<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended 9/30/99
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER 0-16143
FIRST ESSEX BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-2943217
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
71 Main Street, Andover, Ma 01810
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 681-7500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
The number of shares outstanding of each of the registrant's classes of common
stock as of September 30, 1999:
<TABLE>
<CAPTION>
Title of Class Shares Outstanding
-------------- ------------------
<S> <C>
Common Stock, $.10 par value 7,591,900
</TABLE>
<PAGE>
CAUTIONARY STATEMENT FOR PURPOSES OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
------------------------------------------------
The Company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This Report contains certain
"forward-looking statements" including statements concerning plans, objectives,
future events or performance, assumptions, and other statements which are other
than statements of historical fact. The Company wishes to caution readers that
the following important factors, among others, may have affected, and could in
the future affect, the Company's actual results and could cause the Company's
actual results for subsequent periods to differ materially from those expressed
in any forward-looking statement made by, or on behalf of, the Company herein:
(i) the effect of changes in laws and regulations, including federal and state
banking laws and regulations, with which the Company and its wholly-owned
banking subsidiary, First Essex Bank, FSB, must comply, and the associated costs
of compliance with such laws and regulations, either currently or in the future
as applicable; (ii) the effect of changes in accounting policies and practices,
as may be adopted by the regulatory agencies as well as by the Financial
Accounting Standards Board, or of changes in the Company's organization,
compensation and benefit plans; (iii) the effect on the Company's competitive
position within its market area of the increasing consolidation within the
banking and financial services industries, including increased competition from
larger regional and out-of-state banking organizations as well as nonbank
providers of various financial services; (iv) the effect of unforeseen changes
in interest rates; and (v) the effect of changes in the business cycle and
downturns in the local, regional and national economies.
2
<PAGE>
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
<S> <C> <C>
ITEM 1. Financial Statements
Consolidated Balance Sheets as of September 30,1999
and December 31, 1998 4
Consolidated Statements of Operations for the
three months ended September 30, 1999 and 1998 5
Consolidated Statements of Operations for the
nine months ended September 30, 1999 and 1998 6
Consolidated Statements of Stockholders' Equity
for the three months ended September 30, 1999 and 1998 7
Consolidated Statements of Stockholders' Equity
for the nine months ended September 30, 1999 and 1998 8
Consolidated Statements of Cash Flows for the
nine months ended September 30, 1999 and 1998 9
Notes to the Consolidated Financial Statements 10
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
ITEM 3. Quantitative and Qualitative Disclosure
About Market Risk 23
PART II - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 25
</TABLE>
3
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FIRST ESSEX BANCORP, INC.
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 30,917 $ 90,383
Investment securities available-for-sale 432,493 345,840
Stock in Savings Bank Life Insurance Company 1,194 1,194
Stock in Federal Home Loan Bank of Boston 19,985 19,985
Mortgage loans held-for-sale 3,400 2,566
Loans receivable, less allowance for loan
losses of $11,385 and $11,261 778,452 720,056
Foreclosed property 674 575
Bank premises and equipment 11,155 11,715
Accrued interest receivable 7,985 9,170
Intangible assets 22,414 24,394
Other assets 37,359 22,136
---------- ----------
$1,346,028 $1,248,014
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 986,257 $ 934,695
Borrowed funds 258,424 201,499
Mortgagors' escrow accounts 1,673 702
Other liabilities 7,878 14,036
---------- ----------
Total liabilities 1,254,232 1,150,932
---------- ----------
STOCKHOLDERS' EQUITY:
Serial preferred stock: $.10 par value per
share; 5,000,000 shares authorized, no shares
issued or outstanding Common stock, $.10 par
value per share; 25,000,000 shares authorized,
9,745,200 and 9,708,135 shares issued 975 971
Additional paid-in capital 77,851 77,383
Retained earnings 41,869 36,359
Treasury stock, at cost, 2,153,300 and 2,096,500
shares (19,244) (18,335)
Accumulated other comprehensive income (9,655) 704
---------- ----------
Total stockholders' equity 91,796 97,082
---------- ----------
$1,346,028 $1,248,014
========== ==========
</TABLE>
4
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30,
1999 1998
---------- ----------
(Dollars in thousands,
except per share amounts)
<S> <C> <C>
Interest and dividend income:
Mortgage loans $ 7,863 $ 9,320
Other loans 8,806 7,685
Investment securities available-for-sale 7,272 4,680
Investment securities held-to-maturity -- 359
Short-term investments 319 1,100
Other earning assets 264 261
---------- ----------
Total interest and dividend income 24,524 23,405
---------- ----------
Interest expense
Deposits 8,937 9,712
Borrowed funds 3,879 3,230
---------- ----------
Total interest expense 12,816 12,942
---------- ----------
Net interest income 11,708 10,463
Provision for loan losses 600 290
---------- ----------
Net interest income after provision for loan losses 11,108 10,173
Non-interest income
Net gain on sales of mortgage loans 443 294
Net gain on sale of investment securities -- 83
Loan fees 234 209
Other income 1,015 1,146
---------- ----------
Total non-interest income 1,692 1,732
Non-interest expense
Salaries and employee benefits 3,618 3,554
Buildings and equipment 1,081 1,079
Professional services 409 276
Information processing 608 612
Insurance 89 64
Expenses, gains and losses on
and write-downs of, foreclosed property 59 60
Other 950 1,099
Amortization of intangible assets 651 665
---------- ----------
Total non-interest expenses 7,465 7,409
---------- ----------
Income before provision for income taxes 5,335 4,496
Provision for income taxes 2,004 1,698
---------- ----------
Net income $ 3,331 $ 2,798
========== ==========
Earnings per share - Basic $ 0.44 $ 0.37
========== ==========
Earnings per share - Diluted $ 0.43 $ 0.36
========== ==========
Dividends declared per share $ 0.16 $ 0.14
========== ==========
Weighted average number of shares - basic 7,624,433 7,562,568
========== ==========
Weighted average number of shares - diluted 7,787,017 7,825,132
========== ==========
</TABLE>
5
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1999 1998
---------- ----------
(Dollars in thousands,
except per share amounts)
<S> <C> <C>
Interest and dividend income:
Mortgage loans $ 23,677 $ 27,725
Other loans 24,917 20,754
Investment securities available-for-sale 21,325 13,401
Investment securities held-to-maturity -- 5,879
Short-term investments 717 1,558
Other earning assets 789 782
---------- ----------
Total interest and dividend income 71,425 70,099
---------- ----------
Interest expense
Deposits 26,297 26,208
Borrowed funds 10,806 14,256
---------- ----------
Total interest expense 37,103 40,464
---------- ----------
Net interest income 34,322 29,635
Provision for loan losses 1,800 1,160
---------- ----------
Net interest income after provision
for loan losses 32,522 28,475
Non-interest income
Net gain on sales of mortgage loans 978 976
Net gain on sale of investment securities 54 1,049
Loan fees 581 516
Other income 2,856 2,453
---------- ----------
Total non-interest income 4,469 4,994
Non-interest expense
Salaries and employee benefits 10,404 9,662
Buildings and equipment 3,445 3,091
Professional services 1,071 894
Information processing 1,839 1,691
Insurance 245 192
Expenses, gains and losses on
and write-downs of, foreclosed property 407 166
Other 2,907 3,138
Amortization of intangible assets 1,980 1,058
---------- ----------
Total non-interest expenses 22,298 19,892
---------- ----------
Income before provision for income taxes 14,693 13,577
Provision for income taxes 5,526 5,332
---------- ----------
Net income $ 9,167 $ 8,245
========== ==========
Earnings per share - basic $ 1.20 $ 1.09
========== ==========
Earnings per share - diluted $ 1.17 $ 1.05
========== ==========
Dividends declared per share $ 0.48 $ 0.42
========== ==========
Weighted average number of shares - basic 7,624,852 7,554,655
========== ==========
Weighted average number of shares - diluted 7,804,904 7,857,924
========== ==========
</TABLE>
6
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statements of Stockholders' Equity
Three Months Ended September 30, 1999 and 1998
(Unaudited)
<TABLE>
<CAPTION>
Components of Stockholders' Equity
----------------------------------------------------------
Accumulated
Other
Comprehensive Common Paid in Retained Treasury Comprehensive
Income Stock Capital Earnings Stock Income Total
------------- ----- ------- -------- -------- ------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JUNE 30, 1999 $ 975 $77,851 $ 39,754 ($18,335) ($ 7,790) $ 92,455
COMPEHENSIVE INCOME:
NET INCOME $ 3,331 3,331 3,331
OTHER COMPREHENSIVE INCOME:
- UNREALIZED SECURITIES LOSSES,
NET OF $711 TAX BENEFIT,
ARISING DURING THE PERIOD (1,865)
- LESS: RECLASSIFCATION ADJUSTMENT
FOR SECURITY GAINS INCLUDED IN
NET INCOME, NET OF TAX EXPENSE --
--------
TOTAL OTHER COMPREHENSIVE INCOME
INCOME (1,865) (1,865) (1,865)
--------
TOTAL COMPREHENSE INCOME 1,466
========
CASH DIVIDENDS DECLARED (1,216) (1,216)
AVQUISITION OF TREASURY STOCK 0 0 (909) (909)
----- ------- -------- -------- -------- --------
BALANCE AT SEPTEMBER 30, 1999 $ 975 $77,851 $ 41,869 ($19,244) ($ 9,655) $ 91,796
===== ======= ======== ======== ======== ========
Balance at June 30, 1998 $ 966 $76,791 $ 33,018 ($18,335) $ 1,376 $ 93,816
Comprehensive income:
Net income $ 2,798 2,798 2,798
Other comprehensive income:
- Unrealized securities gains,
net of $256 of tax expense,
arising during the period 369
- Less: reclassifcation adjustment
for security gains included in
net income, net of $33 tax expense 50
========
Total other comprehensive income 319 319 319
--------
Total Comprehensive income $ 3,117 0
========
Cash dividends declared (1,059) (1,059)
Stock options exercised 1 6 7
----- ------- -------- -------- -------- --------
Balance at September 30, 1998 $ 967 $76,797 $ 34,757 ($18,335) $ 1,695 $ 95,881
===== ======= ======== ======== ======== ========
</TABLE>
7
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statements of Stockholders' Equity
Nine Months Ended September 30, 1999 and 1998
(Unaudited)
<TABLE>
<CAPTION>
Components of Stockholders' Equity
--------------------------------------------------------
Accumulated
Other
Comprehensive Common Paid in Retained Treasury Comprehensive
Income Stock Capital Earnings Stock Income Total
-------- ----- ------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $ 971 $77,383 $ 36,359 ($18,335) $ 704 $ 97,082
Comprehensive income:
Net income $ 9,167 9,167 $ 9,167
Other comprehensive income:
- Unrealized securities losses,
net of $5,674 of tax benefit,
arising during the period (10,325)
- Less: reclassification adjustment
for security gains included in
net income, net of $20 tax expense 34
--------
Total other comprehensive income (10,359) (10,359) (10,359)
--------
Total comprehensive income ($ 1,192)
========
Cash dividends declared (3,657) (3,657)
Acquisition of treasury stock (909) (909)
Stock options exercised 4 468 472
----- ------- -------- -------- ------- --------
Balance at September 30,1999 $ 975 $77,851 $ 41,869 ($19,244) ($9,655) $ 91,796
===== ======= ======== ======== ======= ========
Balance at December 31, 1997 $ 952 $75,303 $ 29,685 ($15,842) $ 967 $ 91,065
Compehensive income:
Net income $ 8,245 8,245 8,245
Other comprehensive income:
- Unrealized securities gains,
net of $905 tax expense,
arising during the period 1,357
- Less: reclassification adjustment
for security gains included in
net income, net of $420 tax expense 629
--------
Total other comprehensive income 728 728 728
--------
Total comprehensive income $ 8,973
========
Cash dividends declared (3,173) (3,173)
Stock options exercised 15 1,494 1,509
Acquisition of treasury stock (2,493) (2,493)
----- ------- -------- -------- ------- --------
Balance at September 30, 1998 $ 967 $76,797 $ 34,757 ($18,335) $ 1,695 $ 95,881
===== ======= ======== ======== ======= ========
</TABLE>
8
<PAGE>
FIRST ESSEX BANCORP, INC
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 9,167 $ 8,245
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 1,800 1,160
Depreciation and amortization 1,523 1,450
Gain on sales of foreclosed property -- (277)
Write-down of foreclosed property 206 16
Amortization of intangible assets 1,980 1,058
Amortization of investment securities discounts and premiums, net 713 1,228
Proceeds from sales of mortgage loans and mortgage servicing rights 53,019 84,321
Mortgage loans originated for sale (52,875) (75,333)
Realized gains on the sale of investment securities (54) (1,049)
Realized gains on the sale of mortgage loans (978) (976)
Decrease in accrued interest receivable 1,185 745
(Increase) decrease in other assets (223) 3,960
Decrease in other liabilities (68) (2,821)
--------- ---------
Net cash provided by operating activities 15,395 21,727
Cash flows from investing activities: --
Acquisition of branch assets and assumed deposit liabilities, net of cash received -- 65,033
Proceeds from sales of available-for-sale securities 20,006 167,614
Proceeds from maturities and principal payments of available-for-sale securities 67,983 50,982
Proceeds from maturities and principal payments of held-to-maturity securities -- 37,456
Purchases of available-for-sale securities (191,750) (169,179)
Purchases of held-to-maturity securities -- (21,892)
Purchases of Federal Home Loan Bank stock -- (182)
Purchase of bank-owned life insurance (15,000) --
Loans originated and purchased, net of principal collected (62,223) 8,312
Proceeds from sales of foreclosed property 1,722 2,891
Purchases of bank premises and equipment (963) (821)
--------- ---------
Net cash provided by (used in) investing activities (180,225) 140,214
Cash flows from financing activities:
Net increase in demand deposits, NOW accounts and savings accounts 29,291 41,446
Net increase (decrease) in term deposits 22,271 (3,800)
Net increase (decrease) in borrowed funds with maturities of three months or less 11,371 (68,811)
Proceeds from borrowed funds with maturities in excess of three months 109,000 72,000
Repayments of borrowed funds with maturities in excess of three months (63,446) (143,017)
Increase in mortgagors' escrow accounts 971 923
Dividends paid (3,657) (3,169)
Stock options exercised 472 1,509
Common stock repurchases (909) (2,493)
--------- ---------
Net cash provided by (used in) financing activities 105,364 (105,412)
--------- ---------
Net increase (decrease) in cash and cash equivalents (59,466) 56,529
Cash and cash equivalents at beginning of period 90,383 22,542
--------- ---------
Cash and cash equivalents at end of period $ 30,917 $ 79,071
========= =========
Supplemental disclosure of cash flow information:
Interest paid during the year $ 26,340 $ 41,077
Income taxes paid during the year 5,587 5,565
Cost incurred in early repayment of Federal Home Loan Bank advances -- 150
Supplemental schedule of noncash financing and investing activities:
Real estate acquired through, or deeds in lieu of, foreclosure 2,027 661
</TABLE>
9
<PAGE>
FIRST ESSEX BANCORP, INC.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements are unaudited and include the
accounts of First Essex Bancorp, Inc. (the "Company") and its subsidiary, First
Essex Bank, FSB. These financial statements reflect, in management's opinion,
all adjustments (consisting of normal recurring adjustments) necessary for a
fair presentation of the Company's financial position and the results of its
operations and cash flows for the periods presented. These financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's 1998 annual report.
Earnings Per Share
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 the period. Dilutive EPS amounts have been
computed using the weighted average number of common and common equivalent
shares and the dilutive potential common shares (stock options outstanding and
exercisable) during the period.
2. Business Segments
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
operating segments of a business enterprise and descriptive information about
the operating segments in financial statements. Operating segments are
components of an enterprise, which are evaluated regularly by the chief
operating decision-maker in deciding how to allocate resources and in assessing
performance. The Company's chief operating decision-maker is the Chief Executive
Officer and Chairman of the Board of the Company. The adoption of SFAS No. 131
did not have a material effect on the Company's primary financial statements,
but did result in the disclosure of segment information contained herein. The
Company has identified its reportable operating business segment as Community
Banking, based on the products and services provided to its customers.
The Company's community banking business segment consists of commercial banking
and retail banking. The community banking segment is managed as a single
strategic unit and derives its revenues from a wide range of banking services,
including lending activities, and the acceptance of demand, savings and time
deposits.
Nonreportable operating segments of the Company's operations which do not have
similar characteristics to the community banking operations and do not meet the
quantitative thresholds requiring disclosure, are included in the other category
in the disclosure of business segments below. The nonreportable segment
represents the holding company financial information.
The accounting policies used in the disclosure of business segments are the same
as those described in the summary of significant accounting policies. The
consolidation adjustments reflect certain eliminations of intersegment revenue,
cash and investments in subsidiaries.
10
<PAGE>
The following table provides a reconciliation of the community banking segment
information to the consolidated financials.
<TABLE>
<CAPTION>
Consolidation
Adjustments
Community and
Banking Other Eliminations Consolidated
---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
September 30, 1999
Investment securities $ 453,672 $ -- $ -- $ 453,672
Net loans 781,852 -- -- 781,852
Total assets 1,345,486 45,858 (45,316) 1,346,028
Total interest income 71,420 12 (7) 71,425
Total interest expense 37,110 -- (7) 37,103
Net interest income 34,310 12 -- 34,322
Net income 9,161 6 -- 9,167
September 30, 1998
Investment securities 347,206 -- -- 347,206
Net loans 748,145 -- -- 748,145
Total assets 1,241,073 50,330 (49,971) 1,241,432
Total interest income 70,096 101 (98) 70,099
Total interest expense 40,562 -- (98) 40,464
Net interest income 29,534 101 -- 29,635
Net income 8,191 56 (2) 8,247
</TABLE>
11
<PAGE>
ITEM 2. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
First Essex Bancorp, Inc., (the "Company"), is a Delaware corporation whose
primary activity is to act as the parent holding company for First Essex Bank,
FSB (the "Bank").
The Company's net earnings depend to a large extent upon its net interest
income, which is the difference between interest and dividend income earned on
its loans and investments and interest expense paid on its deposits and borrowed
funds. The Company's net earnings also depend upon its provision for loan
losses, non-interest income, non-interest expense and income tax expense.
Interest and dividend income and interest expense are significantly affected by
general economic conditions. These economic conditions, together with conditions
in the local real estate markets, affect the levels of non-performing assets and
provision for loan losses.
RESULTS OF OPERATIONS
Net income for the three months ended September 30, 1999 was $3.3 million
compared to $2.8 million for same period in 1998, or a 19% increase. Net
interest income totaled $11.7 million for the quarter compared to $10.5 million
for the same period in 1998. Non-interest income decreased $40 thousand and
non-interest expenses increased $56 thousand for the three months ended
September 30, 1999.
Net income for the nine months ended September 30, 1999 was $9.2 million
compared to $8.2 million for the same period in 1998, or an 11% increase. Net
interest income totaled $34.3 million for the nine months ended September 30,
1999 as compared to $29.6 million for the same period in 1998. Non-interest
income decreased $.5 million and non-interest expenses increased $2.4 million
for the nine months ended September 30, 1999.
The decreases in non-interest income are attributable to nonrecurring gains on
sale of investment securities in the second quarter of 1998, partially offset by
increased gains on the sale of loans during the third quarter of 1999 and
increased fee income for the nine month period in 1999. The increases in
non-interest expense are primarily related to the amortization of intangible
assets associated with branches acquired during the second quarter of 1998. The
majority of the other changes in non-interest income and non-interest expense
reflect costs associated with the operation of those additional branch
locations.
12
<PAGE>
The following table presents an analysis of average yields earned and rates paid
for the periods indicated:
<TABLE>
<CAPTION>
For the Three Months Ended September 30,
1999 1998
---------------------------------------- ------------------------------------------
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
----------- ----------- ---- ----------- ----------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets
Earning assets
Short-term investments $ 25,771 $ 319 4.95% $ 85,320 $ 1,100 5.16%
Investment securities 459,066 7,272 6.34% 364,031 5,039 5.54%
Total loans (1) 773,147 16,669 8.62% 764,114 17,005 8.90%
Other earning assets 17,449 264 6.05% 17,348 261 6.02%
----------- ----------- ----------- -----------
Total earning assets 1,275,433 24,524 7.69% 1,230,813 23,405 7.61%
Allowance for loan losses (11,356) (11,536)
----------- -----------
Total earning assets less
allowance for loan losses 1,264,077 1,219,277
Other assets 77,413 41,969
----------- -----------
Total assets $ 1,341,490 $ 1,261,246
=========== ===========
Liabilities and Stockholders' Equity
Deposits
NOW accounts $ 52,434 $ 122 0.93% $ 50,757 $ 160 1.26%
Money market accounts 88,222 729 3.31% 83,835 761 3.63%
Savings accounts 247,947 2,082 3.36% 212,157 1,927 3.63%
Time deposits 473,017 6,004 5.08% 492,180 6,864 5.58%
----------- ----------- ----------- -----------
Total interest bearing deposits 861,620 8,937 4.15% 838,929 9,712 4.63%
Borrowed funds 283,449 3,879 5.47% 218,343 3,230 5.92%
----------- ----------- ----------- -----------
Total interest bearing deposits and
borrowed funds 1,145,069 12,816 4.48% 1,057,272 12,942 4.90%
----------- ----------- ----------- -----------
Demand deposits 94,908 90,412
Other liabilities 7,766 18,363
----------- -----------
Total liabilities 1,247,743 1,166,047
Stockholders' equity 93,747 95,199
----------- -----------
Total liabilities and
stockholders' equity $ 1,341,490 $ 1,261,246
=========== ===========
Net interest income $ 11,708 $ 10,463
=========== ===========
Weighted average interest
rate spread 3.21% 2.71%
===== =====
Net yield on average
earning assets (2) 3.67% 3.40%
===== =====
Return on average assets 0.99% 0.89%
===== =====
Return on average equity 14.21% 11.76%
===== =====
</TABLE>
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for loan losses divided by average
earning assets
13
<PAGE>
The following table presents an analysis of average yields earned and rates paid
for the periods indicated:
<TABLE>
<CAPTION>
For the Nine Months Ended September 30,
1999 1998
------------------------------------ ------------------------------------
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
----------- -------- ------- ----------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets
Earning assets
Short-term investments $ 20,940 $ 717 4.57% $ 39,714 $ 1,558 5.23%
Investment securities 456,727 21,325 6.23% 402,158 19,280 6.39%
Total loans (1) 751,855 48,594 8.62% 734,066 48,479 8.81%
Other earning assets 17,423 789 6.04% 17,324 782 6.02%
----------- -------- ----------- --------
Total earning assets 1,246,945 71,425 7.64% 1,193,262 70,099 7.83%
Allowance for loan losses (11,298) (10,879)
----------- -----------
Total earning assets less allowance
for loan losses 1,235,647 1,182,383
Other assets 76,431 67,570
----------- -----------
Total assets $ 1,312,078 $ 1,249,953
----------- -----------
Liabilities and Stockholders' Equity
Deposits
NOW accounts $ 52,134 $ 348 0.89% $ 46,041 $ 458 1.33%
Money market accounts 95,752 2,253 3.14% 72,755 1,574 2.88%
Savings accounts 231,832 5,518 3.17% 185,969 5,230 3.75%
Time deposits 467,824 18,178 5.18% 442,718 18,946 5.71%
----------- -------- ----------- --------
Total interest bearing deposits 847,542 26,297 4.14% 747,483 26,208 4.67%
Borrowed funds 264,836 10,806 5.44% 318,753 14,256 5.96%
----------- -------- ----------- --------
Total interest bearing deposits and
borrowed funds 1,112,378 37,103 4.45% 1,066,236 40,464 5.06%
Demand deposits 91,803 72,180
Other liabilities 10,806 18,313
----------- -----------
Total liabilities 1,214,987 1,156,729
Stockholders' equity 97,091 93,224
----------- -----------
Total liabilities and
stockholders' equity $ 1,312,078 $ 1,249,953
=========== ===========
Net interest income $ 34,322 $ 29,635
======== ========
Weighted average interest
rate spread 3.19% 2.77%
===== =====
Net yield on average
earning assets (2) 3.67% 3.31%
===== =====
Return on average assets 0.93% 0.88%
===== =====
Return on average equity 12.59% 11.79%
===== =====
</TABLE>
(1) Loans on a non-accrual status are included in the average balance.
(2) Net interest income before provision for loan losses divided by average
earning assets.
14
<PAGE>
NET INTEREST INCOME
Net interest income increased by $1.2 million to $11.7 million for the three
months ended September 30, 1999, and increased by $4.7 million to $34.3 million
for the nine months ended September 30, 1999. This represents increases of 11.9%
and 15.8%, respectively, when compared to the same periods of 1998.
INTEREST AND DIVIDEND INCOME
Interest and dividend income increased by $1.1 million (4.8%) to $24.5 million,
and by $1.3 million (1.9%) to $71.4 million for the three and nine month periods
ended September 30, 1999, respectively, from $23.4 million and $70.1 million
recorded in the same periods in 1998. These changes primarily relate to volume
increases in loans and investments partially offset by decreases in the average
yield on earning assets for the nine month period.
INTEREST EXPENSE
Interest expense decreased by $.1 million (1.0%) to $12.8 million, and by $3.4
million (8.3%) to $37.1 million, for the three and nine month periods ended
September 30, 1999 when compared to the same periods in 1998. These decreases
are primarily attributable to a reduction in the average cost of funds to 4.48%
and 4.45% for the three and nine month periods ended September 30, 1999 as
compared to 4.90% and 5.06% for the comparable periods of 1998, partially offset
by volume increases in deposits for both the three and nine month periods and
increased borrowed funds for the three month period.
PROVISION FOR LOAN LOSSES
Losses on loans are provided for under the accrual method of accounting.
Assessing the adequacy of the allowance for loan losses involves substantial
uncertainties and is based upon management's evaluation of the amount required
to meet estimated losses inherent in the loan portfolio after weighing various
factors. Among the factors management may consider are the quality of specific
loans, risk characteristics of the loan portfolio generally, the level of
non-accruing loans, current economic conditions, trends in delinquencies and
charge-offs and collateral values of the underlying security. Ultimate losses
may vary significantly from the current estimates. Losses on loans, including
impaired loans, are charged against the allowance when management believes the
collectability of principal is doubtful.
The provisions for loan losses totaled $.6 million and $1.8 million for the
three and nine month periods ended September 30, 1999, respectively. The
provision for loan losses totaled $.3 million and $1.2 million for the
comparable periods in 1998. Provisions result from management's continuing
internal review of the loan portfolio as well as its judgement as to the
adequacy of the reserves in light of the condition of the regional real estate
and other markets, and the economy in general. As a result of increased loans,
there is an expectation that the Bank will continue to find it necessary to make
provisions for loan losses in the future. See "Financial Condition -
Non-Performing Assets."
NON-INTEREST INCOME
Non-interest income consists of net gains from the sales of mortgage loans and
mortgage loan servicing rights and gains on the sale of investment securities,
together with fee and other non-interest income.
Non-interest income decreased by $40 thousand (2.3%) to $1.7 million and by $.5
million (10.5%) to $4.5 million for the three and nine months ended September
30, 1999, respectively, compared to $1.7 million and $5.0 million for the same
periods in 1998. The decreases in non-interest income are attributable to
nonrecurring gains on sale of investment securities in the second and third
quarters of 1998, partially offset by increased gains on the sale of loans
during the third quarter and increased fee income for the nine month period.
NON-INTEREST EXPENSE
Non-interest expense increased by $56 thousand (0.8%) to $7.5 million for the
three months ended September 30, 1999, and by $2.4 million (12.1%) to $22.3
million for the nine months ended September 30, 1999, compared to $7.4 million
and $19.9 million for the same periods in 1998. This increase is primarily
related to the amortization of intangible assets associated with the branches
acquired at the close of the second quarter of 1998. The remaining increase was
spread throughout the components of non-interest expense and reflects costs
associated with the operation of those additional branch locations.
15
<PAGE>
INCOME TAX EXPENSE
The provision for income taxes increased to $2.0 million and $5.5 million for
the three and nine month periods ended September 30, 1999, respectively, as
compared to $1.7 million and $5.3 million for the same periods of 1998. The
effective tax rate in 1999 is lower due to favorable tax rates on certain
investment income.
FINANCIAL CONDITION
Total assets amounted to $1,346.0 million at September 30, 1999, an increase of
$98.0 million or 7.9% from $1,248.0 million at December 31, 1998.
LOANS
At September 30, 1999, the loan portfolio, including mortgage loans held for
sale, and before consideration of the allowance for loan losses, was $793.2
million, representing 58.9% of total assets, compared to $733.9 million or 58.8%
of total assets at December 31, 1998.
The following table sets forth information concerning the Company's loan
portfolio at the dates indicated. The balances shown in the table are net of
unadvanced funds and unearned discounts and fees.
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------- -------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real Estate:
Residential $153,520 19.4% $189,983 25.9%
Commercial 107,369 13.5 88,774 12.1
Construction 52,950 6.7 43,220 5.9
-------- ----- -------- -----
Total Real Estate Loans 313,839 39.6 321,977 43.9
-------- ----- -------- -----
Owner occupied Commercial Real Estate 61,142 7.7 62,800 8.6
Commercial loans 101,926 12.8 89,690 12.2
Aircraft loans 89,297 11.3 59,657 8.1
Consumer loans
Home Equity, Home Improvement
& Second Mortgage 55,228 7.0 59,003 8.0
Automobile 166,572 21.0 134,613 18.4
Other 5,233 0.7 6,143 0.8
-------- ----- -------- -----
Total consumer loans 227,033 28.6 199,759 27.2
Total loans $793,237 100.0% $733,883 100.0%
======== ===== ======== =====
</TABLE>
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level determined by management
to be adequate to provide for losses inherent in the loan portfolio including
commitments to extend credit. The allowance for loan losses 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.
16
<PAGE>
The determination of the adequacy of the allowance of 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 methodology includes a formula allowance based on 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, a valuation allowance for impaired loans and an
unallocated allowance. The unallocated allowance, based in part on credit
policy, approximates 20% to 25% of the formula and valuation allowances. In
addition, it reflects management's review of overall portfolio quality and
analysis of current levels and trends in charge-off, delinquency and
non-accruing loan data, 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. When an evaluation of these conditions signifies a change
in the level of risk, the Company adjusts the formula allowance. Periodic credit
reviews enable further adjustment to the allowance through the risk-rating of
loans and identification of loans requiring a valuation allowance. In, addition,
the formula model is designed to be self-correcting by taking into account
recent loss experience. The provision for loan losses is set based on the
factors discussed above. In addition, it is management's intent to maintain the
allowance at a level consistent with the Company's peers in the banking
industry.
The following table summarizes the activity in the allowance for loan losses
(including amounts established for impaired loans) for the three and nine months
ended September 30, 1999:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1999
-------------------------
(Dollars in Thousands)
<S> <C> <C>
Balance at beginning of period $ 11,311 $ 11,261
Provision for loan losses 600 1,800
-------- --------
Charge-offs 763 2,284
Recoveries 237 608
-------- --------
Net charge-offs 526 1,676
-------- --------
Balance at end of period $ 11,385 $ 11,385
======== ========
Total loans at end of period $793,237 $793,237
Average loans for the period 773,147 751,855
Allowance to loans ratio 1.44% 1.44%
Net charge-offs to average loans ratio (annualized) 0.27% 0.30%
</TABLE>
NON-PERFORMING ASSETS
Non-performing assets consist of non-accruing loans (including loans impaired
under SFAS No. 114), and foreclosed property. Non-performing assets totaled $4.3
million at September 30, 1999 and $6.1 million at December 31, 1998.
The Bank's policy is to discontinue the accrual of interest on all loans
(including loans impaired under SFAS No. 114), for which payment of interest or
principal is 90 days or more past due or for such other loans as considered
necessary by management if collection of interest and principal is doubtful.
When a loan is placed on non-accrual status, all previously accrued but
uncollected interest is reversed against the current period interest income.
Restructured loans are loans (1) on which concessions have been made in light of
the debtor's financial difficulty with the objective of maximizing recovery and
(2) with respect to which the renegotiated payment terms continue to be met.
17
<PAGE>
The following table indicates the recorded investment of non-performing assets
and the related valuation allowance for impaired loans.
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
Impaired Impaired
Loan Loan
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Non-accruing Loans
Impaired Loans
Requiring a valuation allowance $ 206 $ 206 $ 493 $ 393
Not requiring a valuation 182 -- 1,619 --
388 206 2,112 393
------ ------ ------ ------
Restructured Loans 305 75 447 154
------ ------ ------ ------
Total impaired 693 $ 281 2,559 $ 547
====== ======
Residential Mortgage 1,466 1,526
Other 1,446 1,414
------ ------
Total non-accruing 3,605 5,499
Foreclosed property, net 674 575
------ ------
Total non-performing assets $4,279 $6,074
====== ======
Percentage of non-performing assets
to total assets 0.31% 0.49%
Percentage of allowance for loan
losses to non-accruing loans 320.6% 204.8%
</TABLE>
The valuation allowance for impaired loans is included in the allowance for loan
losses on the balance sheet
INVESTMENTS
At September 30, 1999, the investment portfolio, consisting of short-term
investments, investment securities, mortgage-backed securities, Federal Home
Loan Bank ("FHLB") stock and stock in the Savings Bank Life Insurance Company of
Massachusetts, totaled $453.7 million or 33.7% of total assets, compared to
$367.0 million or 29.4% of total assets at December 31, 1998. Interest and
dividend income on the investment portfolio generated 32.0% of total interest
and dividend income for both the three and nine month periods ended September
30, 1999, respectively, as compared to 27.3% and 30.8% for the same periods of
1998.
To identify and control market risks associated with the investment portfolio,
the Company has established policies and procedures, which include stop loss
limits and stress testing on a periodic basis.
DEPOSITS
Deposits are the primary source of funds for lending and investment activities.
Deposit flows vary significantly and are influenced by prevailing interest
rates, market conditions, economic conditions and competition. At September 30,
1999, the Bank had total deposits of $986.3 million representing a net increase
of $51.6 million compared to total deposits of $934.7 million at December 31,
1998.
While deposit flows are by nature unpredictable, the Bank attempts to manage its
deposits through selective pricing. Due to the uncertainty of market conditions,
it is not possible for the Bank to predict how aggressively it will compete for
deposits in future quarters or the likely effect of any such decision on deposit
levels, interest expense and net interest income. Strategies are currently in
place to aggressively market more stable deposit sources in such accounts as NOW
and Demand Deposits.
18
<PAGE>
BORROWED FUNDS
The Bank is a member of the FHLB and is entitled to borrow from the FHLB by
pledging certain assets. The Bank also utilizes short- term repurchase
agreements with maturities less than three months, as an additional source of
funds. Repurchase agreements are secured by U.S. government and agency
securities. These borrowings are an alternative source of funds compared to
deposits and increased to $258.4 million at September 30, 1999 as compared to
$201.5 million at December 31, 1998.
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 June 30, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
The most recent notification from the Office of Thrift Supervision ("OTS")
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as
set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table. As
of September 30, 1999, 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.
19
<PAGE>
The following table displays the Bank's capital calculations as defined under
prompt corrective action for the periods indicated:
<TABLE>
<CAPTION>
TO BE WELL
FIRST ESSEX BANK, FSB FOR CAPITAL CAPITALIZED UNDER PROMPT
ACTUAL ACTUAL ADEQUACY PURPOSES CORRECTIVE ACTION PROVISION:
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
SEPTEMBER 30, 1999 (UNAUDITED)
Greater than
TANGIBLE CAPITAL (TO ADJUSTED ASSETS) $78,762 5.87% $20,129 or 1.50% n/a
equal to
Greater than
or
TIER 1 (CORE) CAPITAL (TO ADJUSTED ASSETS) 78,762 5.87 40,258 3.00 $67,097 equal to 5.00%
TIER 1 (CORE) (TO RISK WEIGHTED ASSETS) 78,762 8.96 35,177 4.00 52,766 6.00
TOTAL RISK BASED CAPITAL
(TO RISK WEIGHTED ASSETS) 89,756 10.21 70,355 8.00 87,944 10.00
December 31, 1998
Greater than
Tangible Capital ( to Adjusted Assets) $71,154 5.79 $18,429 or
equal to 1.50% n/a
Greater than
Tier 1 (Core) Capital (to Adjusted Assets) 71,154 5.79 36,859 3.00 $61,428 or
equal to 5.00%
Tier 1 Capital (to Risk Weighted Assets) 71,154 9.45 30,114 4.00 45,172 6.00
Total Risk Based Capital
(to Risk Weighted Assets) 80,459 10.69 60,229 8.00 75,286 10.00
</TABLE>
YEAR 2000
The Company is addressing the issues inherent in the impending change of
century, otherwise known as "Year 2000", or "Y2K". The following constitutes the
Company's Year 2000 Readiness disclosure under the Year 2000 Information and
Readiness Disclosure Act. The potential problem with Year 2000 concerns the
inability of information systems, primarily software programs, to properly
recognize and process date sensitive information for the year 2000 and beyond. A
bank-wide project team has been organized to address and resolve Y2K issues. In
addition, the Board has established a Year 2000 Compliance Oversight Committee
to oversee activities of management and others in dealing with Y2K issues.
A principal issue the Company faces is the Y2K readiness of its third party
vendor who supplies the Company's primary application systems that include loan
systems, deposits systems and the general ledger application. This vendor has
completed all remediation and testing phases and is now in the process of
finalizing contingency plans.
The company will continue to monitor progress.
A. The Company's State of Readiness
In preparing for the change of century, the Company has reviewed and assessed
both information technology (IT) and non-IT systems. IT systems include all
significant operating systems (e.g., the deposit system, platform teller system,
financial reporting system, payroll system, loan systems, etc.). The non-IT
systems (otherwise known as "embedded technology") include items such as vault
doors, elevators and security systems. Monitoring the state of readiness is
accomplished by reviewing the various phases of the Company's project plan.
These phases are defined as follows:
1. Awareness - defining the Y2K problem, informing employees and customers,
developing a strategy, project team and plan to resolve issues and risks
attendant to the problem.
2. Assessment - determining the size and complexity of the Y2K problem
together with the magnitude of the effort needed to correct the issues. It
includes establishing an inventory of IT and non-IT systems, identification
of the "mission critical" items, and a determination of the resources
necessary to address the mission critical items.
20
<PAGE>
3. Analysis, renovation (or remediation) and implementation - analyzing and
replacing hardware and software (e.g., personal computers, e-mail, voice
response units, etc.), software reprogramming, third-party vendor
certifications, and other associated changes necessary to correct the items
determined to be mission critical.
4. Validation (or testing) and contingency planning - post-renovation
incremental testing of new, existing and renovated hardware and software,
together with testing the connectivity of new, existing and renovated
systems to each other. The major validation for the Company relates to the
renovation efforts of its third party provider of the Company's major
application systems. Contingency planning accounts for the possibility
that, even with renovation, Y2K issues may still arise.
The following table reflects the Company's progress to date, and expected
completion date, with respect to these phases:
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
COMPLETION COMPLETION/COMPLETED
% (*) DATE
---------- --------------------
<S> <C> <C>
AWARENESS 100% August 1998
--------- ---- -----------
ASSESSMENT 100% August 1998
--------- ---- -----------
ANALYSIS, RENOVATION AND
IMPLEMENTATION 100% June 1999
--------- ---- -----------
VALIDATION AND CONTINGENCY
PLANNING 100% Sept 1999
--------- ---- -----------
</TABLE>
B. Costs To Address the Company's Year 2000 Issues
The following table details the expenditures (period and capital) incurred to
date by the Company, together with the estimated expenditures that will be
incurred to bring the Y2K project to closure. Period expenditures have been or
will be expensed in the period incurred. Capital expenditures have been or will
be capitalized and amortized over the estimated useful life of the item. All
capital expenditures reflect hardware and software upgrades that were either
previously planned or would have occurred in the normal course, and not as a
direct result of Y2K remediation efforts.
<TABLE>
<CAPTION>
%
EXPENDITURES ADDITIONAL TOTAL COMPLETE
DESCRIPTION TO DATE EXPENDITURES EXPENDITURES (*)
-------------------------- ------------ ------------ ------------ --------
<S> <C> <C> <C> <C>
PERIOD EXPENDITURES: ($000's)
-------------------------- ------------ ------------ ------------ --------
MANAGEMENT AND STAFF
SALARIES AND BOARD FEES $275 $ 25 $300 100%
-------------------------- ------------ ------------ ------------ --------
Y2K CONSULTING FEES 110 25 135 82
-------------------------- ------------ ------------ ------------ --------
THIRD PARTY VENDOR EXPENSE
AND SYSTEM TESTING 60 0 60 100
-------------------------- ------------ ------------ ------------ --------
CAPITAL EXPENDITURES:
-------------------------- ------------ ------------ ------------ --------
REPLACEMENT OF
NONCOMPLIANT SYSTEMS 600 0 600 100
-------------------------- ------------ ------------ ------------ --------
</TABLE>
21
<PAGE>
C. The Risks of the Company's Year 2000 Issues
The reasonably likely worst case risk related to Y2K for the Company would be
major and prolonged disruptions in electrical power and telephone
communications. Due to the branch network's dependence on computer and telephone
links for data retrieval and security mechanisms, it would be difficult to
operate in either or both of these situations. The Company has been and will
continue to interact with these suppliers, and review the results of their
testing, to confirm their readiness for the Year 2000. Another risk scenario for
the Company would be temporary business disruptions of its large commercial
borrowers due to their failure(s) to be prepared for Y2K. The financial impact
of this contingency on borrowers could cause income and cash flow shortfalls for
the Company. The Company has implemented a process of surveying and evaluating
its commercial customers with respect to their readiness for the change of
century by means of a questionnaire. This process allows the Company to be more
proactive in planning for this contingency. If warranted, the Company's
Allowance for Loan Losses would be increased and an appropriate charge-off would
be recorded for the estimated impact of the customer's failure to be compliant.
New loans and loan renewals have clauses inserted in the loan documents to
address the borrowers' Y2K readiness. Because the more probable risk scenarios
of the Company would be intermittent, minor and short-term IT systems failures
that were not previously anticipated, the Company is addressing these risks by
means of formulating contingency plans.
D. The Company's Contingency Plans
The Company has developed contingency plans for its core business operations.
Core business operations are those processes that are required to maintain the
ongoing business of the Company. There have been 10 core operations identified.
Contingency plans for these 10 core business operations have been developed and
are 100% complete. These contingency plans have been tested to validate the
feasibility of each plan by means of simulations and/or walk through scenarios.
The testing and validation of these plans was completed by June 30, 1999, which
corresponds with the guideline date imposed by the Federal Financial
Institutions Examination Council (FFIEC) for all financial institutions. The
Company has also completed two simulation walk through tests of the contingency
plans to assure they are viable. These contingency plans will be retested during
the fourth quarter to revalidate the feasibility of each plan.
22
<PAGE>
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". The
statement establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded on the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 2000. A
company may also implement the statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified on or after the selected transition date (and, at the company's
election, before January 1, 1998 or January 1, 1999).
The Company has not yet quantified the impact of adopting SFAS No. 133 on the
financial statements, and has not determined the timing of or method of the
adoption of the statement. The adoption of SFAS No. 133 could have the effect of
increasing the volatility in reported earnings and accumulated other
comprehensive income.
On January 1, 1999, the Company adopted SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise." The statement requires that
after the securitization of mortgage loans held for sale, a company engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. The adoption did not have a material impact on the Company's
financial condition or results of operations.
On January 1, 1999, the Company adopted Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed of Obtained for
Internal use." SOP 98-1 requires computer software costs associated with
internal software to be expensed as incurred until certain capitalization
criteria are met. The adoption did not have a material impact on the Company's
financial statements.
On January 1, 1999,the Company adopted SOP 98-5, "Reporting on the Costs of
Start-Up Activities." This position statement requires all costs associated with
pre-opening, pre-operating and organization activities to be expensed as
incurred. The adoption did not have a material impact on the Company's financial
condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices such as interest rates, foreign currency exchange
rates, commodity prices, and equity prices. The Company's primary market risk
exposure is interest rate risk. The ongoing monitoring and management of this
risk is an important component of the Company's asset/liability management
process which is governed by policies established by the Board of Directors that
are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee (ALCO). In this capacity, ALCO develops guidelines and
strategies impacting the Company's asset/liability related activities based upon
estimated market risk sensitivity, policy limits and overall market interest
rate levels/trends.
INTEREST RATE RISK
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change the interest income and expense streams
associated with the Company's financial instruments also changes thereby
impacting net interest income (NII), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling two-year
horizon, it also utilizes additional tools to monitor potential longer-term
interest rate risk. There have been no material changes in the interest rate
risk reported at the conclusion of the Company's December 31, 1998 year-end.
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of liquidity are customer deposits, borrowings from
the FHLB, scheduled amortization and prepayments of loan principal, cash flow
from operations, maturities of various investments and loan sales.
Management believes it is prudent to maintain an investment portfolio that not
only provides a source of income, but also provides a potential source of
liquidity to meet lending demand and deposit flows. The Bank adjusts the level
of its liquid assets and the mix of its loans and investments based upon
management's judgment as to the quality of specific investment opportunities and
the relative attractiveness of their maturities and yields.
Net cash provided from operating activities totaled $15.4 million for the
nine months ended September 30, 1999 compared to $21.7 million that was
provided for the same period in 1998. The change is primarily related to the
decrease in the origination and sale of mortgage loans during the first nine
months of 1999 compared to the prior period.
Net cash used by investing activities totaled $180.2 million for the nine
months ended September 30, 1999 compared to cash provided by investing
activities of $140.2 million for the comparable period in 1998. The change is
due primarily to the higher level of purchases of investment securities
combined with the reduced volume of sales activity during the first nine
months of 1999 as compared to the same period of 1998, the purchase of
bank-owned life insurance, the increase in loan originations and the
non-recurring cash payment in 1998 associated with the acquisition of
branches and the corresponding assumption of deposits.
Net cash provided by financing activities totaled $105.4 million for the nine
months ended September 30, 1999, compared to net cash used of $105.4 million for
the comparable period in 1998. This change primarily reflects the increased
level of borrowed funds as a result of new borrowings and reduced repayments.
IMPACT OF INFLATION
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles which require
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation.
An important concept in understanding the effect of inflation on financial
institutions is the distinction between monetary and non-monetary items. In a
stable environment, monetary items are those assets and liabilities which are or
will be converted into a fixed amount of dollars regardless of changes in
prices. Examples of monetary items include cash, investment securities, loans,
deposits and borrowings. Non-monetary items are those assets and liabilities
which gain or lose general purchasing power as a result of the relationships
between specific prices for the items and price change levels. Examples of
non-monetary items include equipment and real estate. Additionally, interest
rates do not necessarily move in the same direction, or in the same magnitude,
as the prices of goods and services as measured by the consumer price index.
24
<PAGE>
FIRST ESSEX BANCORP, INC.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a)EXHIBITS:
(3) ARTICLES OF INCORPORATION AND BY-LAWS:
3.1 The Restated Certificate of Incorporation of the Company is
incorporated herein by reference to Exhibit 3.1 to Amendment No. 1
to the Company's Registration Statement on Form S-1, Registration
No. 33-10966, filed with the Securities and Exchange Commission on
April 17, 1987 ("Amendment No. 1 to 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 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.
*10.7- 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.
*10.8- Special Termination Agreement dated January 1, 1994 and restated
as of October 9, 1997 between Leonard A. Wilson and First Essex
Bancorp, Inc. incorporated by reference to Exhibit 10.10 to the
Company's Quarterly report on Form 10-Q for the quarter ended
September 30, 1997.
*10.9- 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.
*10.10- Form of Special Termination Agreement between First Essex
Bancorp, Inc., First Essex Bank, FSB, and each of William F.
Burke, John M. DiGaetano, and Wayne C. Golon, 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.
*10.11- Common Stock Option Agreement with Brian W. Thompson incorporated
herein by reference to Form S-8, Registration No. 333-22183, filed
on February 21, 1997.
*10.12- 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.
*10.13- Deferred Compensation Plan for Directors of First Essex Bancorp,
Inc. and Its Subsidiaries incorporated by reference to Exhibit
10.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
*10.14- First Essex Bancorp, Inc. Senior Management Incentive
Compensation Plan incorporated by reference to Exhibit 10.14 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
*10.15- Agreement between First Essex Bancorp, Inc., First Essex Bank,
FSB and David W. Dailey incorporated by reference to Exhibit 10.15
to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
*10.16- Agreement between First Essex Bank, FSB and David L. Savoie
incorporated by reference to Exhibit 10.16 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.
10.17- The First Essex Bancorp, Inc. Rights Agreement is incorporated
herein by reference to Exhibit 1 to the Company's Report on Form
8-A filed on October 12, 1999.
25
<PAGE>
(27) Financial Data Schedule
* Management contract or compensatory plan.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the registrant during the quarter
ended September 30, 1999.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST ESSEX BANCORP, INC.
(Registrant)
Date: November 9, 1999 By /S/ DOUGLAS E. MOISAN
---------------------
Douglas E. Moisan
Senior Vice President
Principal Accounting Officer
27
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