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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K405
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 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
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( X )
-----
The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant, based on the closing sale price on The Nasdaq
Stock Market on March 13, 1998 was $177,039,689.
As of March 13, 1998, 7,533,888 shares of the registrant's common stock, $.10
par value, were outstanding.
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<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Selected information from the Registrant's Proxy Statement for the annual
meeting to be held May 7, 1998, to be filed with the Securities and Exchange
Commission within 120 days after December 31, 1997, is incorporated by reference
into Part III of this report
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company desires to take advantage of the new "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, 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 the Bank must comply,
the cost of compliance 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 in its market area,
increasing consolidation within the banking industry, and increasing 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; and (v) the effect of changes in the business cycle and
downturns in the New England and national economy.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
Part I
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Part II
Item 5. Market for the Registrant's Equity and Related Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 25
Item 8. Financial Statements and Supplementary Data 30
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 65
Part III
Item 10. Directors and Executive Officers of the Registrant 65
Item 11. Executive Compensation 65
Item 12. Security Ownership of Certain Beneficial Owners and Management 66
Item 13. Certain Relationships and Related Transactions 66
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 66
Signatures 68
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
First Essex Bancorp, Inc.
First Essex Bancorp, Inc. ("First Essex" or the "Company") is a Delaware
corporation whose primary activity is to act as the parent holding company for
First Essex Bank, FSB (the "Bank"). Until December 1, 1993, the business of
First Essex Bancorp, Inc. was conducted through two banking subsidiaries, First
Essex Savings Bank, a Massachusetts-chartered savings bank and First Essex
Savings Bank of New Hampshire, a Guaranty Savings Bank. The New Hampshire bank
was owned through a second tier holding company, First Essex Bancorp of New
Hampshire, Inc., which was merged into First Essex Bancorp, Inc. on December 1,
1993.
On December 30, 1996, Finest Financial Corp. ("Finest"), the parent holding
company of Pelham Bank and Trust Company ("Pelham"), a New Hampshire chartered
bank, was merged into the Company in a transaction that was accounted for as a
purchase. Pelham was simultaneously merged into the Bank. The purchase price was
composed of 1,353,998 shares of common stock issued at a price of $11.50 per
share and a total cash outlay of $16.3 million. Included in the total
acquisition cost was approximately $1.4 million of capitalized costs incurred in
connection with the acquisition. This transaction was accounted for as a
purchase and, accordingly, the consolidated statement of operations includes the
results of Finest's operations since the acquisition.
First Essex Bank, FSB
The Bank was originally founded under a Massachusetts legislative charter issued
in 1847. On December 1, 1993, First Essex Savings Bank converted to a federal
savings bank with a charter issued by the Office of Thrift Supervision, (the
"OTS") under the name of First Essex Bank, FSB. On the same day First Essex
Savings Bank of New Hampshire was merged into First Essex Bank, FSB. As stated
above, the Bank merged with Pelham on December 30, 1996.
At December 31, 1997, the Bank had total assets of $1.2 billion. The Bank is
principally engaged in the business of attracting deposits from the general
public and investing in residential mortgage, construction, commercial real
estate, commercial and consumer loans. The Bank also makes investments in
various investment securities to provide a source of interest and dividend
income. The Bank currently maintains fifteen full service banking offices at
various locations throughout its market area. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation (the "FDIC").
MARKET AREA
First Essex's market area is centered approximately 25 miles north of Boston at
the intersection of two major highways: Interstate Route 93, the major
north-south roadway connecting Boston with the northern Boston suburban
communities and New Hampshire, and Interstate Route 495. The Bank's principal
executive offices are located in Andover, Massachusetts, and its main banking
office and two of its branches are located in Lawrence, Massachusetts. Other
branches are in the surrounding communities of Andover, North Andover,
Haverhill, Lowell and Methuen, Massachusetts and Londonderry, Pelham, Salem and
Windham, New Hampshire.
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CURRENT MARKET CONDITIONS
The New England region, including those portions of northeastern Massachusetts
and southern New Hampshire that constitute First Essex's market area, continues
to experience growth.
Loan demand to finance new and existing home sales has remained strong for the
last three years. Commercial loans to small and mid-size businesses in the area
continue to benefit from a growing economy characterized by expansion with
little price inflation, although the competition among lenders for these loans
remains intense. Automobile sales continued to show strength in 1997 and First
Essex participated in that growth through an indirect automobile lending program
that was begun early in 1994. The general improvement in consumer confidence and
the consumer's willingness to take on additional debt was reflected in the
growth in direct lending to consumers.
REGULATION
General
The Office of Thrift Supervision ("OTS") is the primary regulator of the Company
and the Bank. The Bank's deposits are insured up to applicable limits by the
Bank Insurance Fund ("BIF") of the FDIC. The Company and the Bank must file
reports with the OTS concerning activities and financial condition, in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with or acquisitions of other financial institutions. Periodic
examinations are conducted by the OTS to test the Company's and the Bank's
compliance with various regulatory requirements. The Bank is also a member of
the Federal Home Loan Bank ("FHLB") system, which provides a central credit
facility primarily for member institutions. The Company, as a thrift holding
company, is also required to file certain reports, and otherwise comply, with
the rules and regulations of the OTS and of the Securities and Exchange
Commission ("SEC") under the federal securities laws.
Business Activities
The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit
Insurance Act (the "FDI Act"). The HOLA and the FDI Act were amended by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FDICIA, among other things, requires that federal banking regulators intervene
promptly when a depository institution experiences financial difficulties,
mandates the establishment of a risk-based deposit insurance assessment system
and requires the imposition of numerous additional safety and soundness
operational standards and restrictions. FDICIA contains provisions affecting
numerous aspects of the operations of federal savings institutions and empowers
the OTS and the FDIC, among other agencies, to promulgate regulations
implementing its provision.
Qualified Thrift Lender Test
The HOLA requires saving institutions to meet a qualified thrift lender ("QTL")
test. Under the QTL test, as modified by FDICIA, a savings association is
required to maintain at least 65% of its "portfolio assets" (total assets less
(i) specified liquid assets up to 20% of total assets, (ii) intangibles,
including goodwill, and (iii) the value of property used to conduct the
association's business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) on a monthly basis in 9 out of every 12 months.
2
<PAGE>
Limitation on Capital Distributions
OTS regulations impose limitations upon all capital distributions, other than
stock dividends, by savings institutions. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that meets or exceeds all fully phased-in capital requirements
before and after a proposed capital distribution ("Tier 1 Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice but without the approval of the OTS, make capital
distributions during a calendar year equal to the greater of: (i) 100% of its
net income to date during the calendar year plus the amount that would reduce by
one-half its "surplus capital ratio" (the percentage by which its capital to
assets ratio exceeds the ratio of its fully phased-in capital requirements to
its assets) at the beginning of the calendar year; or (ii) 75% of its net income
for the previous four quarters. Any additional capital distributions would
require prior regulatory approval. In the event the Bank's capital fell below
its fully-phased in requirement or the OTS notified the Bank that it was in need
of more than normal supervision, the Bank's ability to make capital
distributions would be restricted. In addition, the OTS could prohibit any
proposed capital distribution by any institution if it determines that such
distribution would constitute an unsafe or unsound practice. Furthermore, under
the OTS prompt corrective action regulations, which took effect on December 19,
1992, the Bank generally would be prohibited from making any capital
distribution if, after the distribution, the Bank would have (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio
of less than 4% or (iii) a Tier 1 core capital ratio of less than 3%. As of
December 31, 1997, the Bank exceeds all fully-phased in capital requirements.
Branching
The Bank currently meets the tests provided in the HOLA and OTS regulations to
permit savings institutions to branch nationwide. Additionally, the OTS
authority preempts any state law purporting to regulate branching by savings
institutions.
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, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company 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 Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
the components of capital, risk weightings of assets, and other factors.
Quantitative measures are established by regulation regarding minimum amounts
and ratios 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 December 31, 1997, that the
Company meets all capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification received from the OTS
categorized the Company as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Company must
maintain the total risk-based, Tier I risk-based and Tier I adjusted asset
ratios. There are no conditions or events since that notification that
management believes have changed the institution's category.
FDICIA required that the OTS revise risk-based capital standards, with
appropriate transition rules, to ensure that they take account of interest rate
risk, concentration of risk and the risks of nontraditional activities. Under
OTS regulation effective January 1, 1994, a savings institution with interest
rate risk
3
<PAGE>
exposure above a specified percentage must deduct a specified interest rate risk
component when calculating total capital for purposes of determining whether it
meets OTS risk-based capital requirements. As of December 31, 1997, 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 Company 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 capital ratios discussed above, along with the Company's actual capital
amounts and ratios are presented in a table within Note 16 to the consolidated
financial statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report.
INSURANCE OF DEPOSIT ACCOUNTS
As required by FDICIA, in 1993, the FDIC established a risk-based assessment
system for insured depository institutions that takes into account the risks
attributable to different categories and concentrations of assets and
liabilities, the likely amounts of any loss, and the revenue needs of the
insurance fund.
Insurance of deposits may be terminated by the FDIC after notice and hearing,
upon finding by the FDIC that the savings institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations,
or has violated any applicable law, rule, regulation, order or condition imposed
by, or written agreement with, the FDIC. Additionally, if insurance termination
proceedings are initiated against a savings institution, the FDIC temporarily
may suspend insurance on new deposits received by an institution under certain
circumstances. Management is not aware of any activity or condition which could
result in a termination of its deposit insurance.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require financial institutions to maintain
noninterest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). Because required reserves must be maintained in
the form of either vault cash, a noninterest bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As such, the Company has registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. As a unitary savings and loan holding company, the Company
generally will not be restricted under existing laws as to the types of business
activities in which it may engage, provided that the Bank continues to be a QTL.
The HOLA requires the Company to obtain regulatory approvals prior to entering
into certain transactions such as mergers with or acquisitions of other
institutions or holding companies.
LENDING ACTIVITIES
General
At December 31, 1997, the loan portfolio, before deducting the allowance for
possible loan losses, was $718.7 million, representing 60.0% of total assets and
an increase of $14.1 million over the prior year.
4
<PAGE>
Loan originations increased in 1997 primarily due to the growth of the New
England residential real estate market, and in the Massachusetts and New
Hampshire economies generally. The increase also reflects a stronger marketing
effort by the Bank in the commercial and consumer loan areas. First Essex
originates residential first mortgage loans, commercial real estate loans,
construction loans, consumer loans and commercial loans. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition."
The following table sets forth information concerning First Essex's loan
portfolio, including mortgage loans held for sale, at the dates indicated. The
balances shown in the table are net of unadvanced funds and unearned discounts
and fees. Required disclosure regarding maturity distribution is shown on pages
26 and 27.
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<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996 1995 1994 1993
---------------- --------------- --------------- --------------- ---------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
Residential $274,865 38.2% $301,869 42.8% $235,204 47.0% $264,848 61.6% $203,574 70.1%
Commercial 83,077 11.6 102,718 14.6 53,504 10.7 25,786 6.0 28,755 9.9
Construction 31,851 4.4 24,855 3.5 14,210 2.8 15,527 3.6 14,482 5.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate loans $389,793 54.2 $429,442 61.0 $302,918 60.5 306,161 71.2 $246,811 85.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Owner occupied commercial
real estate(1) 52,335 7.3 29,465 4.2 -- -- -- -- -- --
Commercial loans 67,018 9.3 63,695 9.0 66,737 13.4 55,377 12.9 15,416 5.3
Aircraft loans 41,220 5.8 33,802 4.8 14,478 2.9 522 0.1 -- --
Consumer loans:
Home Equity, Home Improvement
& Second Mortgage 59,897 8.3 52,280 7.4 35,257 7.1 25,263 5.9 18,994 6.5
Automobile 103,551 14.4 92,175 13.1 76,590 15.3 34,906 8.1 2,435 0.8
Other 4,901 0.7 3,800 0.5 4,071 0.8 7,582 1.8 6,855 2.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer loans 168,349 23.4 148,255 21.0 115,918 23.2 67,751 15.8 28,284 9.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans $718,715 100.0% $704,659 100.0% $500,051 100.0% $429,811 100.0% $290,511 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>
(1) During 1996, management began to report this category of loans separate from
its other commercial and commercial real estate loans. Management believes this
category of loans is distinguishable from its other commercial lending products.
In 1996 and 1997, the Company reclassified certain loans to this category from
other more historical classification categories.
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Residential Mortgage Loans
The Bank originates residential first mortgage loans in its market area. At
December 31, 1997, the residential mortgage loan portfolio was $274.9 million,
representing 38.2% of the loan portfolio. The Company's residential first
mortgage loan products consist of six month, one-year, three-year, five-year and
seven-year adjustable-rate mortgages and fixed-rate mortgages, having terms of
15 to 30 years.
5
<PAGE>
Commercial Real Estate Loans
The Bank also holds loans secured by commercial real estate, such as
manufacturing, retail, apartment and office buildings. At December 31, 1997,
First Essex's commercial real estate loan portfolio had an outstanding balance
of $83.1 million, representing 11.6% of First Essex's loan portfolio.
Generally, commercial real estate loans in the portfolio have been made to
finance the acquisition or retention of income producing properties. The current
policy of First Essex is to limit commercial real estate loans primarily to
properties in eastern Massachusetts and southern New Hampshire.
Commercial real estate loans generally reprice over periods ranging from six
months to five years based on a published prime rate or other index.
Construction Loans
Construction loans are primarily made to developers and builders for the
construction of commercial and single family properties. Construction loans have
generally been made with maturities of one year or less and a price based on the
published prime, subject to renewal or extension by the Bank. Additionally,
loans are made to qualified individuals for construction of single-family
owner-occupied homes that convert to permanent mortgages upon completion of
construction. At December 31, 1997, the Bank's construction loan portfolio had
an outstanding balance of $31.8 million, representing 4.4% of the loan
portfolio.
Owner-Occupied Commercial Real Estate Loans
Owner-occupied commercial real estate loans are extensions of credit to
commercial borrowers for the construction or purchase of business space,
primarily for the borrower's own use, or loans to commercial borrowers for
operating purposes in which the Bank has taken real estate occupied by the
borrower as collateral. In these instances, the cash flow of the borrower's
business is the primary source of repayment. At December 31, 1997, this
portfolio had total outstandings of $52.3 million, representing 7.3% of the
Bank's loan portfolio.
Commercial Loans
At December 31, 1997, the portfolio of commercial loans totaled $67.0 million,
representing 9.3% of the loan portfolio. The Bank offers secured and unsecured
demand loans, time loans, term loans, lines of credit and working capital loans
which are short term or have adjustable rates. Commercial loans are originated
by the Bank's commercial lending officers who are supported by a credit,
processing and documentation staff.
Aircraft Loans
The Bank also has a niche market in commercial and consumer aircraft lending
which represented 5.8% of the loan portfolio, at December 31, 1997. Commercial
aircraft loans totaled $32.6 million and consumer aircraft loans totaled $8.6
million of the $41.2 million aircraft portfolio.
Consumer Loans
The portfolio of consumer loans, representing 23.4% of the loan portfolio,
consists of automobile loans, fully or partially secured personal loans, boat
loans, aircraft loans, second mortgage loans, home equity loans and education
loans, as well as unsecured personal loans, which totaled $168.3 million at
6
<PAGE>
December 31, 1997. Automobile loans include dealer indirect loans, as well as
loans originated directly in retail branches. The Bank offers a variable rate
home equity line of credit called "First Line Equity Credit". This product
consists of a line of credit, secured by a second mortgage on residential
property, with a monthly adjustable interest rate at a margin above a published
prime rate.
Risks Associated with Commercial Real Estate, Commercial, Owner-Occupied
Commercial Real Estate and Construction Loans
Commercial real estate and commercial lending involve significant additional
risks compared with one-to-four family residential mortgage lending, and,
therefore, typically account for a disproportionate share of delinquent loans
and real estate owned through foreclosure. Such lending generally involves
larger loan balances to single borrowers or groups of related borrowers than
does residential lending, and repayment of the loan depends in part on the
underlying business and financial condition of the borrower and is more
susceptible to adverse future developments. If the cash flow from
income-producing property is reduced (for example, because leases are not
obtained or renewed), the borrower's ability to repay the loan may be materially
impaired. These risks can be significantly affected by considerations of supply
and demand in the market for office, manufacturing and retail space and by
general economic conditions. As a result, commercial real estate and commercial
loans are likely to be subject, to a greater extent than residential property
loans, to adverse conditions in the economy generally.
Construction loans are, in general, subject to the same risks as commercial real
estate loans, but involve additional risks as well. Such additional risks are
due to uncertainties inherent in estimating construction costs, delays arising
from labor problems, shortages of material, uncertain marketability of a
complete project and other unpredictable contingencies that make it relatively
difficult to determine accurately the total loan funds required to complete a
project or the value of the completed project. Construction loan funds are
advanced on the security of the project under construction, which is of
uncertain value prior to the completion of construction. When a construction
project encounters cost overruns, marketing or other problems, it may become
necessary, in order to sustain the project and to preserve collateral values,
for the lender to advance additional funds and to extend the maturity of its
loan. In a declining market, there is no assurance that this strategy will
successfully enable the lender to recover outstanding loan amounts and interest
due. Moreover, foreclosing on such properties results in administrative expense
and substantial delays in recovery of outstanding loan amounts and provides no
assurance that the lender will recover all monies due to it, either by
developing the property, subject to regulatory limitations and to the attendant
risks of development, or by selling the property to another developer.
Residential Loan Servicing and Purchase and Sale of Loans
The Bank generally writes residential mortgage loans to meet the requirements
for sale in the secondary market. From time to time, the Bank sells residential
mortgage loans and residential loan servicing. Such loan sales represent a
potential source of liquidity to meet lending demand and deposit flows. See Item
7 - "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset/Liability Management."
At December 31, 1997, the Bank's residential loan servicing portfolio totaled
$32.1 million.
NON-PERFORMING ASSETS
7
<PAGE>
General
Non-performing assets consist of non-accruing loans (including loans impaired
under the Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan,"), other real estate owned
and other foreclosed property. For further information regarding the impairment
of loans see "Provision for Possible Loan Losses" included in Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Non-Accruing Loans
It is the general practice of the Bank to discontinue accrual of interest on
loans for which payment of interest or principal is 90 days or more past due and
such other loans where collection of interest and principal is doubtful. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on non-accrual status. At December 31,
1997, the Bank's non-accruing loans totaled $5.5 million compared to $4.7
million on December 31, 1996. For further information regarding the Bank's
non-accruing loans, see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations Financial Condition -
Non-Performing Assets."
Restructured Loans
These are loans on which concessions have been made in light of the debtor's
financial difficulty with the objective of maximizing recovery and with respect
to which the renegotiated payment terms are being met. At December 31, 1997 and
1996, the Bank had restructured loans with outstanding principal balances of
$905,000 and $1.0 million, respectively. For further information regarding
restructured loans, see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Non-Performing Assets."
Foreclosed Property
Foreclosed property at December 31, 1997 totaled $891,000, compared to $1.9
million at December 31, 1996.
Foreclosed property consists of real or tangible property that collateralized a
loan prior to foreclosure or repossession. These properties are carried at the
lower of cost or the estimated net realizable values. Any decreases in value
prior to sale are charged to operations.
For further information regarding the Bank's foreclosed property, see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Non-Performing Assets."
INVESTMENT ACTIVITIES
The Bank maintains an investment portfolio to provide a source of interest and
dividend income and a potential source of liquidity to meet lending demand and
deposit flows. At December 31, 1997, the investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities, stock
in the Federal Home Loan Bank of Boston and stock of the Savings Bank Life
Insurance Company of Massachusetts, was $416.0 million, or 34.7% of total
assets.
Interest and dividend income on the investment portfolio generated 30.0% of
total interest and dividend income for the year ended December 31, 1997. See
Item 7 - "Management's Discussion and Analysis of
8
<PAGE>
Financial Condition and Results of Operations - Financial Condition -
Investments" for further information regarding the investment portfolio.
The Bank's investment strategy seeks to provide liquidity and realize current
income while preserving principal. The Bank will generally invest only in
government or corporate bonds or securities issued in the United States and will
only purchase bonds which are rated A or higher at the time of purchase.
DEPOSITS
The Bank offers a range of deposit accounts including regular and passbook
savings, NOW, money market and demand deposit accounts. The Bank offers a number
of relationship products which allow customers to combine balances in checking
and savings accounts in order to avoid service and maintenance fees, and obtain
free banking services. These relationship products also include discounts on
installment loans and bonus rates on certificates of deposit. The Bank also
offers 60-day to 7 year term deposit certificates. Interest rates on these
certificates vary according to the term selected. From time to time, the Bank
promotes various types of accounts with the intention of changing the maturity
schedule of its liabilities.
The Bank offers its retail banking customers a wide range of deposit services
and the convenience of drive- up ATMs. The Bank is a member of the NYCE(TM),
EXCHANGE(TM), TX(TM) and CIRRUS(TM) networks. These networks allow the Bank's
depositors access to their accounts through ATMs at the Bank, other banks and
locations nationwide and worldwide.
COMPETITION
The Bank faces competition both in originating loans and in attracting deposits.
Competition in originating loans comes from a variety of sources, including, but
not limited to, other thrift institutions, commercial banks, mortgage companies,
insurance companies and consumer and commercial finance companies. The Bank
competes for loans principally on the basis of interest rates and loan fees, the
types and terms of loans originated and the quality of services provided to
borrowers. In attracting deposits, the primary competitors are other thrift
institutions, commercial banks, mutual funds and credit unions. The ability to
attract and retain deposits depends on the ability to provide investment
opportunities that satisfy the requirements of investors with respect to rate of
return, liquidity, risk, service, convenience and other factors. The Bank
competes for deposits on the basis of interest rates and by offering convenient
branch locations, extended business hours and an automated teller network.
EMPLOYEES
At December 31, 1997, the Bank had 303 employees, of whom 67 were part-time.
None of the employees of the Bank are represented by a collective bargaining
group and management considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal banking subsidiary, First Essex Bank, FSB, operates
banking facilities in ten locations in northern Massachusetts, and five
locations in southern New Hampshire. The offices of the Bank are in good
physical condition with modern equipment and facilities considered adequate to
meet the banking needs of customers in the communities serviced.
9
<PAGE>
The offices of the Company are located in the Bank's branch office at 71 Main
Street in Andover, Massachusetts.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its business,
none of which is believed by management to be material to the financial
condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders during the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND
RELATED STOCKHOLDER MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on the
National Market System of the National Association of Securities Dealers,
Inc. Automated Quotation System (NASDAQ) under the symbol FESX.
At December 31, 1997, there were 7,536,424 shares outstanding and approximately
1,400 shareholders of record. This does not reflect the number of persons or
entities who hold their stock in nominee or street name through various
brokerage firms.
The price information regarding the Company's common stock in the following
table is based on high and low closing sales prices on NASDAQ.
- --------------------------------------------------------------------------------
10
<PAGE>
Dividend
Price Per Share Declared
HIGH LOW per Share
---- --- ---------
1997
----
First Quarter $16.750 $13.375 $.12
Second Quarter 17.500 14.500 .12
Third Quarter 20.500 16.500 .12
Fourth Quarter 23.250 19.000 .14
1996
----
First Quarter $11.750 $10.187 $.12
Second Quarter 11.000 10.375 .12
Third Quarter 12.000 10.000 .12
Fourth Quarter 14.500 11.625 .12
- --------------------------------------------------------------------------------
The only funds available to the Company for the payment of dividends are cash
and cash equivalents held at the holding company level, dividends from the Bank
and borrowings. In addition, bank regulatory authorities generally restrict the
amounts available for the payment of dividends by the Bank to First Essex to the
net profit of the Bank for that year, see Item 1 "Business - Regulation -
Limitation on Capital Distributions". The Federal Reserve Act also restricts the
Bank in lending or advancing funds to First Essex unless such loans are
collateralized by specific obligations, and limits collateralized loans to 10%
of the Bank's capital stock and surplus.
The Bank is prohibited from paying cash dividends, to the extent that any such
payment would reduce its capital below required regulatory capital levels or
would impair the liquidation account established in connection with its
conversion from mutual to stock form. See Note 16 to the consolidated financial
statements included in response to Item 8 - "Financial Statements and
Supplementary Data" of this report for further discussion.
The payment of dividends by the Bank could carry significant adverse tax
consequences. To the extent that distributions by the Bank to the holding
company exceeds the Bank's current and accumulated earnings and profits (as
computed for federal income tax purposes for taxable years beginning after
December 31, 1951), those distributions would be treated for tax purposes as
first being made out of the Bank's bad debt reserve. In that case, the Bank
would have federal taxable income equal to approximately one and one-half times
the amount of the actual shareholder distribution that is treated as made out of
the Bank's bad debt reserves.
ITEM 6. SELECTED FINANCIAL DATA
11
<PAGE>
<TABLE>
<CAPTION>
At December 31,
1997 1996 1995 1994 1993
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total assets $1,197,459 $1,067,175 $808,792 $806,872 $645,873
Loans receivable 708,145 694,121 493,499 422,574 282,760
Investment securities (1) 416,021 315,749 275,900 346,943 329,823
Foreclosed property 891 1,880 1,756 3,038 6,360
Deposits 744,322 690,953 491,469 456,878 398,233
Borrowed funds 343,557 274,958 245,569 279,948 185,001
Stockholders' equity 91,065 83,141 60,172 54,757 50,749
Years Ended December 31,
1997 1996 1995 1994 1993
(Dollars in thousands, except per share data)
Operating Data:
Interest and
dividend income $90,078 $63,545 $60,914 $45,057 $36,183
Interest Expense 52,377 37,317 37,081 22,707 16,654
---------- ---------- ---------- ---------- ----------
Net interest income 37,701 26,228 23,833 22,350 19,529
Provision for loan losses 2,040 1,415 770 -- --
Net gain (loss) on sales
of securities 439 497 (13) -- --
Net gain on sales of mortgage loans
and mortgage servicing rights 1,628 1,352 1,431 260 730
Net gain on sales of
foreclosed property 502 109 53 141 895
Other income 3,021 2,416 2,290 2,301 2,465
Noninterest expenses 24,866 20,034 19,297 19,331 19,290
Income tax
expense (benefit) 6,672 40 75 (805) (2,621)
---------- ---------- ---------- ---------- ----------
Net income $9,713 $9,113 $7,452 $6,526 $6,950
========== ========== ========== ========== ==========
Per Share Data:
Earnings per share - basic (2) $1.30 $1.51 $1.24 $1.08 $1.15
Earnings per share - diluted (2) 1.25 1.47 1.22 1.08 1.15
Dividends declared 0.50 0.48 0.40 0.28 0.11
Book value at
end of period 12.08 11.20 9.99 9.10 8.44
Selected Financial Ratios:
Return on average assets 0.80% 1.08% 0.91% 0.94% 1.24%
Return on average equity 10.54 14.37 12.79 12.42 14.83
Average equity as a
percentage of average assets 7.32 7.54 7.09 7.56 8.34
Weighted average interest
rate spread 2.77 2.72 2.56 3.02 3.29
Net yield on average
earning assets 3.31 3.22 2.99 3.33 3.60
</TABLE>
(1) Investment securities include short term investments, U.S. government and
agency obligations, mortgage-backed securities, other bonds and
obligations, stock in the Federal Home Loan Bank of Boston and stock in
the Savings Bank Life Insurance Company.
(2) Earnings per share computed in accordance with Statement of Financial
Accounting Standards No. 128.
- --------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
12
<PAGE>
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
General
The results of operations of the Company consist primarily of the results of
operations of the Bank which is the Company's sole subsidiary. Pretax income for
1997 rose $7.2 million or 79% over 1996. The improvement was in part due to the
increase in net average earning assets combined with the increase in the
weighted average interest rate spread. See also Item 1. "Business Current Market
Conditions/Recent Operating Results."
Net income for the year ended December 31, 1997 totaled $9.7 million (or $1.25
per share) compared to $9.1 million (or $1.47 per share) for the same period in
1996. The lower growth in net income (6.6%), compared to pretax income, is
reflective of the Company's return to a fully taxable status in 1997. Earnings
per share (EPS) for 1997 have been computed in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" which is
effective for the 1997 fiscal year. All prior EPS calculations have been
restated in accordance with SFAS No. 128.
13
<PAGE>
Analysis of Average Yields Earned and Rates Paid
The following table presents an analysis of average yields earned and rates paid
for the years indicated
<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996 1995
--------------------------- --------------------------- ---------------------------
Interest Average Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Assets
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Earning Assets
Short-term investments $9,826 $585 5.95% $8,589 $451 5.25% $6,735 $342 5.08%
Investment securities 405,639 26,418 6.51 267,493 16,202 6.06 316,501 19,354 6.11
Other earning assets 7,333 517 7.05 -- -- -- --
Total loans (1) 715,772 62,558 8.74 538,758 46,892 8.70 473,069 41,218 8.71
---------- ------ -------- ------ -------- ------
Total earning assets 1,138,570 90,078 7.91 814,840 63,545 7.80 796,305 60,914 7.65
---------- ------ -------- ------ -------- ------
Allowance for possible loan losses (10,197) (6,734) (6,447)
---------- --------
Total earning assets less allowance
for possible loan losses 1,128,373 808,106 789,858
Other Assets 57,841 32,652 31,889
---------- -------- --------
Total Assets $1,186,214 $840,758 $821,747
========== ======== ========
Liabilities and Stockholders' Equity
NOW accounts 40,806 527 1.29% 32,846 399 1.21% 28,664 325 1.13%
Money market accounts 73,571 1,698 2.31 72,632 1,606 2.21 79,593 1,586 1.99
Savings accounts 123,204 4,134 3.36 49,822 862 1.73 51,069 816 1.60
Time deposits 422,978 24,870 5.88 320,649 19,079 5.95 294,473 17,117 5.81
---------- ------ -------- ------
Total interest bearing
deposits 660,559 31,229 4.73 475,949 21,946 4.61 453,799 19,844 4.37
Borrowed funds 359,390 21,148 5.88 259,070 15,371 5.93 274,956 17,237 6.27
---------- ------ -------- ------ -------- ------
Total interest bearing deposits
and borrowed funds 1,019,949 52,377 5.14 735,019 37,317 5.08 728,755 37,081 5.09
Demand deposits 62,220 30,804 23,550
Other liabilities 17,204 11,530 11,195
---------- -------- --------
Total liabilities 1,099,373 777,353 763,500
Stockholders' equity 86,841 63,405 58,247
---------- -------- --------
Total liabilities and
stockholders' equity $1,186,214 $840,758 $821,747
========== ======== ========
Net interest income $37,701 $26,228 $23,833
======= ======= =======
Weighted average rate spread 2.77% 2.72% 2.56%
==== ==== ====
Net yield on earning assets (2) 3.31% 3.22% 2.99%
==== ==== ====
</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 interest earnings assets
- --------------------------------------------------------------------------------
14
<PAGE>
Rate/Volume Analysis
The following table presents, for the periods indicated, the changes in interest
and dividend income and the changes in interest expense attributable to changes
in interest rates and changes in the volume of interest earning assets and
interest bearing liabilities. The change attributable to both volume and rate
has been allocated proportionally to the two categories
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 31,
1997 Compared to 1996 1996 Compared to 1995
Increase (Decrease) Increase (Decrease)
Due to Due to
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest and dividend income:
Loans before the allowance for
possible loan losses $15,392 $274 $15,666 $6,064 ($390) $5,674
Investment securities 8,917 1,299 10,216 (2,970) (182) (3,152)
Interest on other earning assets 517 0 517 -- -- --
Federal funds sold and short-term investments 70 64 134 97 12 109
------- ----- ------- ------ ----- ------
Total interest and dividend income 24,896 1,637 26,533 3,191 (560) 2,631
------- ----- ------- ------ ----- ------
Interest expense:
Savings deposits 2,122 1,370 3,492 (48) 188 140
Time deposits 6,089 (298) 5,791 1,550 412 1,962
Borrowed funds 5,952 (175) 5,777 (968) (898) (1,866)
------- ----- ------- ------ ----- ------
Total interest expense 14,163 897 15,060 534 (298) 236
------- ----- ------- ------ ----- ------
Net interest and dividend income $10,733 $740 $11,473 $2,657 ($262) $2,395
======= ==== ======= ====== ===== ======
</TABLE>
- --------------------------------------------------------------------------------
Net Interest Income
Net interest income increased by $11.5 million to $37.7 million for the year
ended December 31, 1997, representing a 43.7% increase from $26.2 million in
1996. The increase in net interest income is primarily due to the $323.7 million
increase (39.7%) in average earning assets along with an increase of 9 basis
points in the net yield on average earning assets. As reflected in the above
rate/volume table, the primary contributor to the 1997 increase is the volume
increases in outstanding loans.
Net interest income increased by $2.4 million to $26.2 million for the year
ended December 31, 1996, representing a 10.0% increase from $23.8 million in
1995. The increase in net interest income is primarily due to the $18.5 million
increase (2.3%) in average earning assets along with an increase of 23 basis
points in the net yield on average earning assets. The increase in the net yield
is attributable to the declining interest cost of borrowed funds and interest
bearing deposits.
Interest and Dividend Income
Interest and dividend income increased by $26.5 million (41.8%) to $90.1 million
for the year ended December 31, 1997 from $63.5 million in 1996. This increase
was due to the increase in average earning assets associated with the Finest
acquisition and the increased leveraging. Average earning assets increased from
$814.8 million in 1996 to $1,138.6 million in 1997, a 39.7% increase. The net
yield on average earning assets rose 9 basis points from the 1996 yield of 3.22%
to 3.31% in 1997.
15
<PAGE>
Interest and dividend income increased by $2.6 million (4.3%) to $63.5 million
for the year ended December 31, 1996 from $60.9 million in 1995. This increase
was primarily due to the increase in average earning assets. Average earning
assets increased from $796.3 million in 1995 to $814.8 million in 1996, a 2.3%
increase. The net yield on average earning assets rose 23 basis points from the
1995 yield of 2.99% to 3.22% in 1996.
Interest Expense
Interest expense increased by $15.1 million (40.4%) to $52.4 million for the
year ended December 31, 1997 from $37.3 million in 1996. The increase is also
volume related and attributable to deposits acquired in the Finest acquisition
together with increased borrowings. The total weighted cost of funds increased
slightly from a level of 5.08% in 1996 to 5.14% in 1997.
Interest expense increased slightly by $236,000 (0.6%) to $37.3 million for the
year ended December 31, 1996 from $37.1 million in 1995. The increase is
attributable in part to an increase of $2.1 million in the amount paid on
depositors' accounts offset by a decrease of $1.9 million paid on borrowed
funds. The total weighted cost of funds decreased slightly from a level of 5.09%
in 1995 to 5.08% in 1996.
Provision for Possible Loan Losses
Beginning in 1995, the Company adopted SFAS No. 114, as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114"). Under SFAS
No. 114, the Company considers a loan impaired if it is ninety days or more past
due as to principal and interest, or if management's credit risk assessment
determines that it is probable that principal and interest will not be collected
as contractually scheduled. In addition, loans which are restructured at market
rates and comparable to loans with similar risks are considered impaired only in
the year of the restructuring, so long as they continue to perform according to
the restructured terms. Excluded from the impaired category, but otherwise
considered non-accruing loans, are small balance homogeneous loans which are
ninety days or more past due. Small balance homogeneous loans include
residential mortgage loans, residential construction loans to individuals
(excluding builder construction loans) and consumer loans. The Company evaluates
a loan's level of impairment by measuring the net present value of the expected
future cash flows using the loan's original effective interest rate, or looking
at the fair value of the collateral if the loan is collateral dependent. When
the difference between the net present value of the impaired loan (or fair value
of the collateral if the loan is collateral dependent) is lower than the
recorded investment of the loan, the difference is provided to expense with a
resulting valuation allowance.
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.
Provisions for possible loan losses totaled $2.0 million, $1.4 million and
$770,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Included in those amounts were $635,000, $659,000 and $356,000, respectively, of
provisions for possible losses related to loans impaired under SFAS No. 114.
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 market
16
<PAGE>
and the economy generally. 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."
The Bank's total allowance for possible loan losses was $10.6 million or 190.7%
of non-accruing loans at December 31, 1997 compared to $10.5 million or 222.4%
at December 31, 1996 and $6.6 million or 148.4% at December 31, 1995.
Noninterest Income
Noninterest income consists of net gains or losses from sales of securities, net
gains from sales of loans and loan servicing rights, fee and other noninterest
income.
Noninterest income increased 19.3% to $5.1 million for the year ended December
31, 1997 compared to $4.3 million in 1996. The primary reason for the increase
from 1996 to 1997 was an increased gain on the sale of mortgage loans and
mortgage servicing rights, which rose by $276,000 from $1.4 million in 1996, to
$1.6 million in 1997. Fee income also increased by $631,000 from $2.4 million in
1996 to $3.0 million in 1997.
Noninterest income increased to $4.3 million for the year ended December 31,
1996 compared to $3.7 million in 1995. The primary reason for the increase from
1995 to 1996 was an increased gain on the sale of investment securities, which
rose by $510,000 from a loss of $13,000 in 1995, to a gain of $497,000 in 1996.
Loan fees also increased by $36,000 from $477,000 in 1995 to $513,000 in 1996.
Noninterest Expenses
Noninterest expenses increased by $4.4 million (22.3%) to $24.4 million for the
year ended December 31, 1997 compared to $19.9 million in 1996. Much of this
increase is attributable to operating five more banking offices in 1997 than in
1996.
Noninterest expenses increased by $681,000 (3.5%) to $19.9 million for the year
ended December 31, 1996 compared to $19.2 million in 1995. This increase is
primarily due to a $1.4 million increase in salary and employee benefits and
building and equipment costs, offset by a decrease of $606,000 and $118,000 in
other operating and foreclosed property expenses, respectively.
Salaries and employee benefits increased by $1.6 million (15.6%) to $11.6
million for the year ended December 31, 1997 from $10.1 million in 1996 and $9.0
million in 1995. The increases were primarily due to costs associated with
personnel to support business growth which was more marked in 1997 due to a full
year of operations at five new banking offices.
Building and equipment costs increased $519,000 to $4.1 million for 1997
compared to $3.6 million in 1996 and $3.3 million in 1995. The increase in 1997
was due primarily to costs associated with the full year of operation of two new
branches, one located in Salem, New Hampshire, the other at the Crosspoint
Towers in Lowell, Massachusetts, together with the costs of operating the three
banking offices acquired in the Finest acquisition.
Amortization of goodwill associated with the acquisition of Finest was $780,000
for the year.
All other operating expenses increased in total by $1.0 million (16.6%) to $7.3
million for the year ended December 31, 1997 compared to $6.3 million in 1996
and $7.0 million in 1995.
17
<PAGE>
Income Taxes
The net provision for income taxes amounted to $6.7 million in 1997 compared to
provisions of $40,000 and $75,000 recorded in 1996 and 1995, respectively. The
Company returned to the position of providing income taxes at the full statutory
rates in 1997.
The amounts recorded in each year were based on management's quarterly review of
the operations of the Company, the realizability of the deferred tax asset, and
management's analysis of future taxable income. Management has valued the
deferred tax asset in accordance with regulatory guidelines. For further
information on income taxes, see Note 9 of Notes to Consolidated Financial
Statements.
FINANCIAL CONDITION
Total assets amounted to $1.2 billion at December 31, 1997, an increase of
$130.3 million or 12.2% from $1.1 billion at December 31, 1996. The majority of
the increase ($100.3 million) for 1997 relates to the growth in the investment
portfolio which was $416.0 million at December 31, 1997 compared to $315.7
million a year earlier.
Loans
At December 31, 1997, the loan portfolio, excluding the allowance for possible
loan losses, and including mortgage loans held-for-sale, was $718.7 million,
representing 60.0% of total assets, compared to $704.7 million or 66.0% of total
assets at December 31, 1996. See Item 1 - "Business - Lending Activities -
General" for a table setting forth the composition of the loan portfolio of the
Bank at the end of each of the past five years.
The Bank's indirect automobile lending program resulted in $103.6 million, $92.2
million and $76.6 million of automobile loans for the years ending December 31,
1997, 1996 and 1995, respectively. Aircraft loans, an increasing lending
activity for the Bank, totaled $41.2 million in 1997 compared to $33.8 million
in 1996, and $14.5 million in 1995.
Non-Performing Assets
Non-performing assets consist of non-accruing and restructured loans (including
loans impaired under SFAS No. 114), and foreclosed property. Non-performing
assets totaled $6.4 million at December 31, 1997, compared to $6.6 million at
December 31, 1996 and $6.2 million at December 31, 1995.
The Bank's general practice is to discontinue the accrual of interest on loans
(including loans impaired under SFAS No. 114) for which payment of interest or
principal is ninety 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 current period interest income.
The principal balance of restructured loans was $905,000 for the year ended
December 31, 1997, and $1.0 million for both years ended December 31, 1996 and
1995.
If the non-accruing loans at December 31, 1997 and 1996 had been current in
accordance with their original terms, the amount of interest income that would
have been recorded is $570,000 and $140,000, respectively. Interest income
recognized on impaired loans, using the cash basis of accounting, amounted to
approximately $293,000 for the year ended December 31, 1997 compared to
approximately $244,000 in 1996. The amount of interest that was collected and
recorded as income on non-performing
18
<PAGE>
loans was $465,000 and $350,000 for the years ended December 31, 1997 and 1996
respectively.
Foreclosed property at December 31, 1997 totaled $891,000 compared to $1.9
million at December 31, 1996 and consists mainly of real estate collateral from
loans which were foreclosed.
At December 31, 1997, the recorded investment in loans that are considered to be
impaired under SFAS No. 114 totaled $2.8 million of which $2.5 million had a
related allowance for possible loan losses of $1.0 million. The remaining
$309,000 of impaired loans did not require a related allowance for possible loan
losses. The average recorded investment in impaired loans during 1997 was
approximately $2.6 million.
The following table shows the composition of non-performing assets for the five
years ended December 31, 1997:
- --------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accruing loans:
Real estate $3,159 $2,693 $2,559 $6,548 $9,743
Other 1,480 1,004 814 776 1,325
Restructured loans 905 1,042 1,043 -- --
------ ------- ------ ------- -------
Total non-accruing loans 5,544 4,739 4,416 7,324 11,068
Foreclosed property 891 1,880 1,756 3,038 6,360
------ ------- ------ ------- -------
Total non-performing assets $6,435 $6,619 $6,172 $10,362 $17,428
====== ======= ====== ======= =======
Percentage of non-performing
to total assets 0.54% 0.62% 0.76% 1.28% 2.70%
Percentage of allowance for
possible loan losses
to non-accruing loans 190.7% 222.4% 148.4% 98.8% 70.0%
- --------------------------------------------------------------------------------
The following table summarizes the activity of foreclosed property during the
year ended December 31, 1997:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Other
Residential Construction Commercial Repossessed
Real Estate Real Estate Real Estate Assets Total
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $978 $0 $809 $93 $1,880
Transfer from loans 607 -- 838 2,008 3,453
Write-downs (34) -- -- -- (34)
Sales (1,051) -- (1,344) (2,013) (4,408)
---------- ---------- ---------- ---------- ----------
Balance at end of year $500 $0 $303 $88 $891
========== ========== ========== ========== ==========
</TABLE>
19
<PAGE>
- --------------------------------------------------------------------------------
Allowance for Possible Loan Losses
The allowance for loan losses is maintained at a level determined by management
to be adequate to provide for probable losses inherent in the loan portfolio
including commitments to extend credit. The allowance for loan loss is
maintained through the provision for loan losses, which is a charge to
operations. The potential for loss in the portfolio reflects the risks and
uncertainties inherent in the extension of credit.
The determination of the adequacy of the allowance of possible loan losses is
based upon management's assessment of risk elements in the portfolio, factors
affecting loan quality and assumptions about the economic environment in which
the Company operates. The process includes identification and analysis of loss
potential in various portfolio segments utilizing a credit risk grading process
and specific reviews and evaluations of significant individual problem credits.
In addition, management reviews overall portfolio quality through an analysis of
current levels and trends in charge-off, delinquency and nonaccruing loan data,
review of forecasted economic conditions and the overall banking environment.
These reviews are of necessity dependent upon estimates, appraisals and
judgments, which may change quickly because of changing economic conditions and
the Company's perception as to how these factors may affect the financial
condition of debtors.
The following table summarizes the activity in the allowance for possible loan
losses for the five years ended December 31, 1997:
- --------------------------------------------------------------------------------
20
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $10,538 $6,552 $7,237 $7,747 $11,759
Acquired allowance - Finest -- 4,080 -- -- --
Provision for possible loan losses 2,040 1,415 770 -- --
Charge offs:
Mortgage (1,212) (1,148) (1,448) (1,703) (4,081)
Construction -- (1) (96) (5) --
Owner-occupied commercial
real estate (1) -- -- -- -- --
Commercial (2) (157) (230) (248) (1,023)
Consumer (1,612) (1,029) (711) (155) (467)
--------- --------- --------- --------- ---------
Total Charge-offs (2,826) (2,335) (2,485) (2,111) (5,571)
Recoveries:
Mortgage 575 277 234 535 649
Construction 14 6 279 240 2
Owner-occupied commercial
real estate (1) -- -- -- -- --
Commercial 85 461 431 727 815
Consumer 144 82 86 99 93
--------- --------- --------- --------- ---------
Total Recoveries 818 826 1,030 1,601 1,559
Net Charge-offs (2,008) (1,509) (1,455) (510) (4,012)
--------- --------- --------- --------- ---------
Balance at end of year $10,570 $10,538 $6,552 $7,237 $7,747
========= ========= ========= ========= =========
Total loans at end of year $718,715 $704,659 $500,051 $429,811 $290,507
Average loans for the year 715,772 538,758 473,069 325,922 286,965
Allowance to loans ratio 1.47% 1.50% 1.31% 1.68% 2.67%
Net Charge-offs to average loans ratio 0.28% 0.28% 0.30% 0.16% 1.40%
</TABLE>
(1) During 1996, management began to report this category of loans separate
from its other commercial and commercial real estate loans. Management
believes this category of loans is distinguishable from its other
commercial lending products. In 1996 and 1997, the Company reclassified
certain loans to this category from other more historical classification
categories. In making this reclassification it was determined that no
restatement of charge-offs and/or recoveries, if any, to this new loan
category would be material or meaningful.
- --------------------------------------------------------------------------------
Investments
At December 31, 1997, the Company's investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities,
Federal Home Loan Bank ("FHLB") stock and Savings Bank Life Insurance Company of
Massachusetts stock, totaled $416.0 million or 34.7% of assets, compared to
$315.7 million or 29.6% of assets at December 31, 1996. The portfolio included
U.S. government and agency obligations having a book value of $122.4 million and
a fair value of $123.3 million and mortgage-backed securities with a book value
of $231.6 million and a fair value of $232.0 million. Interest and dividend
income on the Company's investment portfolio generated 30.0% of total interest
and dividend income for the year ended December 31, 1997. During 1997 the
investment portfolio increased by $100.3 million.
To identify and control 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.
The Company does not have any investments in off balance sheet financial
instruments, except as noted in Note 11 to the consolidated financial statements
included in response to Item 8 - "Financial Statements and Supplementary Data"
of this report.
21
<PAGE>
The following table sets forth the composition of the investment portfolio for
the years indicated:
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Short-term investments:
Interest bearing deposits $122 $3,507 $5,086
Federal funds sold 4,000 16,350 4,500
-------- -------- --------
Total short-term investments 4,122 19,857 9,586
Investment securities held-to-maturity:
U.S. government & agency obligations 54,421 9,978 17,080
Mortgage backed securities 109,661 94,487 118,018
Other bonds and obligations 14,917 -- --
-------- -------- --------
Total investment securities held-to-maturity 178,999 104,465 135,098
Investment securities available-for-sale:
U.S. government & agency obligations 67,960 41,962 --
Mortgage-backed securities 121,977 111,062 91,781
Other bonds and obligations 21,966 21,692 23,372
-------- -------- --------
Total investment securities available for sale 211,903 174,716 115,153
Stock in Federal Home Loan Bank of Boston 19,803 15,517 14,869
Stock in Savings Bank Life Insurance Company 1,194 1,194 1,194
-------- -------- --------
Total investments $416,021 $315,749 $275,900
======== ======== ========
Percent of total assets 34.7% 29.6% 34.1%
For further information regarding the Company's investment portfolio,
including information regarding amortized cost and fair value as of December 31,
1997, see notes 1, 4 and 21 to the Company's consolidated financial statements
included in response to Item 8 hereof.
- --------------------------------------------------------------------------------
Set forth below is a breakdown of yields and contractual maturities for the
amortized cost of indicated investment securities at December 31, 1997
- --------------------------------------------------------------------------------
22
<PAGE>
U.S. Other
government bonds Mortgage-
and agency and backed
obligations obligations securities Total
------------- ------------ ---------- ---------
(Dollars in thousands)
Due in 1 year or less:
Amount $9,993 $3,000 $2,075 $15,068
Yield 6.04% 5.66% 4.40% 5.74%
Due from 1 to 2 years:
Amount -- 15,019 -- 15,019
Yield -- 5.26% -- 5.26%
Due from 2 to 3 years:
Amount 8,750 398 -- 9,148
Yield 6.30% 7.25% -- 6.34%
Due from 3 to 5 years:
Amount 47,815 447 26,488 74,750
Yield 6.74% 8.04% 6.44% 6.64%
Due from 5 to 10 years:
Amount 55,040 3,090 14,727 72,857
Yield 7.09% 5.41% 7.19% 7.04%
Due after 10 years:
Amount -- 15,042 187,379 202,421
Yield -- 6.93% 6.64% 6.66%
----------- ---------- ---------- ----------
Total:
Amount $121,598 $36,996 $230,669 $389,263
Yield 6.81% 6.04% 6.63% 6.60%
- --------------------------------------------------------------------------------
Deposits
23
<PAGE>
Deposits have historically been the Bank's 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 December 31, 1997 the Bank had total deposits of $744.3 million,
representing a net increase of $53.4 million compared to $691.0 million at
December 31, 1996. During 1997, the Bank aggressively marketed savings deposit
products resulting in increases of $80.6 million which were offset by decreases
in money market accounts of $28.2 million.
While deposit flows are by nature unpredictable, management attempts to manage
its deposits through selective pricing. Because of the uncertainty of market
conditions, it is not possible for the Bank to predict how aggressively it will
compete for deposits in the future or the likely effect of any such decision on
deposit levels, interest expense and net interest income.
The following table sets forth the composition of average deposits and rates for
the years indicated with respect to categories exceeding 10% of total average
deposits:
<TABLE>
<CAPTION>
1997 1996 1995
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Amount Rate Amount Rate Amount Rate
--------- ---------- --------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW $40,806 1.29% $32,846 1.21% $28,664 1.13%
Money market accounts 73,571 2.31 72,632 2.21 79,593 1.99
Savings and notice accounts 123,204 3.36 49,822 1.73 51,069 1.60
Time deposits 422,978 5.88 320,649 5.95 294,473 5.81
Total interest bearing deposits 660,559 4.73 475,949 4.61 453,799 4.37
Demand deposits 62,220 30,804 23,550
-------- -------- --------
Total deposits $722,779 $506,753 $477,349
======== ======== ========
</TABLE>
At December 31, 1997, 1996 and 1995, outstanding certificates of deposits in
denominations of $100,000 and over had maturities as follows:
Remaining Term to Maturity 1997 1996 1995
------------ ------------- --------------
(Dollars in thousands)
Three months or less $10,644 $13,993 $3,265
Three to six months 6,673 3,998 8,324
Six to twelve months 27,543 11,816 10,549
Over twelve months 16,926 18,530 2,067
------------ ------------- --------------
Total $61,786 $48,337 $24,205
============ ============= ==============
- --------------------------------------------------------------------------------
24
<PAGE>
Borrowed Funds
The primary source of the Bank's borrowings come from the Federal Home Loan Bank
("FHLB"). The Bank also utilizes short term repurchase agreements, generally
with maturities less than three months, as an additional source of funds.
Repurchase agreements are secured by U.S. government and agency securities.
Borrowings are an alternative source of funds compared to deposits and totaled
$343.6 million at December 31, 1997 compared to $275.0 million and $245.6
million at December 31, 1996 and 1995, respectively. The increase in borrowings
in 1997 from 1996 was used to fund the investment portfolio and loan growth
throughout the year. The increase in borrowings in 1996 to 1995 was used to fund
loan growth during the year.
The following table summarizes the maximum and average amounts of borrowings
outstanding, the majority of which are short-term, during 1997, 1996 and 1995
together with the weighted average interest rates thereon.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997 At December 31, 1997
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
FHLB Borrowings $394,184 $342,975 5.94% $319,744 5.98%
Repurchase Agreements 27,708 16,415 4.75 23,813 4.90
<CAPTION>
For the Year Ended December 31, 1996 At December 31, 1996
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
FHLB Borrowings $278,318 $249,278 5.89% $267,275 5.74%
Repurchase Agreements 33,473 12,732 5.28 7,683 5.18
<CAPTION>
For the Year Ended December 31, 1995 At December 31, 1995
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
FHLB Borrowings $285,372 $263,298 6.22% $219,673 6.10%
Repurchase Agreements 27,019 8,432 5.50 25,896 5.72
</TABLE>
- --------------------------------------------------------------------------------
25
<PAGE>
YEAR 2000
The Company began in mid 1997 to address the issues inherent in the impending
change of century, otherwise known as "Year 2000". The potential problem with
year 2000, which is common to most corporations, concerns the inability of
information systems, primarily software programs, to properly recognize and
process date sensitive information for the year 2000 and beyond. The Company has
organized a bank-wide project team empowered to address and resolve all Year
2000 issues, using a comprehensive project plan. Awareness and assessment phases
have been completed. Renovation, testing and implementation phases are in
process.
The majority of the Company's principal software applications are provided by
third party vendors. These vendors service numerous financial institution
customers all of whom have the same, or similar, year 2000 issues. These vendors
have brought, or are currently working to bring, their software programs into
compliance. Anticipated spending by the Company for compliance maintenance and
modification will be expensed as incurred, while the cost of new hardware or
software will be capitalized, and depreciated or amortized over the useful life
of the asset acquired. The Company does not believe that the changes by it or
its third party vendors will have a material effect on the ongoing results of
operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130 and 131, "Reporting Comprehensive
Income" and "Disclosures About Segments of an Enterprise and Related
Information", respectively. Both of these pronouncements are effective for the
Company's 1998 financial statements. SFAS No. 130 will require increased
disclosure regarding a.) unrealized holding gains/losses on securities
classified as available-for-sale; b.) foreign currency translation adjustments,
if any; and, c.) minimum pension liabilities. 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. The Company
continues to evaluate the applicability of this statement to its operations.
26
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET/LIABILITY MANAGEMENT
The Bank's asset/liability management strategy is designed to increase net
interest income and provide adequate earnings in expected future interest rate
environments. As part of this strategy, a balance is sought between the
repricing characteristics of its earning assets and funding sources while
maximizing the spread between interest income and expense. The Bank adjusts the
level of its liquid assets and the mix of its loans and investments based on
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
In order to achieve a better repricing balance between its assets and
liabilities, the Bank continued to originate and hold in portfolio adjustable
rate residential mortgage loans. The Bank generally writes substantially all
newly originated fixed rate residential loans to meet the requirements for sale
in the secondary market. During 1997 the Bank sold $95.2 million of residential
loans. The Bank's commercial real estate, construction, consumer and commercial
business lending programs also provide opportunities to better match the
interest rate sensitivity of its loan portfolio and liabilities due to the
adjustable rate or short term repricing characteristics of these types of loans.
Total loans increased by $14.1 million during the year.
During 1997 investments increased by $111.7 million. This was a result of
management's planned strategy to grow the investment portfolio. These
investments were funded in part by Federal Home Loan Bank borrowings which
increased by $68.6 million from 1996 to 1997.
Deposits increased by $53.4 million in 1997. This was a result of an aggressive
marketing program for savings deposit products in conjunction with the Bank's
150th anniversary, together with the full year effect of two new branches opened
in late 1996.
It is management's opinion that interest rates will continue to remain stable.
With this in mind, the Bank will continue to follow a strategy which seeks to
achieve a balance in the repricing characteristics of its assets and liabilities
and provide adequate earnings in all plausible interest rate environments.
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 its 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 management related activities
based upon estimated market risk sensitivity, policy limits and overall market
interest rate
27
<PAGE>
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 change 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.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all assets and liabilities
reflected on the Company's balance sheet. This sensitivity analysis is compared
to ALCO policy limits which specify a maximum tolerance level for NII exposure
over a one year horizon, assuming no balance sheet growth, given both a 200
basis point (bp) upward and downward shift in interest rates. A parallel and pro
rata shift in rates over a 12 month period is assumed. The following reflects
the Company's NII sensitivity analysis as of December 31, 1997.
Estimated
Rate Change NII Sensitivity
----------- ---------------
+ 200 bp (0.6%)
- 200 bp (1.4%)
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cashflows,
and others. While assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis,
actual results will also differ due to: prepayment/refinancing levels likely
deviating from those assumed, the varying impact of interest rate change caps or
floors on adjustable rate assets, the potential effect of changing debt service
levels on customers with adjustable rate loans, depositor early withdrawals and
product preference changes, and other internal/external variables. Furthermore,
the sensitivity analysis does not reflect actions that ALCO might take in
responding to or anticipating changes in interest rates.
28
<PAGE>
The following table sets forth the maturity and repricing information relating
to interest sensitive assets and liabilities at December 31, 1997. Fixed-rate
mortgage loans and mortgage-backed investments are shown in the table in the
time period corresponding to computed principal amortization based on their
respective contractual maturity. Short term investments, adjustable-rate loans,
investment securities and adjustable mortgage-backed investments are allocated
to the period in which the rates would be next adjusted. The table reflects an
"expected" prepayment assumption on residential, certain consumer and commercial
loans, and mortgage-backed investments. This prepayment assumption was derived
from both past experience and a market consensus of prepayment speeds for
similar types of loans and mortgage-backed investments. Since regular savings
accounts and NOW accounts are not subject to contractual interest rate
adjustments, such accounts have been included in the other deposits category and
are assumed to reprice within 1-3 years and 3-5 years, respectively. The Bank
believes these deposits are less interest rate sensitive over long periods of
time. Other deposits in the 1 - 180 day time period represent anniversary
savings accounts which reprice in six months.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
1-180 181-365 1-3 3-5 5+
Days Days Years Years Years Total
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Short-term investments $4,122 -- -- -- -- $4,122
Investment securities 48,838 -- 11,548 48,224 71,651 180,261
Mortgage-backed securities 80,901 28,858 43,862 31,624 46,393 231,638
Loans held for sale 11,807 -- -- -- -- 11,807
Loans in process 6,565 -- -- -- -- 6,565
Fixed rate loans 52,741 43,913 90,929 48,528 92,473 328,584
Adjustable rate loans 175,299 74,841 37,338 26,653 57,627 371,758
Other earning assets -- -- -- -- 17,291 17,291
--------- -------- -------- -------- -------- ---------
Total rate sensitive assets 380,273 147,612 183,677 155,029 285,435 1,152,026
--------- -------- -------- -------- -------- ---------
Interest-bearing liabilities:
Money market deposit accounts 63,929 -- -- -- -- 63,929
Certificates of deposit 180,039 113,592 84,509 20,204 20,429 418,773
Other deposits 84,945 -- 71,398 44,178 -- 200,521
Borrowed funds 182,411 71,000 83,411 3,707 3,028 343,557
--------- -------- -------- -------- -------- ---------
Total rate sensitive liabilities 511,324 184,592 239,318 68,089 23,457 1,026,780
--------- -------- -------- -------- -------- ---------
Excess (deficiency) of
interest sensitive assets
over interest sensitive
liabilities ($131,051) ($36,980) ($55,641) $86,940 $261,978 $125,246
========= ======== ======== ======== ======== =========
Cumulative excess
(deficiency) of interest
sensitive assets over
interest sensitive
liabilities ($131,051) ($168,031) ($223,672) ($136,732) $125,246
========= ======== ======== ======== ========
Cumulative excess
(deficiency)
percentage of
total assets (10.94) % (14.03) % (18.68) % (11.42) % 10.46 %
========= ======== ======== ======== ========
</TABLE>
29
<PAGE>
- --------------------------------------------------------------------------------
The following table reflects the scheduled maturities of selected loans at
December 31, 1997:
<TABLE>
<CAPTION>
One
One Through Over
Year Five Five
or Less Years Years Total
(Dollars in thousands)
<S> <C> <C> <C> <C>
Construction loans $25,938 $1,877 $4,036 $31,851
Owner-occupied commercial real estate 3,135 8,637 40,563 52,335
Commercial loans 10,530 36,457 20,031 67,018
-------- -------- -------- --------
Total $39,603 $46,971 $64,630 $151,204
======== ======== ======== ========
</TABLE>
A summary of the above categories of loans due after one year as to the rate
variability follows (dollars in thousands):
With predetermined rates $27,054
With floating or adjustable rates 84,547
-------
Total maturing or repricing after one year $111,601
========
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of liquidity are customer deposits, borrowings from
the FHLB, repurchase agreements, 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. At December 31,
1997, short-term investments, bonds and obligations and mortgage-backed
investments totaled $416.0 million, 14.4% of which either matures or is
estimated to be prepaid within one year. At December 31, 1996, short term
investments, bonds and obligations and mortgage backed investments totaled
$315.7 million, 4.7% of which matured within one year.
At December 31, 1997, the Bank had total outstanding borrowings of $343.6
million, 74% of which matures within one year. At year end 1996 the Bank had
outstanding borrowings of $275.0 million, 73% of which matured in one year.
At December 31, 1997, the Bank had outstanding commitments to loan funds under
mortgage, construction and commercial loans and home equity lines of credit,
amounting to $86.2 million, compared to $61.1 million in 1996. Management
believes the sources of liquidity previously discussed are sufficient to meet
its commitments.
30
<PAGE>
Net cash used in operating activities totaled $6.5 million in 1997 compared to
net cash provided of $13.5 million in 1996. Net income was $9.7 million compared
to a net income of $9.1 million for the respective period. Included in these
amounts were non-cash write-downs of foreclosed properties of $34,000 in 1997
and $82,000 in 1996. The provision for possible loan losses recorded in 1997 was
$2.0 million compared to $1.4 million in 1996. Net cash provided by operating
activities totaled $13.5 million in 1996 compared to $5.9 million in 1995. Net
income was $9.1 million compared to a net income of $7.5 million for the
respective periods. Included in these amounts were non-cash write-downs of
foreclosed properties of $82,000 in 1996 and $361,000 in 1995. Provisions for
possible loan losses recorded in 1996 totaled $1.4 million compared to $770,000
in 1995.
Net cash used for investing activities totaled $127.7 million for the year ended
December 31, 1997 compared to $67.3 million in 1996 and net cash provided of
$5.8 million in 1995. The 1997 increase in net cash used by investing activities
over 1996 was primarily attributable to increased purchases of investment
securities. The 1996 increase in net cash used by investing activities over 1995
was primarily attributable to increased purchases of investment securities and
increased loan originations.
Net cash provided by financing activities totaled $118.7 million for the year
ended December 31, 1997 compared to $64.5 million for the comparable period in
1996 and net cash used of $3.0 million in 1995. Net cash provided by the
increase in borrowed funds (net of repayments) totaled $68.6 million in 1997,
compared to $29.4 million in 1996. Net cash provided by deposits totaled $53.4
million in 1997 compared to of $37.3 million in 1996 and $34.6 million in 1995.
Net cash of $3.6 million, $2.9 million and $2.2 million was used to pay
dividends in 1997, 1996 and 1995, respectively.
The Bank is in compliance with and exceeds Federal regulatory capital
requirements. The minimum standards are (i) a total risk-based capital ratio of
8%, (ii) a Tier 1 risk-based capital ratio of 4% or (iii) a Tier 1 core capital
ratio of 3%. As of December 31, 1997, the Bank exceeds all fully phased in
capital requirements.
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 premises and equipment and real estate in
foreclosure. If real estate values decreased sharply, the deflationary impact of
changing prices of real estate securing loans foreclosed upon could
significantly affect a financial institution's performance. 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. In a volatile interest rate environment, liquidity and the management of
the maturity structure of assets and liabilities are critical in maintaining
acceptable profitability levels.
31
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of FIRST ESSEX BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of First Essex
Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of First Essex Bancorp, Inc. and
subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 7, 1998
32
<PAGE>
FIRST ESSEX BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
33
<PAGE>
<TABLE>
<CAPTION>
December 31,
------------
ASSETS
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Cash and cash equivalents $22,542 $38,078
Investment securities available-for-sale (Note 4) 211,903 174,716
Investment securities held-to-maturity
(fair value $180,743,000 and $103,529,000) (Note 4) 178,999 104,465
Stock in Savings Bank Life Insurance Company 1,194 1,194
Stock in Federal Home Loan Bank of Boston (Note 8) 19,803 15,517
Mortgage loans held-for-sale 11,807 8,915
Loans receivable, less allowance for possible loan losses of
$10,570,000 and $10,538,000 (Note 5) 696,338 685,206
Foreclosed property 891 1,880
Bank premises and equipment (Note 6) 10,545 11,609
Accrued interest receivable 8,084 5,970
Goodwill 10,991 11,800
Other assets 24,362 7,825
----------- -----------
Total assets $1,197,459 $1,067,175
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Depositors' accounts (Note 7) $744,322 $690,953
Borrowed funds (Note 8) 343,557 274,958
Mortgagors' escrow accounts 561 1,116
Other liabilities 17,954 17,007
----------- -----------
Total liabilities 1,106,394 984,034
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY (Note 15)
Serial preferred stock $.10 par value per share; 5,000,000 shares
authorized, no shares issued
Common stock $.10 par value per share; 25,000,000 shares
authorized, 9,522,424 and 9,407,433 shares issued 952 941
Additional paid-in-capital 75,303 74,408
Retained earnings 29,685 23,727
Treasury stock, at cost, 1,986,000 shares (15,842) (15,842)
Unrealized gains (losses) on investment
securities available-for-sale, net (Note 1) 967 (93)
----------- -----------
Total stockholders' equity 91,065 83,141
----------- -----------
Total liabilities and stockholders' equity $1,197,459 $1,067,175
=========== ===========
</TABLE>
The accompanying notes are in integral part of these consolidated financial
statements.
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
34
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
---- ---- ----
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C>
Interest and dividend income:
Interest on mortgage loans $38,820 $25,753 $26,024
Interest on other loans 23,738 21,139 15,194
Interest and dividends on investment securities available-for-sale 14,138 7,865 2,374
Interest and dividends on investment securities held-to-maturity 12,280 8,337 16,980
Interest on other earning assets 517 -- --
Interest on short term investments 585 451 342
----------- ----------- -----------
Total interest and dividend income 90,078 63,545 60,914
----------- ----------- -----------
Interest expense:
Interest on depositors' accounts 31,229 21,946 19,844
Interest on borrowed funds 21,148 15,371 17,237
----------- ----------- -----------
Total interest expense 52,377 37,317 37,081
----------- ----------- -----------
Net interest income 37,701 26,228 23,833
Provision for possible loan losses (Note 5) 2,040 1,415 770
----------- ----------- -----------
Net interest income after provision
for possible loan losses 35,661 24,813 23,063
----------- ----------- -----------
Noninterest income:
Net gain on sales of mortgage loans and mortgage servicing rights 1,628 1,352 1,431
Net gain (loss) on sales of investment securities 439 497 (13)
Loan fees 561 513 477
Other fee income 2,460 1,877 1,759
Other 0 26 54
----------- ----------- -----------
Total noninterest income 5,088 4,265 3,708
----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits 11,618 10,051 8,995
Buildings and equipment 4,124 3,605 3,256
Professional services 1,488 1,093 1,135
Information processing 1,654 1,240 1,233
Insurance 324 192 690
Expenses, gains and losses on,
and write-downs of, foreclosed property 609 666 784
Other 3,767 3,078 3,151
Amortization of goodwill 780 -- --
----------- ----------- -----------
Total noninterest expense 24,364 19,925 19,244
----------- ----------- -----------
Income before provision for income taxes 16,385 9,153 7,527
Provision for income taxes (Note 9) 6,672 40 75
----------- ----------- -----------
Net income $9,713 $9,113 $7,452
=========== =========== ===========
Earnings per share - basic (Note 2) $1.30 $1.51 $1.24
=========== =========== ===========
- diluted (Note 2) $1.25 $1.47 $1.22
=========== =========== ===========
Weighted average number of shares - basic (Note 2) 7,498,000 6,047,000 6,021,000
=========== =========== ===========
- diluted (Note2) 7,795,000 6,189,000 6,105,000
=========== =========== ===========
</TABLE>
The accompanying notes are in integral part of these consolidated financial
statements.
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
35
<PAGE>
<TABLE>
<CAPTION>
Years ended December 31, 1997, 1996 and 1995
Unrealized Gains
Additional (Losses) On Investment
Common Paid-In Retained Treasury Securities Available-
Stock Capital Earnings Stock For-Sale, Net Total
-------- -------- -------- -------- ----------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $801 $58,192 $12,638 ($15,842) ($1,032) $54,757
Net income -- -- 7,452 -- -- 7,452
Cash dividends declared -- -- (2,408) -- -- (2,408)
Stock options exercised -- 16 -- -- -- 16
Change in unrealized gains (losses)
on investment securities
available-for-sale, net -- -- -- -- 355 355
-------- -------- -------- -------- --------
Balance at December 31, 1995 801 58,208 17,682 (15,842) (677) 60,172
Net income -- -- 9,113 -- -- 9,113
Cash dividends declared -- -- (3,068) -- -- (3,068)
Stock options exercised 4 329 -- -- -- 333
Issuance of common stock in conjunction
with the acquisition of Finest Financial Corp. 136 15,871 -- -- -- 16,007
Change in unrealized gains (losses)
on investment securities
available-for-sale, net -- -- -- -- 584 584
-------- -------- -------- -------- -------- --------
Balance at December 31, 1996 941 74,408 23,727 (15,842) (93) 83,141
Net income -- -- 9,713 -- -- 9,713
Cash dividends declared -- -- (3,755) -- -- (3,755)
Stock options exercised 11 895 906
Change in unrealized gains (losses)
on investment securities
available-for-sale, net -- -- -- -- 1,060 1,060
-------- -------- -------- -------- -------- --------
Balance at December 31, 1997 $952 $75,303 $29,685 ($15,842) $967 $91,065
======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are in integral part of these consolidated financial
statements.
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
36
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $9,713 $9,113 $7,452
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for possible loan losses 2,040 1,415 770
Provision for depreciation and amortization 1,900 1,719 1,603
Gain on sale of foreclosed property (502) (109) (81)
Write-down of foreclosed property 35 82 361
Amortization of investment securities discounts and premiums, net 511 1,396 1,398
Amortization of goodwill 780 -- --
Provision for deferred (prepaid) income taxes 2,294 (1,908) 55
Proceeds from sales of mortgage loans and mortgage servicing rights 96,821 94,826 80,135
Mortgage loans originated for sale (98,085) (96,568) (81,595)
Realized (gains) losses on sales of investment securities (439) (497) 13
Realized gains on sales of mortgage loans and mortgage servicing rights, net (1,628) (1,352) (1,431)
Changes in assets and liabilities, net of the effect of the purchase of Finest Financial Corp.
Decrease (increase) in accrued interest receivable (2,114) (112) 71
Decrease (increase) in other assets (18,802) 1,704 34
Increase (decrease) in other liabilities 947 3,830 (2,917)
-------- -------- --------
Net cash provided by (used in) operating activities (6,529) 13,539 5,868
-------- -------- --------
Cash flows from investing activities:
Acquisition of Finest Financial, Corp., net of cash acquired -- 3,041 --
Proceeds from sales of available-for-sale securities 71,043 48,217 28,292
Proceeds from maturities and principal payments of available-for-sale securities 38,547 32,339 2,688
Proceeds from maturities and principal payments of held-to-maturity securities 21,071 55,785 78,687
Purchases of available-for-sale securities (145,407) (78,243) (2,412)
Purchases of held-to-maturity securities (96,125) (25,864) (2,094)
Purchases of Federal Home Loan Bank stock (4,286) -- --
Loans originated and purchased, net of principal collected (16,651) (103,446) (99,765)
Proceeds from sales of foreclosed property 4,910 2,604 3,658
Purchases of bank premises and equipment (836) (1,697) (3,303)
-------- -------- --------
Net cash provided by (used in) investing activities (127,734) (67,264) 5,751
-------- -------- --------
Cash flows from financing activities:
Net increase (decrease) in demand deposits, NOW accts and savings accounts 56,579 6,153 (11,029)
Net increase (decrease) in term deposits (3,210) 31,122 45,620
Net increase (decrease) in borrowed funds with maturities of three months or less (49,869) 74,806 7,544
Proceeds from borrowed funds with maturities in excess of three months 159,000 92,500 221,297
Repayments of borrowed funds with maturities in excess of three months (40,532) (137,917) (263,220)
Increase (decrease) in mortgagors' escrow accounts (555) 398 (1,086)
Dividends paid (3,591) (2,900) (2,167)
Stock options exercised 906 333 16
-------- -------- --------
Net cash provided by (used in) financing activities 118,728 64,495 (3,025)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (15,535) 10,770 8,594
Cash and cash equivalents at beginning of the year 38,078 27,308 18,714
-------- -------- --------
Cash and cash equivalents at end of the year $22,543 $38,078 $27,308
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
FIRST ESSEX BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
37
<PAGE>
(continued)
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
(Dollars in thousands)
Supplemental disclosures of cash flow information:
<S> <C> <C> <C>
Interest paid during the year $51,666 $37,165 $37,032
Income taxes paid during the year 7,247 324 --
Supplemental schedule of noncash financing and investing activities:
Real estate acquired through, or deeds in lieu of, foreclosure 1,445 1,961 2,656
Held-to-maturity securities reclassified to available-for-sale -- -- 82,262
Securitized loans transferred to investments available-for-sale -- -- 28,305
Acquisition of Finest Financial Corp.:
Fair value of assets acquired 196,645
Liabilities assumed (164,314)
Common stock issued (16,007)
---------
Cash paid 16,324
=========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
38
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of First Essex
Bancorp, Inc. ("the Company"), and its principal subsidiary, First Essex
Bank, FSB ("the Bank"). All significant intercompany balances have been
eliminated in consolidation.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of income and expenses
during the reporting periods. Operating results in the future could vary
from the amounts derived from management's estimates and assumptions.
INVESTMENT SECURITIES
The Company accounts for its investment securities under Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Under this statement,
investments in debt securities may be classified as held-to-maturity and
measured at amortized cost only if the Company has the positive intent and
ability to hold such securities to maturity. Investments in debt
securities that are not classified as held-to-maturity and equity
securities that have readily determinable fair values are classified as
trading securities or available-for-sale securities. Trading securities
are investments purchased and held principally for the purpose of selling
in the near term; available-for-sale securities are investments not
classified as trading or held-to-maturity. Unrealized holding gains and
losses for trading securities are included in earnings; unrealized holding
gains and losses for available-for-sale securities are reported in a
separate component of stockholders' equity.
At December 31, 1995, the Bank made a one-time reassessment of its
classification of investment securities held-to-maturity and reclassified
$82.3 million to investment securities available-for-sale, with an
unrealized loss of $1.1 million, as allowed by the special report of
implementation of SFAS No. 115. This reclassification does not call into
question the Company's intent to hold its remaining investment securities
classified as held-to-maturity.
Dividend and interest income, including amortization of premiums and
discounts, is included in earnings for all categories of investment
securities. Discounts and premiums related to debt securities are
amortized using a method that approximates the level-yield method,
adjusted for estimated prepayments in the case of mortgage-backed
securities.
In October 1994, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments". The statement is
39
<PAGE>
effective for financial statements issued for fiscal years ending after
December 15, 1994. Derivative Financial Instruments, as defined by SFAS
No. 119, include futures, forwards, swaps or option contracts, or other
financial instruments with similar characteristics. The Company did not
have any such instruments as of December 31, 1997 and 1996, except as
noted in Note 11.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
LOANS RECEIVABLE
Loans are stated at the amount of unpaid principal, net of the allowance
for possible loan losses, unearned discounts and unearned net loan
origination fees. Loan origination fees, discounts and certain direct loan
origination costs are deferred and amortized as an adjustment to the
related loan yield over the contractual life of the loan. When loans are
sold or fully repaid, the unamortized fees, discounts and costs are
recognized in income.
Interest on loans is included in income as earned based upon interest
rates applied to unpaid principal. Interest is not accrued on loans 90
days or greater past due or on other loans when management believes
collection is doubtful. When a loan is placed on nonaccrual status, all
interest previously accrued is reversed against current-period interest
income.
The allowance for possible loan losses is based on management's estimate
of the amount required to reflect the risks in the loan portfolio, based
on circumstances and conditions known or anticipated at each reporting
date. There are inherent uncertainties with respect to the final outcome
of the Bank's loans and nonperforming loans. Because of these inherent
uncertainties, actual losses may differ from the amounts reflected in
these consolidated financial statements. Factors considered in evaluating
the adequacy of the allowance include previous loss experience, current
economic conditions and their effect on borrowers, the performance of
individual loans in relation to contract terms, and estimated fair values
of underlying collateral. Losses are charged against the allowance when
management believes the collectibility of principal is doubtful.
Key elements of the above estimates, including assumptions used in
independent appraisals, are dependent upon the economic conditions
prevailing at the time of the estimates. Accordingly, uncertainty exists
as to the final outcome of certain of the valuation judgments as a result
of economic conditions in the region. The inherent uncertainties in the
assumptions relative to projected sales prices or rental rates may result
in the ultimate realization of amounts on certain loans that are
significantly different from the amounts reflected in these consolidated
financial statements.
Effective January 1, 1995, the Company adopted SFAS No. 114, "Accounting
by Creditors for Impairment of a Loan" as amended by SFAS No. 118 ("SFAS
No. 114"). This standard requires that impaired loans be measured based on
the present value of expected future cash flows discounted at each loan's
effective interest rate or, as a practical expedient, at each loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. The statement also changes the accounting for
in-substance foreclosures and troubled debt restructurings. This statement
was applied prospectively with any adjustment reflected in the provision
for possible loan losses. The adoption of this statement did not have a
material effect on the financial position or results of operations of the
Company.
Mortgage loans held-for-sale are carried at the lower of aggregate cost or
fair value. Gains and losses on
40
<PAGE>
sales of mortgage loans are recognized at the time of sale.
MORTGAGE SERVICING RIGHTS
On January 1, 1996, the Company adopted the provisions of SFAS No. 122,
"Accounting for Mortgage Servicing Rights ("SFAS No. 122"). SFAS No. 122
requires an enterprise involved in mortgage banking activities to
recognize, as separate assets, rights to service mortgage loans for others
regardless of the manner in which the servicing rights are acquired. In
addition, capitalized mortgage servicing rights are required to be
assessed for impairment based on the fair value of those
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
rights. The impact of this statement depends on the volume of mortgage
loans originated and sold, and the servicing rights retained.
On January 1, 1997, the Company adopted SFAS No. 125, "Accounting
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" ("SFAS No. 125"). SFAS No. 125 supercedes SFAS No. 122 and
requires the transfer of financial assets in which the Company surrenders
control over those financial assets to be accounted for as a sale to the
extent that consideration other than beneficial interests in the
transferred assets is received in exchange. Each time the Company
undertakes an obligation to service financial assets it recognizes either
a servicing asset or a servicing liability for that contract, unless it
securitizes the asset, retains all of the securities, and classifies them
as debt securities held-to-maturity. Because the current practice of the
Company is to sell most of the mortgage loans it originates with servicing
released, the adoption of this statement did not have a material effect on
the financial position or results of operations of the Company. The
carrying amount of capitalized mortgage servicing rights at December 31,
1997 and 1996 was $130,000 and $341,000, respectively.
FORECLOSED PROPERTY
Collateral acquired through foreclosure is recorded at the lower of cost
or fair value, less estimated costs to sell, at the time of acquisition.
Subsequent impairments in the fair value of other real estate owned are
accounted for in accordance with SFAS No. 121 (see Bank Premises and
Equipment, below) and are charged to expense in the period incurred. Net
operating income or expense related to foreclosed property is included in
noninterest expense in the accompanying consolidated statements of
operations. Because of current market conditions, there are inherent
uncertainties in the assumptions with respect to the estimated fair value
of other real estate owned. Because of these inherent uncertainties, the
amount ultimately realized on other real estate owned may differ from the
amounts reflected in the consolidated financial statements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, amounts due from banks,
interest-bearing deposits, federal funds sold and investments with
original maturities of less than three months.
41
<PAGE>
BANK PREMISES AND EQUIPMENT
Real estate held for banking purposes, leasehold improvements and
furniture and fixtures are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed principally on the
straight-line method over estimated service lives. Amortization of
leasehold improvements is computed on the straight-line method over the
shorter of the estimated useful lives of the assets or the related lease
term. Expenditures for maintenance, repairs and renewals of minor items
are charged to expense as incurred.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of", which became effective for fiscal years beginning after December 15,
1995. The Company adopted the provisions of SFAS No. 121 on January 1,
1996. SFAS No. 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Based on its review,
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
the Company does not believe that any material impairment of its long
lived assets has occurred. The statement also requires that certain
long-lived assets and identifiable intangibles to be disposed of be
reported at the lower of the carrying amount or fair value less cost to
sell.
INTANGIBLE ASSETS
Intangible assets are the excess of the purchase price over the fair value
of net assets acquired (goodwill) in the acquisition of Finest Financial
Corp. Goodwill is being amortized on a straight-line basis over 15 years.
The Company will periodically evaluate intangible assets for impairment on
the basis of whether these assets are fully recoverable from projected,
undiscounted net cash flows of the related acquired entity, as required
under SFAS No. 121 as discussed earlier. Based on its review, the Company
does not believe that any material impairment of its intangible asset has
occurred.
INCOME TAXES
The Company records income taxes under the liability method. Under this
method, deferred tax assets and liabilities are established for the
temporary differences between the accounting bases and the tax bases of
the Company's assets and liabilities. Deferred taxes are measured using
enacted tax rates that are expected to be in effect when the amounts
related to such temporary differences are realized or settled. The
Company's deferred tax asset is reviewed quarterly and adjustments are
recognized in the provision for income taxes based on management's
judgments relating to realizability.
OTHER ASSETS
Other assets include a $17.3 million long-term fixed rate certificate of
deposit with the Federal Home Loan Bank of Boston at December 31, 1997. No
similar asset existed at December 31, 1996.
42
<PAGE>
RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 and 1995 consolidated
financial statements to conform to the 1997 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130 and 131, "Reporting
Comprehensive Income" and "Disclosures About Segments of an Enterprise and
Related Information", respectively. Both of these pronouncements are effective
for the Company's 1998 financial statements. SFAS No. 130 will require increased
disclosure regarding a.) unrealized holding gains/losses on securities
classified as available-for-sale; b.) foreign currency translation adjustments,
if any; and, c.) minimum pension liabilities. 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. The Company
continues to evaluate the applicability of this statement to its operations.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
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 and
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:
43
<PAGE>
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Net income available to common shareholders $9,713 $9,113 $7,452
Basic EPS:
Basic common stock outstanding 7,498 6,047 6,021
====== ====== ======
Basic EPS $1.30 $1.51 $1.24
====== ====== ======
Diluted EPS:
Basic common stock outstanding 7,498 6,047 6,021
Plus: common stock from options 297 142 84
------ ------ ------
Dilutive common stock outstanding 7,795 6,189 6,105
====== ====== ======
Diluted EPS $1.25 $1.47 $1.22
====== ====== ======
Note: Stock share amounts and dollar amounts in thousands with the exception of
per share amounts.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
3. ACQUISITION
On December 30, 1996, the Company acquired all of the outstanding shares
of the common stock of Finest Financial Corp. ("Finest"). The purchase
price was composed of 1,353,998 shares of common stock issued at a price
of $11.50 per share and a total cash outlay of $16.3 million. Included in
the total acquisition cost was approximately $1.4 million of capitalized
costs incurred in connection with the acquisition. This transaction was
accounted for as a purchase and, accordingly, the consolidated statements
of operations includes the results of Finest's operations since the
acquisition.
The purchase price was allocated to assets acquired and liabilities
assumed based on estimates of fair value at the date of acquisition. The
excess of purchase price over the fair value of assets acquired has been
recorded as goodwill. The fair value of these assets and liabilities is
summarized as follows (in thousands)
44
<PAGE>
- --------------------------------------------------------------------------------
Cash and cash equivalents $19,364
Investment securities available-for-sale 62,128
Net loans 97,458
Premises and equipment 1,584
Goodwill 11,800
Foreclosed property 740
Prepaid expenses and other assets 3,571
Deposits (162,209)
Accrued expenses and other liabilities (2,105)
-------------
Total acquisition cost $32,331
=============
The following is supplemental information reflecting selected unaudited pro
forma results as if this acquisition had been consummated as of January 1,1995:
- --------------------------------------------------------------------------------
December 31,
1996 1995
----------- -----------
(dollars in thousands)
Total revenue (1) $39,798 $36,444
Income before taxes 12,010 7,966
Net income 11,369 8,061
Earnings per share - basic $1.54 $1.09
Earnings per share - diluted $1.50 $1.08
(1) Total revenue includes net interest income and noninterest income
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
4. INVESTMENT SECURITIES
Investment securities at December 31,1997 and 1996 follows:
- --------------------------------------------------------------------------------
45
<PAGE>
<TABLE>
<CAPTION>
1997 1996
(Dollars in thousands)
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Gain Loss Value Cost Gain Loss Value
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities held-to-maturity:
U.S. government and
agency obligations $54,421 961 -- $55,382 $9,978 $44 $ -- $10,022
Mortgage-backed securities 109,661 393 -- $110,054 94,487 10 (990) $93,507
Other bonds and obligations 14,917 390 -- 15,307 -- -- -- --
--------- -------- ------- -------- -------- ---- -------- --------
178,999 1,744 -- 180,743 104,465 54 (990) 103,529
Investment securities available-for-sale:
U.S. government and
agency obligations 67,177 827 (44) 67,960 41,947 15 -- 41,962
Mortgage-backed securities 121,008 969 121,977 111,100 252 (290) 111,062
Other bonds and obligations 22,079 -- (113) 21,966 21,762 4 (74) 21,692
--------- -------- ------- -------- -------- ---- -------- --------
210,264 1,796 (157) 211,903 174,809 271 (364) 174,716
Total investment securities $389,263 $3,540 ($157) $392,646 $279,274 $325 ($1,354) $278,245
========= ======== ======= ======== ======== ==== ======== ========
</TABLE>
- --------------------------------------------------------------------------------
At December 31, 1997 and 1996, U.S. government obligations and
mortgage-backed securities with amortized cost of $134,513,000 and
$144,009,000, respectively, and fair value of $135,289,000 and
$143,212,000, respectively, were pledged to collateralize certain
borrowings, deposit accounts and repurchase agreements.
For the year ended December 31, 1997, there were realized gross gains of
$439,000 from the sale of investment securities available-for-sale. For
the year ended December 31, 1996, there were realized gross gains of
$497,000 from the sale of investment securities, and there were realized
gross losses of $13,000 from the sale of investment securities in 1995.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The following table shows the maturity distribution of the amortized cost of the
Company's investment securities at December 31, 1997.
46
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Less than Greater than
1 year 1-5 Years 5-10 Years 10 Years Total
--------- --------- --------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Investment securities held-to-maturity:
U.S. government and
agency obligations $9,993 $4,958 $39,470 -- $54,421
Mortgage-backed securities (1) -- -- 1,125 108,536 109,661
Other bonds and obligations -- -- -- 14,917 14,917
Investment securities available-for-sale:
U.S. government and
agency obligations -- 51,607 15,570 -- 67,177
Mortgage-backed securities (1) 22,541 70,428 24,977 3,062 121,008
Other bonds and obligations 3,000 18,700 254 125 22,079
--------
$389,263
========
</TABLE>
(1) Maturities of mortgage-backed securities are based on contractual
maturities with scheduled amortization based on expected prepayments.
Actual maturities will differ from the scheduled maturities due to the
timing of actual prepayments.
- --------------------------------------------------------------------------------
The following table shows the maturity distribution of the fair value of the
Company's investment securities at December 31, 1997.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Less than Greater than
1 year 1-5 Years 5-10 Years 10 Years Total
---------- ----------- ------------ ------------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Investment securities held-to-maturity:
U.S. government and
agency obligations $10,013 $5,005 $40,364 -- $55,382
Mortgage-backed securities (1) 21,152 46,780 26,459 15,663 110,054
Other bonds and obligations -- -- 15,307 -- 15,307
Investment securities available-for-sale:
U.S. government and
agency obligations -- 52,072 15,888 -- 67,960
Mortgage-backed securities (1) 22,951 70,803 25,137 3,086 121,977
Other bonds and obligations 2,979 18,608 255 124 21,966
--------
$392,646
========
</TABLE>
(1) Maturities of mortgage-backed securities are based on contractual maturities
with scheduled amortization. Actual maturities will differ from contractual
maturities due to prepayments.
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
47
<PAGE>
December 31, 1997
5. LOANS RECEIVABLE
Major classifications of loans receivable at December 31, 1997 and 1996 follow:
1997 1996
(Dollars in thousands)
Mortgage loans:
Residential $263,058 $292,954
Commercial 83,077 102,718
Construction 31,851 24,855
--------- ---------
Total mortgage loans $377,986 $420,527
--------- ---------
Owner-occupied commercial real estate (1) 52,335 29,465
Commercial 67,018 63,695
Aircraft 41,220 33,802
Consumer loans:
Second Mortgage,Home Equity
& Home Improvement 59,897 52,280
Automobile 103,551 92,175
Other Consumer 4,901 3,800
--------- ---------
Total consumer loans 168,349 148,255
Less:
Allowance for possible loan losses (10,570) (10,538)
--------- ---------
Total loans receivable $696,338 $685,206
========= =========
(1) During 1996, management began to report this category of loans separate
from other commercial and commercial real estate loans. Management
believes this category of loans is distinguishable from other commercial
lending products. In 1996 and 1997, the Company reclassified certain loans
to this category from other more historical classification categories.
- --------------------------------------------------------------------------------
The Company's lending activities are conducted principally in eastern
Massachusetts and southern New Hampshire. The Company originates single
family and multifamily residential loans, commercial real estate loans,
commercial loans, aircraft loans, automobile loans and a variety of
consumer loans. In addition, the Company originates loans for the
construction of residential homes, multifamily properties, commercial real
estate properties and land development. Most loans originated by the
Company are collateralized by real estate. The ability and willingness of
the single family residential and consumer borrowers to honor their
repayment commitments is generally dependent on the level of overall
economic activity within the geographic areas and real estate values. The
ability and willingness of commercial real estate, commercial and
construction loan borrowers to honor their repayment commitments is
generally dependent on the health of the real estate economic sector in
the borrowers' geographic areas and the general economy.
48
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
A summary of changes in the allowance for possible loan losses for the years
ended December 31, 1997, 1996 and 1995 follows:
- --------------------------------------------------------------------------------
1997 1996 1995
(Dollars in thousands)
Balance at beginning of year $10,538 $6,552 $7,237
Acquired allowance - Finest (Note 3) -- 4,080 --
Provision for possible loan losses 2,040 1,415 770
Charge-Offs (2,826) (2,335) (2,485)
Recoveries 818 826 1,030
-------- -------- --------
Balance at end of year $10,570 $10,538 $6,552
======== ======== ========
- --------------------------------------------------------------------------------
Under SFAS No. 114, the Company considers a loan impaired if it is ninety
days or more past due as to principal and interest, or if management's
credit risk assessment determines that it is probable that principal and
interest will not be collected as contractually scheduled. In addition,
loans which are restructured at market rates and comparable to loans with
similar risks are considered impaired only in the year of the
restructuring, so long as they continue to perform according to the
restructured terms. Excluded from the impaired category, but otherwise
considered non-accruing loans, are small balance homogeneous loans which
are ninety days or more past due. Small balance homogeneous loans include
residential mortgage loans, residential construction loans to individuals
(excluding builder construction loans) and consumer loans. The Company
evaluates a loan's level of impairment by measuring the net present value
of the expected future cash flows using the loan's original effective
interest rate, or considering the fair value of the collateral if the loan
is collateral dependent. When the difference between the net present value
of the impaired loan (or fair value of the collateral if the loan is
collateral dependent) is lower than the recorded investment of the loan,
the difference is provided to expense with a resulting valuation
allowance. The average recorded investment in impaired loans was
approximately $2.6 million in 1997 and $1.9 million in 1996.
49
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The following table indicates the recorded investment of non-performing assets
and the related valuation allowance for impaired loans.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
Impaired Loan Impaired Loan
Recorded Valuation Recorded Valuation
Investment Allowance (1) Investment Allowance (1)
------------ ------------- ------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Non-accruing Loans:
Impaired Loans
Requiring a valuation allowance $1,577 $590 $25 $25
Not requiring a valuation allowance 309 -- 286 --
------ ------ ------ ------
1,886 $590 311 $25
Restructured Loans 905 420 1,042 466
------ ------ ------ ------
Total impaired 2,791 $1,010 1,353 $491
====== ======
Residential Mortgage 1,525 2,458
Other 1,228 928
------ ------
Total non-accruing loans 5,544 4,739
Foreclosed property, net 891 1,880
------ ------
Total non-performing assets $6,435 $6,619
====== ======
Percentage of non-performing assets
to total assets 0.54% 0.62%
Percentage of allowance for possible
loan losses to non-accruing loans 190.7% 222.4%
</TABLE>
(1) The valuation allowance for impaired loans is included in the allowance
for possible loan losses on the balance sheet.
- --------------------------------------------------------------------------------
Interest income recognized on impaired loans, using the cash basis of income
recognition, amounted to approximately $293,000 for the year ended December 31,
1997 compared to $244,000 in 1996.
The amount of interest that would have been earned had the nonaccrual and
restructured loans performed in accordance with original terms and conditions
was $570,000, $140,000 and $389,000 for the years ended December 31, 1997, 1996
and 1995 respectively.
The maximum amount of aggregate loans to directors, executive officers and
principal stockholders for the year ended December 31, 1997 was less than 5% of
stockholders' equity.
At December 31, 1997 and 1996, the Bank was servicing loans sold to the Federal
National Mortgage Association,
50
<PAGE>
Federal Home Loan Mortgage Corporation, Massachusetts Home Finance Agency and
various other banks and institutions on a nonrecourse basis (except as discussed
in Note 9), in the amount of $32,114,000 and $95,848,000, respectively. The
amount of loans sold and serviced for others is not included in loans
receivable.
51
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
6. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 1997 and 1996 follows:
- --------------------------------------------------------------------------------
Estimated Useful
1997 1996 Life
----------------
(Dollars in thousands)
Land $1,235 $1,235
Buildings 5,646 5,566 20 to 30 years
Leasehold improvements 4,930 5,102 1 to 13 years
Furniture and fixtures 9,487 9,173 3 to 10 years
Construction in process 11 298
-------- --------
21,309 21,374
Less accumulated depreciation
and amortization 10,764 9,765
-------- --------
$10,545 $11,609
======== ========
Depreciation and amortization expense was $1,900,000, $1,719,000, and $1,603,000
for 1997, 1996 and 1995, respectively.
- --------------------------------------------------------------------------------
52
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
7. DEPOSITORS' ACCOUNTS
A summary of depositors' accounts at December 31, 1997 and 1996 follows:
- --------------------------------------------------------------------------------
1997 1996
(Dollars in thousands)
Personal and business checking
accounts (noninterest-bearing) $61,099 $58,769
NOW accounts 44,178 42,246
Money market accounts 63,929 92,173
Savings accounts 156,343 75,782
Time deposits 418,773 421,983
-------------- -------------
$744,322 $690,953
============== =============
The following is a summary of original maturities of time deposits as of
December 31, 1997:
(Dollars in thousands)
1998 $293,042
1999 84,853
2000 20,300
2001 12,559
2002 6,476
Thereafter 1,543
--------------
$418,773
==============
The following table shows the remaining maturities of certificates of deposits
with balances in excess of $100,000 at December 31, 1997.
(Dollars in thousands)
Three months or less $10,644
Over 3 months and less than 6 months 6,673
Over 6 months and less than 12 months 27,543
12 months and over 16,926
--------------
$61,786
==============
- --------------------------------------------------------------------------------
53
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
8. BORROWED FUNDS
Borrowed funds at December 31, 1997 and 1996 are summarized below:
- --------------------------------------------------------------------------------
1997 1996
(Dollars in thousands)
Due during 1997, interest rates from 5.35% to 6.24% -- $193,000
Due during 1998, interest rates from 5.65% to 6.42% $229,597 60,597
Due during 1999, interest rates from 5.71% to 6.43% 47,000 2,000
Due during 2000, interest rates from 5.29% to 6.52% 36,412 4,660
Due during 2001, interest rates from 6.54% to 6.58% 3,707 3,943
Due during 2010, interest rates at 6.08% 76 78
Due during 2016, interest rates at 7.25% 2,952 2,997
Repurchase agreements 23,813 7,683
----------- ----------
$343,557 $274,958
=========== ==========
- --------------------------------------------------------------------------------
Total lines of credit available under both short-term and long-term
borrowings from the FHLB are dependent upon the amount of FHLB stock owned
and other assets available as collateral with the total credit available
being $495,340,000, of which $175,596,000 was unused at December 31, 1997.
The advances from the FHLB are secured by all FHLB stock (book value of
$19,803,000 and $15,517,000 at December 31, 1997 and 1996, respectively)
and a pledge of certain assets as collateral. Repurchase agreements
outstanding at December 31, 1997 mature in three months or less with
average interest rates of 4.90% and are secured by certain U.S. government
and agency securities.
The following table summaries the maximum and average amounts of borrowings
outstanding during 1997 and 1996 together with the weighted average interest
rates thereon.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997 At December 31, 1997
-----------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
FHLB Borrowings $394,184 $342,975 5.94% $319,744 5.98%
Repurchase Agreements 27,708 16,415 4.75% 23,813 4.90%
<CAPTION>
For the Year Ended December 31, 1996 At December 31, 1996
-----------------------
Maximum Average Weighted Weighted
Amount Amount Average Amount Average
Outstanding Outstanding Interest Rate Outstanding Int. Rate
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
FHLB Borrowings $278,318 $249,278 5.89% $267,275 5.74%
Repurchase Agreements 33,473 12,732 5.28% 7,683 5.18%
</TABLE>
54
<PAGE>
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
9. INCOME TAXES
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 1997 consists of the following:
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Current $ 4,378 1,948 $ 20
Deferred 2,294 (1,908) 55
------- ------- -------
$ 6,672 $ 40 $ 75
======= ======= =======
- --------------------------------------------------------------------------------
The difference between the total expected provision for income taxes computed by
applying the statutory federal income tax rate to income before provision for
income taxes and the recorded provision for income taxes for the three years in
the period ended December 31, 1997 follows:
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Provision at statutory rate $ 5,571 $ 3,112 $ 2,559
State taxes, net of
federal benefit 1,181 783 903
Goodwill amortization 265 -- --
Nondeductible expenses 10 23 --
Tax exempt interest (14) -- --
Dividend received deduction (39) (2) (10)
Tax Credits (101) -- --
Change in valuation allowance -- (4,185) (3,312)
Other, net (201) 309 (65)
------- ------- -------
Provision for income taxes $ 6,672 $ 40 $ 140
======= ======= =======
- --------------------------------------------------------------------------------
In August of 1996, Congress passed the Small Business Job Protection Act of
1996. Included in the bill was the repeal of IRC Section 593, which allowed
thrift institutions special provisions in calculating bad debt deductions for
income tax purposes. Thrift institutions now will be viewed as commercial banks
for income tax purposes. The repeal is effective for tax years beginning after
December 31, 1995.
One effect of this legislative change is to suspend the Bank's bad debt reserve
for income tax purposes as of its base year (October 31, 1988). Any bad debt
reserve in excess of the base year amount is subject to recapture over a
six-year time period. The suspended (i.e. base year) amount is subject to
recapture upon the occurrence of certain events, such as a complete or partial
redemption of the Bank's stock or if the Bank ceases to qualify as a bank for
income tax purposes.
55
<PAGE>
At December 31, 1996, the Bank's surplus includes approximately $7,700,000 of
bad debt reserves, representing the base year amount, for which income taxes
have not been provided. Since the Bank does not intend to use the suspended bad
debt reserve for purposes other than to absorb the losses for which it was
established, deferred taxes in the amount of $3,150,000 have not been recorded
with respect to such reserve.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The components of the net deferred tax asset at December 31, 1997 and 1996
follow:
- --------------------------------------------------------------------------------
1997 1996
---- ----
(dollars in thousands)
Allowance for possible loan losses $2,196 $2,196
Deferred tax loan loss reserve (1,447) (1,447)
Depreciation 768 919
Deferred loan fees 36 107
Deferred compensation 335 288
Pension accrual 424 336
Net operating loss carryforwards -- 1,494
Limited partnership investments (371) (499)
Foreclosed property write-downs -- 40
Contributions -- --
General business credits -- 521
Purchase business combination 880 880
AMT credits -- 435
Charge-off remaining lease payments 17 49
Unrealized (gain) loss on available-for-sale securities (329) --
State income taxes 777 666
Other, net 93 140
------- -------
Net deferred tax asset included in other assets $3,379 $6,125
======= =======
- --------------------------------------------------------------------------------
56
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
10. PENSION BENEFITS
The Company has a defined benefit pension plan covering most employees.
Employees are eligible to participate upon the attainment of age 21 and
the completion of one year of service. Benefits are based primarily on
years of service and employees' final five year average pay.
Contributions by the Company are consistent with the funding requirements
of federal law and regulations. Pension plan assets consist primarily of
mutual funds, bonds and government securities.
The weighted average discount rate was 7.5% in 1997 and 1996, and 7.0% in
1995. The rate of increase in future compensation levels used in
determining the actuarial present value of the projected benefit
obligation was 4.0% in 1997, 1996 and 1995. The expected long-term rate of
return on assets was 8.0% in 1997, 1996 and 1995.
The following table sets forth the plan's funded status and amounts recognized
in the Company's consolidated financial statements at December 31, 1997 and
1996:
- --------------------------------------------------------------------------------
1997 1996
---- ----
(Dollars in thousands)
Actuarial present value of benefit obligation:
Accumulated benefit obligation, including vested
benefits of $3,295,000 and $3,012,000 $3,364 $3,093
======= =======
Projected benefit obligation for service rendered to date 4,721 4,093
Plan assets at fair value 5,737 5,156
------- -------
Excess of plan assets over projected benefit obligation 1,016 1,063
Unrecognized net gain from past experience different
from that assumed and effects of changes in assumptions (2,337) (2,129)
Unrecognized net asset at transition amortized
over approximately 15 years 73 78
------- -------
Accrued pension cost included in other liabilities at
December 31 ($1,248) ($988)
======= =======
Net pension cost for the years ended December 31, 1997, 1996 and 1995 included
the following components:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Service cost - benefits earned during the year $436 $409 $283
Interest cost on projected benefit obligation 307 297 290
Actual return on plan assets (778) (710) (811)
Net amortization and deferral 295 293 422
----- ----- -----
Net pension cost $260 $289 $184
===== ===== =====
57
<PAGE>
- --------------------------------------------------------------------------------
The Company has no material postretirement or postemployment benefit
arrangements other than pension benefits with its employees.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
11. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments, held for purposes other than
trading, include commitments to originate loans, standby letters of
credit, recourse arrangements on sold assets, unadvanced portions of
construction loans and forward commitments. The instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of
the amount recognized in the accompanying consolidated balance sheets. The
contract or notional amounts of these instruments reflect the extent of
involvement the Company has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for loan commitments, standby
letters of credit and recourse arrangements is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments. For forward commitments, the contract or
notional amounts do not represent exposure to credit loss. The Company
controls the credit risk of its forward commitments through credit
approvals, limits and monitoring procedures.
Financial instruments with off-balance sheet risk at December 31, 1997 and 1996
follow:
- --------------------------------------------------------------------------------
Contract
Amount
----------
1997 1996
---- ----
(Dollars in thousands)
Commitments to originate loans $34,132 $20,676
Unused lines of credit 52,053 40,458
Commercial and standby letters of credit 4,430 3,644
Loans sold with recourse 1,840 2,073
Unadvanced portions of
construction loans 21,074 14,759
Forward commitments 11,808 8,915
- --------------------------------------------------------------------------------
Commitments to originate loans are agreements to lend to customers
provided there are no violations of
58
<PAGE>
any conditions established in the contracts. Commitments generally have
fixed expiration dates or other termination clauses and may require
payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is
based upon management's credit evaluation of the borrower.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance by a customer to a third party. The
credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loan facilities to customers.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
LEASE COMMITMENTS
The Company has operating leases on eleven of its facilities. Most of the leases
have renewal options. Total rent expense under these leases for 1997, 1996 and
1995 was $853,000, $712,000 and $661,000, respectively.
The following is a schedule of future minimum lease payments for operating
leases (dollars in thousands):
Year ending December 31,
1998 $887
1999 846
2000 701
2001 592
2002 517
Thereafter 1,219
------
Total future minimum lease payments $4,762
======
EMPLOYMENT AND TERMINATION AGREEMENTS
The Company and the Bank have entered into employment agreements with three
executive officers. One agreement, which commenced January 1, 1997, had an
original term of three years and the other agreements with commencement dates of
January 1, 1997 have an original term of two years. Each agreement is extended
on a daily basis until terminated by the officer, the Company or the Boards of
Directors. The employment agreements generally provide for the continued payment
of specified compensation and benefits to the executive officer for specified
periods after termination, unless the termination is for "cause" as defined in
the employment agreement.
In addition, the Company, the Bank and the officers, referred to above, have
entered into special termination agreements that provide for the payment, under
certain circumstances, of a lump-sum amount upon termination following a "change
of control" which is generally defined to mean a person or group acquiring
ownership of 25% or more of the outstanding common stock of the Company, or
certain other events resulting in a change in control of the Company. The
lump-sum amounts for two of the executive officers' are based on three times
their base annual compensation and two times the other executive officers' base
annual compensation as defined in the agreements and would be in lieu of any
benefits under the officers' employment agreements, but in addition to amounts
payable pursuant to other benefit plans. Four other senior officers have similar
termination agreements effective following a "change of control." The lump-sum
amount for these officers is equivalent to two times the officer's base
59
<PAGE>
annual compensation.
LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incidental to its business,
none of which is believed by management, based on discussion with legal counsel,
to be material to the financial condition or operations of the Company.
12. MANAGEMENT INCENTIVE COMPENSATION PLAN
The Company has a Management Incentive Compensation Plan (the "Incentive
Plan") as a means of recognizing achievement on the part of individual
officers and management as a whole. In 1997, 1996 and 1995 the Company
awarded $168,000, $310,000 and $117,000, respectively, for bonuses in
connection with the Incentive Plan.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
13. STOCK PLANS
The Company has three stock plans. The first was adopted in 1987 as a
performance incentive for its directors, officers, employees and other key
persons (the "1987 Stock Option Plan"). The 1987 Stock Option Plan
provided for the granting of "Incentive Stock Options" and "Non-qualified
Stock Options". Options granted under the 1987 Stock Option Plan have an
exercise price per share equal to at least the fair market value of a
share of the Company's common stock on the date the option is granted and
expire no later than 10 years after the date of grant. As of December 31,
1997, 648,619 shares are reserved for issuance under this plan with
respect to the current outstanding options; no more options may be granted
under this plan.
The second stock plan (the "1996 Stock Option Plan") was assumed under the
terms of the agreement related to the Company's purchase of Finest (Note
2) on December 30, 1996. Non-qualified options totaling 114,465 shares
have been granted under this plan at an exercise price of $7.67 per share
to two former officers of Finest. During 1997, 26,415 options were
exercised. The remaining 88,050 options were vested and exercisable as of
December 31, 1997 and expire October 1, 2005. The weighted average life of
these outstanding options is 7.8 years. The estimated fair value of these
options was recorded as part of the acquisition price and, accordingly,
the pro forma compensation cost discussed below excludes the effect of
these options. No more options may be granted under this plan.
The third stock plan (the "1997 Stock Incentive Plan") was adopted in 1997
as a performance incentive for its directors, officers, and employees.
Incentive stock options, non-qualified stock options, unrestricted stock
awards, conditioned stock awards, performance share awards, and stock
appreciation rights may be granted pursuant to the 1997 Stock Incentive
Plan. Incentive stock options granted under the 1997 Stock Incentive Plan
have an exercise price per share equal to at least the fair market value
of a share of the Company's common stock on the date the option is granted
and expire no later than 10 years after the date of grant. The Company has
reserved 800,000 shares for issuance pursuant to awards granted under the
1997 Stock Incentive Plan.
Effective January 1, 1996, the Company adopted the provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." The Company has elected to
continue to account for stock options at intrinsic
60
<PAGE>
value with disclosure of the effects of fair value accounting on net
income and earnings per share on a pro forma basis. Had compensation costs
for the stock option plans been determined using the fair value method
based upon the Modified Black-Scholes American option model, the Company's
1997, 1996 and 1995 net income and earnings per share from continuing
operations would have been reduced to the following pro forma amounts
(dollars in thousands):
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Net income:
As reported $9,713 $9,113 $7,452
Pro forma 9,361 8,957 7,451
Basic EPS:
As reported $1.30 $1.51 $1.24
Pro forma $1.25 $1.48 $1.24
Diluted EPS:
As reported $1.25 $1.47 $1.22
Pro forma $1.21 $1.45 $1.22
- --------------------------------------------------------------------------------
Pro forma compensation cost may not be representative of that to be
expected in future years.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The following table summarizes various facts and assumptions pertaining to the
1987 Stock Option Plan and the 1997 Stock Incentive Plan for the three years
ended December 31, 1997, 1996 and 1995.
61
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Number of Options
Outstanding at beginning of year 686,899 421,733 428,000
Granted 230,366 356,000 10,000
Expired (21,970) (46,666) (13,500)
Exercised (91,276) (44,168) (2,767)
Outstanding at end of year 804,019 686,899 421,733
Exercisable at end of year 341,065 264,363 233,470
For options exercisable between
$5.25 to $11.375 per share:
Weighted average price per share:
Outstanding at beginning of year $9.129 $7.191 $7.169
Granted -- 11.375 8.500
Expired 11.039 10.283 7.741
Exercised 8.099 7.501 5.792
Outstanding at end of year 9.223 9.129 7.191
Exercisable at end of year 8.232 7.261 7.397
Weighted average remaining contractual life of
options outstanding at December 31, 1997 6.9 years Not applicable Not applicable
Weighted average expected life of options at grant Not applicable 10 years 10 years
Weighted average risk-free interest rates at grant Not applicable 5.70% 6.40%
Weighted average dividend yield at grant Not applicable 4.20% 5.60%
Weighted average expected volatility at grant Not applicable 27.20% 27.20%
For options exercisable between
$16.375 to $22.375 per share:
Weighted average price per share:
Outstanding at beginning of year $ -- Not applicable Not applicable
Granted 18.752 Not applicable Not applicable
Expired 19.750 Not applicable Not applicable
Exercised -- Not applicable Not applicable
Outstanding at end of year 18.749 Not applicable Not applicable
Exercisable at end of year -- Not applicable Not applicable
Weighted average remaining contractual life of
options outstanding at December 31, 1997 9.6 years Not applicable Not applicable
Weighted average expected life of options at grant 10 years Not applicable Not applicable
Weighted average risk-free interest rates at grant 6.20% Not applicable Not applicable
Weighted average dividend yield at grant 2.60% Not applicable Not applicable
Weighted average expected volatility at grant 27.20% Not applicable Not applicable
</TABLE>
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
14. 401(k) PLAN
62
<PAGE>
During 1994, the Company established a 401(k) plan (the "Plan") covering
most of its employees and merged its former Employees' Stock Ownership
Plan ("ESOP") into the Plan. Under the Plan, eligible employees
("participants") may make contributions up to 15% of their compensation,
with certain limitations. The Company may elect to make basic matching
contributions. During 1997 and 1996, the Company made basic matching
contributions equal to 50% of the first 4% of each participant's
compensation, or a maximum of 2%. Basic matching contributions for 1997,
1996 and 1995 amounted to $136,000, $116,000 and $98,000, respectively.
The Plan also provides for discretionary supplemental matching
contributions. These contributions are allocated to participants in the
same manner as described above. Supplemental matching contributions to the
Plan for 1997, 1996 and 1995 amounted to $66,000, $58,000, and $38,000,
respectively.
15. STOCKHOLDERS' EQUITY
At the time of conversion to stock form, the Bank established a
liquidation account in the amount of $41,426,000 (unaudited). In
accordance with Massachusetts statutes, the liquidation account is
maintained for the benefit of Eligible Account Holders who continue to
maintain their accounts in the Bank after the conversion. The liquidation
account is reduced annually to the extent that Eligible Account Holders
have reduced their qualifying deposits. Subsequent increases will not
restore an Eligible Account Holder's interest in the liquidation account.
In the event of a complete liquidation, each Eligible Account Holder is
entitled to receive a distribution from the liquidation account in a
proportionate amount to the current adjusted qualifying balances for the
account then held. The unaudited balance in the liquidation account was
$3,906,000 at December 31, 1997.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
63
<PAGE>
16. 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, 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
December 31, 1997, that the Bank meets all capital adequacy requirements
to which it is subject.
As of December 31, 1997, 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 is aware
of that would have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the
table. As of December 31, 1997, 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.
64
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The following table displays the Bank's capital calculations as defined under
prompt corrective action for the periods indicated:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
To Be Well
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>
December 31, 1997 (unaudited)
Tangible Capital (to Adjusted Assets)
First Essex Bank, FSB $72,319 6.09% $17,822 > or = 1.50% n/a n/a %
Tier 1 (Core) Capital (to Adjusted Assets)
First Essex Bank, FSB 72,319 6.09 35,644 3.00 59,408 > or = 5.00
Tier 1 Capital (to Risk Weighted Assets)
First Essex Bank, FSB 72,319 10.20 28,372 4.00 42,559 6.00
Total Risk Based Capital (to Risk
Weighted Assets)
First Essex Bank, FSB 81,194 11.45 56,744 8.00 70,931 10.00
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>
December 31, 1996
Tangible Capital (to Adjusted Assets)
First Essex Bank, FSB $62,216 5.01% $15,790 > or = 1.50% n/a n/a %
Tier 1 (Core) Capital (to Adjusted Assets)
First Essex Bank, FSB 62,216 5.91 31,396 3.00 $52,327 > or = 5.00
Tier 1 Capital (to Risk Weighted Assets)
First Essex Bank, FSB 62,216 9.67 25,736 4.00 38,604 6.00
Total Risk Based Capital (to
Risk Weighted Assets)
First Essex Bank, FSB 70,289 10.92 51,471 8.00 64,339 10.00
</TABLE>
- --------------------------------------------------------------------------------
65
<PAGE>
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
17. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS - FIRST ESSEX BANCORP, INC.
Condensed financial statements of First Essex Bancorp, Inc. as of December 31,
1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995 follow:
- --------------------------------------------------------------------------------
1997 1996
---- ----
(Dollars in thousands)
Balance Sheets
Assets
Cash and cash equivalents $7,928 $3,663
Investment in First Essex Bank, FSB 84,412 73,924
Other assets 195 7,195
------- -------
Total assets $92,535 $84,782
======= =======
Liabilities and stockholders' equity
Other liabilities $1,470 $1,641
Stockholders' equity 91,065 83,141
------- -------
Total liabilities and stockholders' equity $92,535 $84,782
======= =======
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Statements of Operations
Income
Interest on investments $473 $241 $221
Distributed income of First Essex Bank,FSB -- 7,000 3,000
------- ------ ------
Total income 473 7,241 3,221
------- ------ ------
Expenses
Operating expenses (income) (17) 5 7
------- ------ ------
Income before provision for income taxes and
equity in undistributed net income of
First Essex Bank, FSB 490 7,236 3,214
Provision for income taxes 204 40 75
------- ------ ------
286 7,196 3,139
Equity in undistributed net income of
First Essex Bank, FSB 9,427 1,917 4,313
------- ------ ------
Net income 9,713 9,113 7,452
======= ====== ======
66
<PAGE>
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Statements of Cash Flows
Cash flows from operating activities
Net income $9,713 $9,113 $7,452
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in income of First Essex Bank, FSB (9,427) (8,917) (7,313)
Provision for deferred (prepaid) income taxes 2,294 (1,908) 55
Accretion of investment
securities discounts -- (165)
Decrease in other assets 4,706 1,908 1
(Decrease) in other liabilities (336) (50) (28)
------- -------- -------
Net cash provided by operating activities 6,950 146 2
------- -------- -------
Cash flows from investing activities
Acquisition cost, net of cash received (Note 3) -- (14,224) --
Purchases of investment securities -- -- (2,253)
Maturities of investment securities -- -- 6,297
Dividends and other capital distributions
received from First Essex Bank, FSB -- 14,380 3,000
------- -------- -------
Net cash provided by investing activities -- 156 7,044
------- -------- -------
Cash flows from financing activities
Stock options exercised 906 333 16
Dividends paid (3,591) (2,900) (2,167)
------- -------- -------
Net cash used in financing activities (2,685) (2,567) (2,151)
------- -------- -------
Net increase (decrease) in cash and cash equivalents 4,265 (2,265) 4,895
Cash and cash equivalents at beginning of year 3,663 5,928 1,033
------- -------- -------
Cash and cash equivalents at end of year $7,928 $3,663 $5,928
======= ======== =======
</TABLE>
- --------------------------------------------------------------------------------
18. RESTRICTIONS ON SUBSIDIARY BANK LOANS, ADVANCES AND DIVIDENDS
The Federal Reserve Act restricts the Bank with respect to lending or
advancing funds to the Company unless such loans are collateralized by
specific obligations and limits collateralized loans to 10% of the Bank
capital stock and surplus. At December 31, 1997, no amounts were available
to be transferred from the Bank to the Company in the form of loans or
advances. In addition, under the OTS prompt corrective action regulations,
which took effect on December 19, 1992, the Bank generally would be
67
<PAGE>
prohibited from making any capital distribution if, after the
distribution, the Bank would have (i) a total risk-based capital ratio of
less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or
(iii) a Tier 1 core capital ratio of less than 3%.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
19. QUARTERLY DATA (UNAUDITED)
A summary of quarterly financial data for the years ended December 31, 1997 and
1996 follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31, 1997
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income $22,978 $23,265 $22,765 $21,070
Interest expense 13,389 13,905 13,170 11,913
------- ------- ------- -------
Net interest income 9,589 9,360 9,595 9,157
Provision for possible loan losses 510 510 510 510
------- ------- ------- -------
Net interest income after
provision for possible loan losses 9,079 8,850 9,085 8,647
Noninterest income 1,379 1,250 1,256 1,203
Noninterest expense 6,668 5,529 6,003 6,164
------- ------- ------- -------
Income before income taxes 3,790 4,571 4,338 3,686
Provision for income taxes 1,400 1,921 1,812 1,539
------- ------- ------- -------
Net income $2,390 $2,650 $2,526 $2,147
======= ======= ======= =======
Earnings per share - basic $.32 $.35 $.34 $.29
======= ======= ======= =======
Earnings per share - diluted $.30 $.34 $.33 $.28
======= ======= ======= =======
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31, 1996
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income $16,893 $16,089 $15,580 $14,983
Interest expense 9,782 9,560 9,103 8,872
------- ------- ------- -------
Net interest income 7,111 6,529 6,477 6,111
Provision for possible loan losses 360 240 326 489
------- ------- ------- -------
Net interest income after
provision for possible loan losses 6,751 6,289 6,151 5,622
Noninterest income 1,308 810 1,048 1,099
Noninterest expense (1) 5,344 4,564 5,060 4,957
------- ------- ------- -------
Income before income taxes 2,715 2,535 2,139 1,764
Provision for income taxes 10 11 9 10
------- ------- ------- -------
Net income $2,705 $2,524 $2,130 $1,754
======= ======= ======= =======
Earnings per share - basic $.45 $.42 $.35 $.29
======= ======= ======= =======
Earnings per share - diluted $.43 $.41 $.35 $.28
======= ======= ======= =======
</TABLE>
68
<PAGE>
- --------------------------------------------------------------------------------
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
20. PREFERRED STOCK
The Company's Board of Directors has authorized a series of 100,000 shares
of preferred stock designated as Series A Junior Participating Cumulative
Preferred Stock, par value $0.10 per share ("Series A Stock") and has
declared a dividend distribution of one Preferred Stock Purchase Right
(the "Right") for each outstanding share of the Company's common stock.
Pursuant to the Company's Shareholder Rights Plan, each Right entitles the
holder to purchase from the Company a unit consisting of one one-hundredth
of a share of Series A Stock, par value $0.10 per share, at an initial
cash exercise price of $28 per unit, subject to adjustment. The Rights are
not exercisable and remain attached to all outstanding shares of the
Company's common stock until the earliest of (i) ten days following a
public announcement that a person or group of affiliated or associated
persons (an "Acquiring Person") has acquired beneficial ownership of 20%
or more of the outstanding shares of the Company's common stock (the date
of said announcement being referred to as the "Stock Acquisition Date"),
(ii) ten business days following the commencement of a tender offer or
exchange offer that would result in a person or group becoming an
Acquiring Person or (iii) the declaration by the Company's Board of
Directors that a person is an "Adverse Person," as such term is defined in
the Company's Shareholder Rights Plan.
In the event that a Stock Acquisition Date occurs or the Board determined
that a person is an Adverse Person, each holder of a Right will be
entitled to receive, upon exercise, that number of units of Series A Stock
having a fair value of two times the exercise price of the Right. In the
event that, at any time following the Stock Acquisition Date, (i) the
Company is acquired in a merger or other business combination transaction
or (ii) 50% or more of the Company's assets or earning power is sold, each
holder of a Right shall thereafter have the right to receive, upon
exercise, common stock of the acquiring company having a fair value equal
to two times the exercise price of the Right. The holders of Series A
Stock would be entitled to preferred rights with respect to dividends,
voting and liquidation.
21. FAIR VALUE OF FINANCIAL INSTRUMENTS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, amounts due from banks,
interest-bearing deposits, federal funds sold and investments with
original maturities of less than three months. Cash and cash equivalents
are recorded at cost which approximates fair value.
INVESTMENT SECURITIES
Fair values for investment securities, excluding Federal Home Loan Bank
(FHLB) and Savings Bank Life Insurance (SBLI) stock, are based on quoted
market prices, where available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable instruments.
The carrying values of FHLB and SBLI stock approximates fair value.
69
<PAGE>
LOANS RECEIVABLE
For variable rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair
values for certain mortgage loans (e.g., one-to-four family residential)
are based on quoted market prices of similar loans sold in conjunction
with securitization transactions, adjusted for differences in loan
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
characteristics. The fair values of other loans (e.g., commercial real
estate and rental property mortgage loans, commercial, industrial loans,
and consumer loans) are estimated using a discounted cash flow analysis,
using interest rates currently being offered for loans with similar terms
to borrowers of similar credit quality. The carrying amount of mortgage
loans held-for-sale and accrued interest approximates fair value.
OTHER EARNING ASSETS
Other earning assets consist of a long term fixed rate certificate of
deposit with the Federal Home Loan Bank of Boston. The fair value for this
certificate of deposit is estimated using a discounted cash flow
calculation that applies an interest rate currently being offered on a
time deposit of similar maturity.
DEPOSITORS' ACCOUNTS
The fair values disclosed for certain deposits (e.g., interest and
noninterest-bearing checking, passbook savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand
at the reporting date (i.e., their carrying amounts). Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash
flow calculation that applies interest rates currently being offered on a
schedule of aggregated expected monthly maturities on time deposits. The
carrying amount of accrued interest payable approximates fair value.
BORROWED FUNDS
The carrying amount of borrowings payable within ninety days approximates
fair value. Fair values of other borrowings are estimated using discounted
cash flow analyses based on the Company's current borrowing rates for
similar types of borrowing arrangements. The carrying value for repurchase
agreements approximates fair value due to the short-term nature of these
instruments.
OFF-BALANCE-SHEET INSTRUMENTS
The fair values of the Company's off-balance-sheet instruments (lending
commitments and letters of credit) are based on fees currently charged to
enter into similar agreements, taking into account the remaining terms of
the agreement and the counterparties' credit standing.
At December 31, 1997 and 1996, the estimated fair value of
off-balance-sheet financial instruments, consisting primarily of loan
commitments, were not material.
70
<PAGE>
ASSUMPTIONS
Fair value estimates are made at a specific point in time, based on
relevant market information about specific financial instruments. 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
significant portion of the Company's financial instruments, fair value
estimates are 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.
FIRST ESSEX BANCORP, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
The estimated fair values of the Company's financial instruments follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
----------------- -----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $22,543 $22,543 $38,078 $38,078
Investment securities available-for-sale 211,903 211,903 174,716 174,716
Investment securities held-to-maturity 178,999 180,743 104,465 103,529
Stock in Federal Home Loan Bank
of Boston and Savings Bank Life
Insurance Company 20,997 20,997 16,711 16,711
Loans receivable, net 696,338 700,967 685,206 680,622
Mortgage loans held-for-sale 11,807 11,807 8,915 8,915
Other earning assets 17,291 17,291 -- --
Accrued interest receivable 8,084 8,084 5,970 5,970
Financial liabilities:
Depositors' accounts 744,322 746,127 690,953 692,266
Borrowed funds 343,557 343,445 274,958 275,450
</TABLE>
- --------------------------------------------------------------------------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in, or disagreements with, accountants on accounting
and financial disclosures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
71
<PAGE>
The information required by this item will appear under the headings
"Information Regarding Directors and Nominees", "Executive Officers" and
"Compliance with Section 16(a) of the Exchange Act" of the Company's
definitive Proxy Statement dated April 6, 1998 for the Annual Meeting of
Stockholders to be held May 7, 1998 to be filed with the Securities and
Exchange Commission within 120 days after December 31, 1997 (the "Proxy
Statement"), and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will appear in the Proxy Statement
under the headings "Summary Compensation Table," "Stock Options Granted in
Fiscal 1997," " Aggregated Option/SAR Exercises in Last Fiscal Year and
FY-end Option/SAR Values," "Pension Plan," "Executive Salary Continuation
Agreement," "Employment Contracts, Termination of Employment and Change in
Control Arrangements," and "Compensation/Nominating Committee Interlocks
and Insider Participation" and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will appear in the Proxy Statement under
the headings "Security Ownership of Certain Beneficial Owners and Management"
and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will appear in the Proxy Statement under
the heading "Certain Transactions with Management and Others" and is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)Index of Financial Statements: The following financial
statements appear in response to Item 8 of this Report.
Reports of Independent Public Accountants Consolidated Balance
Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
(a)(2)Index of Financial Statement Schedules: The following financial
statement schedules appear in response to Item 8 of this Report or
as part of this Item 14:
Schedule I - Indebtedness to Related Parties. The information
required by this Schedule is not material and is therefore
omitted.
Schedule II - Guarantees of Securities of other Issuers. Not
applicable.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by First Essex during the fiscal
quarter ended December 31, 1997.
(c) 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
72
<PAGE>
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 the 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 is
incorporated herein by reference to Appendix B to the prospectus
included in the Company's Registration Statement on Form S-8,
registration number 33-21292, filed on April 15, 1988;
10.2- The Shareholder Rights Agreement is 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 the 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
73
<PAGE>
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.
(12) Statements Regarding Computation of Ratios:
Not applicable, as First Essex does not have any debt securities
registered under Section 12 of the Securities Exchange Act of 1934.
(21) Subsidiaries of Registrant:
A list of subsidiaries of the Company is incorporated by reference
to Exhibit 22 to the Company's annual report on Form 10-K for the
fiscal year ended December 31, 1993.
(23) Consent of Experts and Counsel:
Consent of Arthur Andersen LLP is attached hereto as Exhibit 23.
(27) Financial Data Schedules
* Management contract or compensatory plan.
SIGNATURES
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.
FIRST ESSEX BANCORP, INC.
74
<PAGE>
Date: March 12, 1998
by /s/Leonard A. Wilson
-----------------------
Leonard A. Wilson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following people on behalf of the registrant in the
capacities and on the dates indicated.
/s/ Leonard A. Wilson President, Chief Executive Officer and
- ------------------------------------ Director (Principal Executive Officer)
Leonard A. Wilson
75
<PAGE>
<TABLE>
<S> <C> <C>
March 12, 1998
/s/ David W. Dailey Executive Vice President, (Principal March 12, 1998
- ------------------------------------ Financial and Accounting Officer)
David W. Dailey
/s/ Thomas S. Barenboim Director March 12, 1998
- ------------------------------------
Thomas S. Barenboim
/s/ Augustine J. Fabiani Director March 12, 1998
- ------------------------------------
Augustine J. Fabiani
/s/ William L. Lane Director March 12, 1998
- ------------------------------------
William L. Lane
/s/ Frank J. Leone, Jr. Director March 12, 1998
- ------------------------------------
Frank J. Leone, Jr.
Director March 12, 1998
- ------------------------------------
Robert H. Pangione
/s/ Walter W. Topham Director March 12, 1998
- ------------------------------------
Walter W. Topham
/s/ Robert H. Watkinson Director March 12, 1998
- ------------------------------------
Robert H. Watkinson
</TABLE>
- --------------------------------------------------------------------------------
76
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report on First Essex Bancorp, Inc. dated January 7, 1998, included
in this Form 10-K, into the Company's previously filed Registration
Statements on Form S-8 (File Nos. 33-21292, 33-81198, 333-22183 and
333-35057).
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
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