herein by
reference to Form S-8, Registration No. 333-22183, filed on February 21,
1997.
*10.16- First Essex Bancorp, Inc. 1997 Stock Incentive Plan incorporated
herein by reference to Form S-8, Registration No. 333-35057, filed on
September 5, 1997.
11.1 A statement regarding the computation of earnings per share is included
in Item 1 of this report (Note 2 to Notes to Consolidated Financial
Statements).
(27) Financial Data Schedule
* Management contract or compensatory plan
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST ESSEX BANCORP, INC.
-------------------------
(Registrant)
Date: November 13, 1998 By /s/ Thomas P. Coursey
---------------------
Thomas P. Coursey
Senior Vice President
and Principal Accounting Officer
26
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