<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 6/30/99
-------
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 June 30, 1999:
<TABLE>
<CAPTION>
TITLE OF CLASS SHARES OUTSTANDING
<S> <C>
Common Stock, $.10 par value 7,648,700
</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>
ITEM 1. Financial Statements
Consolidated Balance Sheets as of June 30,1999
and December 31, 1998 4
Consolidated Statements of Operations for the
three months ended June 30, 1999 and 1998 5
Consolidated Statements of Operations for the
six months ended June 30, 1999 and 1998 6
Consolidated Statements of Stockholders' Equity
for the six months ended June 30, 1999 and 1998 7
Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998 8
Notes to the Consolidated Financial Statements 9
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
ITEM 3. Quantitative and Qualitative Disclosure
About Market Risk 22
PART II - OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders 24
ITEM 6. Exhibits and Reports on Form 8-K 24
</TABLE>
3
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FIRST ESSEX BANCORP, INC.
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- -----------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 52,019 $ 90,383
Investment securities available-for-sale 441,150 345,840
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 2,250 2,566
Loans receivable, less allowance for loan losses of
$11,311 and $11,261 754,715 720,056
Foreclosed property 467 575
Bank premises and equipment 11,300 11,715
Accrued interest receivable 8,456 9,170
Goodwill 23,065 24,394
Other assets 22,316 22,136
----------- -----------
$ 1,336,917 $ 1,248,014
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 948,717 $ 934,695
Borrowed funds 285,820 201,499
Mortgagors' escrow accounts 638 702
Other liabilities 9,287 14,036
----------- -----------
Total liabilities 1,244,462 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 39,754 36,359
Treasury stock, at cost, 2,096,500 shares (18,335) (18,335)
Accumulated other comprehensive income (7,790) 704
----------- -----------
Total stockholders' equity 92,455 97,082
----------- -----------
$ 1,336,917 $ 1,248,014
----------- -----------
----------- -----------
</TABLE>
4
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30,
1999 1998
--------- ---------
(Dollars in thousands,
except per share amounts)
<S> <C> <C>
Interest and dividend income:
Mortgage loans $7,730 $9,158
Other loans 8,449 6,797
Investment securities available-for-sale 7,368 4,733
Investment securities held-to-maturity -- 2,111
Short-term investments 155 284
Other earning assets 262 261
--------- ---------
Total interest and dividend income 23,964 23,344
--------- ---------
Interest expense
Deposits 8,645 8,424
Borrowed funds 3,781 5,519
--------- ---------
Total interest expense 12,426 13,943
--------- ---------
Net interest income 11,538 9,401
Provision for loan losses 600 435
--------- ---------
Net interest income after provision for loan losses 10,938 8,966
Non-interest income
Net gain on sales of mortgage loans and mortgage servicing rights 220 400
Net gain on sale of investment securities 54 949
Loan fees 171 184
Other fee income 927 739
--------- ---------
Total non-interest income 1,372 2,272
Non-interest expense
Salaries and employee benefits 3,441 3,256
Buildings and equipment 1,185 1,016
Professional services 365 420
Information processing 635 570
Insurance 82 65
Expenses, gains and losses on
and write-downs of, foreclosed property 156 (35)
Other 1,019 1,186
Amortization of intangible assets 665 197
--------- ---------
Total non-interest expenses 7,548 6,675
--------- ---------
Income before provision for income taxes 4,762 4,563
Provision for income taxes 1,797 1,814
--------- ---------
Net income $2,965 $2,749
--------- ---------
--------- ---------
Earnings per share - Basic $0.39 $0.36
--------- ---------
--------- ---------
Earnings per share - Diluted $0.38 $0.35
--------- ---------
--------- ---------
Dividends declared per share $0.16 $0.14
--------- ---------
--------- ---------
Weighted average number of shares - basic 7,636,177 7,550,697
--------- ---------
--------- ---------
Weighted average number of shares - diluted 7,819,729 7,870,587
--------- ---------
--------- ---------
</TABLE>
5
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statement of Operations
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
1999 1998
--------- ---------
(Dollars in thousands,
except per share amounts)
<S> <C> <C>
Interest and dividend income:
Mortgage loans $15,814 $18,405
Other loans 16,111 13,069
Investment securities available-for-sale 14,053 8,721
Investment securities held-to-maturity -- 5,520
Short-term investments 398 458
Other earning assets 525 521
--------- ---------
Total interest and dividend income 46,901 46,694
--------- ---------
Interest expense
Deposits 17,360 16,496
Borrowed funds 6,927 11,026
--------- ---------
Total interest expense 24,287 27,522
--------- ---------
Net interest income 22,614 19,172
Provision for loan losses 1,200 870
--------- ---------
Net interest income after provision
for loan losses 21,414 18,302
Non-interest income
Net gain on sales of mortgage loans and mortgage servicing rights 535 682
Net gain on sale of investment securities 54 966
Loan fees 347 307
Other fee income 1,841 1,307
--------- ---------
Total non-interest income 2,777 3,262
Non-interest expense
Salaries and employee benefits 6,786 6,108
Buildings and equipment 2,364 2,012
Professional services 662 618
Information processing 1,231 1,079
Insurance 156 128
Expenses, gains and losses on
and write-downs of, foreclosed property 348 106
Other 1,955 2,039
Amortization of intangible assets 1,331 393
--------- ---------
Total non-interest expenses 14,833 12,483
--------- ---------
Income before provision for income taxes 9,358 9,081
Provision for income taxes 3,522 3,634
--------- ---------
Net income $5,836 $5,447
--------- ---------
--------- ---------
Earnings per share - basic $0.77 $0.72
--------- ---------
--------- ---------
Earnings per share - diluted $0.75 $0.69
--------- ---------
--------- ---------
Dividends declared per share $0.32 $0.28
--------- ---------
--------- ---------
Weighted average number of shares - basic 7,625,066 7,550,633
--------- ---------
--------- ---------
Weighted average number of shares - diluted 7,813,847 7,874,320
--------- ---------
--------- ---------
</TABLE>
6
<PAGE>
FIRST ESSEX BANCORP, INC.
Consolidated Statements of Stockholders' Equity
Six Months Ended June 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 $5,836 5,836 $5,836
Other comprehensive income:
- Unrealized securities gains,
net of $4,963 of tax benefit,
arising during the period (8,460)
- Less: reclassifcation adjustment
for security gains included in
net income, net of $20 tax expense 34
-------
Total other comprehensive income (8,494) (8,494) (8,494)
-------
Total Comprehensive income ($2,658)
-------
-------
Cash dividends declared (2,441) (2,441)
Stock options exercised 4 468 472
---- ------- ------- -------- ------ -------
Balance at June 30,1999 $975 $77,851 $39,754 ($18,335) ($7,790) $92,455
---- ------- ------- -------- ------ -------
---- ------- ------- -------- ------ -------
Balance at December 31, 1997 $952 $75,303 $29,685 ($15,842) $967 $91,065
Compehensive income:
Net income $5,447 5,447 5,447
Other comprehensive income:
- Unrealized securities gains,
net of $659 tax expense,
arising during the period 989
- Less: reclassifcation adjustment
for security gains included in
net income, net of $386 tax expense 580
-------
Total other comprehensive income 409 409 409
-------
Total Comprehense income $5,856
-------
-------
Cash dividends declared (2,114) (2,114)
Stock options exercised 14 1,488 1,502
Acquisition of treasury stock (2,493) (2,493)
---- ------- ------- -------- ------ -------
Balance at June 30, 1998 $966 $76,791 $33,018 ($18,335) $1,376 $93,816
---- ------- ------- -------- ------ -------
---- ------- ------- -------- ------ -------
</TABLE>
7
<PAGE>
FIRST ESSEX BANCORP, INC
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1999 1998
------- --------
(Dollars in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $5,836 $5,447
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 1,200 870
Provision for depreciation and amortization 1,020 945
Gain on sales of foreclosed property -- (214)
Amortization of intangible assets 1,331 393
Amortization of investment securities discounts and premiums, net 481 963
Proceeds from sales of mortgage loans and mortgage servicing rights 37,697 62,137
Mortgage loans originated for sale (36,846) (56,642)
Realized gains on the sale of investment securities (54) (966)
Realized gains on the sale of mortgage loans and mortgage servicing rights, net (535) (682)
Decrease in accrued interest receivable 714 447
(Increase) decrease in other assets (182) 2,033
Increase in other liabilities 214 8,306
------- --------
Net cash provided by operating activities 10,876 23,037
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 20,006 145,538
Proceeds from maturities and principal payments of available-for-sale securities 47,550 31,823
Proceeds from maturities and principal payments of held-to-maturity securities -- 37,739
Purchases of available-for-sale securities (176,750) (89,554)
Purchases of held-to-maturity securities -- (21,892)
Purchases of Federal Home Loan Bank stock -- (182)
Loans originated and purchased, net of principal collected (36,980) 300
Proceeds from sales of foreclosed property 1,229 1,826
Purchases of bank premises and equipment (605) (390)
------- --------
Net cash provided by (used in) investing activities (145,550) 170,241
Cash flows from financing activities:
Net increase in demand deposits, NOW accounts and savings accounts 8,731 39,150
Net increase of term deposits 5,291 6,256
Net increase (decrease) in borrowed funds with maturities of three months or less 41,617 (78,908)
Proceeds from borrowed funds with maturities in excess of three months 65,000 103,000
Repayments of borrowed funds with maturities in excess of three months (22,296) (106,875)
Increase (decrease) in mortgagors' escrow accounts (64) 26
Dividends paid (2,441) (2,110)
Stock options exercised 472 1,502
Common stock repurchases -- (2,493)
------- --------
Net cash provided by (used in) financing activities 96,310 (40,452)
------- --------
Net increase (decrease) in cash and cash equivalents (38,364) 152,826
Cash and cash equivalents at beginning of period 90,383 22,542
------- --------
Cash and cash equivalents at end of period $52,019 $175,368
------- --------
------- --------
Supplemental disclosure of cash flow information:
Interest paid during the year $24,390 $27,565
Income taxes paid during the year 4,897 3,525
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 48 540
</TABLE>
8
<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. Included in diluted EPS are 183,552 and 319,890
dilutive potential shares for the quarters ended June 30, 1999 and 1998,
respectively.2.
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. The following table provides a
reconciliation of the community banking segment information to the consolidated
financials.
9
<PAGE>
<TABLE>
<CAPTION>
Consolidation
Community Adjustments
Banking Other and Eliminations Consolidated
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
June 30, 1999
Investment securities $462,329 $ -- $ -- $462,329
Net loans 756,965 -- -- 756,965
Total assets 1,336,343 47,997 (47,423) 1,336,917
Total interest income 46,898 8 (5) 46,901
Total interest expense 24,292 -- (5) 24,287
Net interest income 22,606 8 -- 22,614
Net income 5,831 5 -- 5,836
June 30, 1998
Investment securities 309,326 -- -- 309,326
Net loans 761,465 -- -- 761,465
Total assets 1,314,393 51,012 (50,653) 1,314,752
Total interest income 46,692 85 (83) 46,694
Total interest expense 27,605 -- (83) 27,522
Net interest income 19,087 85 -- 19,172
Net income 5,401 47 (1) 5,447
</TABLE>
10
<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 June 30, 1999 was $3.0 million compared to
$2.7 million for same period in 1998, or an 8% increase. Net interest income
totaled $11.5 million for the quarter compared to $9.4 million for the same
period in 1998. Non-interest income decreased $.9 million and non-interest
expenses increased $.9 million for the three months ended June 30, 1999.
Net income for the six months ended June 30, 1999 was $5.8 million compared to
$5.4 million for the same period in 1998, or a 7% increase. Net interest income
totaled $22.6 million for the six months ended June 30, 1999 as compared to
$19.2 million for the same period in 1998. Non-interest income decreased $.5
million and non-interest expenses increased $2.4 million for the six months
ended June 30, 1999.
The decreases in non-interest income are attributable to nonrecurring gains on
sale of investment securities in the second quarter of 1998. 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 volume increases associated with those acquisitions.
11
<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 June 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 $14,129 $155 4.39% $21,363 $286 5.35%
Investment securities 479,474 7,368 6.15 429,395 6,842 6.37
Total loans (1) 750,176 16,179 8.63 718,367 15,955 8.88
Other earning assets 17,422 262 6.02 17,324 261 6.03
---------- ------- ---------- -------
Total earning assets 1,261,201 23,964 7.60 1,186,449 23,344 7.87
Allowance for loan losses (11,252) (10,507)
---------- ----------
Total earning assets less allowance
for loan losses 1,249,949 1,175,942
Other assets 79,215 67,230
---------- ----------
Total assets $1,329,164 $1,243,172
---------- ----------
---------- ----------
Liabilities and Stockholders' Equity
Deposits
NOW accounts $53,781 $106 0.79% $44,320 $152 1.37%
Money market accounts 99,722 754 3.02 67,537 382 2.26
Savings accounts 224,764 1,757 3.13 180,737 1,754 3.88
Time deposits 466,812 6,028 5.17 420,954 6,136 5.83
---------- ------- ---------- -------
Total interest bearing deposits 845,079 8,645 4.09 713,548 8,424 4.72
Borrowed funds 282,247 3,781 5.36 351,569 5,519 6.28
---------- ------- ---------- -------
Total interest bearing deposits and
borrowed funds 1,127,326 12,426 4.41 1,065,117 13,943 5.24
---------- ------- ---------- -------
Demand deposits 91,616 66,293
Other liabilities 11,199 18,932
---------- ----------
Total liabilities 1,230,141 1,150,342
Stockholders' equity 99,023 92,830
---------- ----------
Total liabilities and
stockholders' equity $1,329,164 $1,243,172
---------- ----------
---------- ----------
Net interest income $11,538 $9,401
------- -------
------- -------
Weighted average interest
rate spread 3.19% 2.63%
----- -----
----- -----
Net yield on average
earning assets (2) 3.66% 3.17%
----- -----
----- -----
Return on average assets 0.89% 0.88%
----- -----
----- -----
Return on average equity 11.98% 11.84%
----- -----
----- -----
</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
12
<PAGE>
The following table presents an analysis of average yields earned and rates paid
for the periods indicated:
<TABLE>
<CAPTION>
For the Six Months Ended June 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 $18,511 $ 398 4.30% $16,533 $458 3.56%
Investment securities 455,551 14,053 6.17 441,611 14,241 6.45
Total loans (1) 741,150 31,925 8.61 718,786 31,474 8.76
Other earning assets 17,410 525 6.03 17,312 521 6.00
---------- ------- ---------- -------
Total earning assets
Total earning assets 1,232,622 46,901 7.61 1,194,242 46,694 7.82
Allowance for loan losses (11,269) (10,545)
---------- ----------
Total earning assets less allowance
for loan losses 1,221,353 1,183,697
Other assets 75,938 61,275
---------- ----------
Total assets $1,297,291 $1,244,972
---------- ----------
---------- ----------
Liabilities and Stockholders' Equity
Deposits
NOW accounts $51,983 $ 226 0.87% $43,644 $298 1.37%
Money market accounts 99,538 1,524 3.06 67,123 813 2.42
Savings accounts 223,730 3,436 3.07 172,658 3,303 3.83
Time deposits 465,213 12,174 5.23 417,549 12,082 5.79
---------- ------- ---------- -------
Total interest bearing deposits 840,464 17,360 4.13 700,974 16,496 4.71
Borrowed funds 255,478 6,927 5.42 369,790 11,026 5.96
---------- ------- ---------- -------
Total interest bearing deposits and
borrowed funds 1,095,942 24,287 4.43 1,070,764 27,522 5.14
---------- ------- ---------- -------
Demand deposits 90,242 62,913
Other liabilities 12,317 19,075
---------- ----------
Total liabilities 1,198,501 1,152,752
Stockholders' equity 98,790 92,220
---------- ----------
Total liabilities and
stockholders' equity $1,297,291 $1,244,972
---------- ----------
---------- ----------
Net interest income $ 22,614 $19,172
-------- -------
-------- -------
Weighted average interest
rate spread 3.18% 2.68%
----- -----
----- -----
Net yield on average
earning assets (2) 3.67% 3.21%
----- -----
----- -----
Return on average assets 0.90% 0.87%
----- -----
----- -----
Return on average equity 11.81% 11.81%
----- -----
----- -----
</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>
NET INTEREST INCOME
Net interest income increased by $2.1 million to $11.5 million for the three
months ended June 30, 1999, and increased by $3.4 million to $22.6 million for
the six months ended June 30, 1999. This represents increases of 22.7% and
18.0%, respectively, when compared to the same periods of 1998.
INTEREST AND DIVIDEND INCOME
Interest and dividend income increased by $.6 million (2.7%) to $24.0 million,
and by $.2 million (0.4%) to $46.9 million for the three and six month periods
ended June 30, 1999, respectively, from $23.3 million and $46.7 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.
INTEREST EXPENSE
Interest expense decreased by $1.5 million (10.9%) to $12.4 million, and by $3.2
million (11.8%) to $24.3 million, for the three and six month periods ended June
30, 1999 when compared to the same periods in 1998. These decreases are
primarily attributable to a shift to lower cost core deposit funding sources.
The average balances of core deposits increased by $85.7 million and $91.8
million, while time deposits and borrowed funds decreased by $23.5 million and
$66.6 million, reducing the cost of funds to 4.41% and 4.43% for the three and
six month periods ended June 30, 1999 as compared to 5.24% and 5.14% for the
comparable periods of 1998.
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
nonaccruing loans, current economic conditions, trends in delinquencies and
chargeoffs 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 $1.2 million for the
three and six month periods ended June 30, 1999, respectively. The provision for
loan losses totaled $.4 million and $.9 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 NonPerforming 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 $.9 million (39.6%) to $1.4 million and by $.5
million (14.9%) to $2.8 million for the three and six months ended June 30,
1999, respectively, compared to $2.3 million and $3.3 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 quarter of
1998.
NON-INTEREST EXPENSE
Non-interest expense increased by $.9 million (13.1%) to $7.5 million for the
three months ended June 30, 1999, and by $2.4 million (18.8%) to $14.8 million
for the six months ended June 30, 1999, compared to $6.7 million and $12.5
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 primarily relates to
volume increases associated with those acquisitions.
14
<PAGE>
INCOME TAX EXPENSE
The provision for income taxes decreased to $1.8 million and $3.5 million for
the three and six month periods ended June 30, 1999, respectively, when compared
to 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 $1,336.9 million at June 30, 1999, an increase of $88.9
million or 7.1% from $1,248.0 million at December 31, 1998.
LOANS
At June 30, 1999, the loan portfolio, including mortgage loans held for sale,
and before consideration of the allowance for loan losses, was $768.3 million,
representing 57.5% 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>
June 30, 1999 December 31, 1998
------------------------ -------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real Estate:
Residential $162,251 21.1% $189,983 25.9%
Commercial 94,821 12.4 88,774 12.1
Construction 50,171 6.5 43,220 5.9
-------- ----- -------- -----
Total Real Estate Loans 307,243 40.0 321,977 43.9
-------- ----- -------- -----
Owner occupied Commercial Real Estate 60,670 7.9 62,800 8.6
Commercial loans 102,194 13.3 89,690 12.2
Aircraft loans 82,876 10.8 59,657 8.1
Consumer loans
Home Equity, Home Improvement
& Second Mortgage 53,777 7.0 59,003 8.1
Automobile 155,973 20.3 134,613 18.3
Other 5,543 0.7 6,143 0.8
-------- ----- -------- -----
Total consumer loans 215,293 28.0 199,759 27.2
Total loans $768,276 100.0% $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 probable 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.
15
<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 six months
ended June 30, 1999:
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999
----------------------------
(Dollars in Thousands)
<S> <C> <C>
Balance at beginning of period $11,343 $11,261
Provision for loan losses 600 1,200
-------- --------
Charge-offs 870 1,521
Recoveries 238 371
-------- --------
Net charge-offs 632 1,150
-------- --------
Balance at end of period $11,311 $11,311
-------- --------
-------- --------
Total loans at end of period $768,276 $768,276
Average loans for the period 750,176 741,150
Allowance to loans ratio 1.47% 1.47%
Net charge-offs to average loans ratio (annualized) 0.34% 0.31%
</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 $5.2
million at June 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.
16
<PAGE>
The following table indicates the recorded investment of non-performing assets
and the related valuation allowance for impaired loans.
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
---------------------------- ----------------------------
Impaired Loan Impaired Loan
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
<S> <C> <C> <C> <C>
Non-accruing Loans
Impaired Loans
Requiring a valuation allowance $135 $135 $493 $393
Not requiring a valuation allowance 652 -- 1,619 --
----- ---- ----- ----
787 135 2,112 393
Restructured Loans 439 0 447 154
----- ---- ----- ----
Total impaired 1,226 $135 2,559 $547
---- ----
---- ----
Residential Mortgage 2,153 1,526
Other 1,323 1,414
----- -----
Total non-accruing 4,702 5,499
Foreclosed property, net 467 575
----- -----
Total non-performing assets $5,169 $6,074
----- -----
----- -----
Percentage of non-performing assets
to total assets 0.39% 0.49%
Percentage of allowance for loan
losses to non-accruing loans 240.5% 204.8%
</TABLE>
The valuation allowance for impaired loans is included in the allowance for loan
losses on the balance sheet
INVESTMENTS
At June 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 $462.3 million or 34.6% 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 31.4% and 30.8% of total
interest and dividend income for the three and six month periods ended June 30,
1999, respectively, as compared to 30.5% and 31.5% 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 June 30, 1999,
the Bank had total deposits of $948.7 million representing a net increase of
$14.0 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.
17
<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 $285.8 million at June 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 June 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.
18
<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>
June 30, 1999 (unaudited)
Tangible Capital ( to Adjusted Assets) $75,982 5.71% $19,949 1.50% n/a
Tier 1 (Core) Capital (to Adjusted Assets) 75,982 5.71 39,899 3.00 $66,498 5.00%
Tier 1 (Core) (to Risk Weighted Assets) 75,982 9.08 33,485 4.00 50,228 6.00
Total Risk Based Capital
(to Risk Weighted Assets) 86,453 10.33 66,971 8.00 83,714 10.00
December 31, 1998
Tangible Capital ( to Adjusted Assets) $71,154 5.79 $18,429 1.50% n/a
Tier 1 (Core) Capital (to Adjusted Assets) 71,154 5.79 36,859 3.00 $61,428 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 which are the loan
systems, deposits systems and the general ledger application. This vendor has
developed plans to deal with the Y2K problem and the Company is closely
monitoring the remediation progress of this plan. The Company is also involved
in the testing of all applicable changes that have occurred in the vendor's
software, together with addressing other mission critical systems.
A. The Company's State of Readiness
In preparing for the change of century, the Company has reviewed and assessed
both information technology (IT) and non-IT systems. IT systems include all
significant operating systems (e.g., the deposit system, platform teller system,
financial reporting system, payroll system, loan systems, etc.). The non-IT
systems (otherwise known as "embedded technology") include items such as vault
doors, elevators and security systems. Monitoring the state of readiness is
accomplished by reviewing the various phases of the Company's project plan.
These phases are defined as follows:
1. Awareness - defining the Y2K problem, informing employees and customers,
developing a strategy, project team and plan to resolve issues and risks
attendant to the problem.
2. Assessment - determining the size and complexity of the Y2K problem
together with the magnitude of the effort needed to correct the issues. It
includes establishing an inventory of IT and non-IT systems, identification
of the "mission critical" items, and a determination of the resources
necessary to address the mission critical items.
19
<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 98% 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 $ 250 $ 50 $ 300 85%
- -------------------------------------------------------------------------------------------------------
Y2K CONSULTING FEES 85 50 135 65
- -------------------------------------------------------------------------------------------------------
THIRD PARTY VENDOR EXPENSE AND
SYSTEM TESTING 50 10 60 85
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
CAPITAL EXPENDITURES:
- -------------------------------------------------------------------------------------------------------
REPLACEMENT OF NONCOMPLIANT SYSTEMS 500 100 600 85
- -------------------------------------------------------------------------------------------------------
</TABLE>
20
<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 will be completed by June 30, 1999,
which corresponds with the guideline date imposed by the Federal Financial
Institutions Examination Council (FFIEC) for all financial institutions. These
contingency plans will be retested during the fourth quarter to revalidate the
feasibility of each plan.
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.
21
<PAGE>
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.
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 $10.9 million for the six
months ended June 30, 1999 compared to $23.0 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 experienced during the first six months
of 1999 compared to the prior period.
Net cash used by investing activities totaled $145.6 million for the six months
ended June 30, 1999 compared to cash provided by investing activities of $170.2
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 six months of 1999 as compared to the
same period of 1998 and the non-recurring cash payment in 1998 associated with
the acquisition of branches and corresponding assumption of deposits.
Net cash provided by financing activities totaled $96.3 million for the six
months ended June 30, 1999, compared to net cash used of $40.5 million for the
comparable period in 1998. This change primarily reflects the increased level of
borrowed funds.
22
<PAGE>
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.
23
<PAGE>
FIRST ESSEX BANCORP, INC.
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of the registrant was held on May 6, 1999.
All nominees of the Board of Directors of the registrant were re-elected for a
three-year term. Votes were cast as follows:
1. Election of Three Class III Directors
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
<S> <C> <C>
Thomas S. Barenboim 6,304,240 143,104
William L. Lane 6,312,763 134,581
Robert H. Watkinson 6,314,031 133,313
</TABLE>
Item 6. Exhibits and Reports on Form 8-K
(A)EXHIBITS:
(3) ARTICLES OF INCORPORATION AND BYLAWS:
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 S1, Registration
No. 3310966, filed with the Securities and Exchange Commission on
April 17, 1987 ("Amendment No. 1 to the Form S1");
3.2 The Amended and Restated Bylaws of the Company are incorporated
herein by reference to Exhibit 4.1 of the Company's current report
on Form 8K 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 S8,
registration number 3321292, 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
8K 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 8K 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 10K 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.
24
<PAGE>
*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.
(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 June 30, 1999.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST ESSEX BANCORP, INC.
-------------------------
(Registrant)
Date: August 9, 1999 By /s/ Douglas E. Moisan
---------------------
Douglas E. Moisan
Senior Vice President
and Principal Accounting Officer
26
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