<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 1998 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 0-16358
-----------------------
ANDOVER BANCORP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 04-2952665
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
61 Main Street, Andover, Massachusetts 01810
- -------------------------------------- ------------------
(Address of principal executive office) (Zip Code)
(978) 749-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
Former name, former address and former fiscal year, if changed since last
report.
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 issuer's classes of Common
Stock, as of the latest practicable date is:
Class: Common Stock, par value $0.10 per share
Outstanding as of November 2, 1998: 6,501,551 shares
<PAGE> 2
ANDOVER BANCORP, INC.
AND SUBSIDIARIES
Index
PART I - FINANCIAL INFORMATION
ITEM 1 Financial Statements Page
Consolidated Balance Sheets 1
Consolidated Statements of Operations 2
Consolidated Statements of Changes in
Stockholders' Equity 3
Consolidated Statements of Cash Flows 4-5
Notes to Consolidated Financial
Statements 6
Analysis of Net Yield on Earning Assets 7
ITEM 2 Management's Discussion and Analysis of 8-20
Financial Condition and Results of Operations
For the Quarter Ended September 30, 1998
For the Nine Months Ended September 30, 1998
ITEM 3 Qualitative and Quantitative Market Risk 18
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 21
ITEM 2 Changes in Securities 21
ITEM 3 Defaults upon Senior Securities 21
ITEM 4 Submission of Matters to a Vote of Security Holders 21
ITEM 5 Other Information 21
ITEM 6 Exhibits and Reports on Form 8-K 21
Signatures 22
<PAGE> 3
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Unaudited)
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
(In thousands)
<S> <C> <C>
ASSETS
Cash and due from banks $ 26,044 $ 21,586
Short-term investments 10,800 14,150
----------- -----------
Cash and cash equivalents 36,844 35,736
----------- -----------
Assets held for sale, at lower of
cost or market 6,514 5,537
Investments available for sale (amortized
cost of $152,168 in 1998 and $137,175
in 1997) 155,111 139,054
Investments held to maturity (market value
of $106,734 in 1998 and $130,947 in 1997) 104,482 129,363
Loans 1,027,363 978,823
Allowance for loan losses (10,242) (12,521)
----------- -----------
Net loans 1,017,121 966,302
----------- -----------
Mortgage servicing assets, net 8,407 9,500
Other real estate owned, net 132 406
Premises and equipment, net 9,362 9,593
Accrued interest receivable 7,998 7,567
Stock in FHLBB, at cost 15,747 15,747
Net deferred income taxes receivable 2,291 1,832
Other assets 2,366 2,108
----------- -----------
Total assets $ 1,366,375 $ 1,322,745
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 959,176 $ 946,982
Securities sold under agreements
to repurchase 18,348 10,171
Federal Home Loan Bank advances 256,245 248,561
Mortgagors' escrow accounts 3,099 2,478
Income taxes payable 5,998 2,250
Accrued expenses and other liabilities 5,323 5,224
----------- -----------
Total liabilities 1,248,189 1,215,666
----------- -----------
Stockholders' equity:
Serial preferred stock, $0.10 par value per share;
3,000,000 shares authorized, none issued -- --
Common stock, $0.10 par value per share;
15,000,000 shares authorized; 6,482,836 and 6,459,898
shares issued in 1998 and 1997, respectively 648 517
Additional paid-in capital 59,870 59,619
Retained earnings 55,925 45,814
Accumulated other comprehensive income 1,743 1,129
----------- -----------
Total stockholders' equity 118,186 107,079
----------- -----------
Total liabilities and stockholders' equity $ 1,366,375 $ 1,322,745
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
1
<PAGE> 4
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Unaudited)
QUARTERS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans $ 19,559 $ 17,663 $ 57,854 $ 52,050
Mortgage-backed securities 2,814 3,194 9,114 9,314
Investment securities 1,841 1,730 5,433 5,069
Short-term investments 216 172 663 574
--------- --------- --------- ---------
Total interest and dividend income 24,430 22,759 73,064 67,007
--------- --------- --------- ---------
Interest expense:
Deposits 9,972 9,940 29,739 28,209
Federal Home Loan Bank advances 3,784 2,993 11,664 9,866
Securities sold under agreements to repurchase 161 174 474 316
--------- --------- --------- ---------
Total interest expense 13,917 13,107 41,877 38,391
--------- --------- --------- ---------
Net interest and dividend income 10,513 9,652 31,187 28,616
Provision (credit) for loan losses 400 130 (1,805) 683
--------- --------- --------- ---------
Net interest and dividend income
after provision (credit) for loan losses 10,113 9,522 32,992 27,933
--------- --------- --------- ---------
Non-interest income:
Net gains from sales of assets held for sale
and investments available for sale 165 78 507 248
Mortgage banking income (losses), net (264) 520 (25) 1,706
Gains(losses) on real estate operations, net 13 (235) 37 (820)
Other income 949 905 2,796 2,403
--------- --------- --------- ---------
Total non-interest income 863 1,268 3,315 3,537
--------- --------- --------- ---------
Non-interest expense:
Salaries and employee benefits 2,985 3,027 9,228 8,901
Office occupancy and equipment 774 701 2,181 2,140
Data processing 525 557 1,530 1,416
Professional fees 289 194 718 607
Marketing 211 248 604 743
Mortgage banking expense 124 79 459 275
Other operating expense 717 714 2,288 2,162
--------- --------- --------- ---------
Total non-interest expense 5,625 5,520 17,008 16,244
--------- --------- --------- ---------
Income before income tax expense 5,351 5,270 19,299 15,226
Income tax expense 878 1,922 5,874 5,488
--------- --------- --------- ---------
Net income $ 4,473 $ 3,348 $ 13,425 $ 9,738
========= ========= ========= =========
Basic earnings per share $ 0.69 $ 0.52 $ 2.07 $ 1.52
========= ========= ========= =========
Diluted earnings per share $ 0.67 $ 0.50 $ 2.00 $ 1.47
========= ========= ========= =========
Weighted average shares outstanding - basic 6,481,421 6,435,423 6,474,214 6,403,950
Dilutive impact of stock options 221,636 194,674 225,014 208,626
--------- --------- --------- ---------
Weighted average shares outstanding - diluted 6,703,057 6,630,097 6,699,228 6,612,576
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
2
<PAGE> 5
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Year Ended December 31, 1997 and Nine Months Ended September 30, 1998
(Unaudited)
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCK-
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE HOLDERS
STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
------- ---------- -------- -------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 515 $ 59,222 $ 36,109 $(301) $ 301 $ 95,846
Comprehensive income:
Net income -- -- 13,206 -- -- 13,206
Other comprehensive income -- -- -- -- 828 828
---------
Total comprehensive income 14,034
Dividends declared and
paid $(0.544 per share) -- -- (3,501) -- -- (3,501)
Stock options exercised 2 397 -- 301 -- 700
------- -------- -------- ----- ------ ---------
Balance at December 31, 1997 517 59,619 45,814 -- 1,129 107,079
Comprehensive income:
Net income -- -- 13,425 -- -- 13,425
Other comprehensive income -- -- -- -- 614 614
---------
Total comprehensive income 14,039
Dividends declared and
paid $(0.512 per share) -- -- (3,314) -- -- (3,314)
Adjustment for stock split 130 (130) -- -- -- --
Stock options exercised 1 381 -- -- -- 382
------- -------- -------- ----- ------ ---------
Balance at September 30, 1998 $ 648 $ 59,870 $ 55,925 $ -- $1,743 $ 118,186
======= ======== ======== ===== ====== =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE> 6
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
NINE MONTHS ENDED,
SEPTEMBER 30,
----------------------------
1998 1997
--------- ---------
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,425 $ 9,738
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision (credit) for loan losses (1,805) 683
Net (gains) losses on sales and provisions
for other real estate owned (157) 236
Net gains from sales of investments
available for sale (17) (90)
Net gains from sales of assets held for sale (490) (158)
Depreciation and amortization 1,012 1,062
Amortization of fees, discounts and premiums, net 450 372
Deferred income taxes (909) (582)
(Increase) decrease in:
Assets held for sale (487) (1,015)
Accrued interest receivable (431) (617)
Mortgage servicing assets 2,104 1,048
Other assets (258) 807
Increase (decrease) in:
Mortgagors' escrow accounts 621 530
Accrued income taxes payable 3,748 (473)
Accrued expenses and other liabilities 99 (868)
--------- ---------
Net cash provided by operating activities 16,905 10,673
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases (40,180) (50,979)
Proceeds from sales 3,017 9,089
Proceeds from maturities and redemptions 2,500 2,000
Principal repayments 19,395 6,403
Investment and mortgage-backed securities held to maturity:
Purchases (10,041) (3,511)
Proceeds from maturities and redemptions 8,500 2,500
Principal repayments 26,321 15,605
Purchases of whole loans (18,635) (39,795)
Purchases of mortgage servicing rights (1,011) (2,970)
Net increase in loans (31,015) (29,506)
Capital expenditures on premises and equipment, net (781) (624)
Proceeds from sales of other real estate owned 1,010 2,232
Capital expenditures on other real estate owned -- (54)
--------- ---------
Net cash used by investing activities (40,920) (89,610)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 12,194 99,245
Net increase in securities sold
under agreements to repurchase 8,177 18,919
Proceeds from issuance of FHLB advances 242,600 199,500
Principal repayments of FHLB advances (234,916) (249,207)
Dividends paid (3,314) (2,522)
Stock options exercised 382 245
--------- ---------
Net cash provided by financing activities 25,123 66,180
--------- ---------
Net increase (decrease) in cash equivalents 1,108 (12,757)
Cash and cash equivalents, at beginning of period 35,736 46,089
--------- ---------
Cash and cash equivalents, at end of period $ 36,844 $ 33,332
========= =========
</TABLE>
continued on next page
4
<PAGE> 7
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-------------------------------------------------
(Unaudited)
NINE MONTHS ENDED,
SEPTEMBER 30,
-----------------------
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $42,105 $38,658
Income taxes 3,025 6,451
Cash received during the period for:
Income taxes 82 --
Supplemental noncash investing and financing activities:
Conversion of real estate loans to mortgage-backed
securities held for sale or investments available for sale 38,214 17,048
Transfer of loans to other real estate owned 579 1,798
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE> 8
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1) BASIS OF PRESENTATION
The unaudited consolidated financial statements of Andover Bancorp, Inc.
("Andover" or the "Company") and its subsidiaries, including its principal
subsidiaries, Andover Bank and Andover Bank NH (collectively the "Banks"),
presented herein, should be read in conjunction with the consolidated
financial statements of the Company as of and for the year ended December
31, 1997. Andover Bank (the "Bank") is a state chartered savings bank with
its headquarters located in Andover, Massachusetts. Andover Bank NH
("ABNH") is a state chartered guaranty savings bank established in
September, 1995 and headquartered in Salem, New Hampshire. In the opinion
of management, the unaudited consolidated financial statements presented
herein reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation. Interim results are not
necessarily indicative of results to be expected for the entire year.
2) COMPONENTS OF ACCUMULATED OTHER COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", in the
first quarter of 1998. SFAS No. 130 established standards for reporting and
displaying comprehensive income, which is defined as all changes to equity
except investments by and distributions to shareholders. Net income is a
component of comprehensive income, with all other components referred to in
the aggregate as other comprehensive income. The following table shows the
components of other comprehensive income for the year ended December 31,
1997 and nine months ended September 30, 1998.
<TABLE>
<CAPTION>
Before-tax Tax Net-of
Amount Expense Tax Amount
------ ------- ----------
<S> <C> <C> <C>
Balance at December 31, 1996 $ 502 $ (201) $ 301
Increase in unrealized gains on investments
available for sale for year ended
December 31, 1997 1,377 (549) 828
------ ------- ------
Balance at December 31, 1997 1,879 (750) 1,129
Increase in unrealized gains on investments
available for sale for the nine months
ended September 30, 1998 1,064 (450) 614
------ ------- ------
Balance at September 30, 1998 $2,943 $(1,200) $1,743
====== ======= ======
</TABLE>
3) STOCK SPLIT
The per share data for the first nine months of 1997 has been restated to
reflect a 5 for 4 stock split distributed on May 18, 1998.
4) STOCK REPURCHASE PLAN
On October 22, 1998, the Company announced a plan to repurchase up to 5% of
the Company's currently outstanding shares at prevailing market prices.
6
<PAGE> 9
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NET YIELD ON EARNING ASSETS
---------------------------
(Unaudited)
QUARTERS ENDED SEPTEMBER 30,
1998 1997
-------------------------------- --------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(3) BALANCE PAID RATE(3)
------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 15,349 $ 216 5.58% $ 12,577 $ 172 5.43%
Investment securities (1) 110,193 1,841 6.63 102,771 1,730 6.68
Mortgage-backed securities (1) 170,711 2,814 6.54 186,394 3,194 6.80
---------- ------- ---------- -------
Total investments 296,253 4,871 6.52 301,742 5,096 6.70
---------- ------- ---------- -------
Residential loans (1) (2) 753,500 13,251 6.98 644,300 11,962 7.37
Commercial loans (2) 144,720 3,230 8.85 137,779 3,095 8.91
Construction and land loans 41,772 1,042 9.90 28,212 738 10.38
---------- ------- --------- -------
Total real estate loans 939,992 17,523 7.40 810,291 15,795 7.73
Consumer loans (2) 64,669 1,396 8.56 66,889 1,359 8.06
Commercial loans (2) 27,482 640 9.24 21,507 509 9.39
---------- ------- ---------- -------
Total loans 1,032,143 19,559 7.52 898,687 17,663 7.80
---------- ------- ---------- -------
Total interest-earning assets 1,328,396 24,430 7.30% 1,200,429 22,759 7.52%
------- -------
Allowance for loan losses (10,376) (12,535)
Other real estate owned 248 1,365
Other assets 51,339 58,858
---------- ----------
Total assets $1,369,607 $1,248,117
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 84,939 $ 212 0.99% $ 76,022 $ 189 0.99%
Regular savings accounts 186,030 1,728 3.69 131,654 1,128 3.40
Money market deposit accounts 98,504 699 2.82 108,457 800 2.93
Certificates of deposit 508,813 7,333 5.72 532,934 7,823 5.82
---------- ------- ---------- -------
Total interest-bearing deposits 878,286 9,972 4.10 849,067 9,940 4.29
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements 12,698 161 5.03 13,436 174 5.14
Federal Home Loan Bank advances 267,398 3,784 5.61 203,439 2,993 5.84
---------- ------- ---------- -------
Total borrowed funds 280,096 3,945 5.59 216,875 3,167 5.79
---------- ------- ---------- -------
Total interest-bearing liabilities 1,158,382 13,917 4.77% 1,065,942 13,107 4.88%
------- -------
Demand deposits 86,310 70,867
Other liabilities 11,764 10,674
---------- ----------
Total liabilities 1,256,456 1,147,483
Stockholders' equity 113,151 100,634
---------- ----------
Total liabilities and stock-
holders' equity $1,369,607 $1,248,117
========== ==========
Net interest income $10,513 $ 9,652
======= =======
Interest rate spread 2.53% 2.64%
==== ====
Net yield on earning assets 3.14% 3.19%
==== ====
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
------------------------------ ------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(3) BALANCE PAID RATE(3)
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 16,387 $ 663 5.41% $ 14,139 $ 574 5.43%
Investment securities (1) 108,798 5,433 6.68 101,024 5,069 6.71
Mortgage-backed securities (1) 183,511 9,114 6.64 181,333 9,314 6.87
---------- ------- ---------- -------
Total investments 308,696 15,210 6.59 296,496 14,957 6.74
---------- ------- ---------- -------
Residential loans (1) (2) 745,494 39,549 7.09 634,246 35,161 7.41
Commercial loans (2) 143,060 9,543 8.92 134,774 9,025 8.95
Construction and land loans 37,457 2,838 10.13 32,720 2,461 10.06
---------- ------- ---------- -------
Total real estate loans 926,011 51,930 7.50 801,740 46,647 7.78
Consumer loans (2) 66,069 4,244 8.59 64,030 3,910 8.16
Commercial loans (2) 23,652 1,680 9.50 20,980 1,493 9.51
---------- ------- ---------- -------
Total loans 1,015,732 57,854 7.62 886,750 52,050 7.85
---------- ------- ---------- -------
Total interest-earning assets 1,324,428 73,064 7.38% 1,183,246 67,007 7.57%
------- -------
Allowance for loan losses (11,925) (12,400)
Other real estate owned 303 1,596
Other assets 51,609 57,082
---------- ----------
Total assets $1,364,415 $1,229,524
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 84,296 $ 622 0.99% $ 71,923 $ 539 1.00%
Regular savings accounts 169,928 4,662 3.67 117,635 2,871 3.26
Money market deposit accounts 101,989 2,179 2.86 112,604 2,490 2.96
Certificates of deposit 516,178 22,276 5.77 515,098 22,309 5.79
---------- ------- ---------- -------
Total interest-bearing deposits 872,391 29,739 4.56 817,260 28,209 4.61
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements 12,354 474 5.13 8,612 316 4.91
Federal Home Loan Bank advances 273,849 11,664 5.69 227,415 9,866 5.80
---------- ------- ---------- -------
Total borrowed funds 286,203 12,138 5.67 236,027 10,182 5.77
---------- ------- ---------- -------
Total interest-bearing liabilities 1,158,594 41,877 4.83% 1,053,287 38,391 4.87%
------- -------
Demand deposits 85,917 67,185
Other liabilities 10,434 10,619
---------- ----------
Total liabilities 1,245,945 1,131,091
Stockholders' equity 109,470 98,433
---------- ----------
Total liabilities and stock-
holders' equity $1,364,415 $1,229,524
========== ==========
Net interest income $31,187 $28,616
======= =======
Interest rate spread 2.55% 2.70%
==== ====
Net yield on earning assets 3.15% 3.23%
==== ====
</TABLE>
(1) Included in the average balance amounts are the corresponding components of
the assets held for sale, available for sale and held to maturity. The yield has
been calculated using interest income divided by the average balance of the
amortized historical cost.
(2) Interest on nonaccruing loans has been included only to the extent reflected
in the statement of operations. However, the loan balances are included in the
average amounts outstanding.
(3) The "Average Yield/Rate" calculation is based on an annualized basis
reflecting 92 days in the third quarter of both years and 273 days in the
year-to-date period of 1998 and 1997.
7
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
----------------------------------------
This quarterly report contains certain statements that are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements as a result, among other factors, of the risk factors
set forth in the Company's filings with the Securities and Exchange Commission
and of changes in general economic conditions, changes in interest rates and
changes in the assumptions used in making such forward-looking statements.
RESULTS OF OPERATIONS
GENERAL. Net income amounted to $4.5 million, or $0.67 per diluted share, for
the quarter ended September 30, 1998 as compared to net income of $3.3 million,
or $0.50 per diluted share, in the corresponding quarter of 1997. The current
quarter results include an increase in net interest and dividend income and a
lower effective tax rate offset by a decrease in mortgage banking income.
Andover's annualized return on average assets increased to 1.30% for the third
quarter of 1998 compared to 1.06% in the third quarter of 1997. The annualized
return on average stockholders' equity increased to 15.68% in the third quarter
of 1998 from 13.20% in the third quarter of 1997.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $10.5
million for the third quarter of 1998 as compared to $9.7 million for the same
period in 1997. This increase resulted from a 10.7% increase in total
interest-earning assets, primarily due to higher loan growth resulting from
increased loan originations. The 5 basis point decline in the net yield on
earning assets to 3.14% for the third quarter of 1998, compared to 3.19% in
1997, was due primarily to a 39 basis point decline in the yield on the
residential real estate portfolio. The decline in the yield on earning assets
for 1998 reflects the decline in the market interest rates during the latter
part of 1997 and the first nine months of 1998. This market interest rate
decline has resulted in the current year originations to be at rates lower than
the average yield earned on the loan portfolio for all of 1997. In addition,
there has been competitive pressure on the pricing of loans and deposits,
causing the margin to contract. It is expected that the competitive pressure for
quality loans and retail deposits will continue to result in a smaller spread
between asset yields and the cost of funds into the future. Another factor
causing the continued margin compression being experienced by the Company is the
flatness of the yield curve throughout 1998.
PROVISION (CREDIT) FOR LOAN LOSSES. The allowance for loan losses is established
through a provision for loan losses charged to the statement of operations. The
allowance is reduced by a credit for loan losses as well as loan charge-offs.
Assessing the adequacy of the allowance for loan losses involves substantial
uncertainties and is based upon management's estimation of the amount required
to meet probable loan losses in light of several factors. Among the factors that
management considers are the quality of specific loans, risk characteristics of
the loan portfolio generally, the level of nonaccruing loans in the various
categories, current economic conditions, trends in delinquencies, actual
charge-off experience, and the collateral values of the underlying security.
Because the allowance for loan losses is based on various estimates, and
includes a high degree of judgment by management, subsequent changes in the
general economic prospects of the borrowers may require changes in those
estimates. In addition, regulatory agencies, as an integral part of the
examination process, review the Banks' allowance and may require the Banks to
provide additions to the allowance based on their assessment, which may differ
from management's assessment.
The provision for loan losses for the third quarter of 1998 was $400,000 versus
a provision of $130,000 in the comparable period in 1997. The provision taken in
the third quarter was primarily due to replenishing the allowance for loan
losses after
8
<PAGE> 11
charging off two related lending relationships totalling approximately $500,000.
While nonaccruing loans have declined over 17.3% during the third quarter and
47.0% since year-end 1997, and total overdue loans have decreased by 33.1% from
year-end 1997, net charge-offs totalled $466,000 for the third quarter of 1998
and $474,000 for the nine months ended September 30, 1998. This compares to net
charge-offs of $128,000 and $379,000 for the respective periods in 1997. After
the provision for loan losses, the reserve coverage as a percentage of
nonaccruing loans totalled 246% as of September 30, 1998, as compared to 160%,
for the period ending December 31, 1997. Management also believes that the
allowance for loan losses will be adequate to absorb probable credit losses
inherent in the loan and lease portfolio.
NON-INTEREST INCOME. Net gains from sales and redemptions of loans, investments
and mortgage-backed securities held for sale and available for sale totalled
$165,000 in the third quarter of 1998 as compared to $78,000 in the third
quarter of 1997.
Mortgage banking losses totalled $264,000 in the third quarter of 1998 versus
income of $520,000 in the comparable quarter in 1997 due to a decrease in the
Company's servicing portfolio as well as increased amortization and provisions
for the valuation allowance on the mortgage servicing assets. Amortization
expense totalled $584,000 and $457,000, respectively, for the quarters ended
September 30, 1998 and 1997. In addition, the Company incurred provisions for
the valuation allowance of $500,000 and $50,000 in the third quarters of 1998
and 1997, respectively, due to the high prepayments experienced and expected to
be experienced in the serviced loan portfolio. In this low interest rate
environment, loans repay faster than expected, thereby causing the fair value of
the mortgage servicing assets to decline. If interest rates continue to further
decline or remain at low levels, it is possible that additional provisions for
the valuation allowance may be necessary. The mortgage servicing assets are
assessed for impairment on a quarterly basis.
The following table summarizes the activity in the valuation allowance on
mortgage servicing assets for the quarters and nine months ended September 30,
1998 and 1997:
<TABLE>
<CAPTION>
Quarters Ended Nine Months Ended
September 30, September 30,
-------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 500 $200 $ 400 $200
Provision for valuation allowance 500 50 1,040 50
Charge-offs (105) -- (545) --
----- ---- ------- ----
Balance at end of period $ 895 $250 $ 895 $250
===== ==== ======= ====
</TABLE>
Loans serviced for investors totalled $857.4 million and $1,002.4 million,
respectively, at September 30, 1998 and 1997.
Gains of $13,000 on real estate operations were recognized in the third quarter
of 1998 as compared to losses of $235,000 in the third quarter of 1997. A
significant portion of the losses on real estate operations during the third
quarter of 1997 consisted of operating costs associated with acquiring,
maintaining and disposing of other real estate owned and totalled $190,000,
while provisions for losses on other real estate owned added another $75,000 to
the loss on real estate operations.
Other income totalled $949,000 in the third quarter of 1998 as compared to
$905,000 in the third quarter of 1997 due to higher loan fee and deposit fee
income. These increases reflect the increase in both the loan and deposit
portfolios as well as fees associated with the increased loan payoffs.
9
<PAGE> 12
NON-INTEREST EXPENSE. Non-interest expenses increased by $105,000, or 1.9%, to
$5.6 million in the third quarter of 1998 from $5.5 million in the third quarter
of 1997. The efficiency ratio (a ratio that measures operating expenses as a
percentage of operating income) increased slightly from 49.83% in the third
quarter of 1997 to 50.23% in the comparable period of 1998.
Salaries and employee benefits, the largest component of non-interest expense,
remained stable at $3.0 million for both the third quarter of 1997 and 1998.
Office occupancy and equipment expenses increased 10.4% or $73,000 for the third
quarter of 1998 versus the corresponding period of 1997, primarily due to
increased depreciation of equipment and higher rent expenses on leased
properties.
Professional fees increased $95,000 to $289,000 in the third quarter of 1998
from $194,000 in the third quarter of 1997 due to increased corporate consulting
fees.
Data processing expenses and marketing expenses all experienced modest declines
from the third quarter of 1997 to the corresponding quarter for 1998 while other
operating expenses remained the same.
Mortgage banking expenses increased 60% or $45,000 in the third quarter of 1998
versus 1997's third quarter due to higher interest payments owed to investors on
the serviced loan portfolio.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $878,000 and
1.9 million on its financial statement earnings for the third quarters of 1998
and 1997, respectively. The effective tax rate for the third quarter of 1998 was
16.4%, as compared to 36.5% for the corresponding period in 1997. The decline in
the third quarter of 1998 was due to a tax benefit of $1.1 million resulting
from the favorable resolution of several tax issues that had previously been
fully reserved against.
FINANCIAL CONDITION
Total assets increased 3.3% from $1,322.7 million at December 31, 1997 to
$1,366.4 million at September 30, 1998. Increases in the loan portfolio were
funded by the growth experienced in the deposit balances and FHLB advances
during the first nine months of 1998.
LOANS. The following table shows the composition of the Company's loan portfolio
at September 30, 1998 and December 31, 1997. The balances shown in the table are
net of unadvanced funds and deferred loan origination fees and costs.
<TABLE>
<CAPTION>
9/30/98 12/31/97
------- --------
(In thousands)
<S> <C> <C>
Real estate loans:
Residential $ 742,392 $715,503
Commercial 149,854 142,617
Construction and land 43,332 31,499
---------- --------
Total real estate loans 935,578 889,619
---------- --------
Consumer loans 63,712 68,204
Commercial loans 28,073 21,000
---------- --------
Total loans $1,027,363 $978,823
========== ========
</TABLE>
Total loans increased $48.5 million during the first nine months of 1998 to
$1,027.4 million at September 30, 1998 primarily due to increases in the real
estate portfolio. The increase in the residential loan portfolio was aided by
the favorable interest rate environment causing both a strong home purchase and
heavy mortgage refinance activity.
Originations of all loan types are sensitive to the interest rate environment,
the capacity for borrowing and real estate values, current and anticipated
economic
10
<PAGE> 13
conditions as well as the competitive landscape. Due to the extremely favorable
interest rates in the latter part of 1997 and the first nine months of 1998,
residential loan originations increased over 219.5% from the first nine months
of 1997 to the corresponding period of 1998. Residential loan balances increased
only $26.9 million due to the securitization of certain fixed-rate loans,
regular amortization and increased repayments due to the strong refinance
activity. Residential loan originations totalled $242.0 million and $110.3
million, respectively, for the nine months ended September 30, 1998 and 1997.
Outstanding corporate loans, comprised of commercial real estate, commercial,
construction and land loans, increased $16.1 million during the first nine
months of 1998. Originations of corporate loans reflect the Company's increased
interest for this type of loan, higher real estate values and the formation of
the leasing subsidiary at the end of 1997. Corporate loan originations totalled
$98.5 million and $53.0 million, respectively, for the nine months ended
September 30, 1998 and 1997.
Consumer loan balances decreased by approximately 6.6% on an annualized basis,
to $63.7 million at September 30, 1998, primarily due to payoffs of home equity
balances and second mortgage loans and to the sale of student loans.
RISK ELEMENTS. The following table shows the composition of non-performing
assets at September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
9/30/98 12/31/97
------- --------
(Dollars in thousands)
<S> <C> <C>
Nonaccruing loans $4,158 $7,849
Other real estate owned 132 406
------ ------
Total non-performing assets $4,290 $8,255
====== ======
Total non-performing assets as a
percentage of total assets 0.3% 0.6%
</TABLE>
Significant progress has been made over the past several years in reducing total
non-performing assets. This success has continued as total non-performing assets
decreased 48.0% in the first nine months of 1998 primarily due to nonaccruing
loans returning to performing status or being paid off in their entirety.
A significant portion of the non-performing assets are secured by mixed-use
commercial and multi-family real estate located in Lawrence, Massachusetts. This
city had been especially hard hit with declines in real estate values due to
increased vacancies and rapid turnover in the multi-family investor-owned
properties. These multi-family investor-owned properties represent the majority
of the Bank's collateral on troubled loans and other real estate owned in
Lawrence. Continued deterioration in this market area will adversely impact the
collectibility of residential and commercial real estate loans and may result in
an increase in non-performing assets. At September 30, 1998, approximately $1.7
million, or 40.1%, of nonaccrual loans were secured by properties located in
Lawrence, consisting primarily of mixed-use commercial and multi-family
properties, as compared to approximately $3.4 million at December 31, 1997.
At September 30, 1998, total impaired loans were $4.2 million, of which $1.0
million had related allowances of $115,000 and $3.2 million which did not
require a related allowance. During the nine months ended September 30, 1998,
the average recorded value of impaired loans was $4.7 million.
NONACCRUING LOANS. Management places loans on nonaccrual status when loan
payments are past due 90 days or more, regardless of collateral values. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on nonaccrual status. Loans for which
payments are less than 90 days past due
11
<PAGE> 14
are placed on nonaccrual status when concern exists regarding the ultimate
collectibility of the loan.
The following table shows the composition of nonaccruing loans at September 30,
1998 and December 31, 1997:
<TABLE>
<CAPTION>
9/30/98 12/31/97
------- --------
(Dollars in thousands)
<S> <C> <C>
Residential real estate $ 1,059 $ 2,436
Commercial real estate 2,742 4,866
Commercial 316 513
Consumer 41 34
------- -------
Total nonaccrual loans $ 4,158 $ 7,849
======= =======
Allowance for loan losses $10,242 $12,521
======= =======
Allowance for loan losses as a
percentage of nonaccruing loans 246.3% 159.5%
Allowance for loan losses as a
percentage of total loans 1.0% 1.3%
</TABLE>
RESTRUCTURED LOANS. A restructured loan is one for which the Bank has modified
the loan to provide a temporary reduction in the rate of interest or terms due
to the deterioration in the financial position of the borrower. Restructured
loans are classified as such until the obligation has performed for a reasonable
period of time at a market rate of interest and its ultimate collectibility is
no longer in doubt. At both September 30, 1998 and December 31, 1997,
restructured loans totalled $1.4 million. The weighted average interest rate on
restructured loans as of September 30, 1998 was approximately 6.4%.
OTHER REAL ESTATE OWNED. Other real estate owned is recorded at the lower of the
carrying value of the loan or the net fair value of the property. Operating
expenses and any provisions (credits) to increase (decrease) the valuation
allowance are charged to real estate operations. The Company recorded gains on
real estate operations due to a credit taken to reduce the valuation allowance
in the amount of $107,000 during the second quarter of 1998. Other real estate
owned totalled $132,000 as of September 30, 1998, for a decline of 67.5% since
year-end 1997. The balance outstanding as of the end of the quarter is net of a
$41,000 valuation allowance and is comprised mostly of single family residential
properties. During the first nine months of 1998, sales of other real estate
owned totalled $1.0 million and generated gains of $50,000. During the
comparable period in 1997, gains of $61,000 were recognized on sales of $2.2
million.
12
<PAGE> 15
ALLOWANCE FOR LOAN LOSSES. The following table summarizes the activity in the
Company's allowance for loan losses for the quarters and nine months ended
September 30, 1998 and 1997:
<TABLE>
<CAPTION>
Quarters Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 10,308 $ 12,531 $ 12,521 $ 12,229
Provision (credit) for loan losses 400 130 (1,805) 683
Charge-offs:
Residential real estate (5) (164) (182) (615)
Commercial real estate (96) (203) (632) (684)
Construction and land -- -- -- --
Commercial (510) (15) (510) (70)
Consumer (3) -- (10) (21)
-------- -------- -------- --------
Total charge-offs (614) (382) (1,334) (1,390)
-------- -------- -------- --------
Recoveries:
Residential real estate 21 7 56 6
Commercial real estate 55 21 330 124
Construction and land 30 156 265 323
Commercial 37 60 190 539
Consumer 5 10 19 19
-------- -------- -------- --------
Total recoveries 148 254 860 1,011
-------- -------- -------- --------
Net charge-offs (466) (128) (474) (379)
-------- -------- -------- --------
Balance at end of period $ 10,242 $ 12,533 $ 10,242 $ 12,533
======== ======== ======== ========
Ratio of annualized net
charge-offs to average
loans outstanding 0.18% 0.06% 0.06% 0.06%
</TABLE>
Gross charge-offs totalled $614,000 during the third quarter of 1998 and were
spread out among 13 loans. There were two related lending relationships
totalling approximately $500,000 that were charged off during the third quarter
of 1998. Management periodically analyzes the adequacy of the allowance for loan
losses. See "Results of Operations - Provision for Loan Losses".
INVESTMENTS. As of September 30, 1998, the Company's total investment portfolio
amounted to $270.4 million for a decrease of $12.2 million from December 31,
1997. This decrease was primarily due to principal repayments of mortgage backed
securities both available for sale and held to maturity amounting to $45.7
million, partially offset by the purchase of new investments.
Management continually evaluates its investment alternatives in order to
properly manage the overall balance sheet mix. The timing of purchases, sales
and reinvestment, if any, will be based on various factors including expectation
of movements in market interest rates and loan demand. Notwithstanding these
events, it is the intent of management to grow the earning asset base through
loan originations, loan purchases or investment acquisitions while funding this
growth through a mix of retail deposits, FHLB advances and reverse repurchase
agreements.
13
<PAGE> 16
The following table presents the composition and carrying values of the
investment portfolio at September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
9/30/98 12/31/97
------- --------
(In thousands)
<S> <C> <C>
SHORT-TERM INVESTMENTS $ 10,800 $ 14,150
======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
U.S. government and federal agency obligations $ 53,331 $ 55,777
Other bonds and obligations 28,375 14,573
-------- --------
Total bonds and obligations 81,706 70,350
-------- --------
GNMA mortgage-backed securities 40,534 27,793
FHLMC participation certificates 29,904 36,805
FNMA pass-through certificates 2,967 4,106
-------- --------
Total mortgage-backed securities 73,405 68,704
-------- --------
Total investments available for sale $155,111 $139,054
======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations $ 9,992 $ 10,001
Other bonds and obligations 4,553 7,106
-------- --------
Total bonds and obligations 14,545 17,107
-------- --------
FHLMC participation certificates 33,997 49,217
FNMA pass-through certificates 38,422 48,835
GNMA mortgage-backed securities 2,844 3,383
Collateralized mortgage obligations 14,063 10,021
Other asset-backed securities 611 800
-------- --------
Total mortgage-backed securities 89,937 112,256
-------- --------
Total investments held to maturity $104,482 $129,363
======== ========
Total investments $270,393 $282,567
======== ========
</TABLE>
The following table shows the gross unrealized gains and losses by major
categories of securities as of September 30, 1998:
<TABLE>
<CAPTION>
Unrealized Unrealized
Gains Losses
---------- ----------
(In thousands)
<S> <C> <C>
INVESTMENTS AVAILABLE FOR SALE:
U.S. government and federal agency obligations $1,440 $ --
Other bonds and obligations 707 (6)
Mortgage-backed securities 861 (59)
------ ----
Total investments available for sale $3,008 $(65)
------ ----
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations $ 247 $ --
Other bonds and obligations 116 --
Mortgage-backed securities 1,889 --
------ ----
Total investments held to maturity 2,252 --
------ ----
Total unrealized gains and losses $5,260 $(65)
====== ====
</TABLE>
14
<PAGE> 17
At September 30, 1998, the Company's net unrealized gain on investments
available for sale amounted to $2.9 million, a fair value increase of $1.1
million from an unrealized gain of $1.9 million at December 31, 1997. At
September 30, 1998, the Company's net unrealized gain on investments held to
maturity totalled $2.3 million, for an increase of $668,000 from an unrealized
gain of $1.6 million at December 31, 1997. The changes in the net unrealized
gains on the total investment portfolio from year-end 1997 were primarily due to
a decline in market interest rates at the end of the third quarter of 1998.
DEPOSITS AND BORROWED FUNDS. Total deposits increased $12.2 million to $959.2
million at September 30, 1998 from $947.0 million at December 31, 1997. This
increase was most pronounced in regular savings accounts while demand deposit
and NOW accounts increased $10.1 million and $9.8 million, respectively, for the
first nine months of 1998. Offsetting these increases, however, were declines of
$27.1 million in certificates of deposit and $29.3 million in money market
accounts during the first nine months of 1998. The increase of $48.1 million in
regular savings accounts reflects the shift from term deposits or limited access
accounts into accounts that can be accessed at any time, without penalty. In
addition, the Banks have continued to offer a premium interest rate savings
product for accounts with balances in excess of $50,000.
The following table shows the composition of the Company's deposits at September
30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
9/30/98 12/31/97
------- --------
(In thousands)
<S> <C> <C>
Demand deposit accounts $ 90,185 $ 79,501
Regular savings accounts 194,161 146,041
NOW accounts 95,737 85,917
Money market deposit accounts 78,603 107,919
Certificates of deposit 500,490 527,604
-------- --------
Total deposits $959,176 $946,982
======== ========
</TABLE>
In order to fund the growth in total assets, the Banks augmented their growth in
deposits with increased borrowings. Federal Home Loan Bank advances increased
$7.7 million from December 31, 1997 to $256.2 million at September 30, 1998.
Securities sold under agreements to repurchase increased $8.2 million during the
quarter to $18.3 million at September 30, 1998.
LIQUIDITY. Liquidity refers to the ability of the Company to efficiently meet
the cash needs of borrowers and depositors, while also providing funds for
attractive investment opportunities.
The Company's primary source of funds is dividends from its bank subsidiaries.
ABNH will be limited in its ability to pay dividends until the fourth quarter of
1998. In the third quarter of 1998, the Company paid dividends to its
stockholders in the amount of $1.2 million. In October, 1998, the Company
declared a dividend in the amount of $1.2 million, payable in the fourth quarter
of 1998.
The Banks have a diverse base of funding sources including customer deposits,
borrowed funds, repayments and amortization of the loan and investment
portfolios. A portion of the Banks' deposits represent core deposits, which
management believes are relatively insensitive to fluctuations in interest
rates. Sources of borrowed funds include funds purchased from other banks,
customer repurchase agreements, the sale of securities under repurchase
agreements and, in the case of the Bank, borrowings from the FHLB, of which the
Bank is a voluntary member. The Banks may also obtain funds from the Federal
Reserve Bank of Boston by pledging certain assets.
15
<PAGE> 18
Cash flows provided by operations increased $6.2 million to $16.9 million in the
first nine months of 1998, as compared to $10.7 million in the corresponding
period of 1997 primarily due to an increase in accrued income taxes payable and
accrued expenses. Cash flows used by investing activities decreased by $48.7
million to $40.9 million for the nine months ended September 30, 1998, as
compared to $89.6 million during the equivalent period last year. This decrease
was mainly attributable to a reduction in loan purchases and an increase in the
principal repayments of investments available for sale and held to maturity.
Cash flows provided by financing activities decreased $41.1 million for the nine
months ended September 30, 1998 to $25.1 million, as compared to $66.2 million
in the equivalent period in 1997. This financing activity decline was due to
smaller increases in deposits over 1997's amounts that were partially offset by
increased issuances of FHLB advances.
At September 30, 1998, the Company had home equity, reserve credit and
commercial unadvanced lines of credit totalling $95.3 million. Outstanding
commitments to originate loans totalled $42.1 million. Unadvanced portions of
construction and land loans amounted to $26.8 million. Standby letters of credit
were $2.4 million. Loans sold with recourse totalled $1.8 million. Management
believes that its sources of liquidity are sufficient to meet these commitments
if and as called upon.
CAPITAL RESOURCES. The following table presents regulatory capital ratios under
current Tier 1 leverage capital and risk-based capital requirements as of
September 30, 1998:
<TABLE>
<CAPTION>
Leverage Capital Ratio Risk-Based Capital Ratio
---------------------- ------------------------
Tier 1 Tier 1 Total
------ ------ -----
<S> <C> <C> <C>
Andover Bancorp, Inc. 8.5% 14.3% 15.5%
Andover Bank 8.2% 13.8% 15.0%
Andover Bank NH 8.7% 14.8% 15.6%
</TABLE>
Current minimum regulatory requirements for the Bank and the Company as of
September 30, 1998 were 4.0% for the Tier 1 leverage capital ratio and 4.0% and
8.0%, respectively, for the Tier 1 and total risk-based capital ratios. As a de
novo bank, Andover Bank NH is obligated to maintain a minimum Tier 1 leverage
capital ratio of 8% until September 30, 1998. As of September 30, 1998, the most
recent notification from the FDIC categorized the Banks as well capitalized
under the prompt corrective action provisions.
Therefore, the Banks are entitled to pay the lowest deposit premium possible.
YEAR 2000 READINESS DISCLOSURE. The statements in the following section include
"Year 2000 readiness disclosure" within the meaning of the Year 2000 Information
and Readiness Disclosure Act.
This section contains certain statements that are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1993, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The Company's
readiness for the Year 2000, and the eventual effects of the Year 2000 on the
Company may be materially different than currently projected. This may be due
to, among other things, delays in the completion of the Company's Year 2000
initiative, the failure of its proposed contingency plans, if such contingency
plans become necessary, to achieve their desired result and the failure of third
parties with whom the Company has a significant business relationship to achieve
Year 2000 readiness.
The Year 2000 computer software compliance issues affect Andover and many other
financial institutions and companies in the U.S. Historically, certain computer
programs were written using two digits rather than four to define the applicable
years. As a result, software may recognize a date using the two digits "00" as
1900 rather than the year 2000. Computer programs that do not recognize the
proper date could generate erroneous data or cause systems to fail.
16
<PAGE> 19
The Company started its Year 2000 initiative in early 1997. The Company has
completed its assessment of Year 2000 issues, developed a plan, begun testing
its various software information systems, hardware components and non-technology
systems and arranged for the required human and financial resources to complete
its necessary remediation efforts. The Company plans to complete the
remediating, testing and returning to production all of its critical
applications in accordance with its original plan and expects to have
substantially completed the remediation of all critical applications by December
31, 1998. Testing of the Company's non-critical applications will continue into
1999 and will be completed prior to any anticipated impact of the Year 2000
issue on its operating systems. In the third quarter of 1998, the Company
established a separate test environment to accommodate its Year 2000 testing
activity and will utilize this resource to continue testing customer
applications through the fourth quarter of 1998 and into 1999. The Company has
not established contingency plans for all of its critical and non-critical
applications in the event the Company's remediation efforts fail to make such
applications compliant. The Company has considered various contingency plans for
its critical applications, including the possibility of obtaining alternative
vendors or replacement systems. Based on its assessment of their progress to
date, the Company has determined to rely on the ability of the Company's service
bureau and other critical vendors to achieve Year 2000 readiness. This
assessment has included an on-site visit with the Company's service bureau,
discussions with the critical vendors, each vendor's compliance in meeting its
own targeted deadlines and continual monitoring of each vendor by the Company. A
contingency plan has not been established in the event that these critical
vendors are unable to achieve Year 2000 readiness.
The Company will continue to utilize both internal and external resources to
update, or replace, develop and test all software information systems and
hardware components for Year 2000 modifications. Included in other noninterest
expenses are charges incurred in connection with the modification or replacement
of software and hardware in order for the Company's computer systems to properly
recognize the Year 2000. The expenses incurred and hardware capitalized totalled
approximately $175,000 for the first nine months of 1998. The Company expects
that the majority of the costs that will be incurred (as discussed below) will
be to replace or upgrade existing hardware and software which will be
capitalized and amortized in accordance with the Company's existing accounting
policy while miscellaneous consulting, maintenance and modification costs will
be expensed as incurred.
The Company continues to evaluate the estimated costs associated with achieving
Year 2000 readiness based on its experience to date. Based on current estimates,
the remaining costs of its efforts to achieve Year 2000 readiness will be
approximately $500,000. However, no assurance can be given that the Company or
the third party vendors to whom the Company outsources its information systems
will solve such issues in a successful and timely fashion or that the costs of
such efforts will not exceed current estimates. If the Company does not solve
such issues, or does not do so in a timely manner, the Year 2000 issue could
have a material adverse impact on the Company's business, future operating
results and financial condition.
Bank regulatory agencies have recently issued additional guidance under which
they are assessing Year 2000 readiness. The failure of a financial institution,
such as Andover, to take appropriate action to address Year 2000 issues may
result in enforcement actions which could have a material adverse effect on such
institution, result in the imposition of civil money penalties, or result in the
delay of applications seeking to acquire other entities or otherwise expand the
institution's activities.
17
<PAGE> 20
RECENT ACCOUNTING DEVELOPMENTS. In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes new accounting and reporting standards for derivative instruments.
SFAS No. 133 requires that an entity recognize all derivatives as either assets
or liabilities and measure those instruments at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Early application is encouraged but restatement of prior periods is prohibited.
SFAS No. 133 is not expected to have a material impact on the consolidated
financial statements of the Company.
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK. The Company's interest rate risk
and asset and liability management are the responsibility of Andover's
Asset/Liability Management Committee (ALCO). The ALCO Committee actively manages
and monitors its interest rate risk exposure and reports its findings to the
Board of Directors on a regular basis.
Interest rate risk, including mortgage prepayment risk, or market risk, is by
far the most significant non-credit related risk to which the Company is
exposed. Net interest income, the Banks' primary source of revenue is affected
by changes in interest rates as well as fluctuations in the level and duration
of assets and liabilities on the Company's balance sheet.
The mortgage servicing assets are assessed for impairment on a quarterly basis.
In this low interest rate environment, loans repay faster than expected, thereby
causing the fair value of the mortgage servicing assets to decline. If interest
rates continue to remain at low levels, it is possible that additional
provisions for the valuation allowance on servicing assets may be necessary.
18
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
--------------------------------------------
This quarterly report contains certain statements that are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements as a result, among other factors, of the risk factors
set forth in the Company's filings with the Securities and Exchange Commission
and of changes in general economic conditions, changes in interest rates and
changes in the assumptions used in making such forward-looking statements.
RESULTS OF OPERATIONS
GENERAL. Net income amounted to $13.4 million, $2.00 per diluted share, for the
nine months ended September 30, 1998, compared to net income of $9.7 million,
$1.47 per diluted share, in the corresponding period of 1997.
The financial performance in the first nine months of 1998 was positively
impacted by an increase in net interest income and a credit for loan losses.
This combination led to an increase in Andover's annualized return on average
assets to 1.32% for the first nine months of 1998 as compared to 1.06% in the
comparable period of 1997. The annualized return on average stockholders' equity
increased to 16.40% in the first nine months of 1998 from 13.23% in the
comparable period of 1997.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $31.2
million for the first nine months of 1998, as compared to $28.6 million for the
same period in 1997, an increase of 9.0%. The eight basis point decline in the
net yield on earning assets to 3.15% for the first nine months of 1998, compared
to 3.23% in 1997, was primarily due to a 32 basis point decline in the yield on
residential real estate loans due to lower market interest rates and higher
refinance activity.
PROVISION (CREDIT) FOR LOAN LOSSES. The Company recorded a credit for loan
losses for the first nine months of 1998 of $1.8 million as compared to a
provision for loan losses of $683,000 for the same period of 1997. Among the
factors used to determine that the credit for loan losses was appropriate was
the continued improvement in loan quality, as well as management's assessment of
changes in trends and conditions. Nonaccruing loans decreased by 47.0% during
the first nine months of 1998 while overdue loans decreased by 33.1% over the
same time period.
The improvement in loan quality started to become evident at the end of the
first quarter of 1998; however, management determined that it was prudent to
postpone recognition of a credit for loan losses until it could assess whether a
trend had developed. The decline in the delinquencies and nonaccruing loans was
notable starting in March of 1998, which, when combined with the lowest level of
quarterly additions to non-performing assets during the second quarter of 1998,
contributed to management's assessment of the appropriateness of the allowance
for loan losses. Based on the foregoing, the Company recorded a credit for loan
losses in the amount of $2.3 million in the second quarter of 1998.
NON-INTEREST INCOME. Andover recorded gains from non-interest sources of $3.3
million for the first nine of 1998, as compared to $3.5 million in the
corresponding period of 1997. Net gains from sales of assets held for sale and
investments available for sale totalled $507,000 in 1998 as compared to $248,000
in the same period of 1997.
Mortgage banking losses totalled $25,000 during the first nine months of 1998 as
compared to income of $1.7 million in the corresponding period of 1997 due to
increased amortization and provisions for the valuation allowance on mortgage
servicing assets and
19
<PAGE> 22
a decline in the Company's servicing portfolio resulting from significant
prepayments and refinances. Total amortization and provisions amounted to $2.5
million for the first nine months of 1998 as compared to $1.3 million for the
respective period in 1997.
Gains on real estate operations totalled $37,000 during the first nine months of
1998 as compared to losses of $820,000 in the corresponding period of 1997. A
large component of the loss on real estate operations during the first nine
months of both 1998 and 1997 was comprised of operating costs associated with
acquiring, maintaining and disposing of other real estate owned and totalled
$120,000 and $605,000, respectively. Included in the results for 1998 was a
negative provision for the valuation of other real estate owned totalling
$107,000 as compared to provisions of $275,000 incurred during the corresponding
period in 1997.
Other income totalled $2.8 million in the first nine months of 1998, for an
increase of $393,000, or 16.4%, from $2.4 million recorded in the first nine
months of 1997. The majority of the increase is due to an increase in deposit
and loan service fees resulting from a higher deposit and loan base.
NON-INTEREST EXPENSE. Non-interest expenses increased 4.7% to $17.0 million in
the first nine months of 1998 primarily due to an increase in salaries and
employee benefits. Salaries and benefits increased 3.7% to $9.2 million in 1998
due to increased personnel and salary merit increases and the related taxes
thereon. Data processing expenses increased 8.1% to $1.5 million as a result of
a higher loan and deposit base resulting from the Company's growth. Marketing
expenses decreased 18.7% to $604,000 primarily due to a decreased number of
discretionary promotions. Mortgage banking expenses increased due to the
significant increase in residential mortgage loan originations and refinances.
Office occupancy and equipment and professional fees remained relatively the
same for the first nine months of 1998 as compared to the corresponding period
in 1997. Other operating expenses increased 5.8% to $2.3 million primarily due
to increased general overhead expenses from operating a larger institution.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $5.9 million
and $5.5 million on its financial statement earnings for the first nine months
of 1998 and 1997, respectively. The effective tax rate was 30.4% and 36.0% for
1998 and 1997, respectively. The lower effective rate in 1998 resulted from a
tax benefit of $1.1 million due to the favorable resolution of several tax
issues that had been previously fully reserved against.
20
<PAGE> 23
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
Not Applicable
ITEM 2 Changes in Securities and Use of Proceeds
Not Applicable
ITEM 3 Defaults Upon Senior Securities
Not Applicable
ITEM 4 Submission of Matters to a Vote of Security Holders
None
ITEM 5 Other Information
None
ITEM 6 Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
21
<PAGE> 24
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.
ANDOVER BANCORP, INC.
November 12, 1998 /s/ Gerald T. Mulligan
----------------------------
Gerald T. Mulligan
President and
Chief Executive Officer
November 12, 1998 /s/ Joseph F. Casey
----------------------------
Joseph F. Casey
Chief Financial Officer
and Treasurer
22
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS DATED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 26,044
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 10,800
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 6,514
<INVESTMENTS-CARRYING> 104,482
<INVESTMENTS-MARKET> 106,734
<LOANS> 1,027,363
<ALLOWANCE> 10,242
<TOTAL-ASSETS> 1,366,375
<DEPOSITS> 959,176
<SHORT-TERM> 18,348
<LIABILITIES-OTHER> 14,420
<LONG-TERM> 256,245
0
0
<COMMON> 648
<OTHER-SE> 117,538
<TOTAL-LIABILITIES-AND-EQUITY> 1,366,375
<INTEREST-LOAN> 57,854
<INTEREST-INVEST> 15,210
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 73,064
<INTEREST-DEPOSIT> 29,739
<INTEREST-EXPENSE> 41,877
<INTEREST-INCOME-NET> 31,187
<LOAN-LOSSES> (1,805)
<SECURITIES-GAINS> 507
<EXPENSE-OTHER> 17,008
<INCOME-PRETAX> 19,299
<INCOME-PRE-EXTRAORDINARY> 19,299
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,425
<EPS-PRIMARY> 2.07
<EPS-DILUTED> 2.00
<YIELD-ACTUAL> 3.15
<LOANS-NON> 4,158
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,399
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 12,521
<CHARGE-OFFS> 1,334
<RECOVERIES> 860
<ALLOWANCE-CLOSE> 10,242
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
