<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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, MA 01810
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (978)749-2000
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(Title of Class)
PREFERRED STOCK PURCHASED RIGHTS
(Title of class)
Indicate by check mark whether: the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sale price for the Registrant's Common
Stock on March 2, 1998 as reported by NASDAQ, was $205,734,632.
The number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practicable date, is:
Class: Common Stock, par value $0.10 per share
Outstanding as of March 2, 1998: 5,175,714 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Andover Bancorp, Inc. Definitive Notice of Annual Meeting
and Proxy Statement for the 1998 Annual Meeting of Shareholders are incorporated
by reference into Part III of Form 10-K.
<PAGE> 2
FORM 10-K
CROSS REFERENCE INDEX
Part I
Annual
Report
Page
Item 1 Business.......................................................... 2
Item 2 Properties........................................................ 9
Item 3 Legal Proceedings................................................. 10
Item 4 Submission of Matters to a Vote of Security Holders............... 10
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters............................................... 10
Item 6 Selected Consolidated Financial Data.............................. 11
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 12
Item 8 Financial Statements and Supplementary Data......................(See
Item 14 below)
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.............................. Non-
Applicable
Part III
The information called for by Part III (Items 10 through 13) is incorporated
herein by reference from Andover's Definitive Notice of Annual Meeting and Proxy
Statement for the 1998 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
Part IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements -
Independent Auditors' Report............................... 36
Consolidated Balance Sheets as of December 31, 1997
and 1996................................................... 37
Consolidated Statements of Operations for each of
the years ended December 31, 1997, 1996 and 1995........... 38
Consolidated Statements of Changes in
Stockholders' Equity for each of the years ended
December 31, 1997, 1996 and 1995........................... 39
Consolidated Statements of Cash Flows for each of
the years ended December 31, 1997, 1996 and 1995........... 40-41
Notes to Consolidated Financial Statements................. 42-67
2
<PAGE> 3
(2) All financial statement schedules are omitted because they are not
applicable, the data is not significant, or the required information
is shown elsewhere in this report.
(b) Reports on Form 8-K. There were no reports filed on Form 8-K during
the three months ended December 31, 1997.
(c) List of Exhibits
Exhibits to the Form 10-K have been included only with the copies of
the Form 10-K filed with the SEC. Upon request to Shareholder
Relations, Andover Bancorp, Inc., 61 Main Street, Andover,
Massachusetts 01810, copies of the individual exhibits will be
furnished upon payment of a reasonable fee.
Exhibit No. Description of Exhibits
- ----------- -----------------------
3.1 Restated Certificate of Incorporation of Andover (incorporated herein
by reference to Exhibit 3.1 to Post-Effective Amendment No. 1 to
Andover's Registration Statement on Form S-4 No. 33-11891 filed on
March 5, 1987).
3.2 By-laws of Andover, as amended and restated, January 23, 1997
(incorporated herein by reference to Exhibit 3.2 to Andover's Form
10-K for the fiscal year ended December 31, 1996).
4.1 Specimen of Andover Bancorp, Inc. common stock certificate
(incorporated herein by reference to Exhibit 4 to Andover's
Registration Statement on Form S-4, Registration No. 33-11891, filed
on February 11, 1987).
4.2 Shareholder Rights Agreement between Andover Bancorp, Inc. and The
First National Bank of Boston (incorporated herein by reference to an
Exhibit to Andover's Current Report on Form 8-K dated February 21,
1989).
4.3 Amendment to Shareholder Rights Agreement between Andover Bancorp,
Inc. and The First National Bank of Boston (incorporated herein by
reference to Exhibit 4.2 to Andover's Current Report on Form 8-K dated
February 12, 1990).
10.1 Employment Agreement between Andover, Andover Bank and Gerald T.
Mulligan, dated May 16, 1991 (incorporated herein by reference to
Exhibit 10.1 to Andover's Form 10-K for the fiscal year ended December
31, 1991).
10.2 Special Termination Agreement between Andover, Andover Bank and Gerald
T. Mulligan, dated May 16, 1991, as amended and restated through
January 23, 1997 (incorporated herein by reference to Exhibit 10.2 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
10.3 Special Termination Agreement between Andover, Andover Bank and Joseph
F. Casey, dated December 17, 1992, as amended and restated through
January 23, 1997 (incorporated herein by reference to Exhibit 10.3 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
10.4 Special Termination Agreement between Andover, Andover Bank and
Michael J. Ecker, dated December 17, 1992, as amended and restated
through January 23, 1997 (incorporated herein by reference to Exhibit
10.4 to Andover's Form 10-K for the fiscal year ended December 31,
1996).
3
<PAGE> 4
10.5 Special Termination Agreement between Andover, Andover Bank and John
R. Heerwagen, dated December 17, 1992, as amended and restated through
January 23, 1997 (incorporated herein by reference to Exhibit 10.5 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
10.6 Special Termination Agreement between Andover, Andover Bank and
Octavio C. Bolivar, dated January 24, 1994, as amended and restated,
January 23, 1997 (incorporated herein by reference to Exhibit 10.6 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
10.7 Andover Savings Bank Employees' Stock Ownership Plan and Trust
Agreement and Amendment No. 1 (incorporated herein by reference to
Exhibit 10(c) to Andover's Annual Report on Form 10-K for the fiscal
year ended December 31, 1987).
10.8 Andover Bancorp, Inc. Stock Option Plan dated May 8, 1986, as amended
May 22, 1986, January 29, 1987, and November 2, 1987 (incorporated
herein by reference to Exhibit 10(h) to Andover's Annual Report on
Form 10-K for the fiscal year ended December 31, 1987).
10.9 Special Termination Agreement between Andover, Andover Bank and
Raymond P. Smith, dated December 12, 1995, as amended and restated,
January 23, 1997 (incorporated herein by reference to Exhibit 10.9 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
10.10 Andover Bancorp, Inc. 1995 Stock Incentive Plan, dated February 16,
1995 (incorporated herein by reference to Exhibit 10.11 to Andover's
Annual Report on Form 10-K for the fiscal year ended December 31,
1995).
10.11 Deferred Compensation Plan for Directors of Andover Bancorp, Inc. and
its Subsidiaries, effective July 1, 1993, as amended and restated,
February 22, 1996 (incorporated herein by reference to Exhibit 10.12
to Andover's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.12 Andover Bancorp, Inc. Special Termination Plan, effective January 23,
1997 (incorporated herein by reference to Exhibit 10.12 to Andover's
Form 10-K for the fiscal year ended December 31, 1996).
11 The computation of per share earnings can be readily determined from
the material contained in the Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
12 As the Company does not have any debt securities registered under
Section 12 of the Securities Act of 1933, no ratio of earnings to
fixed charges appears in this Annual Report on Form 10-K.
13 Andover Bancorp, Inc. 1997 Annual Report, which, except for those
portions expressly incorporated herein by reference, is furnished only
for the information of the Securities and Exchange Commission and is
not deemed to be filed.
21 The Company has two subsidiaries, Andover Bank and Andover Bank NH.
Andover Bank is a Massachusetts savings bank in stock form while
Andover Bank NH is a New Hampshire guaranty savings bank in stock
form. Both subsidiaries are included in the Consolidated Financial
Statements filed in the Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
23.1 Consent of KPMG Peat Marwick LLP.
27 Financial Data Schedule
4
<PAGE> 5
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ANDOVER BANCORP, INC.
March 13, 1998 By: /s/ Gerald T. Mulligan
-----------------------------------
Gerald T. Mulligan, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Gerald T. Mulligan President, Chief March 13, 1998
- -------------------------- Executive Officer and
Gerald T. Mulligan Director (Principal
Executive Officer)
/s/ Joseph F. Casey Chief Financial Officer March 13, 1998
- -------------------------- and Treasurer (Principal
Joseph F. Casey Financial and Accounting
Officer)
/s/ Thomas F. Caffrey Director March 13, 1998
- --------------------------
Thomas F. Caffrey
/s/ Naomi A. Gardner Director March 13, 1998
- --------------------------
Naomi A. Gardner
/s/ Cornelius J. McCarthy Director March 13, 1998
- --------------------------
Cornelius J. McCarthy
/s/ Clifford E. Elias Director March 13, 1998
- --------------------------
Clifford E. Elias
/s/ Robert J. Scribner Director March 13, 1998
- --------------------------
Robert J. Scribner
/s/ Fred P. Shaheen Director March 13, 1998
- --------------------------
Fred P. Shaheen
5
<PAGE> 6
EXHIBITS TO FORM 10-K
Andover Bancorp, Inc.
---------------------
EXHIBIT INDEX
-------------
Exhibit No. Description of Exhibit Page No.
- ----------- ---------------------- --------
3.1 Restated Certificate of Incorporation
of Andover (incorporated herein by
reference to Exhibit 3.1 to Post-
Effective Amendment No. 1 to Andover's
Registration Statement on Form S-4,
No. 33-11891 filed on March 5, 1987). --
3.2 By-laws of Andover, as amended
and restated, January 23, 1997
(incorporated herein by reference
to Exhibit 3.2 to Andover's Form
10-K for the fiscal year ended
December 31, 1996). --
4.1 Specimen of Andover Bancorp, Inc.
common stock certificate (incorporated
herein by reference to Exhibit 4 to
Andover's Registration Statement on
Form S-4, Registration No. 33-11891,
filed on February 11, 1987). --
4.2 Shareholder Rights Agreement between
Andover Bancorp, Inc. and The First
National Bank of Boston (incorporated herein by
reference to an Exhibit to
Andover's Current Report on Form 8-K
dated February 21, 1989). --
4.3 Amendment to Shareholder Rights
Agreement between Andover Bancorp, Inc.
and The First National Bank of Boston
(incorporated herein by reference to
Exhibit 4.2 to Andover's Current Report
on Form 8-K dated February 12, 1990). --
10.1 Employment Agreement between Andover,
Andover Bank and Gerald T. Mulligan,
dated May 16, 1991 (incorporated herein
by reference to Exhibit 10.1 to
Andover's Form 10-K for the fiscal
year ended December 31, 1991). --
10.2 Special Termination Agreement between
Andover, Andover Bank and Gerald T.
Mulligan, dated May 16, 1991, as amended
and restated through January 23, 1997
(incorporated herein by reference to
Exhibit 10.2 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
6
<PAGE> 7
10.3 Special Termination Agreement between
Andover, Andover Bank and Joseph F. Casey,
dated December 17, 1992, as amended and
restated through January 23, 1997
(incorporated herein by reference to
Exhibit 10.3 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
10.4 Special Termination Agreement between
Andover, Andover Bank and Michael J.
Ecker, dated December 17, 1992, as
amended and restated through January
23, 1997 (incorporated herein by reference
to Exhibit 10.4 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
10.5 Special Termination Agreement between
Andover, Andover Bank and John R.
Heerwagen, dated December 17, 1992, as
amended and restated through January
23, 1997 (incorporated herein by reference
to Exhibit 10.5 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
10.6 Special Termination Agreement between
Andover, Andover Bank and Octavio C.
Bolivar, dated January 24, 1994 as
amended and restated, January 23, 1997
(incorporated herein by reference
to Exhibit 10.6 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
10.7 Andover Savings Bank Employees' Stock
Ownership Plan and Trust Agreement and
Amendment No. 1 (incorporated herein by
reference to Exhibit 10(c) to Andover's
Annual Report on Form 10-K for the
fiscal year ended December 31, 1987). --
10.8 Andover Bancorp, Inc. Stock Option Plan
dated May 8, 1986, as amended May 22,
1986, January 29, 1987 and November 2,
1987 (incorporated herein by reference
to Exhibit 10(h) to Andover's Annual
Report on Form 10-K for the fiscal year
ended December 31, 1987). --
10.9 Special Termination Agreement between
Andover, Andover Bank and Raymond P.
Smith, dated December 12, 1995, as
amended and restated, January 23,
1997 (incorporated herein by reference
to Exhibit 10.9 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
7
<PAGE> 8
10.10 Andover Bancorp, Inc. 1995 Stock
Incentive Plan, dated February 16, 1995
(incorporated herein by reference to Exhibit 10.11
to Andover's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995). --
10.11 Deferred Compensation Plan for Directors
of Andover Bancorp, Inc. and its
Subsidiaries, effective July 1, 1993, as
amended and restated, February 22, 1996
(incorporated herein by reference to
Exhibit 10.12 to Andover's Annual Report
on Form 10-K for the fiscal year ended
December 31, 1995). --
10.12 Andover Bancorp, Inc. Special Termination
Plan, effective January 23, 1997
(incorporated herein by reference
to Exhibit 10.12 to Andover's Form 10-K for
the fiscal year ended December 31, 1996). --
11 The computation of per share earnings
can be readily determined from the
material contained in the Annual Report
on Form 10-K for the fiscal year ended
December 31, 1997. --
12 As the Company does not have any debt
securities registered under Section 12
of the Securities Act of 1933, no ratio
of earnings to fixed charges appears in
this Annual Report on Form 10-K. --
13 Andover Bancorp, Inc. 1997 Annual Report
which, except for those portions
expressly incorporated herein by
reference, is furnished only for the
information of the Securities and Exchange
Commission and is not deemed to be filed. 9
21 The Company has two subsidiaries, Andover
Bank and Andover Bank NH. Andover Bank is
a Massachusetts savings bank in stock form
while Andover Bank NH is a New Hampshire
guaranty savings bank in stock form. Both
subsidiaries are included in the
Consolidated Financial Statements filed in
the Annual Report on Form 10-K for the
fiscal year ended December 31, 1997. --
23.1 Consent of KPMG Peat Marwick LLP. 89
8
<PAGE> 1
Exhibit 13
================================================================================
[PICTURE] ANDOVER
BANCORP,
INC.
1997
ANNUAL
REPORT
================================================================================
<PAGE> 2
CONTENTS
---------------------------------------------------------
President's Message Page II
Business 2
Market for the Company's Common Stock 10
Selected Consolidated Financial Data 11
Management's Discussion and Analysis 12
Independent Auditors' Report 36
Consolidated Financial Statements 37
Notes to Consolidated Financial Statements 42
ANDOVER BANCORP, INC. IS A $1.3 BILLION BANK HOLDING COMPANY,
HEADQUARTERED IN ANDOVER, MASSACHUSETTS, APPROXIMATELY 25 MILES NORTH
OF DOWNTOWN BOSTON. ANDOVER BANCORP, INC. IS THE PARENT COMPANY OF
ANDOVER BANK AND ANDOVER BANK NH, BOTH SERVING CONSUMERS AND
BUSINESSES LOCATED IN NORTHEASTERN MASSACHUSETTS AND SOUTHERN NEW
HAMPSHIRE WITH A COMPLETE ARRAY OF FINANCIAL PRODUCTS AND SERVICES.
ANDOVER BANK, INCORPORATED IN 1834, OPERATES TEN BANKING OFFICES
LOCATED THROUGHOUT THE MERRIMACK VALLEY. ANDOVER BANK NH, INCORPORATED
IN 1995, HAS LOCATIONS IN SALEM AND LONDONDERRY, NEW HAMPSHIRE.
COVER ILLUSTRATION FEATURES
THE CITY OF LAWRENCE
<PAGE> 3
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
PERCENTAGE
1997 1996 CHANGE
---------- ---------- ----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Total assets $1,322,745 $1,204,813 +10%
Loans, net 966,302 857,806 +13
Deposits 946,982 824,311 +15
Stockholders' equity 107,079 95,846 +12
Non-performing assets 8,255 12,382 -33
OPERATING DATA:
Net interest and dividend income $ 38,705 $ 35,294 +10%
Provision for loan losses 983 2,555 -62
Losses on real estate operations (971) (1,542) -37
Non-interest expense 21,986 19,820 +11
Pre-tax income 20,494 15,916 +29
Net income 13,206 12,479 + 6
PER SHARE DATA: (1)
Net income (basic) $ 2.57 $ 2.44 + 5%
Net income (diluted) 2.49 2.40 + 4
Dividends declared 0.68 0.50 +36
Book value at end of period 20.72 18.67 +11
Book value (2) 20.50 18.61 +10
SELECTED FINANCIAL RATIOS:
Return on average assets 1.06% 1.08%
Return on average equity (2) 13.24 13.89
Net yield on average earning assets 3.22 3.16
Efficiency ratio 49.95 49.43
</TABLE>
BOOK VALUE PER SHARE(1)(2)
At December 31,
[CHART]
1995 1996 1997
---- ---- ----
$16.71 $18.61 $20.50
(1) The per share data has been restated for periods prior to December 31, 1996
to reflect a 20% stock dividend distribution.
(2) Excludes the effect of SFAS No. 115.
================================================================================
COMMITMENT
----------
ANDOVER BANK AND THE CITY OF LAWRENCE HAVE LONG HAD A SPECIAL
RELATIONSHIP. AND, IN 1997, LAWRENCE'S 150TH ANNIVERSARY, THAT
COMMITMENT CONTINUED. WITH THE ESTABLISHMENT OF OUR COMMUNITY
BANKING GROUP, WE HAVE ONCE AGAIN DEMONSTRATED OUR COMMITMENT TO
THE PEOPLE AND BUSINESSES OF LAWRENCE. WORKING WITHIN THE LATINO
COMMUNITY, THIS INNOVATIVE GROUP HAS JOINED FORCES WITH A TEAM
FROM OUR TWO LAWRENCE OFFICES TO HOST SEMINARS, VISIT BUSINESSES
AND EDUCATE CUSTOMERS ON THE PRODUCTS AND SERVICES AVAILABLE TO
THEM. WITH EFFORTS SUCH AS THESE, THE PEOPLE OF LAWRENCE CAN LOOK
FORWARD TO A FUTURE AS GREAT AS THEIR PAST.
[PICTURE]
COMMUNITY BANKING GROUP
CARMEN ESPINAL,COMMUNITY BANKING REPRESENTATIVE
AND JOSE CABRERA, VICE PRESIDENT
================================================================================
I
<PAGE> 4
================================================================================
COMMUNITY
INVOLVEMENT
------------
HELPING OTHERS HELP THEMSELVES HAS ALWAYS BEEN A PRIORITY AT
ANDOVER BANK. NEVER WAS THIS MORE EVIDENT THAN WHEN WE
NOMINATED LAZARUS HOUSE, A TEMPORARY EMERGENCY SHELTER FOR
THE HOMELESS, AS A GRANT RECIPIENT THROUGH THE FEDERAL HOME
LOAN BANK OF BOSTON'S NEW ENGLAND PARTNERSHIPS PROGRAM.
BASED ON ANDOVER BANK'S NOMINATION, LAZARUS HOUSE RECEIVED A
GRANT FROM THE FEDERAL HOME LOAN BANK OF BOSTON, MATCHING A
PREVIOUSLY AWARDED DONATION FROM ANDOVER BANK. THIS DONATION
TO THE LAWRENCE SHELTER PROVES, ONCE AGAIN, THAT ANDOVER
BANK IS HERE TO MAKE A DIFFERENCE.
[PICTURE]
LAZARUS HOUSE, LAWRENCE, MA
JOHN HARNISH, III, LEANDRO PEREZ,
SISTER MARY ELLEN BRODERICK
================================================================================
DEAR SHAREHOLDER:
I am pleased to report earnings for 1997 totalled $13.2 million for a 5.8%
increase over last year's successful results. Return on assets for the year was
1.06% and the return on shareholders' equity totalled 13.24%. Shareholder
dividends of $0.68 per share, paid in 1997, represented a 36% increase over
1996.
STOCK PRICE PERFORMANCE
At December 31,
[GRAPH]
1995 1996 1997
---- ---- ----
$17.60 $25.63 $40.25
In addition, a vigorous stock market, valuing bank and thrift stocks at
historically high earnings and book value multiples, evidenced a 57% increase in
Andover Bancorp's stock price, from the 1996 year end closing price of $25.625
to the 1997 year end closing price of $40.25.
Thus, by traditional standards of bank performance and stockholder returns, the
Company believes 1997 was a very successful year indeed. After stating various
measures of that success, some examination of the strength and quality of those
earnings is appropriate. Of special concern is whether these record earnings
arise from extraordinary, non-recurring events or stem from the core businesses
of the Company and are a product of planning and execution. A review of the
Company's core businesses is instructive in this regard.
RETAIL LENDING
Andover Bank counts its retail franchise as a significant strength. In so doing,
we give importance to growing retail loans which, in fact, grew by 15% during
1997. Residential loans outstanding increased by $96 million, approximately half
from purchasing activity and half from internal origination. Consumer loans,
represented primarily by home equity loans, increased by $9 million. Our retail
loan growth is especially gratifying because of the intense competition for
these products by a full range of financial competitors including banks, credit
unions, finance and mortgage banking companies. And, it has helped increase
total loan balances in the Company by $109 million during the year.
II
<PAGE> 5
LOAN GROWTH
At December 31,
[CHART]
(Outstanding in millions)
1995 1996 1997
---- ---- ----
$768.6 $870.0 $978.8
COMMERCIAL BANKING
While Andover Bank has a solid retail presence, its long stated objective has
been to diversify its earnings and improve asset yields by actively marketing a
wide range of loan products and services to local commercial customers.
Commercial deposit accounts increased by 48% in number and 55% in balances
outstanding. A remarkable 32% increase in low cost demand deposits further
evidences a successful year. Credit for these accomplishments goes chiefly to
our Community Business Banking Group. This group of commercial calling officers
focuses primarily on providing deposit and lending services to many small
businesses within our community.
With regard to commercial lending, we seek to generate prudently these types of
loans and, for the second consecutive year, total loan originations exceeded $50
million. However, the commercial loan portfolio experienced rapid amortization
and payoffs caused, in part, by aggressive long-term, fixed-rate lending by a
myriad of non-bank competitors seeking seasoned loans in our market area.
Nonetheless, we were able to actually increase outstanding balances by almost $8
million.
CONSTRUCTION LENDING
Construction lending has long been an important core business of Andover Bank.
The Bank's experience and knowledge of construction lending, particularly
residential construction lending, are attractive to many of the area's
contractors, builders and developers. This lending group originated
approximately $32 million in new loans. Because of the vigorous market for new
home sales, construction loans repaid rapidly and outstanding balances
experienced a modest decline; however, significant point income was realized
from the origination activity.
DEPOSIT GENERATION
A long-standing objective has been to increase deposits and, again in 1997, we
set out to do just that. We gave particular attention to attracting lower
================================================================================
COMMERCIAL BANKING
------------------
AS ONE OF THE REGION'S LEADING DESTINATIONS FOR FAMILY
ENTERTAINMENT, CANOBIE LAKE PARK HAS BEEN A FIXTURE IN
SOUTHERN NEW HAMPSHIRE FOR NEARLY A CENTURY. WHEN THEY WENT
LOOKING FOR A BANK TO HANDLE THEIR CASH MANAGEMENT NEEDS,
THEY CHOSE ANDOVER BANK. THEY WERE IMPRESSED BY OUR BROAD
PRODUCT LINE - RANGING FROM COMMERCIAL CHECKING TO PAYROLL
SERVICES TO OUR SWEEP ACCOUNT - AS WELL AS OUR COMMITMENT TO
CUSTOMER SERVICE. WE ARE PROUD OF OUR RELATIONSHIP WITH
CANOBIE LAKE PARK, AND LOOK FORWARD TO WORKING WITH THEM
WELL INTO THE NEXT CENTURY.
[PICTURE]
CANOBIE LAKE PARK
SALEM, NH
================================================================================
III
<PAGE> 6
================================================================================
BUSINESS EXPANSION
------------------
AT ANDOVER BANK, WE ARE ALWAYS LOOKING FOR WAYS TO INCREASE
OUR RANGE OF SERVICES. THAT IS WHY WE RECENTLY ENTERED INTO
THE EQUIPMENT LEASING BUSINESS. AS A SUBSIDIARY OF ANDOVER
BANCORP, INC., THE NEWLY ESTABLISHED ANDOVER CAPITAL GROUP,
INC., WILL PROVIDE LEASING AND SECURED EQUIPMENT FINANCING
FOR MOST TYPES OF MAJOR CAPITAL EQUIPMENT TO BUSINESSES
THROUGHOUT NEW ENGLAND. NOT ONLY WILL THIS RESULT IN GREATER
FINANCING OPTIONS FOR OUR EXISTING BUSINESS CUSTOMERS, IT
SHOULD ALSO LEAD TO AN INCREASED COMMERCIAL CUSTOMER BASE.
[PICTURE]
ANDOVER CAPITAL GROUP, INC.
WILLIAM J. CARROLL, EXECUTIVE VICE PRESIDENT
AND GREGORY A. SMITH, PRESIDENT
================================================================================
cost core deposits which consist primarily of all deposits other than time
certificates. The results of 1997 exceeded our expectations. Total deposits
increased by $123 million or 15%. Within that overall deposit total, core
deposits increased by $62 million or 19%. Given the climate of record returns in
the stock market and intense competition for depositor funds from a wide range
of financial intermediaries, we are very pleased with our success in deposit
generation and retention.
DEPOSIT GROWTH
At December 31,
(Outstanding in millions)
[CHART]
1995 1996 1997
---- ---- ----
$743.2 $824.3 $947.0
ANDOVER CAPITAL GROUP, INC.
In the latter part of 1997, the Bank established a leasing subsidiary
headquartered in Boston. Two well experienced and highly regarded leasing
professionals have been employed to manage this subsidiary and to generate lease
finance assets for the Bank. Nine out of ten companies in the United States
lease equipment and regard lease financing as an important part of their
financial structure. Lease assets are expected to provide the Bank with income
diversification and higher yields. In addition, our ability to offer equipment
leasing as a financing alternative for our commercial customers will add to our
product line and enhance our competitive position.
CONCLUSION
We look forward to the new year with optimism and with an energy born of the
knowledge that the business of banking continues to pose new challenges every
day. The Company's directors and employees want all shareholders to know that we
are committed to meeting these challenges and to pursuing opportunities that
will add earnings, strengthen core businesses, expand our franchise, and, above
all, increase shareholder value. And, of course, at this time of year, as we
both reflect back and look forward, we remain abundantly thankful for the
continuing support of our shareholders, our customers and the communities we
serve.
Very truly yours,
/s/ Gerald T. Mulligan
Gerald T. Mulligan
President and Chief Executive Officer
IV
<PAGE> 7
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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, MA 01810
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (978)749-2000
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(Title of Class)
PREFERRED STOCK PURCHASED RIGHTS
(Title of class)
Indicate by check mark whether: the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sale price for the Registrant's Common
Stock on March 2, 1998 as reported by NASDAQ, was $205,734,632.
The number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practicable date, is:
Class: Common Stock, par value $0.10 per share
Outstanding as of March 2, 1998: 5,175,714 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Andover Bancorp, Inc. Definitive Notice of Annual Meeting
and Proxy Statement for the 1998 Annual Meeting of Shareholders are incorporated
by reference into Part III of Form 10-K.
<PAGE> 8
PRELIMINARY NOTE IN REGARD TO FORWARD-LOOKING STATEMENTS. This annual
report on Form 10-K contains forward- looking statements. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors that could cause the registrant's actual results to differ materially
from those contemplated by such forward- looking statements. These factors
include, without limitation, those set forth below under the caption "Certain
Factors That May Affect Future Results".
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS. The following important
factors, among others, could cause actual results to differ materially from
those contemplated by forward-looking statements made in this annual report on
Form 10-K or presented elsewhere by management from time to time. Defined terms
used elsewhere in this annual report have the same meanings herein as therein. A
number of uncertainties exist that could affect the Company's future operating
results, including, without limitation, the Banks' (as defined below) continued
ability to originate quality loans, fluctuation of interest rates, real estate
market conditions in the Banks' lending areas, general and local economic
conditions, the Banks' continued ability to attract and retain deposits, the
Company's (as defined below) ability to control costs, new accounting
pronouncements, and changing regulatory requirements.
PART I
ITEM 1. BUSINESS
GENERAL
Andover Bancorp, Inc. ("Andover" or the "Company") is a Delaware
corporation that was organized in 1987. Although Andover has corporate authority
to engage in any activity permitted by the Delaware General Corporation Law,
Andover's primary activity is to act as the holding company for Andover Bank
(the "Bank") and Andover Bank NH ("ABNH") (collectively the "Banks").
The Bank is a Massachusetts-chartered savings bank which was incorporated
in 1834 and is headquartered in Andover, Massachusetts. On May 8, 1986, Andover
Bank converted from mutual to stock form. Deposits at the Bank are insured by
the Federal Deposit Insurance Corporation ("FDIC") up to $100,000 per separately
insured account and by the Depositors Insurance Fund, Inc. ("DIF") for that
portion of deposits in excess of $100,000.
ABNH is a de novo guaranty savings bank chartered in September, 1995 and
headquartered in Salem, New Hampshire. Deposits at ABNH are insured by the FDIC
up to $100,000 per separately insured account.
The Banks are engaged principally in the business of attracting deposits
from the general public and investing in residential and commercial real estate
loans, in construction, consumer, and corporate loans, and in various
securities. Emphasis is placed on both retail and corporate banking. Retail
activities, an important source of franchise value to the Banks, consist of
branch operations, home mortgage and consumer lending, and mortgage banking. The
Banks offer a variety of retail products through branch offices, automated
teller machines ("ATMs"), its telephone call center and product specialists.
Corporate banking activities consist primarily of commercial real estate,
construction, land and commercial lending. These are conducted primarily through
loan officers and product specialists.
The Company's financial performance in 1997 reflects an increase in net
interest income, non-interest income and a reduction in the provision for loan
losses and losses on real estate operations, offset by an increase in
non-interest expenses.
The Company's financial performance in 1996 was positively impacted by a
one-time gain (in the form of a tax benefit) of $2.5 million and a pre-tax
credit of $225,000 for the execution of a merger termination agreement,
partially offset by a pre-tax loss of $1.1 million from the sale of low yielding
investments and the early extinguishment of debt.
2
<PAGE> 9
MARKET AREA
The Bank's market area is centered in Andover, Massachusetts, approximately
25 miles north of downtown Boston and the Bank operates banking offices in the
towns of Andover, Lawrence, Methuen, North Andover and Tewksbury, which serve
those towns as well as surrounding communities in northeastern Massachusetts and
in southern New Hampshire. ABNH's primary market area is comprised of
communities in southern New Hampshire and operates banking offices in Salem and
Londonderry, New Hampshire. Andover Capital Group, Inc. is located in Boston
with the entire Northeast as its primary market area.
LENDING ACTIVITIES
General. Lending is the principal business of the Banks and loans represent
the largest portion of the Banks' assets. As of December 31, 1997, the Banks'
loan portfolio, prior to the allowance for loan losses, amounted to $978.8
million or 74.0% of total assets. The Banks' loan portfolio increased 12.5%
during 1997 resulting from higher loan origination volume and purchases of $71.3
million in loans.
The primary lending activity has been the origination of first mortgage
loans for the purchase, refinance, or construction of residential properties in
Andover's primary market area and adjacent communities. Such loans are generally
viewed as the least vulnerable to major economic changes. They provide a
relatively stable source of interest income in the loan portfolio. They also
provide a significant source of fee income when they are sold in the secondary
mortgage market and serviced by the Bank. The Bank is an active servicer of
residential loans for investors in the secondary mortgage market.
The Banks originate a variety of other loans for consumer purposes. These
include home equity, personal, and education loans, among others, and constitute
an additional source of interest income in the loan portfolio. The consumer
lending activities of the Banks complement their home mortgage activities and
position them as full service retail lenders. The retail lending activities of
the Banks complement their retail deposit gathering activities and strengthen
their overall retail franchise in their market areas. As of December 31, 1997,
retail loans totalled $783.7 million or 80.1% of total loans.
The Banks also originate non-retail or corporate loans, such as commercial
real estate, commercial, construction and land loans. Historically, these types
of loans have generated higher yields and returns than retail loans, but also
involve additional risk. See "Risk Elements". In addition, the Banks began to
offer lease financing and secured equipment loans through a new subsidiary
described below. See "Commercial Loans". Corporate loans have also been viewed
as a means of maintaining a diversified loan and asset portfolio. As of December
31, 1997, non-retail loans amounted to $195.1 million, or 19.9% of total loans.
Residential Mortgage Loans. Residential mortgage loans totalling $715.5
million represented 73.1% of the total loan portfolio at December 31, 1997.
Included in residential mortgage loans was $10.5 million in outstanding second
mortgages made to facilitate the purchase of principal residences by borrowers
needing large loan amounts under the Bank's "Econo-Max(R)" loan program. An
additional $5.5 million in residential mortgage loans was held for sale at that
date. During 1997, the Bank purchased from other banks and correspondent
origination firms $71.3 million of locally originated residential whole loans.
Nearly all of the loans in the residential mortgage portfolio are secured
by houses located in Massachusetts or in southern New Hampshire. According to
internal policy, the majority of these loans are written to be eligible for sale
in the secondary mortgage market, primarily to the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA").
Residential mortgage loans include both fixed and variable rate mortgages with
original terms of 5 to 30 years. The Bank remains an active seller of originated
home mortgages in the secondary market.
3
<PAGE> 10
Commercial Real Estate Loans. At December 31, 1997, commercial real estate
loans totalled $142.6 million, representing 14.6% of total loans. Approximately
$20.2 million, or 14.2% of these loans, are secured by apartment buildings and
multi-family residential properties. The balance of the commercial real estate
loans is secured by commercial facilities, including office, mixed use, retail
or light manufacturing properties, small shopping centers, and various other
types of commercial real estate. Commercial real estate loans generally amortize
over a period of 15 to 25 years. Variable interest rates on such loans are
generally set at a margin above either the one-year Treasury index or the prime
rate as published in the Wall Street Journal and are subject to periodic
adjustment. Commercial real estate loans with fixed interest rates are set at a
margin above the Federal Home Loan Bank advance rate.
Construction and Land Loans. Construction and land loans totalled $31.5
million at December 31, 1997, representing 3.2% of total loans. At that date,
amounts committed to but not yet advanced in connection with such loans totalled
an additional $21.3 million. At December 31, 1997, outstanding construction
loans totalled $22.2 million and outstanding land loans (including loans for
unimproved land and land development) totalled $9.3 million. Substantially all
of the construction lending is for residential development of detached
single-family homes. Construction and land loans generally have a term of two
years, although the Banks typically are entitled to review and adjust the
interest rate at the end of the first year. The interest rate generally is set
at a margin above the prime rate as published in the Wall Street Journal.
Consumer Loans. Consumer loans totalled $68.2 million at December 31, 1997,
representing 7.0% of total loans. Home equity loans constitute the greatest
portion of the Banks' consumer lending activity and totalled $47.8 million at
December 31, 1997. At that date, unadvanced amounts relating to home equity
loans totalled an additional $72.5 million. Home equity loans are offered both
in fixed-rate and adjustable form with varying terms of three to ten years. The
adjustable rate loans are generally tied to the prime rate as published in the
Wall Street Journal. Home equity loans are subject to the same general
underwriting standards as residential first mortgage loans.
Commercial Loans. At December 31, 1997, commercial loans totalled $21.0
million, or approximately 2.1% of total loans. The interest rate on commercial
loans generally varies at a margin above the prime rate as published in the Wall
Street Journal. Commercial loans may be secured in whole or in part by real
estate unrelated to the principal purpose of the loan or secured by inventories
and receivables and are ordinarily guaranteed by the principals of the borrower.
Commercial loans with fixed interest rates are set at a margin above the Federal
Home Loan Bank advance rate.
During the latter part of 1997, the Company established a new subsidiary
called Andover Capital Group, Inc. This subsidiary offers commercial equipment
leasing and financing as an additional financing option for corporate customers.
Andover Capital Group, Inc. had approximately $1 million outstanding in leases
included in the commercial loan portfolio at December 31, 1997.
Loan Origination. Mortgage loans originate from a number of sources. These
include realtor, builder and customer referrals, direct advertising and
participation in home shows and other events. The Banks employ a number of
mortgage loan originators who maintain regular contact with real estate firms
and other sources of business and who respond to general mortgage inquiries.
These mortgage specialists are assigned specific territories and receive
commissions on closed mortgage loans. Total residential mortgages originated by
the Banks in 1997 amounted to $165.3 million.
Consumer loans are solicited by advertising and by direct mail targeted to
existing deposit and mortgage customers and, from time to time, selected market
area households which have no customer relationship with either Bank. The
primary origination activity in the consumer loan area relates to home equity
lines of credit, totalling $22.5 million in 1997, while other consumer loan
originations totalled $12.0 million.
Commercial real estate, commercial, construction and land loans are
originated from direct solicitation of existing and prospective customers and
from a variety of referral sources. The Banks originated $83.2 million of these
corporate loans during 1997.
4
<PAGE> 11
RISK ELEMENTS
General. Overbuilding and the weakened New England economy and real estate
market were the principal causes for the past deterioration of the loan
portfolio. The Company's operating results continue to be adversely affected by
the loss of interest income from nonaccruing loans and restructured loans,
provision for losses on loans and other real estate owned and costs associated
with collecting, holding and disposing of non-performing assets. For further
information concerning the composition of the loan portfolio, nonaccrual loans,
the allowance for loan losses, and other real estate owned, see Notes 4 and 6 to
the "Consolidated Financial Statements" and Item 7, "Management's Discussion and
Analysis -- Results of Operations -- Financial Condition -- Loans -- Risk
Elements".
Non-performing Assets. Non-performing assets consist of nonaccruing loans
and other real estate owned. During 1997, non-performing assets decreased 33.3%,
or $4.1 million from 1996 levels, to $8.3 million and amounted to 0.6% of total
assets at year-end. The Company places all loans, regardless of collateral
values, on nonaccrual status when principal or interest is past due 90 days or
more. Loans for which payments are less than 90 days past due are placed on
nonaccrual status where there exists serious doubt as to collectibility. At
December 31, 1997, the Bank had $7.8 million in nonaccruing loans and $406,000
in other real estate owned.
Through periodic provisions charged to expense, the Banks maintain an
allowance for losses on loans. The provision for loan losses totalled $983,000
and $2.6 million in 1997 and 1996, respectively, primarily due to loan growth in
each of the years. The provision in 1996 was negatively impacted by the
deterioration of a previously reported problem loan which resulted in a
charge-off totalling $760,000.
Significant Risk Elements. The largest concentration included in risk
elements at December 31, 1997, was non-performing assets within the City of
Lawrence with a carrying value of $3.9 million, or approximately 46.7% of
non-performing assets. This concentration of non-performing assets includes
non-owner occupied, multi-family housing as well as commercial mixed-use
properties. The largest non-performing relationship includes 13 loans totalling
$1.1 million to one borrower. Real estate in Lawrence had been particularly hard
hit by increased vacancies, partially as a result of the reduction in rental
assistance provided by state and federal agencies. Current unit carrying amounts
of other real estate owned have been adjusted to at or below current appraised
values. Andover expects that the disposition of other real estate owned will
continue to involve management's attention and resources as well as
administrative expenses.
Current Market Conditions. The New England region, including those portions
of northeastern Massachusetts and southern New Hampshire that constitute
Andover's market area, experienced a significant economic decline in the early
1990's. While stabilization and even progress has been made recently in
regaining lost jobs and real estate prices, the reverberations of the economic
decline will continue to be felt in 1998. The effects of the economic downturn
and resultant oversupply were especially evident in the condominium,
multi-family and commercial real estate markets, where prices had declined
substantially in many cases. The continued liquidation of these troubled
properties will likely keep prices deflated on certain commercial mixed-use
properties and multi-family homes for the foreseeable future. In the
single-family sector, prices also suffered in the early 1990's. However, prices
for single-family homes appear to have rebounded and origination volumes have
become more sensitive to market interest rates rather than concerns regarding a
declining economy.
INVESTMENT ACTIVITIES
The investment portfolio, an important component of Andover's diversified
asset structure, is a source of earnings in the form of interest and dividends,
provides for diversification and is a source of liquidity. Overall, the
portfolio, comprised of mortgage-backed securities, corporate bonds, U.S.
Treasury and federal agency securities and short-term investments, represented
21.4% of total assets, or $282.6 million as of December 31, 1997.
5
<PAGE> 12
Overall, in 1997, the total investment portfolio produced interest and
dividend income of $19.9 million as compared with $19.3 million in 1996 due to
the restructuring referred to below. The investment portfolio and the sale of
loans generated net gains on sales, redemptions and the marking of certain
securities to market of $422,000 in 1997, as compared to net losses of $265,000
in 1996. Included in the $265,000 loss for 1996 was the loss resulting from the
balance sheet restructuring in the third quarter of 1996 whereby the Company
restructured its balance sheet by selling $40 million of low yielding securities
at a loss of $870,000. The majority of these securities were then replaced with
similar securities at higher yields during the fourth quarter of 1996.. For
additional information on investments, see Notes 1 and 3 to the "Consolidated
Financial Statements" and Item 7, "Management's Discussion and Analysis --
Results of Operations -- Financial Condition -- Investments".
DEPOSITS AND OTHER SOURCES OF FUNDS
The Banks' major sources of funds are deposits, borrowings, principal
payments on loans and mortgage-backed securities, and maturities of investments.
Borrowings are generally used to fund long-term assets and short-term liquidity
requirements or to manage interest rate risk. Total deposits amounted to $947.0
million at December 31, 1997.
The Bank is a member of the Federal Home Loan Bank of Boston ("FHLB") and
is authorized to borrow funds to meet withdrawals of savings deposits or to
expand the loan or investment portfolios. These borrowings are subject to
collateral requirements and borrowing limitations. The Banks also have available
various other sources of funds, including secured borrowings, federal funds
lines of credit from commercial banks and reverse repurchase agreements from
brokerage firms, FHLMC and FNMA. In addition, the Banks have established
overnight repurchase agreements with several corporate customers. The Banks may
also obtain funds from the Federal Reserve Bank of Boston by pledging certain
assets. At December 31, 1997, total borrowings outstanding from these various
sources amounted to $258.7 million.
For additional information concerning the composition and maturity of
deposits and borrowings, see Notes 9, 10 and 11 to the "Consolidated Financial
Statements" and Item 7, "Management's Discussion and Analysis -- Results of
Operations -- Financial Condition -- Deposits -- Borrowings -- Asset and
Liability Management and Market Risk -- Liquidity".
OTHER SERVICES
Investment Services. The Banks make investment and brokerage services
available to their customers through a contract with Liberty Securities
Corporation, an unaffiliated company. Two fully licensed brokers of Liberty
Securities located at the Bank's headquarters are available for consultation on
investment opportunities, including mutual funds, municipal bonds,
government-backed securities and annuities. The Bank received income of
approximately $76,000 from these services in 1997.
COMPETITION
The Banks' lending and deposit-taking activities are concentrated in the
Central Merrimack Valley and the surrounding communities in northeastern
Massachusetts and southern New Hampshire. The Banks face strong competition both
in originating loans and in attracting deposits. Competition in originating
loans in the Banks' expansive lending area comes primarily from thrift
institutions, commercial banks, mortgage companies, credit unions and consumer
finance companies. The Banks compete for loans principally on the basis of
interest rates and loan fees, the types of loans offered, and the quality of
service and convenience provided to borrowers.
In attracting deposits, the Banks' primary competitors are thrift
institutions, commercial banks, credit unions and mutual funds. The attraction
and retention of deposits depends on the Banks' ability to provide investment
opportunities that satisfy the requirements of depositors with respect to the
rate of return, liquidity, risk, service and other factors. The Banks compete
for these deposits by offering competitive rates, convenient branch locations,
extended business hours, alternative delivery channels and automated teller
machines.
6
<PAGE> 13
SUPERVISION AND REGULATION
General. The Company and the Banks are heavily regulated. As a multi-bank
holding company, Andover is supervised by the Board of Governors of the Federal
Reserve Board System ("FRB") and it is also subject to the jurisdiction of the
Massachusetts Board of Bank Incorporation. As a Massachusetts-chartered savings
bank, the Bank is subject to regulation and supervision by the FDIC and the
Massachusetts Commissioner of Banks. As a New Hampshire-chartered guaranty
savings bank, ABNH is subject to regulation and supervision of the FDIC and the
New Hampshire Commissioner of Banks.
Federal Deposit Insurance Corporation. The FDIC insures the Banks' deposit
accounts to the $100,000 maximum per separately insured account. The Banks are
subject to regulation, examination, and supervision by the FDIC and to reporting
requirements of the FDIC. The FDIC has adopted requirements setting minimum
standards for capital adequacy and imposing minimum leverage capital ratios. The
Banks exceeded all applicable requirements at December 31, 1997. Furthermore,
under the capital standards established pursuant to the FDIC Improvement Act of
1991, the Banks are currently well-capitalized. For additional information on
regulatory capital ratios, see Note 13 to the "Consolidated Financial
Statements" and Item 7, "Management's Discussion and Analysis -- Financial
Condition -- Capital Resources".
Massachusetts Commissioner of Banks and New Hampshire Commissioner of
Banks. Massachusetts and New Hampshire statutes and regulations govern, among
other things, investment powers, lending powers, deposit activities, maintenance
of surplus and reserve accounts, the distribution of earnings, the payment of
dividends, issuance of capital stock, branching, acquisitions and mergers and
consolidations. Massachusetts and New Hampshire banks that do not operate in
accordance with the regulations, policies and directives of the respective
Commissioner of Banks may be subject to sanctions for noncompliance. The
Commissioners may, under certain circumstances, suspend or remove officers or
directors who have violated the law, conducted the Banks' business in a manner
which is unsafe, unsound or contrary to the depositor's interest, or been
negligent in the performance of their duties.
In response to a Massachusetts law enacted in 1996, in 1997 the
Massachusetts Commissioner finalized rules that generally give Massachusetts
banks, and their subsidiaries, many powers equivalent to those of national
banks. The Massachusetts Commissioner also has adopted procedures expediting
branching by strongly capitalized banks.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Under
the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"), different types of interstate transactions and activities are
permitted. Interstate transactions and activities provided for under the law
include: (i) bank holding company acquisitions of separately held banks in a
state other than a bank holding company's home state; (ii) mergers between banks
with different home states, including consolidations of affiliated banks; (iii)
establishment of interstate branches either de novo or by branch acquisition;
and (iv) affiliate banks acting as agents for one another for certain banking
functions without being considered a "branch". In general, subject to certain
limitations, nationwide interstate acquisitions are now permissible,
irrespective of state law limitations other than limitations related to deposit
concentrations and bank age requirements. Interstate mergers generally also are
permissible, and affiliated banks may act as agents for one another. Each of the
transactions and activities must be approved by the appropriate federal bank
regulator, with separate and specific criteria established for each category.
In 1996, Massachusetts enacted interstate banking laws in response to
Riegle-Neal. The laws permit, subject to certain deposit and other limitations,
interstate acquisitions, mergers and branching on a reciprocal basis. The new
interstate banking law is likely to make it easier for out-of-state institutions
to attempt to purchase or otherwise acquire a Massachusetts bank, or to compete
with the Bank in Massachusetts. Similarly, the new laws make it easier for
Massachusetts banks to compete outside the state.
7
<PAGE> 14
EMPLOYEES
At December 31, 1997, Andover had 280 full-time equivalent employees. None
of the employees of Andover are represented by a collective bargaining group and
management considers relations with its employees to be good.
SUBSIDIARIES
Andover has two direct subsidiaries, the Bank and ABNH. The Bank has four
wholly-owned subsidiaries and one majority-owned subsidiary. Three of its
subsidiaries were organized to hold real property acquired by the Bank by
foreclosure or acceptances of deeds in lieu of foreclosure. The fourth
subsidiary, ASB Development Corp. ("ASB"), has four subsidiaries and holds title
to a portion of Andover's main office, the loan operation building and to other
income producing property. One subsidiary of ASB holds real estate property that
comprises a portion of Andover's main office location. Two other subsidiaries of
ASB were organized as Massachusetts security corporations to take advantage of
beneficial state tax treatment related to the holding of certain investments.
The fourth subsidiary of ASB, Andover Preferred Capital Corporation ("APCC"), is
99 percent owned by ASB and is a Massachusetts business corporation which has
elected to be taxed as a real estate investment trust for federal and
Massachusetts tax purposes. APCC holds mortgage loans which were previously
originated by Andover Bank. The majority-owned subsidiary, Andover Capital
Group, Inc., provides commercial equipment leasing and financing. ABNH currently
has no subsidiaries.
8
<PAGE> 15
ITEM 2. PROPERTIES
Andover conducts its business from its main office and other properties
listed below, all of which are considered to be in good condition and adequate
and suitable for the purposes for which they are used. Andover also serves
customers through its affiliation with three Automatic Teller Machine ("ATM")
networks: NYCE(R), EXCHANGE(R) and CIRRUS(R) with over 260,000 ATM locations
worldwide. In addition, the Company has an affiliation with Maestro(R) for its
debit card customers. The following table sets forth certain information
relating to bank premises owned or used by Andover and its subsidiaries in
conducting its business.
<TABLE>
<CAPTION>
OWNED OR
LOCATION LEASED
-------- --------
<S> <C> <C>
Andover Bank
- ------------
Main Office:
Andover
61 Main Street...........................................Owned
31-45 Main Street-Annex..................................Owned
11 Chestnut Street.......................................Owned
18-20 Central Street (1)................................Leased
Branches:
Lawrence
450 Essex Street.........................................Owned
305 South Broadway.......................................Owned
Methuen
547 Broadway.............................................Owned
91 Pleasant Valley Street (2)............................Owned
228 Haverhill Street.....................................Owned
North Andover
108 Main Street..........................................Owned
1077 Osgood Street (ATM only) (3).......................Leased
Tewksbury
995 Main Street..........................................Owned
2171 Main Street (4)....................................Leased
Andover
159 River Road...........................................Owned
Andover Bank NH
- ---------------
Main Office:
Salem
130 Main Street (5).....................................Leased
Branch:
Londonderry
62 Nashua Road...........................................Owned
Andover Capital Group, Inc.
- ---------------------------
One Constitution Plaza, Boston (6)......................Leased
</TABLE>
- ---------------
(1) Lease expires February 1, 2004, with a renewal option for an additional four
years.
(2) Land is held under a ground lease which expires December 1, 2006, with
renewal options for an additional 59 years.
(3) Lease expires May 31, 2001, with renewal options for an additional ten
years.
(4) Lease expires January 31, 1999, with a renewal option for an additional five
years.
(5) Lease expires July 31, 1999, with renewal options for an additional four
years.
(6) Lease expires May 31, 1999.
9
<PAGE> 16
ITEM 3. LEGAL PROCEEDINGS
Andover and the Banks are involved in various legal proceedings incidental
to their business, none of which is believed by management to be material to the
financial condition of Andover or the Banks.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
STOCK PRICES AND DIVIDENDS
Andover's Common Stock trades on the Nasdaq National Market tier of The
Nasdaq Stock Market(sm) under the symbol: ANDB. On February 15, 1998, there were
approximately 2,417 holders of record of the 5,168,214 shares of Andover Common
Stock outstanding.
The following table sets forth the comparative market prices per share of
Andover Common Stock based on high and low sale prices as reported on by
Nasdaq(R) and the dividends per share that have been declared by Andover, for
the periods indicated. The per share information has been restated for periods
prior to December 31, 1996 to reflect the Company's 20% stock dividend
distribution.
<TABLE>
<CAPTION>
Price Dividends
----- Declared
Quarter Ended High Low Per Share
------------- -------- ------- ---------
<S> <C> <C> <C> <C>
1995 March 31, 1995.................... $15.73 $11.77 $.0833
---- June 30, 1995.................... 16.56 13.85 .0833
September 30, 1995............... 18.85 15.31 .1000
December 31, 1995................ 19.37 17.19 .1000
1996 March 31, 1996.................... $19.69 $16.87 $.1000
---- June 30, 1996.................... 23.33 17.81 .1250
September 30, 1996............... 22.19 19.06 .1250
December 31, 1996................ 29.25 21.09 .1500
1997 March 31, 1997.................... $30.25 $24.75 $.1500
---- June 30, 1997.................... 31.75 25.75 .1700
September 30, 1997............... 36.75 29.50 .1700
December 31, 1997................ 42.25 32.75 .1900
</TABLE>
The payment of dividends by Andover is subject to the discretion of
Andover's Board of Directors. Holding companies such as Andover engage in no
business other than acting as the holding company of their subsidiaries. The
only funds available to Andover for the payment of dividends are cash and cash
equivalents held at the holding company level, dividends paid by the Banks to
Andover, and borrowings. ABNH will be severely limited in its ability to pay
dividends during its initial years of operation. At December 31, 1997, Andover
held $3.6 million in cash and interest-bearing deposits at the holding company
level.
Dividend payments totalled $3.5 million in 1997 and $2.6 million in 1996.
On January 22, 1998, a dividend of $.19 per share was declared, payable on
February 17, 1998.
10
<PAGE> 17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes selected consolidated financial data of
Andover at or for the periods indicated, and should be read in conjunction with
the consolidated financial statements and related notes thereto included in Item
8 of this Report.
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- --------
(DOLLARS IN THOUSANDS, EXCEPT NUMBER OF OFFICES DATA)
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Total assets.............................. $1,322,745 $1,204,813 $1,110,847 $1,058,672 $831,908
Total loans............................... 978,823 870,035 768,598 645,037 456,813
Allowance for loan losses................. 12,521 12,229 11,665 12,343 13,392
Investments(1)............................ 282,567 276,651 285,232 352,685 294,969
Assets held for sale...................... 5,537 2,220 5,162 2,507 32,280
Deposits.................................. 946,982 824,311 743,205 727,858 558,773
Borrowed funds............................ 258,732 274,418 272,626 251,185 197,637
Stockholders' equity...................... 107,079 95,846 85,165 72,522 70,885
Non-performing assets..................... 8,255 12,382 15,785 23,312 24,651
Number of banking offices and locations... 13 12 11 10 8
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
<S> <C> <C> <C> <C> <C>
Interest and dividend income ................. $90,752 $83,823 $76,886 $63,585 $52,531
Interest expense ............................. 52,047 48,529 44,552 33,421 26,034
------- ------- ------- ------- -------
Net interest and dividend income ............. 38,705 35,294 32,334 30,164 26,497
Provision for loan losses .................... 983 2,555 1,295 -- --
Net gains (losses) from sales of
assets held for sale and investments (1) ... 422 (265) 324 (234) 396
Losses on real estate operations, net ........ (971) (1,542) (2,003) (2,617) (4,547)
Other income ................................. 5,307 4,804 4,870 4,007 2,885
Merger expense (recovery) .................... -- (225) 1,000 -- --
Non-interest expense ......................... 21,986 20,045 18,258 17,496 15,224
------- ------- ------- ------- -------
Income before income tax expense
and extraordinary item ..................... 20,494 15,916 14,972 13,824 10,007
Income tax expense ........................... 7,288 3,264 5,634 4,781 2,449
------- ------- ------- ------- -------
Income before extraordinary item ............. 13,206 12,652 9,338 9,043 7,558
Extraordinary item ........................... -- (173) -- -- --
------- ------- ------- ------- -------
Net income ................................... $13,206 $12,479 $ 9,338 $ 9,043 $ 7,558
======= ======= ======= ======= =======
PER SHARE DATA: (2)
Earnings per common share (basic):
Income per share before extraordinary
item ..................................... $ 2.57 $ 2.47 $ 1.84 $ 1.80 $ 1.53
Extraordinary item per share, net of tax ... -- (0.03) -- -- --
------- ------- ------- ------- -------
Net income per share ....................... $ 2.57 $ 2.44 $ 1.84 $ 1.80 $ 1.53
======= ======= ======= ======= =======
Earnings per common share (diluted):
Income per share before extraordinary
item ..................................... $ 2.49 $ 2.43 $ 1.82 $ 1.77 $ 1.51
Extraordinary item per share, net of tax ... -- (0.03) -- -- --
------- ------- ------- ------- -------
Net income per share ....................... $ 2.49 $ 2.40 $ 1.82 $ 1.77 $ 1.51
======= ======= ======= ======= =======
Dividends declared ........................... $ 0.68 $ 0.50 $ 0.37 $ 0.33 $ 0.13
Book value at end of period .................. 20.72 18.67 16.75 14.36 14.24
Book value (3) ............................... 20.50 18.61 16.71 15.28 13.86
SELECTED FINANCIAL RATIOS:
Return on average assets .................... 1.06% 1.08% 0.87% 0.94% 0.96%
Return on average equity (3) ................ 13.24 13.89 11.51 12.36 11.60
Average equity as a percentage
of average assets (3) .................... 8.00 7.76 7.59 7.57 8.30
Dividend payout ratio ....................... 27.31 20.83 20.33 18.64 8.61
Weighted average interest rate spread ....... 2.67 2.66 2.71 2.91 3.20
Net yield on average earning assets ......... 3.22 3.16 3.14 3.26 3.56
Efficiency ratio ............................ 49.95 49.43 51.76 51.20 51.81
</TABLE>
- ---------------
(1) Includes investment securities, mortgage-backed securities and short-term
investments, both available for sale and held to maturity.
(2) The per share data has been restated for periods prior to December 31, 1996
to reflect the 20% stock dividend distribution.
(3) Excludes the effect of SFAS No. 115.
11
<PAGE> 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
General. The Company's results of operations depend to a great extent on
the Banks' net interest income, which is the difference between income earned on
their loan and investment portfolios and the interest paid on their deposits and
borrowed funds, the size of the provisions for loan losses and losses on real
estate operations and operating expenses. Net interest income is primarily
affected by the level of earning assets as a percentage of total assets, the
level of interest-bearing liabilities, yields earned on assets and rates paid on
liabilities. Earnings are also affected by non-interest income which consists
primarily of mortgage banking income, transaction account fees, gains and losses
on sales of the investment portfolio and real estate operations. The levels of
operating expenses and income taxes also affect earnings.
The following is a discussion and analysis of the Company's consolidated
results of operations for the last three years and its financial condition at
the end of fiscal 1997 and 1996. This section is intended to be read in
conjunction with the Consolidated Financial Statements and accompanying
footnotes.
The following also contains forward-looking statements. There are a number
of important factors that could cause the Company's actual results to differ
materially from those contemplated by such forward-looking statements. These
factors include, without limitation, those set forth under the caption "Certain
Factors That May Affect Future Results".
RESULTS OF OPERATIONS
Andover generated net income of $13.2 million or $2.49 per diluted share,
$12.5 million or $2.40 per diluted share and $9.3 million or $1.82 per diluted
share in 1997, 1996 and 1995, respectively. Andover's return on average assets
decreased slightly in 1997 to 1.06%, as compared to 1.08% in 1996 and 0.87% in
1995. Return on average stockholders' equity decreased slightly in 1997 to
13.24%, as compared to 13.89% in 1996 and 11.51% in 1995. The Company's
financial performance in 1997 was impacted by an increase in total earning
assets as well as the net yield on those assets. The financial performance in
1996 was positively impacted by a one-time gain (in the form of a tax benefit)
of $2.5 million and a pre-tax credit of $225,000 for the execution of a merger
termination agreement, partially offset by a pre-tax loss of $1.1 million from
the sale of low-yielding investments and the early extinguishment of debt. The
financial performance in 1995 was negatively impacted by a pre-tax charge to
earnings of $1.0 million taken in connection with the failed acquisition of
Finest Financial Corp., the parent company of Pelham Bank and Trust Company.
Net Interest and Dividend Income. Net interest and dividend income was
$38.7 million in 1997, up from $35.3 million in 1996 and $32.3 million in 1995.
Net interest income increased $3.4 million during 1997 and $3.0 million during
1996 as a result of higher average earning asset volumes in both of those years.
Market interest rates have been fairly volatile over the past several years.
During 1997, the interest rate margin of 3.22% and the interest rate spread of
2.67% were favorably impacted by the restructure of the balance sheet undertaken
in the latter part of 1996. This restructure enabled the Company to recognize a
6 basis point increase in the yield on interest-earning assets while maintaining
only a 5 basis point increase on the rate paid on interest-bearing liabilities.
The impact of the growth in interest-earning assets during 1996 was partially
muted by continued contractions in the interest rate spread. This contraction is
primarily the result of increased rates paid on deposits and totalled 2.66% in
1996. The yield on interest-earning assets increased 3 basis points in 1996 to
7.50% while the rate paid on interest-bearing liabilities experienced an
increase of 8 basis points to 4.84%. Since average earning assets rose faster
than average interest-bearing liabilities, the net yield increased 2 basis
points in 1996 to 3.16%. The amount of foregone interest income from nonaccruing
and restructured loans totalled $716,000 in 1997, $909,000 in 1996 and $1.0
million in 1995.
Average earning assets increased 7.4% in 1997 to $1,200.7 million as of
December 31, 1997, and increased 8.6% during 1996 to $1,118.1 million. The
increase in each of the two years was primarily due to higher loan growth
resulting from increased loan originations and purchases.
12
<PAGE> 19
Total average loans increased $80.9 million during 1997 and $146.4 million
during 1996 primarily due to retained loan originations and whole loan
purchases. The yield on real estate loans increased 2 basis points during 1997
to 7.76% while decreasing 2 basis points in 1996 to 7.74%. The yield on consumer
loans decreased 36 basis points during 1997 to 8.20% while decreasing 58 basis
points during 1996 to 8.56%. The main reason for the decline during 1997 is due
to the highly-competitive environment for home equity loans, causing the Banks
to offer lower interest rates on this product, while the decline in 1996 was
primarily due to decreases in the prime lending rate. The yield on commercial
loans decreased 9 basis points during 1997 to 9.54% and 158 basis points during
1996 to 9.63%. The decline in the commercial loan yield during 1997 was
primarily due to competitive pricing as well as a higher proportion of fixed
rate loans. The yield in 1996 decreased due to the decrease in the prime lending
rate while the commercial loan yields were favorably impacted by a reduction in
nonaccrual loans and higher amortized fee income during 1995.
The volatility in the interest rates has also impacted the yields earned on
the investment portfolio. The yield on short-term investments increased 21 basis
points during 1997 to 5.45% and decreased 57 basis points in 1996 to 5.24%. The
yields earned on investment securities increased 59 basis points to 6.68% in
1997 while decreasing in 1996 to 6.09%. The yield on mortgage-backed securities
increased 1 basis point during 1997 to 6.83% and increased 11 basis points in
1996 to 6.82%. The 1997 increase in the federal funds rate of 25 basis points
and decrease of 50 basis points during 1996 impacted the short-term investment
yield in a corresponding manner. The increase in the yield on the investment
securities is primarily due to the 1996 balance sheet restructure, whereby lower
yielding securities were sold at a loss and the proceeds from such sale were
reinvested at a higher market interest rate.
The rate paid on interest-bearing deposits increased 19 basis points in
1997 to 4.62% and 18 basis points in 1996 to 4.43%. Core deposits, which include
NOW, savings and money market accounts, usually have rates lower than those paid
on certificates of deposit. However, to grow the core deposit balances, the
Banks have offered promotional rates on certain products. The impact of these
promotional rates on the savings rate has been an increase of 98 basis points in
1997 and 18 basis points in 1996. Average balances, meanwhile, have grown by
$45.5 million and $4.8 million, respectively, in 1997 and 1996. The Banks have
moderated the increase in the rates paid on money market accounts and had an
increase in the rate paid of only 9 basis points and 24 basis points,
respectively, in 1997 and 1996. However, the balances maintained in money market
accounts have declined in each of those years as customers have migrated to the
regular savings account. The balances maintained in NOW accounts have increased
modestly in both years while the rates have remained fairly stable during that
same time period. Certificate of deposit average balances increased $72.7
million and the rates paid increased 6 basis points during 1997, while also
increasing $26.3 million and 15 basis points, respectively, in 1996.
The Company has continued its reliance on borrowed funds as an alternative
source of funds to deposits in order to grow average earning assets. During
1997, the Company was successful in attracting new deposits, therefore, the
average balance on borrowed funds decreased $50.4 million and the rate paid
decreased 4 basis points to 5.81%. In 1996, average balances increased $39.4
million and the rate paid decreased 31 basis points to 5.85%. The decline in the
rate paid in both years was partly attributable to the early extinguishment of
$19.1 million of borrowed funds in the third quarter of 1996.
Although the net yield on earning assets increased slightly during 1997,
primarily due to the balance sheet restructuring undertaken in 1996, overall, a
continued compression has been experienced in the margins over the past two
years which has led to an interest rate spread of 2.67% in 1997, up modestly
from 2.66% in 1996. The decline in the spread in 1996 totalled 5 basis points.
13
<PAGE> 20
The following table presents an analysis of the average yields earned and rates
paid for the years indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------ ---------------------------- -----------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
---------- -------- ------- ------- ------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments........... $ 13,691 $ 746 5.45% $ 10,874 $ 570 5.24% $ 10,775 $ 626 5.81%
Investment securities (1) ....... 101,491 6,783 6.68 88,347 5,380 6.09 112,342 7,009 6.24
Mortgage-backed securities (1) .. 180,889 12,362 6.83 195,137 13,304 6.82 229,111 15,375 6.71
---------- ------- ---------- ------- ---------- -------
Total investments ............... 296,071 19,891 6.72 294,358 19,254 6.54 352,228 23,010 6.53
---------- ------- ---------- ------- ---------- -------
Residential loans ............... 650,089 48,043 7.39 593,867 44,045 7.42 480,825 35,760 7.44
Commercial loans ................ 136,234 12,253 8.99 129,548 11,488 8.87 111,468 9,808 8.80
Construction and land loans ..... 32,395 3,237 9.99 25,992 2,465 9.48 17,192 1,745 10.15
---------- ------- ---------- ------- ---------- -------
Total real estate loans(1) (2) .. 818,718 63,533 7.76 749,407 57,998 7.74 609,485 47,313 7.76
Consumer loans(2) ............... 64,816 5,317 8.20 55,081 4,717 8.56 50,606 4,625 9.14
Commercial loans(2) ............. 21,074 2,011 9.54 19,255 1,854 9.63 17,295 1,938 11.21
---------- ------- ---------- ------- ---------- -------
Total loans ..................... 904,608 70,861 7.83 823,743 64,569 7.84 677,386 53,876 7.95
---------- ------- ---------- ------- ---------- -------
Total interest-earning assets ... 1,200,679 90,752 7.56% 1,118,101 83,823 7.50% 1,029,614 76,886 7.47%
------- ------- -------
Allowance for loan losses ........ (12,395) (11,846) (11,749)
Other real estate owned .......... 1,416 2,869 6,720
Other assets ..................... 56,967 49,655 44,336
---------- ---------- ----------
Total assets .................. $1,246,667 $1,158,779 $1,068,921
========== ========== ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing deposits:
NOW accounts..................... $ 74,202 $ 740 1.00% $ 66,708 $ 661 0.99% $ 63,049 $ 711 1.13%
Regular savings accounts ........ 122,045 4,060 3.33 76,506 1,800 2.35 71,659 1,554 2.17
Money market deposit
accounts ...................... 113,325 3,381 2.98 125,923 3,639 2.89 133,989 3,548 2.65
Certificates of deposit ......... 518,368 30,070 5.80 445,682 25,592 5.74 419,385 23,433 5.59
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
deposits ...................... 827,940 38,251 4.62 714,819 31,692 4.43 688,082 29,246 4.25
---------- ------- ---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements ... 9,614 481 5.00 15,062 783 5.20 14,798 897 6.06
Federal Home Loan Bank
advances ...................... 227,726 13,315 5.85 272,655 16,054 5.89 233,489 14,409 6.17
---------- ------- ---------- ------- ---------- -------
Total borrowed funds ............ 237,340 13,796 5.81 287,717 16,837 5.85 248,287 15,306 6.16
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
liabilities ................... 1,065,280 52,047 4.89% 1,002,536 48,529 4.84% 936,369 44,552 4.76%
------- ------- -------
Demand deposits .................. 69,942 57,913 45,328
Other liabilities ................ 11,702 8,465 6,111
---------- ---------- ----------
Total liabilities ............... 1,146,924 1,068,914 987,808
Stockholders' equity ............. 99,743 89,865 81,113
---------- ---------- ----------
Total liabilities and stock-
holders' equity ............... $1,246,667 $1,158,779 $1,068,921
========== ========== ==========
Net interest income .............. $38,705 $35,294 $32,334
======= ======= =======
Interest rate spread ............. 2.67% 2.66% 2.71%
==== ==== ====
Net yield on earning assets ...... 3.22% 3.16% 3.14%
==== ==== ====
</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 is 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.
14
<PAGE> 21
Rate/Volume Analysis. The following table shows the changes in interest
income and interest expense caused by changes in the volume of interest earning
assets and interest bearing liabilities, and changes in interest rates received
and paid, respectively. The change attributable to a mix of volume and rate has
been allocated proportionally to the change due to volume and the change due to
rate.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1997 COMPARED TO 1996 1996 COMPARED TO 1995
-------------------------------- --------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
DUE TO DUE TO
-------------------- --------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Interest and Dividend Income
Loans:
<S> <C> <C> <C> <C> <C> <C>
Residential loans ................... $ 4,155 $ (157) $ 3,998 $ 8,384 $ (99) $ 8,285
Commercial loans .................... 600 165 765 1,603 77 1,680
Construction and land loans ......... 634 138 772 841 (121) 720
-------- -------- -------- -------- -------- --------
Total real estate ................. 5,389 146 5,535 10,828 (143) 10,685
Consumer ............................ 805 (205) 600 394 (302) 92
Commercial .......................... 174 (17) 157 206 (290) (84)
-------- -------- -------- -------- -------- --------
Total interest on loans ........... 6,368 (76) 6,292 11,428 (735) 10,693
-------- -------- -------- -------- -------- --------
Investments:
Short-term investments ............... 153 23 176 6 (62) (56)
Investment securities ................ 848 555 1,403 (1,465) (164) (1,629)
Mortgage-backed securities ........... (974) 32 (942) (2,313) 242 (2,071)
-------- -------- -------- -------- -------- --------
Total interest and dividends on
investments ...................... 27 610 637 (3,772) 16 (3,756)
-------- -------- -------- -------- -------- --------
Total interest and dividend
income ........................... 6,395 534 6,929 7,656 (719) 6,937
-------- -------- -------- -------- -------- --------
Interest Expense
Savings deposit ...................... 989 1,092 2,081 10 277 287
Time certificates .................... 4,214 264 4,478 1,498 661 2,159
Reverse repurchase agreements ........ (274) (28) (302) 16 (130) (114)
Notes payable ........................ (2,628) (111) (2,739) 2,330 (685) 1,645
-------- -------- -------- -------- -------- --------
Total interest expense ............. 2,301 1,217 3,518 3,854 123 3,977
-------- -------- -------- -------- -------- --------
Net increase (decrease) in net interest
and dividend income .................. $ 4,094 $ (683) $ 3,411 $ 3,802 $ (842) $ 2,960
======== ======== ======== ======== ======== ========
</TABLE>
Provision for Loan Losses. The allowance for loan losses is established
through a provision for loan losses charged to the statement of operations.
Assessing the adequacy of the allowance for loan losses involves substantial
uncertainties and is based upon management's evaluation of the amounts required
to meet estimated losses 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 charge-offs, and
collateral values of the underlying security. Ultimate loan losses may vary
significantly from current estimates and future additions may be necessary. 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.
15
<PAGE> 22
The provision for loan losses in 1997, 1996 and 1995 was $983,000, $2.6
million and $1.3 million, respectively. Net charge-offs amounted to $691,000 in
1997 compared to $2.0 million in both 1996 and 1995. The decline in the
provision in 1997 reflects, among other things, a 33% reduction in
non-performing assets and reduced levels of delinquencies, combined with high
levels of recoveries. Partially offsetting the reasons for the decline, however,
was loan growth of 12% realized during 1997. The increased provision in 1996 was
due to loan growth of 13% and the deterioration of a previously reported problem
loan resulting in a charge-off of $760,000. Among the factors used to determine
that a provision was necessary in 1995 were the level of nonaccrual and
restructured loans, delinquencies and charge-offs and loan growth of over 19%.
While management believes that it has been reasonable in its analysis of
the allowance for loan losses and in estimating the net fair values of other
real estate owned, management is unable to predict the ultimate course of the
economy or the extent of its impact on the Company's financial condition. See
"Financial Condition -- Risk Elements" and Notes 1 and 4 to the "Consolidated
Financial Statements".
Non-interest Income. The Company recorded income from non-interest sources
of $4.8 million in 1997, $3.0 million in 1996 and $3.2 million in 1995. The
increase of $1.8 million in 1997 was primarily due to a reduction in the losses
on real estate operations, higher fee income on deposits and an increase in the
gains generated by the investment portfolio. The decrease of $194,000 in 1996
was primarily due to losses generated by the investment portfolio as part of the
balance sheet restructuring.
Net gains from sales and redemptions of investments totalled $158,000 in
1997 and $269,000 in 1995, as compared to net losses on sales and redemptions of
$686,000 in 1996. The loss on sale of investments in 1996 was primarily due to
the balance sheet restructuring whereby the Company sold approximately $40
million of low yielding investments at a loss of $870,000 in the third quarter
and reinvested the proceeds in higher yielding assets. See "Financial Condition
- -- Investments" and Notes 1 and 3 to the "Consolidated Financial Statements".
The Company recorded net gains from sales of assets held for sale of
$264,000 in 1997, $421,000 in 1996 and $55,000 in 1995. Included in the net
gains for 1997 and 1996 were gains totalling $447,000 and $423,000,
respectively, from the adoption of new accounting rules on originated mortgage
servicing rights. Additionally, gains resulting from the old accounting rules on
the capitalization of excess mortgage servicing fees totalled $264,000 and
$144,000, respectively, for the years ending December 31, 1996 and 1995. See
"Financial Condition -- Loans" and Notes 1, 2 and 5 to the "Consolidated
Financial Statements".
Andover may incur gains and losses on the sale of the loans that it
originates. These loans are generally securitized prior to sale in the form of
mortgage-backed securities which are guaranteed by a government agency and are
then held for sale. Because loans held for sale are stated at the lower of cost
or market value and mortgage-backed securities held for sale are stated at fair
value, periods of rising interest rates cause the values of loans and
mortgage-backed securities held for sale to decrease, resulting in a charge to
income. The Company frequently enters into forward delivery contracts to reduce
exposure to this risk from rising interest rates. Forward delivery contracts
may, however, increase exposure to the risk from declining interest rates if
sufficient loans or mortgage-backed securities held for sale bearing interest
rates specified by the contracts are not available to meet the delivery
schedules under the contracts. See Note 18 to the "Consolidated Financial
Statements".
Mortgage banking income represents the gross servicing fee income less
amortization and provisions for the valuation allowance of the mortgage
servicing assets. The Company retains as a service fee a portion of the interest
paid by the borrower. A valuation allowance was established in 1996 and the
provisions charged against earnings totalled $285,000 and $200,000,
respectively, for the years ended December 31, 1997 and 1996. In a low interest
rate environment, the underlying residential loans will repay faster than
expected, causing the fair value of the mortgage servicing assets to decline.
This prepayment risk results in increased provisions and charge-offs to the
valuation allowance, and thus lower mortgage banking income. Mortgage banking
income totalled $2.0 million in 1997, $2.1 million in 1996 and $1.8 million in
1995. The increased gross servicing income in each of the years was due to an
increase in the total loans serviced for others. However, in 1997 and 1996, the
amortization of the
16
<PAGE> 23
mortgage servicing assets increased correspondingly. The net mortgage banking,
or servicing, income, therefore, declined modestly during 1997 and increased
$326,000 during 1996. The table below summarizes the Company's results from
servicing loans for investors.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
--------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Gross servicing income.................................................$ 4,054 $ 3,523 $ 2,611
Amortization and provisions for valuation allowance.................... (2,039) (1,428) (842)
-------- -------- ---------
Net mortgage banking income............................................$ 2,015 $ 2,095 $ 1,769
======== ======== ========
Average loans serviced for investors...................................$977,659 $841,598 $628,450
Year-end loans serviced for investors..................................$971,041 $877,683 $780,356
</TABLE>
During 1997, 1996 and 1995, the Company purchased mortgage servicing rights
to $228.8 million, $180.0 million and $303.6 million, respectively, in
residential first mortgage loans. These purchased balances are included in the
balance of loans serviced for investors. As part of its long-term business plan,
the Company intends to continue purchasing mortgage servicing to increase the
use of its existing servicing capacity and increase loan service revenue when it
is deemed appropriate. The Company also expects to continue selling mortgages in
the secondary market while retaining the servicing rights and therefore,
servicing income related to this activity is accordingly expected to continue
for the foreseeable future. See Notes 1 and 5 to the "Consolidated Financial
Statements".
Losses on real estate operations totalled $971,000 in 1997, $1.5 million in
1996 and $2.0 million in 1995. Real estate operations consist of provisions for
the valuation allowance, operating costs of maintaining other real estate owned,
gains or losses on sales of properties and costs associated with the foreclosure
of nonaccrual properties, less any rental income on other real estate owned. The
Company accounts for other real estate owned at the lower of cost or estimated
net fair value. Declines in value subsequent to foreclosure or substantive
repossession result in a charge to the valuation allowance.
Replenishing the valuation allowance caused by charge-offs taken as a
result of declines in value resulted in a charge of $350,000, $554,000 and
$750,000 to real estate operations in 1997, 1996 and 1995, respectively.
Deterioration in the New England real estate market during the early 1990's led
to high levels of other real estate owned and corresponding administrative
costs. Gains on sales of other real estate owned totalled $110,000 in 1997,
$162,000 in 1996 and $582,000 in 1995. The costs of foreclosing on loans, as
well as the administrative costs of maintaining the non-performing assets,
correspond with the volume of problem assets and totalled $757,000 in 1997, $1.2
million in 1996 and $2.0 million in 1995. These costs will continue to be
incurred until the level of non-performing assets significantly decreases. See
"Financial Condition -- Risk Elements" and Note 6 to the "Consolidated Financial
Statements".
Other income totalled $3.3 million, $2.7 million, and $3.1 million in 1997,
1996 and 1995, respectively, and was derived primarily from customer service
charges and fees. Deposit account service charges, representing the largest
component of such other income, totalled $1.8 million in 1997, and $1.6 million
in both 1996 and 1995. Loan late charges and other fees declined modestly during
1997 after increasing almost 80% in 1996 over 1995's level. The fees recognized
in 1997 reflect lower level of delinquencies while the level recognized in 1996
reflects the increase in total loans. Rental income increased 31% during 1997 to
$319,000 while declining by the same percentage in 1996 due to a vacancy in
retail space owned by the Company during 1996, which became fully tenanted in
1997. During 1996, the Company recognized a loss of $208,000 on a non-marketable
asset while the results in 1995 reflect a gain on a non- marketable security.
Notwithstanding these one-time events, other income has remained relatively flat
over the past three years and includes income from Liberty Securities, IRA, safe
deposit and ATM fees and other miscellaneous charges. See Note 14 to the
"Consolidated Financial Statements".
17
<PAGE> 24
Non-interest Expense. Non-interest expenses increased $2.2 million or 10.9%
to $22.0 million in 1997. Non-interest expenses increased $562,000 or 2.9% to
$19.8 million in 1996. The increases in both 1997 and 1996 are primarily due to
operating a larger institution in each of the years. This has resulted in higher
staffing levels, an increased number of branches and alternative delivery
systems, and growth in the number of loans and deposits.
Salaries and employee benefits, the largest component of non-interest
expenses, increased $1.5 million to $11.9 million in 1997 and increased $723,000
in 1996 to $10.3 million. The increase in each of the years was primarily due to
increased staffing, merit increases and increased costs associated with the
various benefits programs offered by the Company. See Note 15 to the
"Consolidated Financial Statements".
Office occupancy and equipment increased $129,000 to $2.9 million in 1997
and increased $418,000 in 1996 to $2.8 million. The increase in 1997 was
primarily due to an increase in real estate taxes, reflecting an increase in the
values of Company owned properties as well as an increase in service maintenance
contracts on various equipment owned by the Company. The increase in 1996 was
the result of increased depreciation and rental expenses resulting from a new
branch facility, a full year of service in another branch facility and the
opening of a remote ATM. Additionally in 1996, the Company shortened its
estimate of the useful life of one of its branches causing depreciation expense
to increase. See Note 7 to the "Consolidated Financial Statements".
Data processing expenses totalled $1.9 million in 1997, $1.7 million in
1996 and $1.4 million in 1995. Data processing expenses increased $267,000 in
1997 and $221,000 in 1996 due to a higher loan and deposit base resulting from
the purchase of loans and mortgage loan servicing and internal loan and deposit
growth. In addition, the introduction of alternative delivery systems, via
customers' computers, debit cards and by a telephone service center, have caused
overall processing costs to increase in each of the two years.
Marketing expenses totalled $988,000 in 1997, $976,000 in 1996 and $847,000
in 1995. Marketing expenses increased modestly in 1997 and $129,000 in 1996 due
to a number of discretionary promotions for various retail products as well as
continued promotions relating to the expansion of ABNH, particularly during
1996.
Mortgage banking expenses totalled $430,000 in 1997, $406,000 in 1996 and
$311,000 in 1995. Costs included in mortgage banking expenses are commissions
and related expenses paid to the mortgage loan originators, net of any deferred
origination expenses, and costs associated with servicing the portfolio for
outside investors. These costs increased modestly in 1997 and 1996 due to higher
loan origination volume as well as a larger servicing portfolio.
Professional fees, including corporate legal expense and accounting and
auditing expenses, totalled $862,000 in 1997, $1.3 million in 1996 and $681,000
in 1995. The decline of $466,000 in 1997 was due to a reduction in various
consulting and tax planning projects. The increase of $647,000 in 1996 was
primarily due to costs incurred implementing tax planning strategies undertaken
during the third quarter in the amount of $400,000. Additionally, increased
corporate legal fees and miscellaneous consulting contracts contributed to the
increase in 1996.
Deposit insurance premiums were $124,000, $15,000 and $892,000 in 1997,
1996 and 1995, respectively. Deposit insurance premiums increased $109,000 in
1997 due to an increase in the FDIC assessment rates, combined with higher
levels of deposits. Deposit insurance premiums decreased $877,000 in 1996 due to
significantly reduced FDIC assessment rates. The Banks are in the lowest risk
category for calculating FDIC insurance premiums.
In 1996, the Company recognized a recovery of $225,000 from the execution
of a merger termination agreement while it incurred a charge of $1.0 million in
1995 resulting from the same. See Note 19 to the "Consolidated Financial
Statements".
18
<PAGE> 25
Other operating expenses totalled $2.9 million in 1997, $2.6 million in
1996 and $2.1 million in 1995. The increases of $326,000 in 1997 and $431,000 in
1996 are primarily due to running a larger organization. This is reflected in
more loan and deposit accounts, higher staffing levels and more branches and
locations in each of the two years. Correspondingly, increases result from
higher postage expenses, office supplies and printing costs as well as telephone
costs and increased contributions. Besides these costs, the fee structure for
the directors was increased in 1997. In addition, a $155,000 non-recurring
charge was incurred in 1996 with respect to an insurance related adjustment for
the former Chief Executive Officer of the Bank pursuant to the terms of his
retirement agreement.
Federal and State Income Tax Expense. The Company recorded tax expenses of
$7.3 million, $3.1 million and $5.6 million in 1997, 1996 and 1995,
respectively. The increase of $4.2 million in 1997 and decrease of $2.5 million
in 1996 were mainly due to a one time benefit of $2.5 million as a result of a
change in federal tax law in 1996. Recognition of deferred tax assets and
liabilities is based on the expected future tax consequences of temporary
differences between the financial reporting and tax basis of the Company's
assets and liabilities. Measurement of deferred tax assets and liabilities is
based upon the provision of enacted tax laws and the effects of future changes
in tax laws or rates.
Management believes the existing net deductible temporary differences that
give rise to the net deferred income tax asset will reverse in periods in which
the Company generates net taxable income. For the years ending December 31,
1997, 1996 and, 1995, the Company generated taxable income of approximately
$20.4 million, $8.1 million and $3.8 million, respectively. Taxable income
differs from pretax book income primarily as a result of loan losses and
provision for losses on other real estate owned being recognized in a different
period than for book income. The Company recorded a reduction of the valuation
allowance due to increased recoverable federal income taxes of $500,000 in 1997
and 1996 and $600,000 in 1995.
At December 31, 1997, the net deferred tax asset is supported by
recoverable income taxes of approximately $11.1 million. The total income tax
expense has been increased to reflect the adjustment to the deferred tax assets
for the tax impact of the Massachusetts tax rate reduction as part of the Bank
Tax Reform Law signed by the Governor of Massachusetts on July 27, 1995.
Management believes that the net deferred income tax asset at December 31, 1997
will be realized based upon the significant reduction in the level of
non-performing assets over the past several years. It is management's belief
that the valuation allowance is adequate to reduce the total deferred tax asset
to an amount that is more likely than not to be realized. It should be noted,
however, that factors beyond management's control, such as the general state of
the economy and real estate values, can affect future levels of taxable income
and that no assurance can be given that sufficient taxable income will be
generated to fully absorb gross deductible temporary differences. See Note 12 to
the "Consolidated Financial Statements".
FINANCIAL CONDITION
Total assets increased $117.9 million, or 9.8%, to $1,322.7 million at
December 31, 1997. The growth in total assets was primarily due to an increase
of $108.8 million in total loans as well as an increase of $5.9 million in
investments. Total assets at December 31, 1996 amounted to $1,204.8 million, an
increase of $94.0 million or 8.5% from $1,110.8 million at December 31, 1995,
resulting primarily from an increase in total loans of $101.4 million, offset by
a modest decline in the investment portfolio.
LOANS
Total loans at December 31, 1997, prior to the allowance for loan losses,
amounted to $978.8 million compared with $870.0 million at December 31, 1996, an
increase of $108.8 million or 12.5%, primarily due to internally generated loan
growth combined with purchases of $71.3 million in residential whole loans. At
December 31, 1997, 67.3% of Andover's total loan portfolio consisted of loans
with adjustable rates as compared to 66.7% at December 31, 1996.
19
<PAGE> 26
The following table shows the composition of the Company's loan portfolio
at the dates indicated. The balances shown are net of unadvanced funds, loan
premiums or discounts and deferred loan origination fees and costs.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ ------------------- ------------------ -----------------
(DOLLARS IN THOUSANDS)
Real estate loans:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential ............... $715,503 73.1% $619,955 71.3% $ 558,231 72.6% $ 452,708 70.2% $ 297,779 65.2%
Commercial ................ 142,617 14.6 136,454 15.7 121,909 15.9 108,725 16.8 85,339 18.6
Construction and land ..... 31,499 3.2 35,001 4.0 18,138 2.4 18,021 2.8 13,991 3.1
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Total real estate loans... 889,619 90.9 791,410 91.0 698,278 90.9 579,454 89.8 397,109 86.9
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Consumer loans:
Home improvement, second
mortgage and home equity
line of credit ........... 58,605 6.0 49,670 5.7 43,463 5.6 42,602 6.6 39,338 8.6
Personal .................. 3,161 0.3 3,467 0.4 3,369 0.4 2,751 0.4 2,073 0.5
Guaranteed education ...... 3,086 0.3 3,755 0.4 2,149 0.3 4,759 0.8 2,847 0.6
Collateral ................ 3,352 0.4 2,332 0.3 2,189 0.3 2,052 0.3 1,504 0.3
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Total consumer loans ..... 68,204 7.0 59,224 6.8 51,170 6.6 52,164 8.1 45,762 10.0
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Commercial loans ........... 21,000 2.1 19,401 2.2 19,150 2.5 13,419 2.1 13,942 3.1
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Total loans .............. 978,823 100.0% 870,035 100.0% 768,598 100.0% 645,037 100.0% 456,813 100.0%
===== ===== ==== ==== ====
Allowance for loan losses.. (12,521) (12,229) (11,665) (12,343) (13,392)
-------- -------- --------- --------- ---------
Net loans ................ $966,302 $857,806 $ 756,933 $ 632,694 $ 443,421
======== ======== ========= ========= ==========
</TABLE>
Total real estate loans increased $98.2 million in 1997 to $889.6 million
at December 31, 1997, primarily due to the purchase of $71.3 million in
residential whole loans combined with stable residential and commercial real
estate loan originations. Origination volumes have also been affected by the
interest rate environment over the past five years and are sensitive to market
rates, particularly in the refinancing arena. As can be determined by the
following table, loan originations were extremely high in 1993, the year with
the lowest interest rates. Loan originations were strong in 1997 and 1996 due to
a favorable interest rate environment while loan originations dropped in 1995
due to the higher interest rates existing during most of that year. Residential
loan originations totalled $165.3 million in 1997, $168.3 million in 1996 and
$132.1 million in 1995. These originations are not fully reflected in loans
outstanding due to the securitization of residential real estate loans into
mortgage-backed securities held for sale or available for sale of $24.1 million
in 1997, $44.0 million in 1996 and $20.3 million in 1995, as well as regular
amortization and prepayments.
The majority of the Company's residential loans are underwritten to be
eligible for sale in the secondary market. Andover sells most of the eligible
30-year fixed-rate loans it originates. A loan which the Company intends to sell
may be sold directly or converted into mortgage-backed securities and sold in
that form. Residential loans sold either directly or in the form of
mortgage-backed securities amounted to $27.7 million in 1997, $39.8 million in
1996 and $21.6 million in 1995. The portfolio of residential mortgage loans
serviced for others totalled $971.0 million at December 31, 1997, compared to
$877.7 million at December 31, 1996 and $780.4 million at December 31, 1995.
20
<PAGE> 27
The following table shows the composition of the Company's loan
originations and loan purchases for the years indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS)
Real estate loans:
<S> <C> <C> <C> <C> <C>
Residential fixed rate....................................... $ 81,342 $ 89,830 $ 88,990 $ 83,775 $229,827
Residential variable rate ................................... 83,917 78,453 43,138 96,657 81,308
-------- -------- -------- -------- --------
Total residential originations ............................. 165,259 168,283 132,128 180,432 311,135
Commercial .................................................. 32,858 32,800 17,991 17,745 14,537
Construction and land ....................................... 31,800 41,888 31,543 30,498 26,110
-------- -------- -------- -------- --------
Total real estate loan originations ........................ 229,917 242,971 181,662 228,675 351,782
-------- -------- -------- -------- --------
Residential whole loan purchases ............................ 71,297 32,474 56,665 -- --
Commercial whole loan purchases ............................. -- -- 3,213 -- --
-------- -------- -------- -------- --------
Total real estate purchases ................................ 71,297 32,474 59,878 -- --
-------- -------- -------- -------- --------
Total real estate loan originations and purchases .......... 301,214 275,445 241,540 228,675 351,782
-------- -------- -------- -------- --------
Consumer loans:
Home equity line of credit .................................. 22,527 22,063 10,350 14,614 22,411
Other consumer .............................................. 11,988 9,497 8,022 5,723 2,134
-------- -------- -------- -------- --------
Total consumer loans ....................................... 34,515 31,560 18,372 20,337 24,545
-------- -------- -------- -------- --------
Commercial loans .............................................. 18,591 19,732 16,933 10,437 6,161
-------- -------- -------- -------- --------
Total loan originations and purchases............... $354,320 $326,737 $276,845 $259,449 $382,488
======== ======== ======== ======== ========
</TABLE>
Outstanding commercial loans increased $1.6 million in 1997 to $21.0
million at December 31, 1997. Commercial real estate loans increased $6.2
million in 1997 to $142.6 million at December 31, 1997, while construction and
land loan balances decreased $3.5 million to $31.5 million in the same period.
While originations of corporate loans, comprised of commercial real estate,
commercial, construction and land loans, are sensitive to the interest rate
environment, the capacity for borrowing, current and anticipated economic
conditions and real estate values have a more critical role. During the
declining real estate markets in the early 1990's, commercial real estate and
development loans were particularly hard hit. Origination volume for corporate
loans decreased in 1991 and 1992, corresponding with the declining real estate
values and business conditions. Origination volume for these loans have
increased over the past three years, reflecting stabilizing values and the
Company's interest in corporate lending. However, due to the highly competitive
market for these loans, the origination volume slipped slightly in 1997 but it
does not represent a reduction in the Company's interest or capacity for these
types of loans. Total originations of corporate loans were $83.2 million in
1997, $94.4 million in 1996 and $66.5 million in 1995.
Loans transferred into real estate owned totalled $2.1 million, $1.7
million and $3.2 million in 1997, 1996 and 1995, respectively. Commercial real
estate, construction and land, and commercial loans involve significant risks
compared with single-family residential mortgage and consumer lending. See Item
1, "Business -- Lending Activities".
Consumer loans outstanding increased 15.2%, or $9.0 million to $68.2
million at December 31, 1997, from $59.2 million at year-end 1996. During 1997,
the Company continued to aggressively price its home equity lines of credit and
was able to keep originations of these loans in excess of $20 million in both
1997 and 1996. Other consumer loans include secured student loans, collateral
loans and second mortgage loans. Prior to 1996, the Company had experienced a
two-year decline in consumer originations. Originations of consumer loans are
also sensitive to changes in the interest rate environment.
21
<PAGE> 28
RISK ELEMENTS
The following table shows the composition of non-performing assets at
December 31:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccruing loans .............. $ 7,849 $10,699 $11,627 $14,516 $11,531
Other real estate owned ........ 406 1,683 4,158 8,796 13,120
------- ------- ------- ------- -------
Total non-performing assets ... $ 8,255 $12,382 $15,785 $23,312 $24,651
======= ======= ======= ======= =======
Total non-performing assets as a
percentage of total assets .... 0.6% 1.0% 1.4% 2.2% 3.0%
</TABLE>
During 1997, continued progress was made in reducing non-performing assets
with a reduction of $4.1 million or 33.3% primarily due to a reduction of
nonaccruing loans. Of the $7.8 million in nonaccruing loans at December 31,
1997, $1.9 million are less than 90 days past due but have exhibited some other
credit weakness. Andover had experienced a sharp increase in the level of
non-performing assets and a corresponding rise in foregone income, loan losses
and other costs associated with non-performing assets beginning in 1990 due to
the deteriorating New England real estate market and economy. A significant
portion of Andover's non-performing assets are secured by mixed-use commercial
and multi-family real estate located in Lawrence, Massachusetts. This city has
been especially hard hit with declining real estate values and increasing
vacancies in multi-family, investor-owned properties, which represents the
majority of Andover's collateral on troubled loans 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 increased
level of non-performing assets in 1998. At December 31, 1997, approximately $3.4
million of nonaccruing loans and almost all of the other real estate owned were
secured by properties located in Lawrence. The largest relationship included in
the non-performing asset balances totalled $1.1 million, consisting primarily of
multi-family, investor-owned, real estate.
The amount of accruing loans secured by properties in Lawrence totalled
approximately $44.8 million at December 31, 1997. The largest multi-family
borrower relationships included in the accruing Lawrence portfolio totalled $1.3
million and $1.1 million, respectively, at December 31, 1997. Substantially all
of the remaining accruing loans at year end in Lawrence were secured by
residential properties.
At December 31, 1997, total impaired loans were $6.4 million, of which $2.5
million had related allowances of $0.3 million and $3.9 million which did not
require a related impairment allowance. All of the $6.4 million in impaired
loans have been measured using the fair value of the collateral method. During
the period ended December 31, 1997, the average recorded value of impaired loans
was $7.7 million and the related amount of interest income recognized was
$199,000.
See Notes 1, 4 and 6 to the "Consolidated Financial Statements" for further
information.
Nonaccruing Loans. Management places loans, regardless of collateral
values, on nonaccrual status when principal or interest is past due 90 days or
more. All previously accrued but uncollected interest is reversed against
current period interest income when a loan is placed on nonaccrual status. When
collection procedures do not bring a loan to performing status, Andover
generally institutes action to foreclose upon the property or to acquire it by
deed in lieu of foreclosure. Loans for which payments are less than 90 days past
due are placed on nonaccrual status where there exists serious doubt as to the
ultimate collectibility of the loan.
22
<PAGE> 29
The following table shows the composition of nonaccruing loans at December
31:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Residential real estate ........................................ $ 2,436 $ 2,838 $ 3,037 $ 4,232 $ 2,595
Commercial real estate ......................................... 4,866 6,901 7,195 8,004 6,313
Construction and land .......................................... --- 79 --- 382 483
Commercial ..................................................... 513 727 1,136 1,381 1,660
Consumer ....................................................... 34 154 259 517 480
------- ------- ------- ------- -------
Total nonaccrual loans ....................................... $ 7,849 $10,699 $11,627 $14,516 $11,531
======= ======= ======= ======= =======
Allowance for loan losses....................................... $12,521 $12,229 $11,665 $12,343 $13,392
======= ======= ======= ======= =======
Allowance for loan losses as a percentage of
nonaccruing loans ........................................... 159.5% 114.3% 100.3% 85.0% 116.1%
Allowance for loan losses as a percentage of
total loans ................................................. 1.3% 1.4% 1.5% 1.9% 2.9%
</TABLE>
During 1997, loans on nonaccrual decreased 26.6% to $7.8 million,
throughout all loan categories. Interest income of approximately $1.2 million
would have been recorded in 1997 on nonaccruing loans if those loans had been on
a current basis in accordance with their original terms. Interest income
actually recognized in 1997 on nonaccruing loans amounted to approximately
$130,000. Additionally, another $359,000 in interest payments were received on
nonaccruing loans during 1997 and applied as a reduction of the loan balance
instead of as interest income.
Restructured Loans. A restructured loan is one for which the Bank has
modified the terms to provide a temporary reduction in the rate of interest
below the prevailing market interest rates at the time of modification and, in
most instances, an extension of payments of principal or interest or both due to
the deterioration in the financial position of the borrowers. Restructured loans
are not returned to performing status until the obligation has performed for a
reasonable period of time, its ultimate collectibility is no longer in doubt and
is at a market rate of interest. Restructured loans totalled $1.4 million and
$2.2 million at December 31, 1997 and 1996, respectively. Interest rate
modifications typically do not exceed one year. The weighted average interest
rate on restructured loans as of December 31, 1997 was 5.77%.
Other Real Estate Owned. Andover's other real estate owned remained at
rather high levels after rising significantly in the early 1990's due to the
deterioration in the New England real estate market and economy. During 1997,
other real estate owned decreased 75.9%. The valuation allowance represents
management's estimate of the net fair value of other real estate owned.
The following table shows the composition of other real estate owned at
December 31:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Residential real estate ............. $ 239 $ 456 $ 1,131 $ 1,245 $ 1,522
Commercial real estate .............. 66 544 572 3,484 5,374
Multi-family real estate ............ 336 658 1,820 2,405 3,914
Construction and land ............... --- 201 1,048 2,377 3,396
-------- -------- -------- -------- --------
641 1,859 4,571 9,511 14,206
Valuation allowance ................. (235) (176) (413) (715) (1,086)
-------- -------- -------- -------- --------
Total other real estate owned... $ 406 $ 1,683 $ 4,158 $ 8,796 $ 13,120
======== ======== ======== ======== ========
</TABLE>
23
<PAGE> 30
All other real estate owned is carried at the lower of the carrying value
of the loan or the estimated net fair value of the property constructively or
actually received. Initial writedowns to net fair value are charged to the
allowance for loan losses and totalled $836,000 in 1997, $890,000 in 1996 and
$1.7 million in 1995. Subsequent provisions for losses due to the deterioration
in real estate values are charged to real estate operations and totalled
$350,000 in 1997, $554,000 in 1996 and $750,000 in 1995. Gains of $110,000,
$162,000 and $582,000 were recognized on sales of $3.2 million, $4.0 million and
$8.0 million in other real estate owned in 1997, 1996 and 1995, respectively.
Due to the level of nonaccrual loans at December 31, 1997, continued
foreclosures are likely to occur in 1998 resulting in continued foreclosure and
related operating expenses. The impact of existing non-performing assets on
future interest income will be largely dependent upon converting these assets to
earning status, either through a return to performing status or through
foreclosure and subsequent disposition of the property. It is expected that the
level of foreclosures and related expenses will continue to adversely impact
earnings in 1998.
Allowance for Loan Losses. The following table summarizes the activity in
Andover's allowance for loan losses during the five years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year ............ $ 12,229 $ 11,665 $ 12,343 $ 13,392 $ 16,054
Balance of Acquired Institution ......... -- -- -- 1,715 --
Provision ............................... 983 2,555 1,295 -- --
Charge-offs:
Residential real estate ............ (767) (822) (1,501) (1,271) (610)
Commercial real estate ............. (920) (2,208) (867) (1,614) (1,541)
Construction and land .............. --- -- (57) (41) --
Commercial ......................... (90) (100) (171) (194) (814)
Consumer ........................... (27) (153) (171) (149) (121)
-------- -------- -------- -------- --------
Total charge-offs .................. (1,804) (3,283) (2,767) (3,269) (3,086)
-------- -------- -------- -------- --------
Recoveries:
Residential real estate ............ 27 45 120 4 32
Commercial real estate ............. 142 178 183 141 130
Construction and land .............. 324 588 2 57 --
Commercial ......................... 597 461 461 280 232
Consumer ........................... 23 20 28 23 30
-------- -------- -------- -------- --------
Total recoveries ................... 1,113 1,292 794 505 424
-------- -------- -------- -------- --------
Net charge-offs ......................... (691) (1,991) (1,973) (2,764) (2,662)
-------- -------- -------- -------- --------
Balance at end of year .................. $ 12,521 $ 12,229 $ 11,665 $ 12,343 $ 13,392
======== ======== ======== ======== ========
Ratio of net charge-offs to average loans
outstanding ........................... 0.08% 0.24% 0.29% 0.48% 0.61%
</TABLE>
Net charge-offs totalled $691,000 in 1997, $2.0 million in both 1996 and
1995. The ratio of net charge-offs to average loans, however, has continued its
steady decline from the levels experienced in 1993 and total only 0.08% for
1997.
The allowance for loan losses as a percentage of total loans decreased to
1.3% at December 31, 1997, from 1.4% and 1.5% at December 31, 1996 and 1995,
respectively, due to continued loan growth and to a lesser extent, the purchase
of whole loans. Management analyzes the adequacy of the allowance for loan
losses on a periodic basis. See "Results of Operations -- Provision for Loan
Losses". Management measures the adequacy of its
24
<PAGE> 31
allowance for loan losses by assigning loans into risk categories based on a
loan classification system modelled after the bank regulatory classification
system. While management believes that its allowance for loan losses is adequate
to cover potential losses, there are uncertainties regarding future events.
Deterioration in the real estate market or economy may result in additional
nonaccruing loans, charge-offs and a need for provisions for loan losses to
maintain an adequate allowance. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Banks'
allowance for loan losses. Such agencies may require the Banks to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination. Allocation of the allowance for loan
losses to the various categories of the portfolio is also made periodically,
based on management's judgment in weighing various factors, including the
quality of specific loans, the level of nonaccruing loans in the various
categories, current economic conditions, trends in delinquencies and prior
charge-offs, and the collateral value of the underlying security. Because the
allowance for loan losses is based on various estimates, including loan
collectibility and real estate values, and includes a high degree of judgment,
subsequent changes in the general economic prospects of the borrowers may
require changes in those estimates.
The Banks monitor the loan portfolio and related allowance through the use
of "account plans" prepared for nonaccruing loans and other loans identified by
management as needing closer monitoring. The "account plans" are prepared for
loans which have been assigned adverse credit risk ratings and have been
considered in determining the appropriate level of allowance for loan losses.
The largest exposure to a single borrower included in non-performing loans at
December 31, 1997, was approximately $1.1 million, consisting primarily of
multi-family, investor-owned, real estate.
The changes in the allowance allocated to each category of loan directly
corresponds to the level of nonaccrual loans and adversely classified loans as
well as the level of outstanding loans. Andover historically has experienced
lower losses in its residential mortgage loan portfolio and, therefore,
allocations applicable to this portfolio are lower.
The following table summarizes the allocation of the allowance for loan
losses at December 31:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------------------- ------------------ --------------------- -------------------- -------------------
LOAN LOAN LOAN LOAN LOAN
CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
AS A % OF AS A % OF AS A % OF AS A % OF AS A % OF
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN
LOAN CATEGORY ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO
------------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Real Estate:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential .......... $ 2,399 73% $ 2,154 71% $ 1,794 73% $ 1,855 70% $ 975 65%
Commercial ........... 5,526 15 5,952 16 7,381 16 7,633 17 6,108 19
Construction and land. 697 3 802 4 549 2 971 3 791 3
------- --- ------- --- ------- --- ------- --- ------ ---
Total real estate.... 8,622 91 8,908 91 9,724 91 10,459 90 7,874 87
Consumer ............... 421 7 392 7 344 7 478 8 388 10
Commercial ............. 821 2 848 2 1,201 2 1,113 2 1,455 3
Unallocated ............ 2,657 -- 2,081 -- 396 -- 293 -- 3,675 --
------- --- ------- --- ------- --- ------- --- ------ ---
Totals .......... $12,521 100% $12,229 100% $11,665 100% $12,343 100% $13,392 100%
======= === ======= === ======= === ======= === ======= ===
</TABLE>
Notwithstanding the foregoing allocations, the entire allowance for loan
losses is available to absorb charge-offs in any category of loans.
25
<PAGE> 32
INVESTMENTS
As of December 31, 1997, Andover's investment portfolio totalled $282.6
million, for a modest increase of 2.1% from $276.7 million at year end 1996. The
Company manages the investment portfolio in accordance with the investment
policy adopted by the Board of Directors. The primary objectives are to provide
interest and dividend income, to ensure adequate liquidity and achieve an
acceptable asset/liability gap position while diversifying the asset mix. The
investment portfolio is also evaluated in comparison to returns that are earned
by the loan portfolio. In the third quarter of 1996, approximately $40 million
of low yielding investments were sold and the proceeds from such sales were
reinvested in similar securities at higher yields.
The primary component of the total investment portfolio is mortgage-backed
securities, which accounted for 64.0% of total investments at December 31, 1997.
The remaining portion of the total investment portfolio consists of U.S.
government and federal agency obligations, corporate bonds, short-term
investments in federal funds sold, and other investment grade securities. U.S.
government and federal agency obligations represent the fastest growing
component of the investment portfolio and totalled 23.3% as of December 31,
1997, as compared to 15.6% at year end 1996.
All of the mortgage-backed securities represent undivided interests in
pools of mortgages which have been formed into pass-through securities and sold
to investors by the Government National Mortgage Association ("GNMA"), the
Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National
Mortgage Association ("FNMA"). Securities issued by GNMA, a wholly-owned U.S.
government corporation, are fully guaranteed as to the timely payment of
principal and interest. Securities issued by FHLMC and FNMA, government
sponsored corporations, carry each corporation's guarantee as to the timely
payment of interest and the ultimate payment of principal. Cash flows from the
underlying mortgages of all mortgage-backed securities are passed through to
Andover in the form of monthly payments of interest, scheduled principal
amortization, and prepayments of mortgage balances. These securities, therefore,
have unpredictable cash flows. The approximate market value of adjustable rate
mortgage-backed securities included in the investment portfolio totalled $32.8
million at December 31, 1997.
The carrying amount of callable securities included in investments
available for sale and investments held to maturity totalled $37.0 million and
$10.0 million, respectively, as of December 31, 1997.
Debt securities are classified as held to maturity only when there is
positive intent and ability to hold them to maturity. Such securities are
recorded at amortized cost. Trading securities are debt and equity securities
held principally for the purpose of selling in the near term. The Company does
not have any securities designated as trading securities. Such securities are
recorded at fair value, with unrealized gains and losses recorded in earnings.
Investments available for sale are any debt or equity security not classified as
either held to maturity or trading securities. Investments available for sale
are recorded at their fair value with changes in fair values recorded as a
separate component of stockholders' equity, net of the related income taxes.
There was an increase in the unrealized gain of approximately $2.9 million
in the investment portfolio, from a net unrealized gain of $583,000 as of
December 31, 1996, to $3.5 million as of December 31, 1997, resulting from a
decrease in market interest rates. Changes in interest rates and their impact on
the unrealized gain or loss in the investment portfolio are not material factors
in the Company's overall investment strategy. This is largely due to the fact
that neither the changes nor their impact can be controlled by the Company.
Additionally, investment purchases are often match funded by long-term advances
in order to achieve a consistent spread on a particular investment.
See Notes 1, 2 and 3 to the "Consolidated Financial Statements" for further
information.
26
<PAGE> 33
The following table sets forth information regarding the carrying amounts
of the investment portfolio at December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
SHORT-TERM INVESTMENTS.......................................................... $ 14,150 $ 25,600 $ 9,000
======== ======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
U.S. government and federal agency obligations.................................. $ 55,777 $ 41,740 $ 52,490
Other bonds and obligations .................................................... 14,573 14,993 14,382
-------- -------- --------
Total bonds and obligations ................................................ 70,350 56,733 66,872
-------- -------- --------
GNMA mortgage-backed securities ................................................ 27,793 27,526 37,195
FHLMC participation certificates ............................................... 36,805 25,103 4,420
FNMA pass-through certificates ................................................. 4,106 4,763 ---
Collateralized mortgage obligations ............................................ --- --- 482
-------- -------- --------
Total mortgage-backed securities ........................................... 68,704 57,392 42,097
-------- -------- --------
Total investments available for sale........................................ $139,054 $114,125 $108,969
======== ======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations.................................. $ 10,001 $ 1,448 $ 1,500
Other bonds and obligations .................................................... 7,106 9,686 12,758
-------- -------- --------
Total bonds and obligations .............................................. 17,107 11,134 14,258
-------- -------- --------
FHLMC participation certificates ............................................... 49,217 63,639 78,649
FNMA pass-through certificates ................................................. 48,835 57,192 67,375
GNMA mortgage-backed securities ................................................ 3,383 3,899 4,458
Other asset-backed securities .................................................. 800 1,062 1,407
Collateralized mortgage obligations ............................................ 10,021 --- 1,116
-------- -------- --------
Total mortgage-backed securities ......................................... 112,256 125,792 153,005
-------- -------- --------
Total investments held to maturity........................................ $129,363 $136,926 $167,263
======== ======== ========
Total investments......................................................... $282,567 $276,651 $285,232
======== ======== ========
</TABLE>
The following table presents an analysis of the maturity distribution and
average yields of investments available for sale and held to maturity at
December 31, 1997. Mortgage-backed securities are shown in the periods
corresponding to scheduled principal amortization computed based on their
weighted average maturities and weighted average rates without regard to
prepayments.
<TABLE>
<CAPTION>
LENGTH OF TIME TO MATURITY
-----------------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
YEAR BUT YEARS BUT
WITHIN WITHIN WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS
------------------- ------------------- ------------------- -------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Investments available for sale:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total bonds and obligations... $ 4,002 7.07% $ 66,284 6.67% $ -- .--% $ 64 10.03%
Total mortgage-backed
securities ................. 2,671 6.78 12,661 6.78 21,429 6.78 31,943 6.58
-------- -------- -------- --------
Total investments
available for sale ..... $ 6,673 6.95% $ 78,945 6.69% $ 21,429 6.78% $ 32,007 6.59%
======== ==== ======== ==== ======== ==== ======== ====
Investments held to maturity:
Total bonds and obligations... $ 2,528 6.37% $ 13,124 6.39% $ 1,455 6.46$ -- .--%
Total mortgage-backed
securities ................ 5,632 6.96 25,919 6.98 43,284 6.99 37,421 6.93
-------- -------- -------- --------
Total investments held
to maturity ........... $ 8,160 6.78% $ 39,043 6.78% $ 44,739 6.97% $ 37,421 6.93%
======== ==== ======== ==== ======== ==== ======== ====
<CAPTION>
LENGTH OF TIME TO MATURITY
-----------------------------
TOTAL
-------------------
AMOUNT YIELD
-------- --------
Investments available for sale:
<S> <C> <C>
Total bonds and obligations... $ 70,350 6.70%
Total mortgage-backed
securities ................. 68,704 6.69
--------
Total investments
available for sale ..... $139,054 6.69%
======== ====
Investments held to maturity:
Total bonds and obligations... $ 17,107 6.39%
Total mortgage-backed
securities ................ 112,256 6.97
--------
Total investments held
to maturity ........... $129,363 6.89%
======== ====
</TABLE>
27
<PAGE> 34
The following table presents unrealized gains and losses by major
categories of securities as of December 31, 1997. At that date, Andover's net
unrealized gains on investments held to maturity amounted to $1.6 million. The
unrealized gains of $1.9 million on investments available for sale is included
in stockholders' equity, net of applicable income taxes at December 31, 1997.
<TABLE>
<CAPTION>
UNREALIZED UNREALIZED
GAINS LOSSES
---------- ----------
(IN THOUSANDS)
INVESTMENTS AVAILABLE FOR SALE:
<S> <C> <C>
U.S. government and federal agency obligations............................. $ 912 $ (4)
Other bonds and obligations................................................ 168 --
Mortgage-backed securities................................................. 806 (3)
------ ------
Total investments available for sale.................................... 1,886 (7)
------ ------
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations............................. $ 46 $ --
Other bonds and obligations................................................ 86 (2)
Mortgage-backed securities................................................. 1,717 (263)
------ ------
Total investments held to maturity.................................... $1,849 $(265)
====== ======
Total unrealized gains and losses..................................... $3,735 $(272)
====== ======
</TABLE>
DEPOSITS
Total deposits increased $122.7 million during 1997 to $947.0 million as of
December 31, 1997, and increased $81.1 million during 1996. With the exception
of money market deposit accounts, all categories of deposits increased in total
balances during 1997 and 1996. This reflects the Company's desire to offer
competitive products and pricing in order to grow the core deposit balances. The
success of this strategy is reflected in the growth in demand deposits, NOW
accounts and regular savings accounts. The growth in the regular savings
accounts is due to the introduction of a tiered savings product. This account
offers customers a premium rate on balances in excess of $50,000. Management
believes the decline in the money market balances are the result of a shift to
the new savings product. In the current interest rate environment, depositors
are shifting from longer maturity term deposits into core deposit accounts
without fixed maturities or into shorter maturity term deposits. The Bank
believes that this trend will continue into 1998 as long as interest rates
remain at these fairly low rates. See Note 9 to the "Consolidated Financial
Statements" for further information.
The following table reflects the balance of deposit accounts of Andover at
each date indicated and the weighted average interest rates at December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------ ------------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
PERCENT AVERAGE PERCENT AVERAGE PERCENT AVERAGE
OF INTEREST OF INTEREST OF INTEREST
AMOUNT TOTAL RATE AMOUNT TOTAL RATE AMOUNT TOTAL RATE
-------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand deposit accounts ..... $ 79,501 8.4% .--% $ 60,245 7.3% .--% $ 54,516 7.3% .--%
NOW accounts ................ 85,917 9.1 1.02 75,297 9.1 1.01 67,275 9.1 1.00
Regular savings accounts .... 149,607 15.8 3.61 96,690 11.8 2.87 68,052 9.2 2.20
Money market
deposit accounts .......... 104,353 11.0 2.96 116,019 14.1 2.90 130,437 17.5 2.90
Variable rate certificates... 5,182 0.5 5.43 8,459 1.0 5.24 13,279 1.8 5.64
Fixed rate certificates ..... 522,422 55.2 5.89 467,601 56.7 5.80 409,646 55.1 5.86
-------- ----- -------- ----- -------- -----
Total deposits ............ $946,982 100.0% 4.27% $824,311 100.0% 4.18% $743,205 100.0% 4.13%
======== ===== ==== ======== ===== ==== ======== ===== ====
</TABLE>
Deposits are derived from customers who work or reside in the Company's
market area and surrounding communities, and from businesses located in that
area.
The following table presents Andover's outstanding time certificates in
denominations of $100,000 and over, with remaining maturities at December 31:
<TABLE>
<CAPTION>
REMAINING TERM TO MATURITY 1997 1996 1995
-------------------------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Three months or less.................................... $15,085 $15,662 $ 9,801
Over three months to six months......................... 7,413 7,793 7,812
Over six months to twelve months........................ 23,953 23,215 18,520
Over twelve months...................................... 38,675 25,136 16,885
------- ------- -------
$85,126 $71,806 $53,018
======= ======= =======
</TABLE>
28
<PAGE> 35
BORROWINGS
Total borrowings decreased $15.7 million during 1997 to $258.7 million as
of December 31, 1997, from $274.4 million at December 31, 1996 and increased
$1.8 million during 1996. While the Banks continue to rely on borrowed funds as
an alternative source of funds to grow interest earning assets, due to the
success in generating deposits, the ratio of total borrowings to total assets
continues to drop and represents less than 20% of total assets, down from a high
of almost 25% at year end 1995. The amount of callable advances included in
total borrowings totalled $35.0 million as of December 31, 1997. These advances
are callable at the discretion of the FHLB of Boston, starting in 1999 and at
intervals thereafter.
During the third quarter of 1996, the Bank elected early prepayment of
$19.1 million of above market interest rate FHLB advances as part of a balance
sheet restructuring. The Bank incurred a pre-tax loss of $298,000, or $173,000
net of tax, on this transaction; however, by repurchasing new advances, the Bank
was able to reduce the effective rate from approximately 8.20% down to less than
6.00%.
See Notes 10 and 11 to the "Consolidated Financial Statements" for further
information.
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
The Banks' earnings are largely dependent on its net interest income, which
is the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. The Company seeks to reduce its exposure to
changes in interest rates, or market risk, through active monitoring and
management of its interest rate risk exposure. The policies and procedures for
managing both on and off balance sheet activities are established by Andover's
asset/liability management committee (ALCO). The Board of Directors reviews and
approves the ALCO policy annually and monitors related activities on an ongoing
basis.
Market risk is the risk of loss from adverse changes in market prices and
rates. The Banks' market risk arises primarily from interest rate risk inherent
in its lending and deposit taking activities.
The main objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on the Company's net interest income
and preserve capital, while adjusting the Company's asset/liability structure to
obtain the maximum yield-cost spread on that structure. The Company relies
primarily on its asset/liability structure to control interest rate risk.
However, a sudden and substantial increase in interest rates may adversely
impact earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the same
basis.
The following two tables reflect different methods of disclosing the
Company's exposure to a change in interest rates and its potential impact on the
Company's net interest income. The gap analysis uses estimated prepayments,
contractual maturities and next repricing dates while the market risk analysis
excludes the next repricing dates. The interest rate sensitivity of the
Company's assets and liabilities in both tables would vary substantially if
different assumptions were used or if actual experience differs from the
assumptions provided.
29
<PAGE> 36
One method used to measure the interest rate risk exposure is the Company's
gap analysis, which involves comparing the difference between assets and
liabilities that mature or reprice during a given period of time. These
differences are a primary component of the risk to net interest income. A gap is
considered positive when the amount of interest sensitive assets exceeds the
amount of interest sensitive liabilities, and is considered negative when the
amount of interest sensitive liabilities exceeds the amount of interest
sensitive assets.
The following table illustrates the Company's gap position, or the
estimated maturity and repricing structure of its interest sensitive assets and
interest sensitive liabilities, at December 31, 1997.
<TABLE>
<CAPTION>
[Greater than] [Greater than]
1-180 181-365 1-3 3-5 5+
DAYS DAYS YEARS YEARS YEARS TOTAL
-------- -------- --------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Interest sensitive assets:
<S> <C> <C> <C> <C> <C> <C>
Short-term investments .................. $ 14,150 $ -- $ -- $ -- $ -- $ 14,150
Investments available for sale .......... 29,246 39,447 32,347 23,845 14,169 139,054
Investments held to maturity ............ 11,014 15,528 42,710 29,519 30,592 129,363
Variable rate loans ..................... 228,591 161,202 169,620 68,422 22,937 650,772
Fixed rate loans ........................ 24,941 25,091 87,017 63,144 120,009 320,202
Other interest sensitive assets ......... 21,284 -- -- -- -- 21,284
-------- -------- --------- -------- -------- ----------
Total interest sensitive assets ....... 329,226 241,268 331,694 184,930 187,707 1,274,825
Interest sensitive liabilities:
Money market deposit accounts ........... 24,470 23,002 25,438 14,024 17,419 104,353
Certificates of deposit ................. 167,141 148,828 188,019 23,507 109 527,604
Other deposits .......................... 39,645 36,877 61,609 37,594 59,799 235,524
Total borrowed funds .................... 116,042 37,699 84,319 13,199 7,473 258,732
-------- -------- --------- -------- -------- ----------
Total interest sensitive liabilities... 347,298 246,406 359,385 88,324 84,800 1,126,213
-------- -------- --------- -------- -------- ----------
Net interest rate sensitivity gap ......... $(18,072) $ (5,138) $ (27,691) $ 96,606 $102,907 $ 148,612
========= ========= ========= ======== ======== ==========
Cumulative net interest rate
sensitivity gap ......................... $(18,072) $(23,210) $ (50,901) $ 45,705 $148,612
========= ========= ========= ======== ========
Cumulative net interest rate
sensitivity gap as a percentage of
total assets ............................ (1.4)% (1.8)% (3.8)% 3.5% 11.2%
AT DECEMBER 31, 1996:
Cumulative net interest rate
sensitivity gap ......................... $ (44,123) $(86,938) $ (110,079) $ (8,224) $ 126,169
========= ======== ========== ======== =========
Cumulative net interest rate
sensitivity gap as a percentage of
total assets ............................ (3.7)% (7.2)% (9.1)% (0.7)% 10.5%
</TABLE>
The balance of interest sensitive asset and liability accounts has been
allocated among the various periods using common industry techniques and market
consensus data. Fixed rate mortgage loans are shown in the table in the time
period corresponding to scheduled principal amortization and anticipated
prepayments using annual conditional prepayment rates that vary from 8.8% -
10.5% at December 31, 1997, as compared with 9.2% - 10.5% at December 31, 1996.
Variable rate loans, securities, certificates of deposit and borrowed funds are
allocated to the period in which the rates could be next adjusted or to their
final contractual maturity for the fixed rate instruments. Mortgage-backed
securities are allocated using annual conditional prepayment rates of 7.7% -
20.7% at December 31, 1997, versus 4.2% - 19.8% at December 31, 1996. Other
interest sensitive assets include assets held for sale and FHLB stock.
Nonaccruing loans have been excluded from both the gap analysis and the market
risk analysis.
30
<PAGE> 37
A substantial portion of regular savings, money market and NOW accounts are
considered core deposits by management and, therefore, relatively insensitive to
interest rates. In addition, any future changes to the interest rates paid on
these accounts are at the sole discretion of management. Despite the foregoing
factors, these deposits, included in the "Other Deposits" category, have been
allocated between each time period based on the Banks' own historical
experience, or decay rates, in determining the deposit runoff.
The other method used to measure interest rate risk is the market risk
analysis. The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 1997.
<TABLE>
<CAPTION>
EXPECTED MATURITY DATE AT DECEMBER 31, 1997
----------------------------------------------------------------------------------------
FAIR VALUE AT
1998 1999 2000 2001 2002 THEREAFTER TOTAL 12/31/97
---- ---- ---- ---- ---- ---------- ----- --------
(DOLLARS IN MILLIONS)
Interest sensitive assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed rate securities ............... $ 65.2 $ 25.8 $ 42.7 $ 36.4 $ 17.2 $ 45.3 $ 232.6 $ 238.5
Average interest rate .............. 6.93% 6.90% 6.62% 6.71% 6.91% 7.01% 6.85%
Variable rate securities ............ $ 21.8 $ 6.0 $ 5.2 $ 4.0 $ 3.0 $ 10.0 $ 49.9 $ 45.7
Average interest rate .............. 5.91% 6.51% 6.51% 6.53% 6.54% 6.59% 6.26%
Fixed rate retail loans ............. $ 41.8 $ 37.8 $ 35.1 $ 29.7 $ 23.5 $106.7 $ 274.6 $ 275.1
Average interest rate .............. 7.42% 7.44% 7.47% 7.48% 7.29% 7.39% 7.41%
Variable rate retail loans .......... $153.0 $ 83.2 $ 69.7 $ 51.5 $ 38.2 $111.7 $ 507.3 $ 509.6
Average interest rate .............. 7.69% 7.50% 7.51% 7.52% 7.53% 7.55% 7.57%
Fixed rate corporate loans .......... $ 8.2 $ 7.7 $ 5.4 $ 3.5 $ 2.6 $ 18.2 $ 45.6 $ 46.4
Average interest rate .............. 8.87% 8.95% 9.06% 8.88% 8.87% 8.86% 8.90%
Variable rate corporate loans ....... $ 31.9 $ 31.1 $ 19.5 $ 13.0 $ 12.9 $ 35.1 $ 143.5 $ 145.1
Average interest rate ............... 9.53% 9.55% 9.38% 9.06% 9.09% 8.57% 9.19%
Other interest sensitive assets ... $ 21.3 -- -- -- -- -- $ 21.3 $ 21.4
Average interest rate .............. 6.57% -- -- -- -- -- 6.57% --
------ ------ ------ ------ ------ ------ -------- --------
Total interest sensitive assets ..... $343.2 $191.6 $177.6 $138.1 $ 97.4 $327.0 $1,274.8 $1,281.8
====== ====== ====== ====== ====== ====== ======== ========
Interest sensitive liabilities:
Savings & money market
deposit accounts .................. $107.2 $ 35.7 $ 27.0 $ 20.4 $ 15.4 $ 48.3 $ 254.0 $ 254.0
Average interest rate .............. 3.31% 3.31% 3.31% 3.31% 3.31% 3.31% 3.31%
Certificates of deposit ............. $316.0 $166.3 $ 21.7 $ 14.0 $ 9.6 -- $ 527.6 $ 530.5
Average interest rate .............. 5.73% 6.12% 6.10% 6.38% 6.14% -- 5.89%
NOW accounts ........................ $ 16.8 $ 13.5 $ 10.9 $ 8.8 $ 7.0 $ 28.9 $ 85.9 $ 85.9
Average interest rate .............. 1.02% 1.02% 1.02% 1.02% 1.02% 1.02% 1.02%
Total borrowed funds ................ $153.7 $ 39.3 $ 20.0 $ 8.2 $ 25.0 $ 12.5 $ 258.7 $ 258.6
Average interest rate .............. 5.70% 6.11% 6.07% 5.97% 5.81% 5.84% 5.85%
------ ------ ------ ------ ------ ------ -------- --------
Total interest sensitive
liabilities ....................... $593.7 $254.8 $ 79.6 $ 51.4 $ 57.0 $ 89.7 $1,126.2 $1,129.0
====== ====== ====== ====== ====== ====== ======== ========
</TABLE>
Market risk sensitive instruments are generally defined as on and off
balance sheet derivatives and other financial instruments. Expected maturities
are contractual maturities adjusted for prepayments of principal. The Company
uses certain assumptions to estimate fair values and expected maturities. For
interest sensitive assets, expected maturities are based upon contractual
maturity, projected repayments and prepayments of principal using the same
ratios used for the gap analysis presented above. Retail loans include
residential and consumer loans while corporate loans are comprised of commercial
real estate, commercial, construction and land loans. For interest sensitive
liabilities, the same decay rates and contractual maturities used for the gap
analysis are used for the market risk analysis. The only difference between the
two analyses on the interest sensitive liabilities are the callable features on
the FHLB advances. The gap analysis reflects the call dates while the market
risk analysis uses the advances contractual maturity dates.
31
<PAGE> 38
The following table reflects the scheduled maturities of selected loans at
December 31, 1997:
<TABLE>
<CAPTION>
ONE OVER
LESS THAN THROUGH FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
-------- ---------- ----- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Construction and land loans.................. $10,954 $16,605 $3,940 $31,499
Commercial loans............................. 6,393 12,258 2,349 21,000
------- ------- ------ -------
$17,347 $28,863 $6,289 $52,499
======= ======= ====== =======
</TABLE>
Of the loans maturing after one year, $4.5 million, or 12.8%, have fixed
rates and $30.7 million, or 87.2%, have floating or variable rates.
LIQUIDITY
The Company's primary source of funds is dividends from its bank
subsidiaries. Dividends from the Bank to the Company totalled $7.0 million in
1997, $4.5 million in 1996 and $1.5 million in 1995. ABNH will be severely
limited in its ability to pay dividends during its initial years of operation.
ABNH was capitalized with an initial contribution of $4.0 million in 1995 and
additional contributions of $3.0 million in 1997 and $1.0 million in 1996.
The Company made payments of dividends to stockholders in the amount of
$3.5 million, $2.6 million and $1.9 million, respectively, for the years ended
December 31, 1997, 1996 and 1995.
The goal of the Company's liquidity management process is to assess funding
requirements so as to efficiently meet the cash needs of borrowers and
depositors, while also providing funds for attractive investment opportunities.
The Banks have a diverse base of funding. Sources of liquidity include
maturation, amortization and prepayment of the investment and loan portfolios.
Another source of liquidity is funds purchased from other banks, the sale of
securities under repurchase agreements, customer repurchase agreements, and
borrowings from the FHLB, of which Andover Bank is a voluntary member. The Banks
may also obtain funds from the Federal Reserve Bank of Boston by pledging
certain assets.
At December 31, 1997, the Company had home equity, reserve credit and
commercial unused lines of credit totalling $90.1 million. Outstanding
commitments to originate loans totalled $37.0 million. Unadvanced portions of
construction and land loans amounted to $21.3 million. Standby letters of credit
were $2.4 million. Loans sold with recourse totalled $2.8 million. Management
believes that its sources of liquidity are sufficient to meet these commitments
if and as called upon.
See Notes 10, 11, 13, 17 and 18 to the "Consolidated Financial Statements"
for further information.
Cash flows provided by operating activities decreased by $4.6 million to
$14.0 at December 31, 1997, and increased by $552,000 to $18.6 million at
December 31, 1996. The change in 1997 was primarily due to a reduced provision
for loan losses and an increase in assets held for sale. The change in 1996 was
attributable to increased net income offset by a decrease in assets held for
sale. Cash flows used by investing activities increased by $46.8 million to
$128.6 million during 1997 and increased $33.3 million during 1996 to $81.7
million. The increase in 1997 was attributable to a reduction in sales of
investments available for sale combined with a $38.8 million increase in whole
loans purchased during the year. The increase in 1996 was primarily due to
purchases of investments available for sale. Cash flows provided by financing
activities increased by $23.2 million to $104.2 million during 1997 mainly
attributable to an increase in total deposits. The increase of $45.7 million
during 1996 was also primarily due to a significant increase in total deposits.
32
<PAGE> 39
CAPITAL RESOURCES
At December 31, 1997, the Company reported total capital of $107.1 million,
or 8.1% of total assets as compared to $95.8 million, or 8.0% at December 31,
1996. The Company and the Banks continue to maintain capital ratios in excess of
all applicable regulatory minimums.
The capital position of banks and bank holding companies are regulated by
various Federal and state agencies. The following table presents regulatory
capital ratios under current regulatory and risk-based capital requirements as
of December 31, 1997:
<TABLE>
<CAPTION>
RISK BASED CAPITAL RATIO
------------------------
LEVERAGE RATIO TIER 1 TOTAL
-------------- ------ -----
<S> <C> <C> <C>
Andover Bancorp, Inc.................... 8.2% 13.8% 15.0%
Andover Bank............................ 7.7 13.1 14.4
Andover Bank NH.......................... 8.7 15.3 16.1
</TABLE>
Current minimum regulatory requirements as of December 31, 1997 were 4.0%
for the leverage ratio and 4.0% and 8.0%, respectively for the Tier 1 and total
risk based capital ratios. Under the FDIC's prompt corrective action regulations
promulgated pursuant to the FDIC Improvement Act of 1991, the Banks have
sufficient capital to be considered "well capitalized". Therefore, the Banks are
entitled to pay the lowest deposit premium possible.
See Item 1, "Business -- Supervision and Regulation" and Note 13 to the
"Consolidated Financial Statements" for further information.
IMPACT OF INFLATION
The Consolidated Financial Statements and related consolidated financial
data presented herein have been prepared in accordance with generally accepted
accounting principles which require the measurement of financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The
primary impact of inflation on operations of Andover is reflected in increased
operating costs. Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the price of
goods and services.
IMPACT OF THE YEAR 2000 ISSUE
Included in other noninterest expenses in 1997 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 dates beyond
December 31, 1999. The Company has completed its assessment of Year 2000 issues,
developed a plan, and arranged for the required resources to complete the
necessary remediation efforts.
The Company will utilize both internal and external resources to reprogram,
or replace, and test the software for Year 2000 modifications. The Company plans
to complete the Year 2000 project within one year, or not later than December
31, 1998. The total remaining cost of the Year 2000 project is estimated at
$275,000 to $400,000. Through December 31, 1997, the Company has incurred and
expensed approximately $50,000 related to the assessment of, and preliminary
efforts in connection with, its Year 2000 project and the development of a
remediation plan.
The Company will incur costs through the year 2000; however, it does not
anticipate that material incremental costs will be incurred in any single
period. Additionally, a significant portion of costs pertaining to the Year 2000
33
<PAGE> 40
project are not expected to be incremental to the Company, but rather represent
a reprioritization of existing internal systems technology resources.
Since the Company outsources all of its major data processing systems, it
has initiated formal communications with all of its significant vendors to
determine the extent to which the Company is vulnerable to those third parties'
failure to remediate their own Year 2000 issue. There can be no guarantee that
the systems of other companies on which the Company's systems rely will be
timely remediated. Therefore, the Company could possibly be negatively impacted
to the extent other entities not affiliated with the Company are unsuccessful in
properly addressing this issue.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
RECENT ACCOUNTING DEVELOPMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS 129, "Disclosures of Information about Capital Structure", which is
effective for 1997 financial statements. The Company's disclosures currently
comply with the provisions of this statement.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income".
SFAS 130 establishes 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. Also in June 1997, the FASB issued SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information", which establishes
standards for reporting information about operating segments. An operating
segment is defined as a component of a business for which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and evaluate performance.
SFAS 131 requires a company to disclose certain income statement and balance
sheet information by operating segment, as well as provide a reconciliation of
operating segment information to the company's consolidated balances. SFAS 130
and SFAS 131 are effective for 1998 annual financial statements and are not
expected to have a material impact on the consolidated financial statements.
34
<PAGE> 41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.......................................................... 36
Consolidated Balance Sheets as of December 31, 1997 and 1996.......................... 37
Consolidated Statements of Operations for each of the years ended
December 31, 1997, 1996 and 1995................................................... 38
Consolidated Statements of Changes in Stockholders' Equity for each of the
years ended December 31, 1997, 1996 and 1995....................................... 39
Consolidated Statements of Cash Flows for each of the years ended
December 31, 1997, 1996 and 1995................................................... 40-41
Notes to Consolidated Financial Statements............................................ 42-67
</TABLE>
35
<PAGE> 42
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
ANDOVER BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of Andover
Bancorp, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Andover
Bancorp, Inc. and subsidiaries as of December 31, 1997 and 1996 and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
Boston, Massachusetts
January 22, 1998
36
<PAGE> 43
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
ASSETS
<S> <C> <C>
Cash and due from banks (note 18) ............................................... $ 21,586 $ 20,489
Short-term investments (note 3) ................................................. 14,150 25,600
----------- -----------
Cash and cash equivalents ...................................................... 35,736 46,089
----------- -----------
Assets held for sale, at lower of cost or market (note 2) ....................... 5,537 2,220
Investments available for sale (amortized cost of $137,175 in 1997
and $113,623 in 1996) (notes 3, 10 and 11) ..................................... 139,054 114,125
Investments held to maturity (market value $130,947 in 1997 and
$137,007 in 1996) (notes 3, 10 and 11) ......................................... 129,363 136,926
Loans (notes 4 and 11) .......................................................... 978,823 870,035
Allowance for loan losses (note 4) .............................................. (12,521) (12,229)
----------- -----------
Net loans .................................................................... 966,302 857,806
----------- -----------
Mortgage servicing assets, net (note 5) ......................................... 9,500 8,006
Other real estate owned, net (note 6) ........................................... 406 1,683
Premises and equipment, net (note 7) ............................................ 9,593 10,194
Accrued interest receivable ..................................................... 7,567 7,164
Stock in FHLB of Boston, at cost (notes 8 and 11) ............................... 15,747 15,747
Net deferred income taxes receivable (note 12) .................................. 1,832 1,374
Other assets .................................................................... 2,108 3,479
----------- -----------
Total assets ........................................................... $ 1,322,745 $ 1,204,813
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (note 9)............................................................ $ 946,982 $ 824,311
Securities sold under agreements to repurchase (note 10) ..................... 10,171 2,833
Federal Home Loan Bank advances (note 11) .................................... 248,561 271,585
Mortgagors' escrow accounts .................................................. 2,478 2,294
Income taxes payable (note 12) ............................................... 2,250 2,570
Accrued expenses and other liabilities ....................................... 5,224 5,374
----------- -----------
Total liabilities ....................................................... 1,215,666 1,108,967
----------- -----------
Commitments and contingencies (notes 7 and 18)
Stockholders' equity (notes 13 and 15):
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;
5,168,114 and 5,154,792 shares issued in 1997 and 1996, respectively ........ 517 515
Additional paid-in capital ................................................... 59,619 59,222
Retained earnings ............................................................ 45,814 36,109
Treasury stock, at cost (20,862 shares in 1996) .............................. -- (301)
Unrealized gains on investments available for sale, net (notes 3 and 12) ..... 1,129 301
----------- -----------
Total stockholders' equity .............................................. 107,079 95,846
----------- -----------
Total liabilities and stockholders' equity .............................. $ 1,322,745 $ 1,204,813
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
37
<PAGE> 44
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest and dividend income:
<S> <C> <C> <C>
Loans ................................................. $ 70,861 $ 64,569 $ 53,876
Mortgage-backed securities ............................ 12,362 13,304 15,375
Investment securities ................................. 5,753 4,436 6,039
Dividends on equity securities (note 8) ............... 1,030 944 970
Short-term investments ................................ 746 570 626
-------- -------- --------
Total interest and dividend income .................. 90,752 83,823 76,886
-------- -------- --------
Interest expense:
Deposits (note 9) .................................... 38,251 31,692 29,246
Federal Home Loan Bank advances ...................... 13,315 16,054 14,409
Securities sold under agreements to repurchase ....... 481 783 897
-------- -------- --------
Total interest expense .............................. 52,047 48,529 44,552
-------- -------- --------
Net interest and dividend income .................... 38,705 35,294 32,334
Provision for loan losses (note 4) ...................... 983 2,555 1,295
-------- -------- --------
Net interest and dividend income after provision
for loan losses ................................... 37,722 32,739 31,039
-------- -------- --------
Non-interest income:
Net gains from sales of assets
held for sale (note 2) ................................ 264 421 55
Net gains (losses) from sales and redemptions
of investments available for sale (note 3) ............ 158 (686) 269
Mortgage banking income, net (note 5) .................. 2,015 2,095 1,769
Losses on real estate operations, net (note 6) ......... (971) (1,542) (2,003)
Other income (note 14) ................................. 3,292 2,709 3,101
-------- -------- --------
Total non-interest income ............................. 4,758 2,997 3,191
-------- -------- --------
Non-interest expense:
Salaries and employee benefits (note 15) ............... 11,886 10,346 9,623
Office occupancy and equipment (note 7) ................ 2,885 2,756 2,338
Data processing ........................................ 1,933 1,666 1,445
Marketing .............................................. 988 976 847
Professional fees ...................................... 862 1,328 681
Mortgage banking expense ............................... 430 406 311
Deposit insurance premiums ............................. 124 15 892
Merger expense (recovery) (note 19) .................... -- (225) 1,000
Other operating expense ................................ 2,878 2,552 2,121
-------- -------- --------
Total non-interest expense ............................ 21,986 19,820 19,258
-------- -------- --------
Income before income tax expense and extraordinary item 20,494 15,916 14,972
Income tax expense (note 12) ............................ 7,288 3,264 5,634
-------- -------- --------
Income before extraordinary item ...................... 13,206 12,652 9,338
Extraordinary item, net of tax (notes 11 and 12) ........ -- (173) --
-------- -------- --------
Net income ............................................ $ 13,206 $ 12,479 $ 9,338
======== ======== ========
Average number of common shares outstanding, basic ...... 5,148 5,105 5,063
Average number of common shares outstanding, diluted .... 5,303 5,203 5,133
Earnings per common share (basic):
Income per share before extraordinary item ............. $ 2.57 $ 2.47 $ 1.84
Extraordinary item per share, net of tax ............... -- (0.03) --
-------- -------- --------
Net income per share ................................... $ 2.57 $ 2.44 $ 1.84
======== ======== ========
Earnings per common share (diluted):
Income per share before extraordinary item ............. $ 2.49 $ 2.43 $ 1.82
Extraordinary item per share, net of tax ............... -- (0.03) --
-------- -------- --------
Net income per share ................................... $ 2.49 $ 2.40 $ 1.82
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
38
<PAGE> 45
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
UNREALIZED
GAINS
(LOSSES) ON TOTAL
ADDITIONAL INVESTMENTS STOCK-
COMMON PAID-IN RETAINED TREASURY AVAILABLE HOLDERS'
STOCK CAPITAL EARNINGS STOCK FOR SALE (1) EQUITY
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ..... $ 513 $ 71,172 $ 18,701 $ (13,247) $ (4,617) $ 72,522
Net income ...................... -- -- 9,338 -- -- 9,338
Dividends declared and paid
($0.37 per share) .............. -- -- (1,856) -- -- (1,856)
Stock options exercised (note 15) 2 343 -- -- -- 345
Change in unrealized gains
(losses) on investments
available for sale (note 3) ... -- -- -- -- 4,816 4,816
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1995 ..... 515 71,515 26,183 (13,247) 199 85,165
Net income ...................... -- -- 12,479 -- -- 12,479
Dividends declared and paid
($0.50 per share) .............. -- -- (2,553) -- -- (2,553)
Stock options exercised (note 15) -- 41 -- 612 -- 653
Stock dividend .................. -- (12,334) -- 12,334 -- --
Change in unrealized gains
(losses) on investments
available for sale (note 3) .... -- -- -- -- 102 102
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1996 ..... 515 59,222 36,109 (301) 301 95,846
Net income ...................... -- -- 13,206 -- -- 13,206
Dividends declared and paid
($0.68 per share) .............. -- -- (3,501) -- -- (3,501)
Stock options exercised (note 15) 2 397 -- 301 -- 700
Change in unrealized gains
(losses) on investments
available for sale (note 3) .... -- -- -- -- 828 828
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1997 ..... $ 517 $ 59,619 $ 45,814 $ -- $ 1,129 $ 107,079
========= ========= ========= ========= ========= =========
</TABLE>
- ------------------
(1) Net of related tax effect.
The accompanying notes are an integral part of the consolidated financial
statements.
39
<PAGE> 46
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income .................................................. $ 13,206 $ 12,479 $ 9,338
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ................................... 983 2,555 1,295
Net losses on sales and provisions
for other real estate owned ................................ 240 392 168
Net (gains) losses from sales and redemptions of
investments available for sale ............................. (158) 686 (269)
Net gains from sales of assets held for sale ................ (264) (421) (55)
Depreciation and amortization ............................... 1,397 1,396 1,155
Amortization of fees, discounts and premiums, net ........... 405 412 557
Deferred income taxes ....................................... (1,008) (618) 3,401
(Increase) decrease in:
Assets held for sale ....................................... (3,053) 1,232 (2,600)
Accrued interest receivable ................................ (403) -- (217)
Mortgage servicing assets .................................. 1,592 741 698
Other assets ............................................... 1,371 (664) 1,810
Increase (decrease) in:
Mortgagors' escrow accounts ................................ 184 (1,232) 1,283
Accrued income taxes payable ............................... (320) 1,181 909
Accrued expenses and other liabilities ..................... (150) 438 552
--------- --------- ---------
Net cash provided by operating activities ................. 14,022 18,577 18,025
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases .................................................. (50,979) (100,311) --
Proceeds from sales ........................................ 14,658 86,641 54,985
Proceeds from maturities and redemptions ................... 3,000 6,023 8,923
Principal repayments ....................................... 9,889 8,174 8,608
Investment and mortgage-backed securities held to maturity:
Purchases .................................................. (18,571) (2,991) (20,858)
Proceeds from maturities and redemptions ................... 2,500 6,000 5,528
Principal repayments ....................................... 23,449 27,008 20,603
Net change FHLB stock ....................................... -- (2,576) (803)
Purchases of whole loans .................................... (71,297) (32,474) (59,878)
Purchases of mortgage servicing assets ...................... (3,086) (2,138) (3,555)
Net increase in loans ....................................... (40,454) (76,855) (68,835)
Capital expenditures on premises and equipment, net ......... (796) (2,053) (878)
Proceeds from sales of other real estate owned .............. 3,182 3,958 7,972
Capital expenditures on other real estate owned ............. (54) (128) (260)
--------- --------- ---------
Net cash used by investing activities ...................... (128,559) (81,722) (48,448)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits .................................... 122,671 81,106 15,347
Net increase (decrease) in securities sold
under agreements to repurchase ............................. 7,338 (6,379) 5,212
Proceeds from issuance of FHLB advances ..................... 293,514 450,469 322,450
Principal repayments of FHLB advances ....................... (316,538) (442,298) (306,221)
Dividends paid .............................................. (3,501) (2,553) (1,856)
Stock options exercised ..................................... 700 653 345
--------- --------- ---------
Net cash provided by financing activities .................. 104,184 80,998 35,277
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .......... (10,353) 17,853 4,854
Cash and cash equivalents, beginning of year .................. 46,089 28,236 23,382
--------- --------- ---------
Cash and cash equivalents, end of year ........................ $ 35,736 $ 46,089 $ 28,236
========= ========= =========
</TABLE>
Statement continued on next page.
40
<PAGE> 47
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
Supplemental disclosures of cash flow information:
Cash paid during the year for:
<S> <C> <C> <C>
Interest ................................................... $52,129 $48,787 $44,314
Income taxes ............................................... 7,866 3,355 1,809
Cash received during the year for:
Income taxes ............................................... -- 585 499
Supplemental noncash investing and financing activities:
Conversion of real estate loans to mortgage-backed
securities held for sale or investments available for sale ... 24,068 43,995 20,314
Transfer of loans to other real estate owned .................. 2,091 1,747 3,242
Transfer of investment securities held to
maturity to investments available for sale ................... -- -- 38,684
Transfer of mortgage-backed securities held to
maturity to investments available for sale ................... -- -- 12,507
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
41
<PAGE> 48
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Andover Bancorp, Inc. (the "Company") is a Delaware corporation and the
holding company of Andover Bank and Andover Bank NH (collectively the "Banks").
Andover Bank (the "Bank") is a state-chartered savings bank with its
headquarters located in Andover, Massachusetts. Andover Bank NH ("ABNH") is a
guaranty savings bank chartered in September 1995, and headquartered in Salem,
New Hampshire. The Company provides a variety of loan and deposit services to
its customers through 13 locations. The Company is supervised by the Board of
Governors of the Federal Reserve System ("FRB") and it is also subject to the
jurisdiction of the Massachusetts Board of Bank Incorporation, while the Bank is
subject to regulation and supervision by the Federal Deposit Insurance
Corporation ("FDIC") and the Massachusetts Commissioner of Banks (the
"Commissioner"). The Bank's deposits are insured by the FDIC and the Depositors
Insurance Fund, Inc. ("DIF"). ABNH is subject to regulation and supervision of
the FDIC and the New Hampshire Commissioner of Banks. ABNH's deposits are
insured by the FDIC.
The accounting and reporting policies of Andover Bancorp, Inc. and
subsidiaries conform with generally accepted accounting principles and general
practices within the banking industry. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and income and expenses for the period. Actual results could differ
significantly from those estimates. Material estimates that are particularly
susceptible to change relate to the allowance for loan loss, valuation of
mortgage servicing assets and other real estate owned as well as the valuation
of deferred tax assets. The following is a summary of the more significant
accounting policies.
Principles of Consolidation
The consolidated financial statements include the accounts of Andover
Bancorp, Inc. and its subsidiaries, including its principal subsidiaries Andover
Bank and Andover Bank NH. All intercompany accounts and transactions have been
eliminated in consolidation. Certain amounts in the prior years' financial
statements have been reclassified to conform with the current year's
presentation for comparative purposes. Such reclassifications had no effect on
net income.
Mortgage Banking Activities
Loans held for sale in the secondary market are stated at the lower of
aggregate amortized cost or market value. Market value is estimated based on
outstanding investor commitments or, in the absence of such commitments, current
investor yield requirements. Net unrealized losses, if any, are provided for in
a valuation allowance by charges to operations. When loans are sold, a gain or
loss is recognized to the extent that the sale proceeds exceed or are less than
the carrying amount of the loans. Gains and losses are determined using the
specific identification method.
The gains and losses resulting from the sales of loans with servicing
retained are adjusted to recognize the present value of differences between the
loan yield to the investor and the interest rate on the loan, plus the normal
servicing fee (and any required guaranty fee) over the estimated lives of the
related loans. The resulting excess mortgage servicing fee ("excess") was
capitalized for loan sales prior to January 1, 1996.
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" ("SFAS
122"). SFAS 122 was superseded, for transactions recorded after December 31,
1996, by Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS 125"). Both SFAS 122 and SFAS 125 require that a mortgage banking
enterprise recognize a servicing asset or liability and other retained interests
as an allocation of the carrying amount of the assets sold between the asset
sold and the servicing obligation and other retained interests based on the
relative fair value of the assets sold to the interests retained. SFAS 125 also
required that mortgage servicing rights be evaluated for impairment based on the
asset's fair value. As a result of adopting SFAS 122 and SFAS 125, gains on
sales of loans and recognition of originated mortgage servicing rights totalled
$447,000 and $423,000 for the years ended December 31, 1997 and 1996,
respectively.
42
<PAGE> 49
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Mortgage loan servicing rights purchased or originated are amortized
against mortgage banking income using a method which approximates the level
yield method in proportion to, and over the period of, estimated net servicing
income. Prepayment experience on each mortgage servicing asset is reviewed
periodically and, when actual prepayments exceed estimated prepayments, the
balance of the mortgage servicing asset is adjusted by a charge to the valuation
allowance. On a regular basis, the mortgage servicing assets are assessed for
impairment based on the fair value of such rights. The fair value is estimated
using market prices when available or, alternatively, using a valuation model
that calculates the present value of future servicing asset cash flows using
discount rates and prepayment assumptions that management believes market
participants would use. Any impairment in the fair value of those mortgage
servicing assets is recognized by a charge to the valuation allowance. The risk
characteristics of the underlying loans used to measure impairment of originated
and purchased mortgage loan servicing rights include the loan type, interest
rate, loan origination date, term to maturity and geographic location.
Investments
Investments include short-term, available for sale, held to maturity and
trading. Debt securities are classified as held to maturity only when there is
positive intent and ability to hold them to maturity. Such securities are
recorded at amortized cost, adjusted for amortization of premiums and accretion
of discounts and adjusted as necessary for estimated prepayments. Trading
securities are debt and equity securities held principally for the purpose of
selling in the near term. Such securities are recorded at fair value, with
unrealized gains and losses recorded in earnings. Investments available for sale
are any debt and equity securities not classified as either held to maturity or
trading securities. Such investments are recorded at fair value with changes in
fair value recorded as a separate component of stockholders' equity, net of the
related income tax effect. Originated mortgage loans converted to
mortgage-backed securities to be sold are classified as trading. Gains and
losses on sales of investment and mortgage-backed securities are recognized
using the specific identification method. Premiums and discounts on investment
and mortgage-backed securities are amortized or accreted into income by use of
the level-yield method. The yields on mortgage-backed securities are affected by
prepayments and changes in interest rates. If a decline in fair value below the
amortized cost basis of an investment or mortgage-backed security is judged to
be other than temporary, the cost basis of the security is written down to fair
value. The amount of the writedown is included as a charge against gain on sale
of securities. Short-term investments with original maturities of 90 days or
less are carried at cost, which approximates market value.
Loans
Accrual of interest income on loans and amortization of net deferred loan
fees are discontinued when loan payments are 90 days or more past due or earlier
when concern exists as to the ultimate collection of principal or interest. When
loans are placed on nonaccrual status, the interest receivable on the loan is
reversed against interest income of the current period. Non-performing loans are
generally not returned to performing status until the obligation is brought
current, the loan becomes well-secured and in the process of collection and, in
either case, when concern no longer exists as to the collectibility of principal
or interest. Interest received on nonaccruing loans is either applied against
principal or reported as income according to management's judgment as to the
collectibility of principal. Income received on impaired loans is recognized in
income similar to nonaccrual loans.
Loan origination fees and related direct incremental loan origination costs
are deferred and amortized over the life of the related loans as yield
adjustments using the level yield method. When loans are sold or paid off, the
unamortized fees and costs are recognized to income. Purchased loan discounts
and premiums are amortized or accreted into income over the weighted average
repricing term of the underlying loans.
Impaired loans are commercial, commercial real estate, and individually
significant mortgage and consumer loans for which it is probable that the
Company will not be able to collect all amounts due according to the contractual
terms of the loan agreement. The definition of "impaired loans" is not the same
as the definition of "nonaccrual loans", although the two categories overlap.
Nonaccrual loans include impaired loans and are those on which the accrual of
interest is discontinued when collectibility of principal or interest is
uncertain or payments of principal or interest have become contractually past
due 90 days. The Company may choose to place a loan on nonaccrual status due to
payment delinquency, while not classifying the loan as impaired due to
insignificant payment delays
43
<PAGE> 50
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
and insignificant shortfalls in payment amounts. Factors considered by
management in determining impairment include payment status and collateral
value. The amount of impairment for these types of impaired loans is determined
by the difference between the present value of the expected cash flows related
to the loan, using the original contractual interest rate, and its recorded
value, or, as a practical expedient in the case of collateral dependent loans,
the difference between the fair value of the collateral and the recorded amount
of the loans. When foreclosure is probable, impairment is measured based on the
fair value of the collateral. Restructured, accruing loans entered into prior to
1995 are not required to be reported as impaired unless such loans are not
performing according to their restructured terms. Loan restructurings at below
current market rates entered into after 1994 are reported as impaired loans, and
impairment is measured as described above using the loan's pre-modification rate
of interest.
Allowance for Loan Losses
The Banks maintain an allowance for probable losses that are inherent in
their loan portfolios. The allowance is increased by provisions charged to
operating expense and by recoveries of previously charged-off loans. The
allowance is decreased as loans are charged-off.
The allowance is an amount that management believes will be adequate for
loan losses based on evaluations of collectibility and prior loss experience,
changes in the nature and volume of the loan portfolio, overall portfolio
quality, specific problem loans and current and anticipated economic conditions
that may affect the borrower's ability to pay. A substantial portion of the
Banks' loans are secured by real estate in Massachusetts and New Hampshire.
Accordingly, the ultimate collectibility of a substantial portion of the Banks'
loan portfolio is susceptible to changes in market conditions in these areas.
Management believes the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Banks' allowance for loan
losses. Such agencies may require the Banks to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination.
Other Real Estate Owned
Other real estate owned is comprised of properties acquired through
foreclosure proceedings, acceptance of a deed in lieu of foreclosure or when the
Bank is in possession of the collateral. Real estate owned is recorded at the
lower of the carrying value of the loan or the net fair value of the property.
Losses arising from the acquisition of such properties are charged against the
allowance for loan losses. Operating expenses, net of related income, and any
provisions to increase the valuation allowance are charged to real estate
operations. Subsequent declines in net fair value are charged-off to the
valuation allowance while gains and losses upon disposition are reflected in
real estate operations. Management believes the allowance is adequate to provide
for potential losses. However, future additions to the valuation allowance may
be necessary based on changes in economic conditions.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation or amortization is computed on the straight-line method over the
lesser of the estimated useful lives of the assets or over the terms of their
respective leases for leasehold improvements. It is the Company's general
practice to charge the cost of maintenance and repairs to operations when
incurred; major expenditures for improvements are capitalized and depreciated.
44
<PAGE> 51
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Income Taxes
Income taxes are accounted for using the asset and liability method of
accounting. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax basis and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The valuation allowance
related to deferred tax assets is recognized when, in management's judgment, it
is more likely than not that all, or a portion of, such deferred tax assets will
not be realized.
Employee Benefits
The Company accounts for pension and postretirement benefits on the net
periodic cost method for financial reporting purposes. This method recognizes
the compensation cost of an employee's benefit over that employee's approximate
service period.
The Company continues to follow APB Opinion No. 25 "Accounting for Stock
Issued to Employees" as permitted by Statement of Financial Accounting Standards
No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"). For companies
that elect to continue using APB 25, SFAS 123 requires disclosure of the pro
forma effect of using the fair value method of accounting for stock-based
compensation that is encouraged by SFAS 123. See footnote 15 for the expanded
disclosures required by SFAS 123 regarding pro forma net income and earnings per
share.
Earnings Per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128
replaces the existing accounting rules for computing earnings per share and
makes the new rules comparable to international standards. Basic earnings per
share excludes common stock equivalents and is computed by dividing net income
by the weighted average number of common shares outstanding for the period.
Diluted earnings per share gives effect to all potential dilutive common shares
using the average market price of the Company's common stock for the period plus
the weighted average number of common shares outstanding for the equivalent
period of time. All prior period earnings per share have been restated to comply
with SFAS 128. Additionally, the per share data has been restated for the
periods prior to December 31, 1996 to reflect a 20% stock dividend distribution.
A reconciliation of the common shares outstanding for the three years ended
December 31, follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Average number of common shares outstanding, basic.............. 5,148 5,105 5,063
Dilutive impact of stock options................................ 155 98 70
----- ----- -----
Average number of common shares outstanding, diluted............ 5,303 5,203 5,133
</TABLE>
The numerator in the earnings per common share calculation is net income,
as reported, for both the basic and dilutive calculations.
45
<PAGE> 52
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
(2) ASSETS HELD FOR SALE
The composition of assets held for sale at December 31 follows:
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans..................................$5,537 $5,624 $2,220 $2,220
====== ====== ====== ======
</TABLE>
Proceeds from sales, realized and unrealized gains and losses on assets
held for sale for the years ended December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Proceeds from sales....................$27,732 $39,839 $21,552
Realized gains on sales................ 498 829 329
Realized losses on sales............... 260 382 274
</TABLE>
Proceeds from sales of investment trading accounts totalled $9,990,000 for
the year ended December 31, 1995. Realized losses on such sales were $10,000 in
1995.
(3) INVESTMENTS
The amortized cost and approximate fair value of the investment portfolio
at December 31 follow:
<TABLE>
<CAPTION>
1997
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- --------- --------- ---------
(IN THOUSANDS)
SHORT-TERM INVESTMENTS:
<S> <C> <C> <C> <C>
Federal funds sold ....................... $ 14,150 $ -- $ -- $ 14,150
========= ========= ========= =========
INVESTMENTS AVAILABLE FOR SALE:
U. S. government and federal
agency obligations ...................... $ 54,869 $ 912 $ (4) $ 55,777
Other bonds and obligations .............. 14,405 168 -- 14,573
FHLMC participation certificates ......... 36,329 476 -- 36,805
FNMA pass-through certificates ........... 4,012 94 -- 4,106
GNMA mortgage-backed securities .......... 27,560 236 (3) 27,793
--------- --------- ---------
$ 137,175 $ 1,886 $ (7) $ 139,054
========= ========= =========
INVESTMENTS HELD TO MATURITY:
U. S. government and federal
agency obligations ...................... $ 10,001 $ 46 $ -- $ 10,047
......................
Other bonds and obligations .............. 7,106 86 (2) 7,190
FHLMC participation certificates ......... 49,217 837 (37) 50,017
FNMA pass-through certificates ........... 48,835 724 (213) 49,346
GNMA mortgage-backed securities .......... 3,383 81 -- 3,464
Collateralized mortgage obligations ...... 10,021 75 -- 10,096
Other asset-backed securities ............ 800 -- (13) 787
--------- --------- ---------
$ 129,363 $ 1,849 $ (265) $ 130,947
========= ========= ========= =========
Total investments........................ $ 280,688 $ 3,735 $ (272) $ 284,151
========= ========= ========= =========
<CAPTION>
1996
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- --------- --------- ---------
(IN THOUSANDS)
SHORT-TERM INVESTMENTS:
<S> <C> <C> <C> <C>
Federal funds sold ....................... $ 25,600 $ -- $ -- $ 25,600
========= ========= ========= =========
INVESTMENTS AVAILABLE FOR SALE:
U. S. government and federal
agency obligations ...................... $ 41,304 $ 475 $ (39) $ 41,740
Other bonds and obligations .............. 14,955 70 (32) 14,993
FHLMC participation certificates ......... 25,175 36 (108) 25,103
FNMA pass-through certificates ........... 4,712 51 -- 4,763
GNMA mortgage-backed securities .......... 27,477 202 (153) 27,526
--------- --------- --------- ---------
$ 113,623 $ 834 $ (332) $ 114,125
========= ========= ========= =========
INVESTMENTS HELD TO MATURITY:
U. S. government and federal
agency obligations ...................... $ 1,448 $ -- $ (16) $ 1,432
......................
Other bonds and obligations .............. 9,686 79 (33) 9,732
FHLMC participation certificates ......... 63,639 640 (360) 63,919
FNMA pass-through certificates ........... 57,192 394 (647) 56,939
GNMA mortgage-backed securities .......... 3,899 50 -- 3,949
Collateralized mortgage obligations ...... -- -- -- --
Other asset-backed securities ............ 1,062 -- (26) 1,036
--------- --------- --------- ---------
$ 136,926 $ 1,163 $ (1,082) $ 137,007
========= ========= ========= =========
Total investments........................ $ 276,149 $ 1,997 $ (1,414) $ 276,732
========= ========= ========= =========
</TABLE>
46
<PAGE> 53
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Proceeds from sales, realized gains and losses on investments available for
sale for the years ended December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Proceeds from sales.....................................$14,658 $86,641 $54,985
Realized gains on sales and redemptions................ 199 236 510
Realized losses on sales and redemptions............... 41 922 241
</TABLE>
There were no sales of investments held to maturity in 1997, 1996 and 1995.
The amortized cost and fair value of mortgage-backed and asset-backed
securities available for sale and held to maturity at December 31 follow:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------- --------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
--------------------- --------------------- --------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Originated ......... $ 881 $ 925 $ 33,157 $ 33,867 $ 892 $ 920 $ 38,052 $ 38,101
Purchased .......... 67,020 67,779 79,099 79,843 56,472 56,472 87,740 87,742
-------- -------- -------- -------- -------- -------- -------- --------
$ 67,901 $ 68,704 $112,256 $113,710 $ 57,364 $ 57,392 $125,792 $125,843
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
The amortized cost and fair value of adjustable rate investments available
for sale and held to maturity by type at December 31 follow:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------- ------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
------------------- ------------------- ------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FHLMC participation certificates ...... $ 881 $ 925 $ -- $ -- $ 892 $ 920 $ -- $ --
FNMA pass-through certificates ........ 4,012 4,106 2,869 2,951 -- -- 3,350 3,438
GNMA mortgage-backed securities ....... 27,560 27,793 -- -- 27,477 27,526 -- --
------- ------- ------- ------- ------- ------- ------- -------
$32,453 $32,824 $ 2,869 $ 2,951 $28,369 $28,446 $ 3,350 $ 3,438
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
The carrying amounts of callable securities included in investments
available for sale and investments held to maturity totalled $37,038,000 and
$10,001,000 in 1997 and $30,779,000 and $1,448,000 in 1996.
The maturity distribution of investments available for sale and held to
maturity at December 31 follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------- --------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
-------------------- -------------------- -------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Within 1 year....................... $ 6,622 $ 6,673 $ 8,160 $ 8,241 $ 32,430 $ 32,428 $ 10,189 $ 10,175
1 to 5 years ....................... 77,743 78,945 39,043 39,489 33,515 32,908 35,903 35,950
5 to 10 years ...................... 21,168 21,429 44,739 45,334 13,637 13,618 48,091 48,136
........
Over 10 years ...................... 31,642 32,007 37,421 37,883 34,041 35,171 42,743 42,746
-------- -------- -------- -------- -------- -------- -------- --------
$137,175 $139,054 $129,363 $130,947 $113,623 $114,125 $136,926 $137,007
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
- -----------------------
Maturities of mortgage-backed securities are based on contractual maturities
with scheduled amortization. Actual maturities will differ from contractual
maturities due to prepayments.
47
<PAGE> 54
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Securities pledged at December 31 follow:
<TABLE>
<CAPTION>
SECURITIES SOLD
CUSTOMER UNDER AGREEMENTS
GOVERNMENT DEPOSITS REPURCHASE AGREEMENTS TO REPURCHASE
------------------ ------------------- ------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
---- ----- ---- ----- ---- -----
(IN THOUSANDS)
AT DECEMBER 31, 1997
<S> <C> <C> <C> <C> <C> <C>
Fixed rate bonds available for sale .............. $ 999 $1,024 $ -- $ -- $ -- $ --
GNMA mortgage-backed securities
available for sale ............................. -- -- 8,994 9,019 -- --
U.S. government obligations available for sale ... -- -- -- -- 5,035 5,119
AT DECEMBER 31, 1996
Fixed rate bonds available for sale .............. 998 1,003 -- -- -- --
U.S. government obligations available for sale ... -- -- 5,222 5,166 -- --
</TABLE>
(4) LOANS
The Company's lending activities are conducted principally in eastern
Massachusetts and southern New Hampshire. The Company grants single-family and
multi-family residential loans, commercial real estate loans, commercial loans
and a variety of consumer loans. In addition, the Company grants loans for the
construction of residential homes, commercial real estate properties and for
land development. The ability and willingness of the single-family residential
and consumer borrowers to honor their repayment commitments is generally
dependent on the level of overall economic activity within the borrowers'
geographic areas and real estate values. The ability and willingness of
commercial real estate, commercial and construction loan borrowers to honor
their repayment commitments are generally dependent on the health of the real
estate economic sector in the borrowers' geographic areas and the general
economy.
The composition of loans, shown net of unadvanced funds, loan premiums or
discounts and deferred loan origination fees and costs, at December 31 follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN THOUSANDS)
Real estate loans:
<S> <C> <C>
Residential .............................. $ 715,503 $ 619,955
Commercial ............................... 142,617 136,454
Construction and land .................... 31,499 35,001
--------- ---------
Total real estate loans ............... 889,619 791,410
--------- ---------
Consumer loans:
Home improvement, second mortgage and home
equity line of credit ................. 58,605 49,670
Personal ................................. 3,161 3,467
Guaranteed education ..................... 3,086 3,755
Collateral ............................... 3,352 2,332
--------- ---------
Total consumer loans .................. 68,204 59,224
--------- ---------
Commercial loans ........................... 21,000 19,401
--------- ---------
Total loans ........................... 978,823 870,035
Allowance for loan losses .................. (12,521) (12,229)
--------- ---------
Net loans ............................. $ 966,302 $ 857,806
========= =========
</TABLE>
48
<PAGE> 55
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
An analysis of the allowance for loan losses for the years ended December
31, follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year................... $12,229 $11,665 $12,343
Provision...................................... 983 2,555 1,295
Charge-offs.................................... (1,804) (3,283) (2,767)
Recoveries..................................... 1,113 1,292 794
------- ------- -------
Balance at end of year......................... $12,521 $12,229 $11,665
======= ======= =======
</TABLE>
The balance of loans on nonaccrual status because of delinquency or other
problem characteristics amounted to $7,849,000 and $10,699,000 at December 31,
1997 and 1996, respectively.
The reduction in interest income for the years ended December 31,
associated with nonaccrual loans, follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Interest income in accordance with original loan terms........... $1,191 $1,566 $1,596
Interest income recognized....................................... (130) (315) (118)
Interest income applied as a reduction in loan balance........... (359) (342) (438)
------ ------ ------
Foregone interest income....................................... $ 702 $ 909 $1,040
====== ====== ======
The components of impaired loans at December 31 follow:
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Total impaired loans............................................. $6,356 $ 9,122 $11,718
Impaired loans with reserve...................................... 2,476 2,686 4,876
Impaired loan reserve............................................ 280 516 804
Impaired loans without reserve................................... 3,880 6,436 6,842
Impaired loans average balance................................... 7,653 10,680 12,084
Interest income recognized....................................... 199 242 170
Interest income that would have
been recognized under original terms........................... 738 919 820
</TABLE>
The impaired loan reserve represents an allocation from the existing
allowance for loan losses. At December 31, 1997, the Company had $1,372,000 of
restructured loans outstanding. The entire amount of restructured loans are
performing and are included in the impaired loan totals.
A summary of the activity with respect to loans made to directors and
officers and their related interests whose total aggregate loan balances
exceeded $60,000 during the years ended December 31, follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Balance at beginning of year..................................... $1,537 $1,710
New loans granted................................................ 396 37
Retirement/reduction of directors and officers................... -- (109)
Repayment of principal........................................... (230) (101)
------ ------
Balance at end of year........................................... $1,703 $1,537
====== ======
</TABLE>
49
<PAGE> 56
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
The outstanding balances of loans to directors and principal officers
included above totalled $496,000 and $208,000, respectively, at December 31,
1997 and 1996. Loans included above were made in the Bank's ordinary course of
business, on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons, and did not involve more than the normal risk of collectibility.
(5) MORTGAGE SERVICING ASSETS
A summary of the components of the mortgage servicing assets, including the
valuation allowance, for the years ended December 31, follows:
<TABLE>
<CAPTION>
MORTGAGE
SERVICING VALUATION
EXCESS RIGHTS ALLOWANCE TOTAL
------ ------ --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance as of December 31, 1994 ..................... $2,399 $ 1,353 $ -- $ 3,752
Purchased and capitalized ........................... 144 3,555 -- 3,699
Amortization ........................................ (240) (602) -- (842)
------ ------- ----- -------
Balance as of December 31, 1995 ..................... 2,303 4,306 -- 6,609
Purchased and capitalized ........................... 264 2,561 -- 2,825
Amortization ........................................ (360) (868) -- (1,228)
Provision for valuation allowance ................... -- -- (200) (200)
------ ------- ----- -------
Balance as of December 31, 1996 ..................... 2,207 5,999 (200) 8,006
Purchased and capitalized ........................... -- 3,533 -- 3,533
Amortization ........................................ (360) (1,394) -- (1,754)
Provision for valuation allowance ................... -- -- (285) (285)
Charge-offs ......................................... -- (85) 85 --
------ ------- ----- -------
Balance as of December 31, 1997 ..................... $1,847 $ 8,053 $(400) $ 9,500
====== ======= ===== =======
</TABLE>
At December 31, 1997, 1996 and 1995 mortgage loans partially or wholly
owned by others and serviced by the Company amounted to approximately
$971,041,000, $877,683,000 and $780,356,000, respectively, and are not reflected
in the accompanying consolidated financial statements because they are not
assets of the Company. During 1997, 1996 and 1995, the Company purchased
mortgage servicing rights to $228.8 million, $180.0 million and $303.6 million,
respectively, in residential first mortgage loans. These purchased balances are
included in the loans serviced for others reflected above. Gains resulting from
the capitalization of originated and excess mortgage servicing rights are
included in net gains on assets held for sale. Amortization of the mortgage
servicing assets and the provisions for the valuation allowance are included as
a reduction of mortgage banking income.
50
<PAGE> 57
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
(6) OTHER REAL ESTATE OWNED
The composition of other real estate owned at December 31 follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Residential real estate............................. $ 239 $ 456
Commercial real estate.............................. 66 544
Multi-family real estate............................ 336 658
Construction and land............................... -- 201
----- ------
641 1,859
Valuation allowance................................. (235) (176)
----- ------
$ 406 $1,683
===== ======
An analysis of the valuation allowance for the years ended December 31,
follows:
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year ........... $ 176 $ 413 $ 715
Provision .............................. 350 554 750
Net charge-offs ........................ (291) (791) (1,052)
Balance at end of year ................. $ 235 $ 176 $ 413
===== ===== =======
</TABLE>
Proceeds from the sale of other real estate owned totalled $3,182,000,
$3,958,000 and $7,972,000 during 1997, 1996 and 1995 respectively.
The components of losses on real estate operations, net, for the years ended
December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Net gains on sales ............................. $ 110 $ 162 $ 582
Rental income .................................. 26 44 123
Provisions for other real estate owned ......... (350) (554) (750)
Other operating expenses, net .................. (465) (787) (1,314)
Foreclosure expenses ........................... (292) (407) (644)
----- ------- -------
$(971) $(1,542) $(2,003)
===== ======= =======
(7) PREMISES AND EQUIPMENT
The composition of premises and equipment at December 31 follows:
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Land and buildings ................................... $11,809 $11,560
Furniture, fixtures and equipment .................... 3,321 4,775
Leasehold improvements ............................... 192 173
Construction in progress ............................. 41 163
------- -------
15,363 16,671
Less: accumulated depreciation ....................... (5,770) (6,477)
------- -------
$ 9,593 $10,194
======= =======
</TABLE>
Rent expense was $126,000, $108,000 and $81,000 for the years ended
December 31, 1997, 1996 and 1995, respectively. Rental income on portions of the
Company owned and occupied premises totalled $319,000, $244,000 and $354,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
51
<PAGE> 58
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
A summary of future minimum rental expense and income under non-cancellable
operating leases at December 31, 1997 follows:
<TABLE>
<CAPTION>
MINIMUM MINIMUM
RENTAL RENTAL
EXPENSE INCOME
------- ------
(IN THOUSANDS)
<C> <C> <C>
1998................................................ $195 $316
1999................................................ 113 165
2000................................................ 114 149
2001................................................ 96 76
2002................................................ 72 4
Thereafter.......................................... 142 --
</TABLE>
(8) STOCK IN FEDERAL HOME LOAN BANK OF BOSTON
As a voluntary member of the Federal Home Loan Bank ("FHLB") of Boston, the
Bank is required to invest in $100 par value stock of the FHLB of Boston in the
amount of 1% of its outstanding home loans or 5% of its outstanding advances
from the FHLB of Boston, whichever is higher. As and when such stock is
redeemed, the Bank would receive from the FHLB of Boston an amount equal to the
par value of the stock. At its discretion, the FHLB of Boston may declare
dividends on this stock. Such dividends, which are included in dividend income
on equity securities, amounted to $1,020,000, $934,000 and $877,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.
(9) DEPOSITS
The composition of deposits at December 31 follows:
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Non-interest bearing:
Demand deposit accounts....................... $ 79,501 .--% $ 60,245 .--%
Interest bearing:
NOW accounts.................................. 85,917 1.02 75,297 1.01
Regular savings accounts...................... 149,607 3.61 96,690 2.87
Money market deposit accounts................. 104,353 2.96 116,019 2.90
Variable rate certificates.................... 5,182 5.43 8,459 5.24
Fixed rate certificates....................... 522,422 5.89 467,601 5.80
-------- --------
Total deposits........................... $946,982 4.27% $824,311 4.18%
======== ==== ======== ====
</TABLE>
Time certificates in excess of $100,000 at December 31, 1997 and 1996
amounted to $85,126,000 and $71,806,000, respectively.
A summary of interest expense on deposits for the years ended December 31,
follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Now accounts ....................................... $ 740 $ 661 $ 711
Regular savings accounts ........................... 4,060 1,800 1,554
Money market deposit accounts ...................... 3,381 3,639 3,548
Certificates of deposit ............................ 30,070 25,592 23,433
------- ------- -------
Total interest expense on deposits............. $38,251 $31,692 $29,246
======= ======= =======
</TABLE>
Interest forfeitures resulting from early withdrawals from certificates of
deposit are credited to interest expense on deposits. Interest forfeitures
amounted to $148,000, $128,000 and $187,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
52
<PAGE> 59
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
The average interest rate on time certificates at December 31, 1997, by the
earlier of its repricing or period of maturity, follows:
<TABLE>
<CAPTION>
AVERAGE
AMOUNT RATE
------ -------
(DOLLARS IN THOUSANDS
<S> <C> <C>
Maturity in:
1998.................................................. $315,191 5.70%
1999.................................................. 167,564 6.10
2000.................................................. 22,706 6.07
2001.................................................. 13,234 6.27
2002.................................................. 8,909 6.14
--------
$527,604 5.87%
======== ====
</TABLE>
Included in the table above are variable rate time certificates, the
majority of which mature in 1998.
(10) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). These agreements are treated as financings, and
the obligations to repurchase securities sold are reflected as a liability in
the consolidated balance sheets and the securities underlying the agreements
remain in the asset accounts. The securities underlying the agreements are held
by third parties as custodian. In addition, the Banks have established overnight
corporate customer repurchase agreements whereby collateral is set aside by the
Banks' custodian and the rates paid approximate short term deposit rates. This
product allows the customer to invest excess cash at a market interest rate.
Generally, the outstanding collateral consists of U.S. government obligations
and GNMA mortgage-backed securities.
Information concerning securities sold under agreements to repurchase for
the years ended December 31, follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Outstanding at December 31.............................. $10,171 $2,833 $ 9,212
Outstanding collateral:
Amortized cost....................................... 14,029 5,222 13,820
Fair value........................................... 14,138 5,166 13,911
Average balance outstanding during the year............. 9,614 15,062 14,798
Maximum outstanding at any month-end.................... 21,752 36,499 32,382
Weighted average rate at year-end....................... 5.17% 4.35% 5.82%
Weighted average rate during the year................... 5.00% 5.20% 6.06%
</TABLE>
The repurchase agreements outstanding at December 31, 1997 matured on
January 1 and February 11, 1998. The reverse repurchase agreements outstanding
at December 31, 1996 matured on January 1, 1997 while those outstanding at
December 31, 1995 matured on January 17, 1996.
The Bank has established reverse repurchase lines of credit in the amount
of $310.0 million. These lines would be subject to the amount of securities
available for collateralization purposes.
53
<PAGE> 60
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
(11) FEDERAL HOME LOAN BANK ADVANCES
A summary of Federal Home Loan Bank advances by contractual maturities at
December 31 follows:
<TABLE>
<CAPTION>
1997 1996
--------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------ -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Within 1 year..................................... $143,570 5.73% $209,133 5.89%
Over 1 year to 2 years............................ 39,269 6.09 43,570 5.58
Over 2 years to 3 years........................... 20,048 6.06 6,269 5.68
Over 3 years to 5 years........................... 33,199 5.93 10,138 5.86
Over 5 years...................................... 12,475 5.93 2,475 6.29
-------- --------
$248,561 5.85% $271,585 5.84%
======== ==== ======== ====
</TABLE>
Included in the above table are $35,000,000 in callable advances using
their scheduled maturity dates. These advances have call dates beginning in 1999
and at subsequent intervals thereafter. In accordance with an agreement with the
FHLB of Boston, the Bank is required to maintain qualified collateral, as
defined by the FHLB, as collateral for its advances. This collateral is
primarily composed of the Bank's investment in the FHLB stock, its residential
mortgage and investment portfolios not otherwise pledged (see notes 3, 8 and
10). The Bank has the capacity to borrow an additional $540.0 million in
advances from the FHLB of Boston as of December 31, 1997. The Bank has lines of
credit established with various lenders totalling $310.0 million at December 31,
1997. These available sources would be subject to the amount of qualifying
collateral available for securitization purposes.
In the third quarter of 1996, the Bank elected early prepayment of selected
above market interest rate FHLB advances. A pretax loss of $298,000 was incurred
on the extinguishment of $19.1 million of such debts. The loss is recorded as an
extraordinary item, net of a tax benefit of approximately $125,000 (see note
12).
(12) FEDERAL AND STATE INCOME TAXES
The current and deferred components of income tax expense (benefit) for the
years ended December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current income tax expense:
Federal ..................................... $ 7,447 $3,520 $1,938
State ....................................... 843 361 299
------- ------ ------
8,290 3,881 2,237
------- ------ ------
Deferred income tax expense (benefit):
Federal ..................................... (389) (8) 2,857
State ....................................... (113) (109) 1,140
Change in valuation allowance ............... (500) (500) (600)
------- ------ ------
(1,002) (617) 3,397
------- ------ ------
Income tax expense before extraordinary item ..... 7,288 3,264 5,634
Federal and state tax effect of extraordinary item -- (125) --
------- ------ ------
Total income tax expense ....................... $ 7,288 $3,139 $5,634
======= ====== ======
</TABLE>
54
<PAGE> 61
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
The causes of the difference between the total expected income tax expense
computed by applying the Federal statutory rate to income before income taxes
and the reported income tax expense for the years ended December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Federal income tax expense at statutory rate ..................... $7,173 $ 5,571 $5,240
Tax effect of:
Dividends received deduction ................................ -- (2) (9)
State tax, net of federal benefit before valuation allowance,
excluding state impact of law change ...................... 475 589 935
Federal and state benefit of adjustment to deferred taxes
resulting from change in federal tax law .................. -- (2,500) --
Change in valuation allowance ............................... (500) (500) (600)
Other, net .................................................. 140 106 68
------ ------- ------
Income tax expense before extraordinary item ..................... $7,288 $ 3,264 $5,634
====== ======= ======
Effective income tax rate before extraordinary item 35.6% 20.5% 37.6%
====== ======= ======
</TABLE>
The existing net deductible temporary differences that give rise to the net
deferred income tax asset are expected to reverse in periods in which the
Company will generate net taxable income. At December 31, 1997, the net deferred
tax asset is supported by recoverable income taxes of approximately $11.1
million. It is management's belief that the valuation allowance is adequate to
reduce the total deferred tax asset to an amount that is more likely than not to
be realized. It should be noted, however, that factors beyond management's
control, such as the general state of the economy and real estate values, can
affect levels of taxable income and that no assurance can be given that
sufficient taxable income will be generated to fully absorb gross deductible
temporary differences.
The components of the net deferred taxes receivable for the years ended
December 31, follow:
<TABLE>
<CAPTION>
1997 1996
------ ------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses ...................................... $4,010 $3,954
Unrealized losses on writedown of other real estate owned ...... 37 190
Deferred benefits .............................................. 722 618
Depreciation ................................................... 278 32
Excess mortgage servicing fees ................................. 156 --
Other .......................................................... 502 520
------ ------
Gross deferred assets ........................................ 5,705 5,314
Valuation allowance ............................................ (328) (828)
------ ------
Net deferred tax assets before deferred tax liabilities .......... 5,377 4,486
------ ------
Deferred tax liabilities:
Deferred expenses .............................................. 2,465 2,571
Excess mortgage servicing fees ................................. -- 9
Security valuation adjustments on investments
available for sale .......................................... 745 201
Miscellaneous security valuation adjustments ................... 225 225
Other .......................................................... 110 106
------ ------
Gross deferred liabilities ................................... 3,545 3,112
------ ------
Net deferred income taxes receivable ............................. $1,832 $1,374
====== ======
</TABLE>
55
<PAGE> 62
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996, and 1995
In August 1996, provisions repealing the current thrift bad debt rules were
passed by Congress as part of "The Small Business Job Protection Act of 1996".
The new rules eliminated the 8% of taxable income method for deducting additions
to the tax bad debt reserves for all thrifts beginning after December 31, 1995.
These rules also required that thrift institutions recapture all or a portion of
their bad debt reserves added since the base year (the last taxable year
beginning before January 1, 1988). The Company had previously recorded a
deferred tax liability equal to the bad debt recapture and as such, the new
rules had no effect on net income or federal income tax expense. In addition,
the Company had recorded a deferred tax liability on a portion of the base year
reserves. As a result of the change in rules, the deferred tax liability was
reversed and recognized as a $2.5 million decrease in tax expense for 1996.
The unrecaptured base year reserves will not be subject to recapture as
long as the institution continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continue to be subject
to provisions of the present law that requires recapture in the case of certain
excess distributions to shareholders. The tax effect of pre-1988 bad debt
reserves subject to recapture in the case of certain excess distributions is
approximately $3.9 million.
(13) STOCKHOLDERS' EQUITY
Preferred Stock
The Company has established a series of 100,000 shares of preferred stock
designated as Series A Junior Participating Cumulative Preferred Stock, par
value $0.10 per share ("Series A Stock") and has declared a dividend of one
Preferred Stock Purchase Right (the "Right") for each outstanding share of the
Company's Common Stock.
Pursuant to a Shareholder Rights Plan, each Right entitles the holder to
purchase a unit consisting of one one-hundredth of a share of Series A Stock,
par value $0.10 per share, at an initial cash exercise price of $90.00 per unit,
subject to adjustment. The Rights are not exercisable and remain attached to all
outstanding shares of Common Stock until the earliest of (i) ten days following
a public announcement that a person or group of affiliated or associated persons
(an "Acquiring Person") has acquired beneficial ownership of 20% or more of the
outstanding shares of Common Stock (the date of said announcement being referred
to as the "Stock Acquisition Date"), (ii) ten business days following the
commencement of a tender offer or exchange offer that would result in a person
or group becoming an Acquiring Person or (iii) the declaration by the Board of
Directors that a person is an "Adverse Person", as such term is defined in the
Shareholder Rights Plan.
In the event that a Stock Acquisition Date occurs or the Board of Directors
determines that a person is an Adverse Person, each holder of a Right will be
entitled to receive upon exercise that number of units of Series A Stock having
a market value of two times the exercise price of the Right. In the event that,
at any time following the Stock Acquisition Date, (i) the Company is acquired in
a merger or other business combination transaction or (ii) 50% or more of the
Company's assets or earning power is sold, each holder of a Right shall
thereafter have the right to receive, upon exercise, common stock of the
acquiring company having a market value equal to two times the exercise price of
the Right. The Rights have no voting or dividend privileges and, until they
become exercisable, have no dilutive effect on the earnings of the Company.
The holders of Series A Stock would be entitled to preferred rights with
respect to dividends, voting and liquidation.
Retained Earnings
The Company may not declare or pay cash dividends on its common stock if
the effect thereof would cause its net worth to be reduced below regulatory net
worth requirements or if such declaration and payment would otherwise violate
regulatory requirements.
In connection with the Bank's conversion to a stock savings bank, a
liquidation account was established for the benefit of eligible deposit account
holders in the event of a complete liquidation. At December 31, 1997, the amount
of the liquidation account was approximately $712,000 (unaudited).
On October 17, 1996, the Company declared a 20% stock dividend distributed
on November 13, 1996. All earnings per share, dividends and share information
prior to December 31, 1996, has been retroactively adjusted to reflect this
stock dividend.
56
<PAGE> 63
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
The Banks are subject to various regulatory capital requirements
administered by 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 Banks' financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Banks
must meet specific capital guidelines that involve quantitative measures of the
Banks' assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Banks' 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 Banks to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to risk
weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes that as of December 31, 1997, the Banks
meet all capital adequacy requirements to which they are subject.
As of December 31, 1997, the most recent notification from the FDIC
categorized the Banks as well capitalized under the prompt corrective action
provisions. To be categorized as well capitalized, the Banks must maintain total
capital risk-based, Tier 1 capital risk-based, and Tier 1 capital leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes would cause a change in the Banks'
categorization.
The Company's and both Banks' actual capital amounts and ratios in addition
to the minimum capital requirements and well capitalized capital requirements at
December 31 follow:
<TABLE>
<CAPTION>
TO BE WELL
MINIMUMS CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY ACTION PROVISIONS
-------------- --------------------------------------- -----------------------------------------
(DOLLARS IN THOUSANDS)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997
Risk-based capital ratio:
Total Capital
Andover Bancorp, Inc. ... $115,474 15.0% $61,435 [Greater than or equal to] 8.0% $76,794 [Greater than or equal to] 10.0%
Andover Bank ............ 103,677 14.4 57,676 [Greater than or equal to] 8.0 72,095 [Greater than or equal to] 10.0
Andover Bank NH ......... 7,801 16.1 3,866 [Greater than or equal to] 8.0 4,832 [Greater than or equal to] 10.0
Tier 1 capital
Andover Bancorp, Inc. ... 105,875 13.8 30,718 [Greater than or equal to] 4.0 46,076 [Greater than or equal to] 6.0
Andover Bank ............ 94,665 13.1 28,838 [Greater than or equal to] 4.0 43,257 [Greater than or equal to] 6.0
Andover Bank NH ......... 7,403 15.3 1,933 [Greater than or equal to] 4.0 2,899 [Greater than or equal to] 6.0
Leverage capital ratio:
Tier 1 capital
Andover Bancorp, Inc. ... 105,875 8.2 51,901 [Greater than or equal to] 4.0 64,877 [Greater than or equal to] 5.0
Andover Bank ............ 94,665 7.7 48,892 [Greater than or equal to] 4.0 61,115 [Greater than or equal to] 5.0
Andover Bank NH ......... 7,403 8.7 3,402 [Greater than or equal to] 4.0 4,252 [Greater than or equal to] 5.0
AS OF DECEMBER 31, 1996
Risk-based capital ratio:
Total Capital
Andover Bancorp, Inc. ... 104,368 14.6 57,123 [Greater than or equal to] 8.0 71,404 [Greater than or equal to] 10.0
Andover Bank ............ 96,730 14.1 54,962 [Greater than or equal to] 8.0 68,702 [Greater than or equal to] 10.0
Andover Bank NH ......... 4,441 16.4 2,165 [Greater than or equal to] 8.0 2,707 [Greater than or equal to] 10.0
Tier 1 capital
Andover Bancorp, Inc. ... 95,442 13.4 28,562 [Greater than or equal to] 4.0 42,843 [Greater than or equal to] 6.0
Andover Bank ............ 88,142 12.8 27,481 [Greater than or equal to] 4.0 41,221 [Greater than or equal to] 6.0
Andover Bank NH ......... 4,346 16.1 1,083 [Greater than or equal to] 4.0 1,624 [Greater than or equal to] 6.0
Leverage capital ratio:
Tier 1 capital
Andover Bancorp, Inc. ... 95,442 8.0 47,634 [Greater than or equal to] 4.0 59,543 [Greater than or equal to] 5.0
Andover Bank ............ 88,142 7.7 46,073 [Greater than or equal to] 4.0 57,592 [Greater than or equal to] 5.0
Andover Bank NH ......... 4,346 10.7 1,618 [Greater than or equal to] 4.0 2,022 [Greater than or equal to] 5.0
</TABLE>
57
<PAGE> 64
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
(14) OTHER INCOME
Components of other income for the years ended December 31, follow:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Deposit account service charges ............ $1,761 $1,557 $1,579
Loan late charges and other fees ........... 407 437 243
Rental income .............................. 319 244 354
Gain on sale of a non-marketable security... -- -- 220
Other ...................................... 805 471 705
------ ------ ------
$3,292 $2,709 $3,101
====== ====== ======
</TABLE>
(15) EMPLOYEE BENEFITS
Pension Plan
The Company sponsors a non-contributory defined benefit pension plan that
covers all employees who meet specified age and length of service requirements,
which is administered by the Savings Banks Employees Retirement Association
("SBERA"). The plan provides for benefits to be paid to eligible employees at
retirement based primarily upon their years of service with the Company and
compensation levels near retirement. Contributions to the plan are funded
currently and reflect benefits attributed to employees' service to date, as well
as services expected to be earned in the future. The plan assets are invested
primarily in U.S. government obligations, corporate bonds and equity securities.
The funded status of the plan for the years ended October 31, the plan's
latest valuation dates, and amounts to be amortized systematically over
subsequent periods follow:
<TABLE>
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Vested benefits ......................................... $ 3,077 $ 2,758
Non-vested benefits ..................................... 51 70
------- -------
Accumulated benefit obligation .......................... 3,128 2,828
Additional benefits related to future compensation levels 2,817 2,164
------- -------
Projected benefit obligation ............................ 5,945 4,992
Plan assets at fair value ............................... 5,194 4,269
------- -------
Plan assets less than projected benefit obligation ...... (751) (723)
Unrecognized net gain ................................... (426) (293)
Unamortized transition asset ............................ (182) (196)
------- -------
Accrued pension cost .................................... $(1,359) $(1,212)
======= =======
Net periodic pension expense for the years ended December 31, follows:
<CAPTION>
1997 1996 1995
----- ----- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Service cost - benefits earned during the year ....... $ 564 $ 545 $ 401
Interest cost on projected benefit obligation ........ 364 357 315
Actual return on plan assets ......................... (645) (528) (531)
Net amortization and deferral ........................ 243 213 301
----- ----- -----
Net periodic pension expense ......................... $ 526 $ 587 $ 486
===== ===== =====
Assumptions used to develop the net periodic pension benefit obligation
follow:
Discount rate......................................... 7.00% 7.50% 7.00%
Rate of increase in compensation levels............... 4.75% 5.00% 5.00%
Assumptions used to develop the net periodic pension expense follow:
Discount rate.......................................... 7.50% 7.00% 8.00%
Rate of increase in compensation levels................ 5.00% 5.00% 5.00%
Expected long-term rate of return on assets............ 9.00% 9.00% 9.00%
</TABLE>
58
<PAGE> 65
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Postretirement Benefits Other Than Pensions
In addition to the Bank's non-contributory defined benefit pension plan,
the Bank provides health care and life insurance benefits for certain retired
employees and dependents. This unfunded plan also covered active employees over
the age of 55 and 20 years of service to the Bank as of the date of adoption for
health benefits and subject to a limitation upon retirement.
The status of the plan for the years ended December 31, follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees and dependents ......................... $333 $248
Active employees ................................ -- --
---- ----
Total accumulated postretirement benefit obligation $333 $248
==== ====
Accrued postretirement benefit cost ............... $282 $269
==== ====
</TABLE>
The net periodic postretirement benefit expense for the years ended
December 31, 1997, 1996 and 1995 totalled $21,000, $17,000 and $17,000,
respectively.
Stock Option Plans
The Company has stock options available under two separate plans for the
benefit of certain officers and non-employee directors. The first plan, the 1986
Stock Option Plan, had 600,000 shares of authorized but unissued common stock.
All but 3,600 shares were granted prior to the Plan's expiration in 1996. A
second plan, the Stock Incentive Plan, was adopted in 1995 with 249,134 shares
of authorized but unissued common stock. The exercise price of any option
granted will be equal to the fair market value of the Common Stock on the date
the option is granted. Stock options are exercisable over various periods
commencing on the date of the grant and in no event later than ten years after
the date of the grant.
A summary of stock option activity for the years ended December 31,
follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------- --------------------- ----------------------
WTD. AVG. WTD. AVG. WTD. AVG.
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year....... 390,691 $15.74 336,612 $13.43 285,468 $11.73
Granted........................... 47,800 38.13 105,600 20.71 85,800 17.47
Exercised......................... (34,184) 12.56 (49,721) 10.80 (34,656) 9.47
Forfeited......................... -- -- (1,800) 12.26 -- --
------- -------- -------
Outstanding at end of year............. 404,307 18.65 390,691 15.74 336,612 13.43
======= ======= =======
Exercisable at end of year............. 380,506 18.61 360,691 15.55 312,612 13.12
======= ======= =======
Shares reserved for future grants...... 189,934 237,734 346,934
======= ======= =======
A summary of options outstanding and exercisable by price range as of December 31 follows:
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -----------------------------------------------------
OUTSTANDING WTD. AVG. EXERCISABLE
RANGE OF AS OF REMAINING WTD. AVG. AS OF WTD. AVG.
EXERCISE PRICES 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE 12/31/97 EXERCISE PRICE
--------------- ----------- ---------------- -------------- ----------- --------------
(IN YEARS)
<S> <C> <C> <C> <C> <C> <C>
$ 2.7000 - $ 5.0000 17,007 4.1 $ 4.6582 17,007 $ 4.6582
$ 8.0000 - $ 9.0000 26,995 4.8 $ 8.2560 26,995 $ 8.2560
$11.8750 - $15.7500 82,725 6.0 $12.7062 82,725 $12.7062
$17.5000 - $17.7500 124,780 7.2 $17.5540 112,780 $17.5598
$18.5000 - $21.5000 105,000 8.3 $20.7211 95,400 $20.9089
$27.3750 - $27.5000 7,900 9.2 $27.4129 6,299 $27.3908
$40.2500 - $40.2500 39,900 9.9 $40.2500 39,300 $40.2500
------- -------
404,307 7.3 $18.6538 380,506 $18.6138
======= === ======== ======= ========
</TABLE>
59
<PAGE> 66
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997, 1996 and 1995
The Company applies APB Opinion No. 25 in accounting for stock options and,
accordingly, no compensation expense has been recognized in the financial
statements. Had the Company determined compensation expense based on the fair
value at the grant date for its stock options under SFAS 123, the Company's net
income would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net income as reported...................................... $13,206 $12,479 $9,338
Pro forma net income........................................ 12,803 12,156 9,032
Earnings per common share as reported (basic)............... 2.57 2.44 1.84
Pro forma earnings per common share (basic)................. 2.49 2.38 1.79
Earnings per common share as reported (diluted)............. 2.49 2.40 1.82
Pro forma earnings per common share (diluted)............... 2.41 2.34 1.76
</TABLE>
Pro forma net income reflects only options granted since 1995, therefore,
the full impact of calculating the compensation expense for stock options under
SFAS 123 is not reflected in the pro forma net income amounts provided above
since options granted prior to January 1, 1995 are not considered. The per share
weighted average fair value of stock options granted during 1997, 1996 and 1995
was $10.35, $4.59 and $4.25, respectively, on the date of grant. These fair
values were determined using the Black Scholes option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Expected dividend yield..................................... 3.00% 3.00% 3.00%
Risk-free interest rate..................................... 5.84% 6.65% 5.44%
Expected volatility......................................... 25.00% 25.00% 25.00%
Expected life (years)....................................... 7.00 6.20 5.72
</TABLE>
Employee Stock Ownership Plan
The Company maintains an Employee Stock Ownership Plan (the "ESOP") that
covers all employees who meet specified age and length of service requirements.
Contributions are made for the purchase of additional shares of Company stock
and accordingly, a charge to salaries and employee benefits expense is recorded.
During 1997, the Company changed the fiscal year end of the ESOP to October 31,
1997 to coincide with the fiscal year end of the defined benefit pension plan.
Approximately 12,253 shares of common stock were purchased in the open market
during 1997 at an average price of $30.56 per share, which when combined with
forfeited shares are allocated to participants proportionately to their gross
wages. In 1996, 14,063 shares were purchased at an average price of $23.05 per
share while 19,819 shares were purchased in 1995 at an average price of $20.19
per share. Contributions by the Bank to the ESOP for participants for the year
ended October 31, 1997 and the years ended December 31, 1996 and 1995 were
$385,000, $325,000 and $402,000, respectively.
Thrift Incentive Plan
The Company has an employee tax deferred thrift incentive plan (401K) under
which individual employee contributions to the plan are matched within certain
limitations by the Banks. All employees who meet specified age and length of
service requirements are eligible to participate in the 401K plan. The amounts
matched by the Banks are included in salaries and employee benefits expense. The
amounts matched for the years ended December 31, 1997, 1996 and 1995 were
$71,000, $54,000 and $49,000, respectively.
Officers Incentive Compensation Plan
The Incentive Compensation Plan provides for the payment of bonuses to
officers under certain circumstances based upon the Company's pre-tax earnings
adjusted for gains or losses from sales of assets, targeted returns on assets
and equity, its performance versus its peer group, and the individual's
accomplishment of established goals and objectives. Amounts are to be allocated
to participants as determined by the Company's Compensation and Option Committee
based on the recommendation of the President and subject to approval by its
Board of Directors. In 1997, 1996 and 1995, $318,000, $293,000 and $255,000,
respectively, was charged to salaries and employee benefits expense under this
plan.
60
<PAGE> 67
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997, 1996 and 1995
Executive Officer Employment and Termination Agreements
The Company maintains an employment agreement with its President and Chief
Executive Officer. The employment agreement generally provides for the continued
payment of specified compensation and benefits for specified periods after
termination, unless the termination is for "cause" as defined in the employment
agreement. In addition, the Company has entered into special termination
agreements with its President and Chief Executive Officer and certain other
executives which provide for the payment, under certain circumstances, of
lump-sum amounts upon termination following a "change of control" which is
generally defined to mean a person or group acquiring ownership of 25% or more
of the shares of the Company.
Deferred Compensation Plan
The Company has adopted a deferred compensation plan for its directors
whereby a non-employee director can elect to defer earned fees to future years
with benefits commencing at retirement. In 1996, this unfunded plan was amended
to allow the directors to change their deferred compensation account to
equivalent stock units in the Company's common stock, permit distribution upon
retirement to be paid in shares of common stock, or to choose to receive
interest credits based on an equivalent rate on a term certificate of deposit.
The deferred compensation attributed to the directors for the years ended
December 31, 1997, 1996 and 1995 totalled $88,900, $54,300 and $48,100,
respectively. In 1997, 3,421 equivalent stock units were purchased at an average
price of $29.92 and in 1996, 9,223 equivalent stock units were purchased at an
average price of $20.12.
(16) FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets and liabilities that are not
considered financial assets or liabilities include real estate acquired by
foreclosure, the deferred income tax asset, office properties and equipment, and
core deposit and other intangibles. In addition, the tax ramifications related
to the realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in any of the
estimates. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company. The estimated fair value amounts
have been determined by using available quoted market information or other
appropriate valuation methodologies.
The fair value estimates provided are made at a specific point in time,
based on relevant market information and the characteristics of the financial
instrument. The estimates do not provide for any premiums or discounts that
could result from concentrations of ownership of a financial instrument. Because
no active market exists for a portion of the Company's financial instruments,
certain fair value estimates are based on subjective judgments regarding current
economic conditions, risk characteristics of the financial instruments, future
expected loss experience, prepayment assumptions, and other factors. The
resulting estimates involve uncertainties and therefore cannot be determined
with precision. Changes made to any of the underlying assumptions could
significantly affect the estimates.
Financial instruments actively traded in a secondary market have been
valued at December 31 using quoted available market prices follow:
<TABLE>
<CAPTION>
1997 1996
---------------------- ---------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets held for sale..................... $ 5,537 $ 5,624 $ 2,220 $ 2,220
Investments available for sale........... 139,054 139,054 114,125 114,125
Investments held to maturity............. 129,363 130,947 136,926 137,007
</TABLE>
61
<PAGE> 68
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
December 31, 1997, 1996 and 1995
The fair values at December 31 of financial instruments with stated
maturities have been estimated by discounting cash flows with a discount rate
approximately equal to the current market rate for similar instruments follow:
<TABLE>
<CAPTION>
1997 1996
------------------------ ------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans receivable, net............................ $966,302 $976,150 $857,806 864,334
Mortgage servicing assets........................ 9,500 10,488 8,006 8,895
Fixed rate certificates.......................... 522,422 525,322 467,601 469,223
Federal Home Loan Bank advances.................. 248,561 248,435 271,585 271,517
The fair values at December 31 of financial instruments with no maturity or
short-term maturities that approximate their carrying amounts are as follow:
<CAPTION>
1997 1996
------------------------ ------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash and due from banks.......................... $ 21,586 $ 21,586 $20,489 $20,489
Short-term investments............................ 14,150 14,150 25,600 25,600
Accrued interest receivable...................... 7,567 7,567 7,164 7,164
Stock in FHLB.................................... 15,747 15,747 15,747 15,747
Demand deposit accounts.......................... 79,501 79,501 60,245 60,245
NOW accounts..................................... 85,917 85,917 75,297 75,297
Regular savings accounts......................... 149,607 149,607 96,690 96,690
Money market deposit accounts.................... 104,353 104,353 116,019 116,019
Variable rate certificates....................... 5,182 5,182 8,459 8,459
Securities sold under agreements to repurchase... 10,171 10,171 2,833 2,833
Mortgagors' escrow accounts...................... 2,478 2,478 2,294 2,294
</TABLE>
The following methods and assumptions were used to estimate fair value of
each class of financial instrument for which it is practicable to estimate fair
value. The fair values for investments available for sale and held to maturity
are based on quoted bid prices received from securities dealers. Commitments to
originate loans and forward commitments to sell loans have been considered in
the value of assets held for sale. Loans are estimated by discounting
contractual cash flows adjusted for prepayment estimates and using discount
rates approximately equal to current market rates on loans with similar
characteristics and maturities. The incremental credit risk for non-performing
loans has been considered in the determination of the fair value of loans.
Excess servicing is based on the present value of the estimated cash flows using
a current risk rate and taking into consideration estimated prepayments. Fixed
rate certificates and Federal Home Loan Bank advances are based on the
discounted value of contractual cash flows. The discount rates used are
representative of approximate rates currently offered on instruments with
similar remaining maturities. The fair values for cash and short-term
investments approximate their carrying amounts because of the short maturity of
these instruments. The fair values of accrued interest receivable, variable rate
certificates, securities sold under agreements to repurchase and mortgagors'
escrow accounts approximate their carrying amounts because of the short-term
nature of these financial instruments. The fair value of stock in the Federal
Home Loan Bank of Boston equals its carrying amount as reported in the balance
sheet because this stock is redeemable only at full par by the FHLB. The fair
values of demand deposit accounts, NOW accounts, regular savings accounts and
money market accounts are equal to their respective carrying amounts since they
are equal to the amounts payable on demand at the reporting date. The Company's
commitments for unused lines and outstanding standby letters of credit and
unadvanced portions of loans are at floating rates and, therefore, there is no
fair value adjustment.
62
<PAGE> 69
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
December 31, 1997, 1996 and 1995
(17) CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The following are the condensed financial statements for Andover Bancorp,
Inc., referred to as the "Parent Company" for purposes of this Note only, as of
December 31 follow:
BALANCE SHEETS
<TABLE>
<CAPTION>
1997 1996
-------- -------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash and interest-bearing deposits in subsidiaries .............. $ 3,611 $ 3,015
Investment in subsidiaries, at equity ........................... 103,272 92,977
Other assets .................................................... 349 2
-------- -------
Total assets .......................................... $107,232 $95,994
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accrued income taxes ....................................... $ 2 $ 2
Accrued expenses ........................................... 151 146
-------- -------
Total liabilities ..................................... 153 148
-------- -------
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; 5,168,114 and 5,154,792 shares issued
in 1997 and 1996, respectively .......................... 517 515
Additional paid-in capital ................................. 59,619 59,222
Retained earnings .......................................... 45,814 36,109
Treasury stock, at cost (20,862 shares in 1996) ............ -- (301)
Unrealized gains on investments available for sale, net .... 1,129 301
-------- -------
Total stockholders' equity ............................ 107,079 95,846
-------- -------
Total liabilities and stockholders' equity ............ $107,232 $95,994
======== =======
STATEMENTS OF OPERATIONS
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
------- ------- ------
(IN THOUSANDS)
<S> <C> <C> <C>
Dividends from bank subsidiaries ........................ $ 7,000 $ 4,500 $1,500
Interest income from deposits in subsidiaries ........... 94 74 95
------- ------- ------
Total operating income ............................... 7,094 4,574 1,595
Non-interest expenses ................................... 334 240 1,362
------- ------- ------
Income before income tax expense (benefit) and
equity in net income of subsidiaries ................. 6,760 4,334 233
Income tax expense (benefit) ............................ 21 93 (380)
------- ------- ------
Income before equity in net income of subsidiaries ...... 6,739 4,241 613
Equity in net income of subsidiaries .................... 6,467 8,238 8,725
------- ------- ------
Net income .............................................. $13,206 $12,479 $9,338
======= ======= ======
</TABLE>
The Parent Company's statements of changes in stockholders' equity are
identical to the consolidated statements of changes in stockholders' equity and
therefore are not presented here.
63
<PAGE> 70
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ................................................. $13,206 $12,479 $ 9,338
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiaries ......... (6,467) (8,238) (8,725)
(Increase) decrease in other assets ........................ (347) -- 423
Increase in other liabilities .............................. 5 51 34
------- ------- -------
Net cash provided by operating activities ............. 6,397 4,292 1,070
------- ------- -------
Cash flows from investing activities:
Investments in subsidiary .................................. (3,000) (1,000) (4,000)
------- ------- -------
Net cash used by investing activities ................. (3,000) (1,000) (4,000)
------- ------- -------
Cash flows from financing activities:
Stock options exercised .................................... 700 653 345
Dividends paid to stockholders ............................. (3,501) (2,553) (1,856)
------- ------- -------
Net cash used by financing activities ................. (2,801) (1,900) (1,511)
------- ------- -------
Net increase (decrease) in cash and interest-bearing
deposits in subsidiaries ...................................... 596 1,392 (4,441)
Cash and interest-bearing deposits in subsidiaries at
beginning of year ............................................. 3,015 1,623 6,064
------- ------- -------
Cash and interest-bearing deposits in subsidiaries at
end of year ................................................... $ 3,611 $ 3,015 $ 1,623
======= ======= =======
Supplemental cash flow information: Cash paid during the year for:
Income taxes ............................................... $ 21 $ 13 $ --
</TABLE>
(18) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, COMMITMENTS AND
CONTINGENCIES
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans, standby letters of credit,
recourse arrangements on assets sold, and forward commitments to sell loans. The
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the Consolidated Balance Sheets. The
contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters of
credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. For forward commitments to sell loans and mortgage-backed
securities, the contract or notional amounts do not represent exposure to credit
loss. The Company monitors the credit risk of its forward commitments through
credit approvals, limits, and monitoring procedures.
64
<PAGE> 71
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
Financial instruments with off-balance sheet risk at December 31 follow:
<TABLE>
<CAPTION>
CONTRACT OR
NOTIONAL AMOUNT
------------------------
1997 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Financial instruments whose contract amounts represent credit risk:
Commitments to originate loans:
Fixed rate loans..................................................... $15,993 $11,041
Adjustable rate loans................................................ 20,976 16,853
------- -------
Total commitments to originate loans............................... 36,969 27,894
Unadvanced lines on home equity and reserve lines of credit............ 77,391 72,097
Unadvanced lines on commercial loans................................... 12,671 11,096
Unadvanced portions of construction and land loans..................... 21,300 18,560
Standby letters of credit.............................................. 2,367 1,805
Loans sold with recourse............................................... 2,777 4,180
Financial instruments whose notional or contract amounts exceed the amount
of credit risk:
Forward commitments to sell loans and mortgage-backed securities $ 7,820 $ 3,000
</TABLE>
Commitments to originate loans, unused lines of credit, and unadvanced
portions of loans are agreements to lend to a customer provided there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since a portion of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on management's credit
evaluation of the borrower. Collateral held varies but may include accounts
receivable, inventory, equipment and real estate. Standby letters of credit are
conditional commitments issued by the Company to guarantee the performance by a
customer to a third party. The credit risk in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company has retained credit risk on certain residential mortgage loans
sold with recourse prior to June, 1990. Accordingly, the Company has retained
the risk of loss resulting from any foreclosures on such loans.
Forward commitments to sell loans or mortgage-backed securities are
contracts which the Company enters into for the purpose of reducing the interest
rate risk associated with originating loans for sale. In order to fulfill a
forward commitment, the Company typically exchanges its current production of
loans for mortgage-backed securities through FNMA or FHLMC which are then
delivered to a national securities firm at a future date at prices or yields
specified by the contracts. Risks may arise from the possible inability of the
Company to originate loans to fulfill these contracts, in which case the Company
would normally purchase securities in the open market to deliver against the
contract. Unrealized gains and losses on contracts used for the Company's closed
loans and pipeline of loans expected to close are considered in adjusting
carrying values of the loans held for sale to the lower of cost or market.
As a nonmember of the Federal Reserve System, the Company is required to
maintain certain reserve requirements of vault cash and/or deposits with the
Federal Reserve Bank of Boston. The amount of this reserve requirement, included
in "Cash and due from banks", was $828,000 and $4,543,000 at December 31, 1997
and 1996, respectively.
A number of legal claims against the Company arising in the normal course of
business were outstanding at December 31, 1997. Management, after reviewing
these claims with legal counsel, is of the opinion that the resolution of these
claims will not have a material effect on the Company's financial position.
65
<PAGE> 72
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
(19) ACQUISITIONS
On September 19, 1994, the Company signed a definitive agreement to acquire
Finest Financial Corp. ("Finest") and its subsidiary, Pelham Bank and Trust
Company. In the second quarter of 1995, the stockholders of Finest failed to
approve the merger and Andover recorded a charge to earnings of $1.0 million in
connection with merger related expenses. In the second quarter of 1996, the
Company executed a merger termination agreement with Finest which resulted in a
pretax recovery of $225,000.
(20) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarterly earnings per share is calculated by dividing quarterly net income
by the average shares outstanding each quarter. Therefore, the sum of the
quarters may not equal the net earnings per common share for the year. A
discussion of the difference between basic and diluted earnings per share is
presented in footnote 1. The per share data has been restated for the first
three quarters of 1996 to reflect a 20% stock dividend distributed on November
13, 1996.
Summaries of consolidated operating results on a quarterly basis for the
years ended December 31, follow:
<TABLE>
<CAPTION>
1997 QUARTERS
-----------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH
------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest and dividend income.................... $21,965 $22,283 $22,759 $23,745
Interest expense................................ 12,486 12,798 13,107 13,656
------- ------- ------- -------
Net interest and dividend income................ 9,479 9,485 9,652 10,089
Provision for loan losses....................... 330 223 130 300
Losses on real estate operations............... (357) (228) (235) (151)
Non-interest income............................. 1,350 1,504 1,503 1,372
Non-interest expense........................... 5,168 5,556 5,520 5,742
------- ------- ------- -------
Income before income tax expense ............... 4,974 4,982 5,270 5,268
Income tax expense.............................. 1,766 1,800 1,922 1,800
------- ------- ------- -------
Net income....................................... $ 3,208 $ 3,182 $ 3,348 $ 3,468
======= ======= ======= =======
Basic earnings per common share................ $ 0.62 $ 0.62 $ 0.65 $ 0.67
======= ======= ======= =======
Diluted earnings per common share.............. $ 0.61 $ 0.60 $ 0.63 $ 0.65
======= ======= ======= =======
Dividends declared per share.................... $ 0.15 $ 0.17 $ 0.17 $ 0.19
======= ======= ======= =======
</TABLE>
66
<PAGE> 73
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1996 QUARTERS
----------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Interest and dividend income .................. $ 20,070 $ 20,714 $ 21,390 $ 21,649
Interest expense .............................. 11,586 11,897 12,496 12,550
-------- -------- -------- -------
Net interest and dividend income .............. 8,484 8,817 8,894 9,099
Provision for loan losses ..................... 395 360 1,305 (a) 495
Losses on real estate operations .............. (477) (391) (371) (303)
Non-interest income ........................... 1,313 1,321 297 (b) 1,608
Merger expense (recovery) ..................... -- (225) -- --
Non-interest expense .......................... 4,617 4,997 5,436 4,995
-------- -------- -------- -------
Income before income tax expense (benefit)
and extraordinary item ...................... 4,308 4,615 2,079 4,914
Income tax expense (benefit) .................. 1,576 1,695 (1,743)(c) 1,736
-------- -------- -------- -------
Income before extraordinary item .............. 2,732 2,920 3,822 3,178
-------- -------- -------- -------
Extraordinary item, net of tax ................ -- -- (173) --
-------- -------- -------- -------
Net income .................................... $ 2,732 $ 2,920 $ 3,649 $ 3,178
========= ======== ======== ========
Earnings per common share (basic):
Income per share before extraordinary item... $ 0.54 $ 0.57 $ 0.75 $ 0.62
Extraordinary item per share, net of tax .... -- -- (0.03) --
-------- -------- -------- -------
Net income per share ........................ $ 0.54 $ 0.57 $ 0.72 $ 0.62
======== ======== ======== =====
Earnings per common share (diluted):
Income per share before extraordinary item... $ 0.53 $ 0.56 $ 0.73 $ 0.60
Extraordinary item per share, net of tax .... -- -- (0.03) --
-------- -------- -------- -------
Net income per share ........................ $ 0.53 $ 0.56 $ 0.70 $ 0.60
======== ======== ======== =======
Dividends declared per share .................. $ 0.10 $ 0.13 $ 0.13 $ 0.15
======== ======== ======== =======
</TABLE>
(a) Increased provision for loan losses reflects the restructuring of a
previously reported potential problem loan and increased loan growth.
(b) Includes a pre-tax loss of $870,000 from the sale of low yielding
investments.
(c) Includes a tax benefit of $2.5 million from a change in federal tax law.
67
<PAGE> 74
FORM 10-K
CROSS REFERENCE INDEX
Part I
Page
Item 1 Business......................................................... 2
Item 2 Properties....................................................... 9
Item 3 Legal Proceedings................................................ 10
Item 4 Submission of Matters to a Vote of Security Holders.............. 10
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters.............................................. 10
Item 6 Selected Consolidated Financial Data............................. 11
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 12
Item 8 Financial Statements and Supplementary Data......................(See
Item 14 below)
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................. Non-
Applicable
Part III
The information called for by Part III (Items 10 through 13) is incorporated
herein by reference from Andover's Definitive Notice of Annual Meeting and Proxy
Statement for the 1998 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
Part IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements -
Independent Auditors' Report.............................. 36
Consolidated Balance Sheets as of December 31, 1997
and 1996.................................................. 37
Consolidated Statements of Operations for each of the
years ended December 31, 1997, 1996 and 1995............. 38
Consolidated Statements of Changes in Stockholders'
Equity for each of the years ended
December 31, 1997, 1996 and 1995.......................... 39
Consolidated Statements of Cash Flows for each of the
years ended December 31, 1997, 1996 and 1995.............. 40-41
Notes to Consolidated Financial Statements................ 42-67
68
<PAGE> 75
(2) All financial statement schedules are omitted because they are
not applicable, the data is not significant, or the required
information is shown elsewhere in this report.
(b) Reports on Form 8-K. There were no reports filed on Form 8-K
during the three months ended December 31, 1997.
(c) List of Exhibits
Exhibits to the Form 10-K have been included only with the copies
of the Form 10-K filed with the SEC. Upon request to Shareholder
Relations, Andover Bancorp, Inc., 61 Main Street, Andover,
Massachusetts 01810, copies of the individual exhibits will be
furnished upon payment of a reasonable fee.
Exhibit No. Description of Exhibits
- ----------- -----------------------
3.1 Restated Certificate of Incorporation of Andover (incorporated
herein by reference to Exhibit 3.1 to Post-Effective Amendment
No. 1 to Andover's Registration Statement on Form S-4 No.
33-11891 filed on March 5, 1987).
3.2 By-laws of Andover, as amended and restated, January 23, 1997
(incorporated herein by reference to Exhibit 3.2 to Andover's
Form 10-K for the fiscal year ended December 31, 1996).
4.1 Specimen of Andover Bancorp, Inc. common stock certificate
(incorporated herein by reference to Exhibit 4 to Andover's
Registration Statement on Form S-4, Registration No. 33-11891,
filed on February 11, 1987).
4.2 Shareholder Rights Agreement between Andover Bancorp, Inc. and
The First National Bank of Boston (incorporated herein by
reference to an Exhibit to Andover's Current Report on Form 8-K
dated February 21, 1989).
4.3 Amendment to Shareholder Rights Agreement between Andover
Bancorp, Inc. and The First National Bank of Boston (incorporated
herein by reference to Exhibit 4.2 to Andover's Current Report on
Form 8-K dated February 12, 1990).
10.1 Employment Agreement between Andover, Andover Bank and Gerald T.
Mulligan, dated May 16, 1991 (incorporated herein by reference to
Exhibit 10.1 to Andover's Form 10-K for the fiscal year ended
December 31, 1991).
10.2 Special Termination Agreement between Andover, Andover Bank and
Gerald T. Mulligan, dated May 16, 1991, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.2 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.3 Special Termination Agreement between Andover, Andover Bank and
Joseph F. Casey, dated December 17, 1992, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.3 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.4 Special Termination Agreement between Andover, Andover Bank and
Michael J. Ecker, dated December 17, 1992, as amended and
restated through January 23, 1997 (incorporated herein by
reference to Exhibit 10.4 to Andover's Form 10-K for the fiscal
year ended December 31, 1996).
69
<PAGE> 76
10.5 Special Termination Agreement between Andover, Andover Bank and
John R. Heerwagen, dated December 17, 1992, as amended and
restated through January 23, 1997 (incorporated herein by
reference to Exhibit 10.5 to Andover's Form 10-K for the fiscal
year ended December 31, 1996).
10.6 Special Termination Agreement between Andover, Andover Bank and
Octavio C. Bolivar, dated January 24, 1994, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.6 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.7 Andover Savings Bank Employees' Stock Ownership Plan and Trust
Agreement and Amendment No. 1 (incorporated herein by reference
to Exhibit 10(c) to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1987).
10.8 Andover Bancorp, Inc. Stock Option Plan dated May 8, 1986, as
amended May 22, 1986, January 29, 1987, and November 2, 1987
(incorporated herein by reference to Exhibit 10(h) to Andover's
Annual Report on Form 10-K for the fiscal year ended December 31,
1987).
10.9 Special Termination Agreement between Andover, Andover Bank and
Raymond P. Smith, dated December 12, 1995, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.9 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.10 Andover Bancorp, Inc. 1995 Stock Incentive Plan, dated February
16, 1995 (incorporated herein by reference to Exhibit 10.11 to
Andover's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.11 Deferred Compensation Plan for Directors of Andover Bancorp, Inc.
and its Subsidiaries, effective July 1, 1993, as amended and
restated, February 22, 1996 (incorporated herein by reference to
Exhibit 10.12 to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.12 Andover Bancorp, Inc. Special Termination Plan, effective January
23, 1997 (incorporated herein by reference to Exhibit 10.12 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
11 The computation of per share earnings can be readily determined
from the material contained in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1997.
12 As the Company does not have any debt securities registered under
Section 12 of the Securities Act of 1933, no ratio of earnings to
fixed charges appears in this Annual Report on Form 10-K.
13 Andover Bancorp, Inc. 1997 Annual Report, which, except for those
portions expressly incorporated herein by reference, is furnished
only for the information of the Securities and Exchange
Commission and is not deemed to be filed.
21 The Company has two subsidiaries, Andover Bank and Andover Bank
NH. Andover Bank is a Massachusetts savings bank in stock form
while Andover Bank NH is a New Hampshire guaranty savings bank in
stock form. Both subsidiaries are included in the Consolidated
Financial Statements filed in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1997.
23.1 Consent of KPMG Peat Marwick LLP.
70
<PAGE> 77
SHAREHOLDER INFORMATION
TRANSFER AGENT AND REGISTRAR - BANKBOSTON, NA
Our Transfer Agent is responsible for our shareholder records, issuance of stock
certificates, distribution of our dividend and the IRS Form 1099 and
administration of our dividend reinvestment and stock purchase program. Your
requests as shareholders, concerning these matters, are most efficiently
answered by corresponding directly with BankBoston, NA at the following address:
BankBoston, NA
Shareholder Services
Mail Stop 45-02-64, PO Box 8040
Boston, MA 02266
781*575*3001 800*730*4001
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN/GENERAL INFORMATION
Shareholders may obtain a brochure containing a detailed description of the Plan
or other general shareholder information by corresponding directly with Andover
Bancorp, Inc. at the following address:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
KPMG Peat Marwick LLP
99 High Street
Boston, MA 02110
FORM 10K
An additional copy of Andover's Annual Report for 1997 on Form 10-K, as filed
with the Securities and Exchange Commission pursuant to the Securities and
Exchange Act of 1934, may be obtained without charge by contacting:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
FDIC COMPLIANCE
A copy of this report is being made available to the public on request as
required by the Federal Deposit Insurance Corporation ("FDIC"). The contents of
this report have not been reviewed, or confirmed for the accuracy or relevance
by the FDIC. A copy of Management's Report on the effectiveness of the Company's
internal control structure over financial reporting and the Independent
Accountants' Report of KPMG Peat Marwick LLP thereon, may be obtained without
charge by contacting:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
================================================================================
ANDOVER BANK DIRECTORS
Thomas F. Caffrey*
Paul J. Donahue, Sr.
Clifford E. Elias*
John E. Fenton Jr.
Naomi A. Gardner*
Frank D. Goldstein
Cornelius J. McCarthy*
Gerald T. Mulligan*
Robert W. Phinney
Irving E. Rogers, III
Robert J. Scribner*
Fred P. Shaheen*
*Also Directors of
Andover Bancorp, Inc.
ANDOVER BANK NH DIRECTORS
John P. Bachini
John D. Collins
George J. Khoury
Gerald T. Mulligan
Robert W. Phinney
Raymond P. Smith
Marie S. Tucarella
ANNUAL MEETING
The Annual Meeting of the Shareholders of Andover Bancorp,
Inc. will be held at 10 a.m. on Thursday, April 30, 1998 at
the Andover Town House, 20 Main Street, Andover,
Massachusetts.
================================================================================
<PAGE> 78
================================================================================
[GRAPHIC]
ANDOVER BANK
----------------------
MEMBER FDIC/DIF
Main Office
61 Main Street
Andover, MA 01810
159 River Road
Andover, MA 01810
450 Essex Street
Lawrence, MA 01840
305 South Broadway
Lawrence, MA 01843
547 Broadway
Methuen, MA 01844
228 Haverhill Street
Methuen, MA 01844
91 Pleasant Valley Street
Methuen, MA 01844
108 Main Street
North Andover, MA 01845
995 Main Street
Tewksbury, MA 01876
2171 Main Street
Tewksbury, MA 01876
ANDOVER BANK NH
----------------------
MEMBER FDIC
MAIN OFFICE
130 Main Street
Salem, NH 03079
62 Nashua Road (Rt. 102)
Londonderry, NH 03053
ANDOVER CAPITAL GROUP, INC.
-------------------------------
One Constitution Plaza
Boston, MA 02129
TELEPHONE SALES
& SERVICE CENTER
----------------------
1 800 2CALL AB
0685-AR-98
================================================================================
<PAGE> 1
Exhibit 23.1
INDEPENDENT AUDITORS CONSENT
The Board of Directors and Stockholders
ANDOVER BANCORP, INC.:
We consent to incorporation by reference in Registration Statement No. 33-21975
on Form S-8 of Andover Bancorp, Inc. of our report dated January 22, 1998,
relating to the consolidated balance sheets of Andover Bancorp, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1997, which report
is included herein.
/s/ KPMG PEAT MARWICK LLP
Boston, Massachusetts
March 13, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS DATED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 21,586
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 14,150
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 5,537
<INVESTMENTS-CARRYING> 129,363
<INVESTMENTS-MARKET> 130,947
<LOANS> 978,823
<ALLOWANCE> 12,521
<TOTAL-ASSETS> 1,322,745
<DEPOSITS> 946,982
<SHORT-TERM> 10,171
<LIABILITIES-OTHER> 9,952
<LONG-TERM> 248,561
0
0
<COMMON> 517
<OTHER-SE> 106,562
<TOTAL-LIABILITIES-AND-EQUITY> 1,322,745
<INTEREST-LOAN> 70,861
<INTEREST-INVEST> 19,891
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 90,752
<INTEREST-DEPOSIT> 38,251
<INTEREST-EXPENSE> 52,047
<INTEREST-INCOME-NET> 38,705
<LOAN-LOSSES> 983
<SECURITIES-GAINS> 422
<EXPENSE-OTHER> 21,986
<INCOME-PRETAX> 20,494
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,206
<EPS-PRIMARY> 2.57
<EPS-DILUTED> 2.49
<YIELD-ACTUAL> 3.22
<LOANS-NON> 7,849
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,372
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 12,229
<CHARGE-OFFS> 1,804
<RECOVERIES> 1,113
<ALLOWANCE-CLOSE> 12,521
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
