<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended June 30, 1998 or
[X] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ____________ to ______________
Commission File Number 0-16358
-----------
ANDOVER BANCORP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 04-2952665
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
61 Main Street, Andover, Massachusetts 01810
- -------------------------------------- -------------------
(Address of principal executive office) (Zip Code)
(978) 749-2000
---------------------------------------------------
(Registrant's telephone number, including area code)
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of each of the issuer's classes of Common
Stock, as of the latest practicable date is:
Class: Common Stock, par value $0.10 per share
Outstanding as of August 3, 1998: 6,480,736 shares
<PAGE> 2
ANDOVER BANCORP, INC.
AND SUBSIDIARIES
----------------
Index
PART I - FINANCIAL INFORMATION
ITEM 1 Financial Statements Page
Consolidated Balance Sheets 1
Consolidated Statements of Operations 2
Consolidated Statements of Changes in
Stockholders' Equity 3
Consolidated Statements of Cash Flows 4-5
Notes to Consolidated Financial
Statements 6
Analysis of Net Yield on Earning Assets 7
ITEM 2 Management's Discussion and Analysis of 8-19
Financial Condition and Results of Operations
For the Quarter Ended June 30, 1998
For the Six Months Ended June 30, 1998
ITEM 3 Qualitative and Quantitative Market Risk ---
(incorporated by reference to Andover's
Annual Report on Form 10-K for the fiscal
year ended December 31, 1997).
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 20
ITEM 2 Changes in Securities 20
ITEM 3 Defaults upon Senior Securities 20
ITEM 4 Submission of Matters to a Vote of Security Holders 20
ITEM 5 Other Information 20
ITEM 6 Exhibits and Reports on Form 8-K 20
Signatures 21
<PAGE> 3
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Unaudited)
<TABLE>
<CAPTION>
JUNE 30, 1998 DECEMBER 31, 1997
------------- -----------------
(In thousands)
<S> <C> <C>
ASSETS
Cash and due from banks $ 25,084 $ 21,586
Short-term investments 16,300 14,150
---------- ----------
Cash and cash equivalents 41,384 35,736
---------- ----------
Assets held for sale, at lower of
cost or market 5,207 5,537
Investments available for sale (amortized
cost of $157,859 in 1998 and $137,175
in 1997) 159,586 139,054
Investments held to maturity (market value
of $121,671 in 1998 and $130,947 in 1997) 120,095 129,363
Loans 1,029,669 978,823
Allowance for loan losses (10,308) (12,521)
---------- ----------
Net loans 1,019,361 966,302
---------- ----------
Mortgage servicing assets, net 8,814 9,500
Other real estate owned, net 248 406
Premises and equipment, net 9,491 9,593
Accrued interest receivable 8,003 7,567
Stock in FHLBB, at cost 15,747 15,747
Net deferred income taxes receivable 1,419 1,832
Other assets 2,987 2,108
---------- ----------
Total assets $1,392,342 $1,322,745
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 971,993 $ 946,982
Securities sold under agreements
to repurchase 16,787 10,171
Federal Home Loan Bank advances 277,690 248,561
Mortgagors' escrow accounts 2,321 2,478
Income taxes payable 4,086 2,250
Accrued expenses and other liabilities 5,320 5,224
---------- ----------
Total liabilities 1,278,197 1,215,666
---------- ----------
Stockholders' equity:
Serial preferred stock, $0.10 par value per share;
3,000,000 shares authorized, none issued --- ---
Common stock, $0.10 par value per share;
15,000,000 shares authorized; 6,480,736 and 6,435,328
shares issued in 1998 and 1997, respectively 518 517
Additional paid-in capital 59,983 59,619
Retained earnings 52,618 45,814
Accumulated other comprehensive income 1,026 1,129
---------- ----------
Total stockholders' equity 114,145 107,079
---------- ----------
Total liabilities and stockholders' equity $1,392,342 $1,322,745
========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
1
<PAGE> 4
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
QUARTERS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------- -------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans $ 19,366 $ 17,241 $ 38,295 $ 34,387
Mortgage-backed securities 3,077 3,043 6,300 6,120
Investment securities 1,844 1,787 3,592 3,339
Short-term investments 200 212 447 402
----------- ----------- ----------- -----------
Total interest and dividend income 24,487 22,283 48,634 44,248
----------- ----------- ----------- -----------
Interest expense:
Deposits 9,898 9,501 19,767 18,269
Federal Home Loan Bank advances 4,011 3,218 7,880 6,873
Securities sold under agreements to repurchase 224 79 313 142
----------- ----------- ----------- -----------
Total interest expense 4,133 12,798 27,960 25,284
----------- ----------- ----------- -----------
Net interest and dividend income 10,354 9,485 20,674 18,964
Provision (credit) for loan losses (2,250) 223 (2,205) 553
----------- ----------- ----------- -----------
Net interest and dividend income
after provision (credit) for loan losses 12,604 9,262 22,879 18,411
----------- ----------- ----------- -----------
Non-interest income:
Net gains from sales of assets held for sale
and investments available for sale 192 141 342 170
Mortgage banking income, net 223 584 239 1,186
Gains(losses) on real estate operations, net 100 (228) 24 (585)
Other income 904 779 1,847 1,498
----------- ----------- ----------- -----------
Total non-interest income 1,419 1,276 2,452 2,269
----------- ----------- ----------- -----------
Non-interest expense:
Salaries and employee benefits 3,146 2,987 6,243 5,874
Office occupancy and equipment 752 755 1,407 1,439
Data processing 493 434 1,005 859
Marketing 162 276 393 495
Professional fees 202 224 429 413
Mortgage banking expense 109 117 335 196
Deposit insurance premiums 34 30 69 59
Other operating expense 805 733 1,502 1,389
----------- ----------- ----------- -----------
Total non-interest expense 5,703 5,556 11,383 10,724
----------- ----------- ----------- -----------
Income before income tax expense 8,320 4,982 13,948 9,956
Income tax expense 3,070 1,800 4,996 3,566
----------- ----------- ----------- -----------
Net income $ 5,250 $ 3,182 $ 8,952 $ 6,390
=========== =========== =========== ===========
Basic earnings per share $ 0.81 $ 0.49 $ 1.38 $ 0.99
=========== =========== =========== ===========
Diluted earnings per share $ 0.78 $ 0.48 $ 1.34 $ 0.97
=========== =========== =========== ===========
Weighted average shares outstanding - basic 6,477,526 6,434,669 6,470,551 6,428,676
Dilutive impact of stock options 227,062 173,737 222,123 174,030
----------- ----------- ----------- -----------
Weighted average shares outstanding - diluted 6,704,588 6,608,406 6,692,674 6,602,706
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
2
<PAGE> 5
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Year Ended
---------------------------------------------------------------------
December 31, 1997 and Six Months Ended June 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCK-
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE HOLDERS
STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
----- ------- -------- ----- ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $515 $59,222 $ 36,109 $(301) $ 301 $ 95,846
Comprehensive income:
Net income --- --- 13,206 --- --- 13,206
Other comprehensive income --- --- --- --- 828 828
---- ------- -------- ----- ------- ---------
Total comprehensive income --- -- 13,206 --- 828 14,034
Dividends declared and
paid ($0.54 per share) --- --- (3,501) --- --- (3,501)
Stock options exercised 2 397 --- 301 --- 700
---- ------- -------- ----- ------- ---------
Balance at December 31, 1997 517 59,619 45,814 --- 1,129 107,079
Comprehensive income:
Net income --- --- 8,952 --- --- 8,952
Other comprehensive income --- --- --- --- (103) (103)
---- ------- -------- ----- ------- ---------
Total comprehensive income --- --- 8,952 --- (103) 8,849
Dividends declared and
paid ($0.33 per share) --- --- (2,148) --- --- (2,148)
Stock options exercised 1 364 --- --- 365
---- ------- -------- ----- ------- ---------
Balance at June 30, 1998 $518 $59,983 $ 52,618 $ --- $ 1,026 $ 114,145
==== ======= ======== ===== ======= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE> 6
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED,
JUNE 30,
--------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,952 $ 6,390
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision (credit) for loan losses (2,205) 553
Net (gains) losses on sales and provisions
for other real estate owned (141) 169
Net gains from sales of investments
available for sale (17) (87)
Net gains from sales of assets held for sale (325) (83)
Depreciation and amortization 660 719
Amortization of fees, discounts and premiums, net 235 237
Deferred income taxes 462 84
(Increase) decrease in:
Assets held for sale 655 161
Accrued interest receivable (436) (550)
Mortgage servicing assets 1,182 637
Other assets (879) 358
Increase (decrease) in:
Mortgagors' escrow accounts (157) 31
Accrued income taxes payable 1,836 (439)
Accrued expenses and other liabilities 96 (1,116)
--------- ---------
Net cash provided by operating activities 9,918 7,064
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases (37,543) (50,979)
Proceeds from sales 3,017 8,087
Proceeds from maturities and redemptions 1,500 2,000
Principal repayments 12,174 3,570
Investment and mortgage-backed securities held to maturity:
Purchases (10,041) ---
Proceeds from maturities and redemptions --- 2,000
Principal repayments 19,237 9,897
Purchases of whole loans (13,873) (2,310)
Purchases of mortgage servicing rights (496) (2,600)
Net increase in loans (37,463) (18,464)
Capital expenditures on premises and equipment, net (558) (478)
Proceeds from sales of other real estate owned 803 1,668
Capital expenditures on other real estate owned --- (54)
--------- ---------
Net cash used by investing activities (63,243) (47,663)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 25,011 95,880
Net increase in securities sold
under agreements to repurchase 6,616 3,579
Proceeds from issuance of FHLB advances 192,700 130,000
Principal repayments of FHLB advances (163,571) (186,788)
Dividends paid (2,148) (1,647)
Stock options exercised 365 243
--------- ---------
Net cash provided by financing activities 58,973 41,267
--------- ---------
Net increase in cash and cash equivalents 5,648 668
Cash and cash equivalents, at beginning of period 35,736 46,089
--------- ---------
Cash and cash equivalents, at end of period $ 41,384 $ 46,757
========= =========
</TABLE>
continued on next page
4
<PAGE> 7
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-------------------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED,
JUNE 30,
--------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $26,856 $25,559
Income taxes 1,547 3,829
Cash received during the period for:
Income taxes 82 ---
Supplemental noncash investing and financing activities:
Conversion of real estate loans to mortgage-backed
securities held for sale or investments available for sale 25,133 11,028
Transfer of loans to other real estate owned 504 1,525
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
5
<PAGE> 8
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1) BASIS OF PRESENTATION
The unaudited consolidated financial statements of Andover Bancorp, Inc.
("Andover" or the "Company") and its subsidiaries, including its principal
subsidiaries, Andover Bank and Andover Bank NH (collectively the "Banks"),
presented herein, should be read in conjunction with the consolidated
financial statements of the Company as of and for the year ended December
31, 1997. Andover Bank (the "Bank") is a state chartered savings bank with
its headquarters located in Andover, Massachusetts. Andover Bank NH
("ABNH") is a state chartered guaranty savings bank established in
September, 1995 and headquartered in Salem, New Hampshire. In the opinion
of management, the unaudited consolidated financial statements presented
herein reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation. Interim results are not
necessarily indicative of results to be expected for the entire year.
2) COMPONENTS OF ACCUMULATED OTHER COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", in the
first quarter of 1998. SFAS No. 130 established standards for reporting and
displaying comprehensive income, which is defined as all changes to equity
except investments by and distributions to shareholders. Net income is a
component of comprehensive income, with all other components referred to in
the aggregate as other comprehensive income. The following table shows the
components of other comprehensive income for the year ended December 31,
1997 and six months ended June 30, 1998.
<TABLE>
<CAPTION>
Before-tax Tax Net-of
Amount Expense Tax Amount
<S> <C> <C> <C>
Balance at December 31, 1996 $ 502 $(201) $ 301
Increase in unrealized gains on investments
available for sale for year ended
December 31, 1997 1,377 (549) 828
------- ----- -------
Balance at December 31, 1997 1,879 (750) 1,129
Decrease in unrealized gains on investments
available for sale for the six months
ended June 30, 1998 (153) 50 (103)
------- ----- -------
Balance at June 30, 1998 $ 1,726 $(700) $ 1,026
======= ===== =======
</TABLE>
3) STOCK SPLIT
The per share data for the first six months of 1997 was restated to reflect
a 5 for 4 stock split distributed on May 18, 1998. The effect of this stock
split on the Company's diluted earnings per share and dividends per share
for the second quarter and year-to-date results of 1997 is presented below:
<TABLE>
<CAPTION>
As Reported As Restated
----------- -----------
<S> <C> <C>
Net income per share - quarter ended 6/30/97 $0.60 $0.48
Dividends declared per share - quarter ended 6/30/97 $0.17 $0.14
Net income per share - year-to-date 6/30/97 $1.21 $0.97
Dividends declared per share - year-to-date 6/30/97 $0.32 $0.26
</TABLE>
6
<PAGE> 9
<TABLE>
<CAPTION>
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NET YIELD ON EARNING ASSETS
---------------------------
(Unaudited)
QUARTERS ENDED JUNE 30,
1998 1997
------------------------------------- -------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(3) BALANCE PAID RATE(3)
------- ---- ------ ------- ---- ------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 14,705 $ 200 5.46% $ 15,710 $ 212 5.41%
Investment securities (1) 111,485 1,844 6.63 106,520 1,787 6.73
Mortgage-backed securities (1) 187,625 3,077 6.58 176,849 3,043 6.90
---------- ------- ---------- -------
Total investments 313,815 5,121 6.55 299,079 5,042 6.76
---------- ------- ---------- -------
Residential loans (1) (2) 752,995 13,313 7.09 631,865 11,520 7.31
Commercial loans (2) 142,310 3,146 8.87 131,627 2,934 8.94
Construction and land loans 36,728 945 10.32 35,647 918 10.33
---------- ------- ---------- -------
Total real estate loans 932,033 17,404 7.49 799,139 15,372 7.72
Consumer loans (2) 66,262 1,398 8.46 64,333 1,322 8.24
Commercial loans (2) 23,301 564 9.71 22,460 547 9.77
---------- ------- ---------- -------
Total loans 1,021,596 19,366 7.60 885,932 17,241 7.81
---------- ------- ---------- -------
Total interest-earning assets 1,335,411 24,487 7.35% 1,185,011 22,283 7.54%
------- -------
Allowance for loan losses (12,634) (12,398)
Other real estate owned 249 1,774
Other assets 54,591 57,759
---------- ----------
Total assets $1,377,617 $1,232,146
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 86,564 $ 210 0.97% $ 72,812 $ 181 1.00%
Regular savings accounts 169,498 1,565 3.70 116,968 935 3.21
Money market deposit accounts 100,987 709 2.82 112,248 819 2.93
Certificates of deposit 516,109 7,414 5.76 523,370 7,566 5.80
---------- ------- ---------- -------
Total interest-bearing deposits 873,158 9,898 4.55 825,398 9,501 4.62
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements 17,066 224 5.26 6,649 79 4.77
Federal Home Loan Bank advances 280,331 4,011 5.74 221,459 3,218 5.83
---------- ------- ---------- -------
Total borrowed funds 297,397 4,235 5.71 228,108 3,297 5.80
---------- ------- ---------- -------
Total interest-bearing liabilities 1,170,555 14,133 4.84% 1,053,506 12,798 4.87%
------- -------
Demand deposits 87,771 69,274
Other liabilities 9,932 10,766
---------- ----------
Total liabilities 1,268,258 1,133,546
Stockholders' equity 109,359 98,600
---------- ----------
Total liabilities and stock-
holders' equity $1,377,617 $1,232,146
========== ==========
Net interest income $10,354 $ 9,485
======= =======
Interest rate spread 2.51% 2.67%
===== =====
Net yield on earning assets 3.11% 3.21%
===== =====
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1998 1997
------------------------------------ ----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(3) BALANCE PAID RATE(3)
------- ---- ------ ------- ---- ------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 16,364 $ 447 5.51% $ 14,933 $ 402 5.43%
Investment securities (1) 108,090 3,592 6.70 100,060 3,339 6.73
Mortgage-backed securities (1) 190,017 6,300 6.69 178,760 6,120 6.90
---------- ------- ---------- -------
Total investments 314,471 10,339 6.63 293,753 9,861 6.77
---------- ------- ---------- -------
Residential loans (1) (2) 741,424 26,298 7.15 629,603 23,199 7.43
Commercial loans (2) 142,217 6,313 8.95 133,390 5,929 8.96
Construction and land loans 35,264 1,796 10.27 35,011 1,724 9.93
---------- ------- ---------- -------
Total real estate loans 918,905 34,407 7.55 798,004 30,852 7.80
Consumer loans (2) 66,781 2,848 8.60 62,577 2,551 8.22
Commercial loans (2) 21,706 1,040 9.66 20,712 984 9.58
---------- ------- ---------- -------
Total loans 1,007,392 38,295 7.67 881,293 34,387 7.87
---------- ------- ---------- -------
Total interest-earning assets 1,321,863 48,634 7.42% 1,175,046 44,248 7.59%
------- -------
Allowance for loan losses (12,712) (12,331)
Other real estate owned 331 1,713
Other assets 52,304 56,086
---------- ----------
Total assets $1,361,786 $1,220,514
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 83,970 $ 410 0.98% $ 69,839 $ 350 1.01%
Regular savings accounts 161,743 2,934 3.66 110,510 1,743 3.18
Money market deposit accounts 103,760 1,479 2.87 114,712 1,690 2.97
Certificates of deposit 519,922 14,944 5.80 506,031 14,486 5.77
---------- ------- ---------- ------
Total interest-bearing deposits 869,395 19,767 4.58 801,092 18,269 4.60
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements 12,180 313 5.18 6,161 142 4.65
Federal Home Loan Bank advances 277,129 7,880 5.73 239,601 6,873 5.78
---------- ------- ---------- -------
Total borrowed funds 289,309 8,193 5.71 245,762 7,015 5.76
---------- ------- ---------- -------
Total interest-bearing liabilities 27,960 4.87% 1,046,854 25,284 4.87%
------- -------
Demand deposits 85,717 65,781
Other liabilities 9,766 10,564
---------- ----------
Total liabilities 1,254,187 1,123,199
Stockholders' equity 107,599 97,315
---------- ----------
Total liabilities and stock-
holders' equity $1,361,786 $1,220,514
========== ==========
Net interest income $20,674 $18,964
======= =======
Interest rate spread 2.55% 2.72%
===== ====
Net yield on earning assets 3.15% 3.25%
===== =====
</TABLE>
(1) Included in the average balance amounts are the corresponding components of
the assets held for sale, available for sale and held to maturity. The yield has
been calculated using interest income divided by the average balance of the
amortized historical cost.
(2) Interest on nonaccruing loans has been included only to the extent reflected
in the statement of operations. However, the loan balances are included in the
average amounts outstanding.
(3) The "Average Yield/Rate" calculation is based on an annualized basis
reflecting 91 days in the second quarter of both years and 181 days in the
year-to-date period of 1998 and 1997.
7
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE QUARTER ENDED JUNE 30, 1998
-----------------------------------
This quarterly report contains certain statements that are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements as a result, among other factors, of the risk factors
set forth in the Company's filings with the Securities and Exchange Commission
and of changes in general economic conditions, changes in interest rates and
changes in the assumptions used in making such forward-looking statements.
RESULTS OF OPERATIONS
GENERAL. Net income amounted to $5.3 million, or $0.78 per diluted share, for
the quarter ended June 30 1998 as compared to net income of $3.2 million, or
$0.48 per diluted share, in the corresponding quarter of 1997. The current
quarter results include an increase in net interest income and a credit for loan
losses totalling $2.3 million. Andover's annualized return on average assets
increased to 1.53% for the second quarter of 1998 compared to 1.04% in the
second quarter of 1997. The annualized return on average stockholders' equity
increased to 19.26% in the second quarter of 1998 from 12.94% in the second
quarter of 1997.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $10.4
million for the second quarter of 1998 as compared to $9.5 million for the same
period in 1997. This increase resulted from a 13% increase in total
interest-earning assets, primarily due to higher loan growth resulting from
increased loan originations. The 10 basis point decline in the net yield on
earning assets to 3.11% for the second quarter of 1998, compared to 3.21% in
1997, was due primarily to a 22 basis point decline in the yields on the
residential real estate and investment portfolios. The decline in the yield on
earning assets for 1998 reflects the decline in the long-term market interest
rates during the latter part of 1997 and the first half of 1998. This market
interest rate decline has resulted in the originations of the current year to be
at rates lower than the average yield earned on the loan portfolio for all of
1997. In addition, there has been competitive pressure on the pricing of loans
and deposits, causing the margin to contract. It is expected that the
competitive pressure for quality loans and retail deposits will continue to
result in a tighter spread between asset yields and the cost of funds.
PROVISION (CREDIT) FOR LOAN LOSSES. The allowance for loan losses is established
through a provision for loan losses charged to the statement of operations. The
allowance is reduced by a credit for loan losses as well as loan charge-offs.
Assessing the adequacy of the allowance for loan losses involves substantial
uncertainties and is based upon management's estimation of the amount required
to meet probable loan losses in light of several factors. Among the factors that
management considers are the quality of specific loans, risk characteristics of
the loan portfolio generally, the level of nonaccruing loans in the various
categories, current economic conditions, trends in delinquencies, actual
charge-off experience, and the collateral values of the underlying security.
Because the allowance for loan losses is based on various estimates, and
includes a high degree of judgment by management, subsequent changes in the
general economic prospects of the borrowers may require changes in those
estimates. In addition, regulatory agencies, as an integral part of the
examination process, review the Banks' allowance and may require the Banks to
provide additions to the allowance based on their assessment, which may differ
from management's assessment.
As a result of the improvement in loan quality, as well as management's
assessment of changes in trends, conditions and other relevant factors, a credit
for loan losses of $2.3 million was recorded during the second quarter of 1998
versus a provision of $223,000 in the comparable period in 1997. Nonaccruing
loans declined over 23% during
8
<PAGE> 11
the second quarter and almost 36% since year-end 1997. Total overdue loans have
declined over several quarters and decreased by 26% from year-end 1997. Net
charge-offs totalled $35,000 for the second quarter of 1998 and $8,000 for the
six months ended June 30, 1998. These modest amounts compare favorably to the
$66,000 and $251,000 recorded for the respective periods in 1997. These factors,
among others, reflect the continued improvement in loan quality and led to the
credit for loan losses taken for the second quarter. After the credit for loan
losses, the reserve coverage as a percentage of nonaccruing loans totalled 205%
as of June 30, 1998, as compared to 194% and 160%, for the periods ending March
31, 1998 and December 31, 1997.
The improvement in loan quality noted above started to become evident at the end
of the first quarter of 1998; however, management determined that it was prudent
to postpone recognition of a credit for loan losses until it could assess
whether a trend had developed. In addition, management considered that the
winter months have historically had a negative impact on the investor-owned,
multi-family properties, causing higher delinquencies during those time periods.
The decline in the delinquencies and nonaccruing loans was notable starting in
March of 1998, which, when combined with the lowest level of quarterly additions
to non-performing assets during the second quarter of 1998, contributed to
management's assessment of the appropriateness of the allowance for loan losses
as of June 30, 1998. Management also believes that the allowance for loan losses
will be adequate to absorb probable credit losses inherent in the loan and lease
portfolio.
NON-INTEREST INCOME. Net gains from sales and redemptions of loans, investments
and mortgage-backed securities held for sale and available for sale totalled
$192,000 in the second quarter of 1998 as compared to $141,000 in the second
quarter of 1997.
Mortgage banking income totalled $223,000 in the second quarter of 1998 versus
$584,000 in the comparable quarter in 1997 due to a decrease in the Company's
servicing portfolio as well as increased amortization and provisions for the
valuation allowance on the mortgage servicing assets. Amortization expense
totalled $363,000 and $348,000, respectively, for the quarters ended June 30,
1998 and 1997. In addition, the Company incurred provisions for the valuation
allowance of $120,000 in the second quarter of 1998 due to the high prepayments
experienced and expected to be experienced in the serviced loan portfolio. In
this low interest rate environment, loans repay faster than expected, thereby
causing the fair value of the mortgage servicing assets to decline. If interest
rates continue to remain at low levels, it is possible that additional
provisions for the valuation allowance may be necessary. The mortgage servicing
assets are assessed for impairment on a quarterly basis. Loans serviced for
investors totalled $879.2 million and $1,038.8 million, respectively, at June
30, 1998 and 1997.
Gains of $100,000 on real estate operations were recognized in the second
quarter of 1998 as compared to losses of $228,000 in the second quarter of 1997.
The gain on real estate operations in the second quarter of 1998 resulted
primarily from a negative provision for the valuation allowance in the amount of
$107,000. A significant portion of the losses on real estate operations during
the second quarter of 1997 was operating costs associated with acquiring,
maintaining and disposing of other real estate owned and totalled $194,000,
while provisions for losses on other real estate owned added another $75,000 to
the loss on real estate operations.
Other income totalled $904,000 in the second quarter of 1998 as compared to
$779,000 in the second quarter of 1997 due to higher loan fee and deposit fee
income. These increases reflect the increase in both the loan and deposit
portfolios as well as fees associated with the increased loan payoffs.
NON-INTEREST EXPENSE. Non-interest expenses increased by $147,000, or 2.6%, to
$5.7 million in the second quarter of 1998 from $5.6 million in the second
quarter of 1997. However, the efficiency ratio (a ratio that measures operating
expenses as a percentage of operating income) declined from 51.2% in the second
quarter of 1997 to 49.7% in the comparable period of 1998.
9
<PAGE> 12
Salaries and employee benefits, the largest component of non-interest expense,
increased $159,000, or 5.3%, from $3.0 million for the second quarter of 1997 to
$3.1 million in the current year's corresponding quarter. This increase was
primarily due to an increase in the number of employees and salary increases as
well as higher benefits due to a larger employee base.
Data processing expenses increased $59,000, or 13.6%, to $493,000 in the second
quarter of 1998 from $434,000 in the second quarter of 1997. This was due to an
increase in the number of loans and deposits serviced by the Company. In
addition, the costs incurred by the Company to conduct business via alternative
delivery systems, such as the telephone or personal computer, continue to
increase.
Marketing expenses decreased to $162,000 for the quarter ended June 30, 1998
from $276,000 for the second quarter of 1997 due to a decline in discretionary
promotions of residential loans and deposits.
Professional fees decreased $22,000 to $202,000 in the second quarter of 1998
from $224,000 in the second quarter of 1997 due to decreased corporate legal and
consulting expenses.
Office occupancy and equipment, mortgage banking expense and deposit insurance
premiums remained the same for the second quarter of 1998 as compared to the
corresponding period in 1997.
Other operating expenses increased to $805,000 in the second quarter of 1998
from $733,000 in the second quarter of 1997 due to expenses incurred in
operating a larger institution. These expenses include corporate insurance,
telephone expenses and postage expenses.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $3.1 million
and $1.8 million on its financial statement earnings for the second quarters of
1998 and 1997, respectively. The effective tax rate for the second quarter of
1998 was 36.9%, as compared to 36.1% for the corresponding period in 1997.
FINANCIAL CONDITION
Total assets increased 5.26% from $1,322.7 million at December 31, 1997 to
$1,392.3 million at June 30, 1998. Increases in both the loan and investment
portfolios were funded by the growth experienced in the deposit balances and
FHLB advances during the first half of 1998.
LOANS. The following table shows the composition of the Company's loan portfolio
at June 30, 1998 and December 31, 1997. The balances shown in the table are net
of unadvanced funds and deferred loan origination fees and costs.
6/30/98 12/31/97
------- --------
(In thousands)
Real estate loans:
Residential $ 748,783 $715,503
Commercial 142,896 142,617
Construction and land 39,353 31,499
---------- --------
Total real estate loans 931,032 889,619
---------- --------
Consumer loans 66,199 68,204
Commercial loans 32,438 21,000
---------- --------
Total loans $1,029,669 $978,823
========== ========
Total loans increased $50.8 million during the first six months of 1998 to
$1,029.7 million at June 30, 1998 primarily due to increases in the real estate
portfolio. The
10
<PAGE> 13
increase in the residential loan portfolio was aided by the favorable interest
rate environment causing both a strong home purchase and heavy mortgage
refinance markets.
Originations of all loan types are sensitive to the interest rate environment,
the capacity for borrowing and real estate values, current and anticipated
economic conditions as well as the competitive landscape. Due to the extremely
favorable interest rates in the latter part of 1997 and the first half of 1998,
residential loan originations increased over 140% from the first half of 1997 to
the corresponding period of 1998. Residential loan balances increased only $33.3
million due to the securitization of certain fixed-rate loans, regular
amortization and increased repayments due to the strong refinance activity.
Residential loan originations totalled $117.5 million and $83.7 million,
respectively, for the six months ended June 30, 1998 and 1997.
Outstanding corporate loans, comprised of commercial real estate, commercial,
construction and land loans, increased $19.6 million during the first six months
of 1998. Originations of corporate loans reflect the Company's increased
interest for this type of loan, higher real estate values and the formation of
the leasing subsidiary at the end of 1997. Corporate loan originations totalled
$65.3 million and $38.4 million, respectively, for the six months ended June 30,
1998 and 1997.
Consumer loan balances decreased by approximately 2.9% on an annualized basis,
to $66.2 million at June 30, 1998, primarily due to payoffs of home equity
balances and second mortgage loans.
RISK ELEMENTS. The following table shows the composition of non-performing
assets at June 30, 1998 and December 31, 1997:
6/30/98 12/31/97
------- --------
(Dollars in thousands)
Nonaccruing loans $5,028 $7,849
Other real estate owned 248 406
------ ------
Total non-performing assets $5,276 $8,255
====== ======
Total non-performing assets as a
percentage of total assets 0.4% 0.6%
Significant progress has been made over the past several years in reducing total
non-performing assets. This success has continued as total non-performing assets
decreased 36.1% in the first six months of 1998 primarily due to nonaccruing
loans returning to performing status or being paid off altogether.
A significant portion of the non-performing assets are secured by mixed-use
commercial and multi-family real estate located in Lawrence, Massachusetts. This
city had been especially hard hit with declines in real estate values due to
increased vacancies and rapid turnover in the multi-family investor-owned
properties. These multi-family investor-owned properties represent the majority
of the Bank's collateral on troubled loans and other real estate owned in
Lawrence. Continued deterioration in this market area will adversely impact the
collectibility of residential and commercial real estate loans and may result in
an increase in non-performing assets. At June 30, 1998, approximately $2.1
million, or 41.5%, of nonaccrual loans were secured by properties located in
Lawrence, consisting primarily of mixed-use commercial and multi-family
properties, as compared to approximately $3.4 million at December 31, 1997.
At June 30, 1998, total impaired loans were $4.5 million, of which $1.1 million
had related allowances of $111,000 and $3.4 million which did not require a
related allowance. During the six months ended June 30, 1998, the average
recorded value of impaired loans was $5.2 million.
11
<PAGE> 14
Nonaccruing Loans. Management places loans on nonaccrual status when loan
payments are past due 90 days or more, regardless of collateral values. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on nonaccrual status. Loans for which
payments are less than 90 days past due are placed on nonaccrual status when
concern exists regarding the ultimate collectibility of the loan.
The following table shows the composition of nonaccruing loans at June 30, 1998
and December 31, 1997:
6/30/98 12/31/97
------- --------
(Dollars in thousands)
Residential real estate $ 1,299 $ 2,436
Commercial real estate 3,358 4,866
Commercial 348 513
Consumer 23 34
------- -------
Total nonaccrual loans $ 5,028 $ 7,849
======= =======
Allowance for loan losses $10,308 $12,521
======= =======
Allowance for loan losses as a
percentage of nonaccruing loans 205.0% 159.5%
Allowance for loan losses as a
percentage of total loans 1.0% 1.3%
Restructured Loans. A restructured loan is one for which the Bank has modified
the loan to provide a temporary reduction in the rate of interest or terms due
to the deterioration in the financial position of the borrower. Restructured
loans are classified as such until the obligation has performed for a reasonable
period of time at a market rate of interest and its ultimate collectibility is
no longer in doubt. At June 30, 1998 and December 31, 1997, restructured loans
totalled $1.3 million and $1.4 million, respectively. The weighted average
interest rate on restructured loans as of June 30, 1998 was approximately 6.2%.
Other Real Estate Owned. Other real estate owned is recorded at the lower of the
carrying value of the loan or the net fair value of the property. Operating
expenses and any provisions (credits) to increase (decrease) the valuation
allowance are charged to real estate operations. The Company recorded gains on
real estate operations due to a credit taken to reduce the valuation allowance
in the amount of $107,000 during the second quarter of 1998. Other real estate
owned totalled $248,000 as of June 30, 1998, for a decline of 39% since year-end
1997. The balance outstanding as of the end of the quarter is net of a $41,000
valuation allowance and is comprised mostly of single family residential
properties. During the first six months of 1998, sales of other real estate
owned totalled $803,000 and generated gains of $34,000. During the comparable
period in 1997, gains of $31,000 were recognized on sales of $1.7 million.
12
<PAGE> 15
ALLOWANCE FOR LOAN LOSSES. The following table summarizes the activity in the
Company's allowance for loan losses for the quarters and six months ended June
30, 1998 and 1997:
<TABLE>
<CAPTION>
Quarters Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 12,593 $ 12,374 $ 12,521 $ 12,229
Provision (credit) for loan losses (2,250) 223 (2,205) 553
Charge-offs:
Residential real estate (27) (150) (177) (452)
Commercial real estate (273) (228) (536) (480)
Construction and land --- --- --- ---
Commercial --- --- --- (55)
Consumer (4) (1) (6) (21)
-------- -------- -------- --------
Total charge-offs (304) (379) (719) (1,008)
-------- -------- -------- --------
Recoveries:
Residential real estate 32 --- 35 ---
Commercial real estate 86 14 274 103
Construction and land 40 80 235 167
Commercial 105 215 153 479
Consumer 6 4 14 8
-------- -------- -------- --------
Total recoveries 269 313 711 757
-------- -------- -------- --------
Net charge-offs (35) (66) (8) (251)
-------- -------- -------- --------
Balance at end of period $ 10,308 $ 12,531 $ 10,308 $ 12,531
======== ======== ======== ========
Ratio of annualized net
charge-offs to average
loans outstanding 0.01% 0.03% 0.00% 0.06%
</TABLE>
Gross charge-offs totalled $304,000 during the second quarter of 1998 and were
spread out among 15 loans. The largest charge-off during the quarter was
$80,000. Management periodically analyzes the adequacy of the allowance for loan
losses. See "Results of Operations - Provision for Loan Losses."
INVESTMENTS. As of June 30, 1998, the Company's total investment portfolio
amounted to $296.0 million for an increase of $13.4 million from December 31,
1997. This increase was primarily due to the purchase of $47.6 million in
investments, both available for sale and held to maturity. These purchases were
mostly GNMA mortgage-backed securities and other corporate bonds and
obligations.
Management continually evaluates its investment alternatives in order to
properly manage the overall balance sheet mix. The timing of purchases, sales
and reinvestment, if any, will be based on various factors including expectation
of movements in market interest rates and loan demand. Notwithstanding these
events, it is the intent of management to grow the earning asset base through
loan originations, loan purchases or investment acquisitions while funding this
growth through a mix of retail deposits, FHLB advances and reverse repurchase
agreements.
13
<PAGE> 16
The following table presents the composition and carrying values of the
investment portfolio at June 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
6/30/98 12/31/97
------- --------
(In thousands)
<S> <C> <C>
SHORT-TERM INVESTMENTS $ 16,300 $ 14,150
======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
U.S. government and federal agency obligations $ 52,710 $ 55,777
Other bonds and obligations 26,331 14,573
-------- --------
Total bonds and obligations 79,041 70,350
-------- --------
GNMA mortgage-backed securities 44,885 27,793
FHLMC participation certificates 32,234 36,805
FNMA pass-through certificates 3,426 4,106
-------- --------
Total mortgage-backed securities 80,545 68,704
-------- --------
Total investments available for sale $159,586 $139,054
======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations $ 15,992 $ 10,001
Other bonds and obligations 7,069 7,106
-------- --------
Total bonds and obligations 23,061 17,107
-------- --------
FHLMC participation certificates 37,635 49,217
FNMA pass-through certificates 41,609 48,835
GNMA mortgage-backed securities 3,059 3,383
Collateralized mortgage obligations 14,064 10,021
Other asset-backed securities 667 800
-------- --------
Total mortgage-backed securities 97,034 112,256
-------- --------
Total investments held to maturity $120,095 $129,363
======== ========
Total investments $295,981 $282,567
======== ========
</TABLE>
The following table shows the gross unrealized gains and losses by major
categories of securities as of June 30, 1998:
<TABLE>
<CAPTION>
Unrealized Unrealized
Gains Losses
----- ------
(In thousands)
<S> <C> <C>
INVESTMENTS AVAILABLE FOR SALE:
U.S. government and federal agency obligations $ 834 $ ---
Other bonds and obligations 269 ---
Mortgage-backed securities 718 (94)
------ -----
Total investments available for sale $1,821 $ (94)
------ -----
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations $ 91 $ ---
Other bonds and obligations 72 ---
Mortgage-backed securities 1,504 (91)
------ -----
Total investments held to maturity 1,667 (91)
------ -----
Total unrealized gains and losses $3,488 $(185)
====== =====
</TABLE>
14
<PAGE> 17
At June 30, 1998, the Company's net unrealized gain on investments available for
sale amounted to $1.7 million, a fair value decline of $152,000 from an
unrealized gain of $1.9 million at December 31, 1997. At June 30, 1998, the
Company's net unrealized gain on investments held to maturity totalled $1.6
million, for a modest decline of $8,000 from an unrealized gain of $1.6 million
at December 31, 1997. The changes in the net unrealized gains on the total
investment portfolio from year-end 1997 were primarily due to a slight upturn in
market interest rates at the end of the second quarter of 1998.
DEPOSITS AND BORROWED FUNDS. Total deposits increased $25.0 million to $972.0
million at June 30, 1998 from $947.0 million at December 31, 1997. This increase
was most pronounced in regular savings accounts while demand deposit and NOW
accounts increased $9.0 million and $8.2 million, respectively, for the first
six months of 1998. Offsetting these increases, however, were declines of $12.5
million in certificates of deposit and $10.4 million in money market accounts
during the first six months of 1998. The increase of $30.8 million in regular
savings accounts reflects the shift from term deposits or limited access
accounts into accounts that can be accessed at any time, without penalty. In
addition, the Banks have continued to offer a premium interest rate savings
product for accounts with balances in excess of $50,000.
The following table shows the composition of the Company's deposits at June 30,
1998 and December 31, 1997:
6/30/98 12/31/97
-------- --------
(In thousands)
Demand deposit accounts $ 88,466 $ 79,501
Regular savings accounts 176,823 146,041
NOW accounts 94,069 85,917
Money market deposit accounts 97,488 107,919
Certificates of deposit 515,147 527,604
-------- --------
Total deposits $971,993 $946,982
======== ========
In order to fund the growth in total assets, the Banks augmented their growth in
deposits with increased borrowings. Federal Home Loan Bank advances increased
$29.1 million from December 31, 1997 to $277.7 million at June 30, 1998.
Securities sold under agreements to repurchase increased $6.6 million during the
quarter to $16.8 million at June 30, 1998.
LIQUIDITY. Liquidity refers to the ability of the Company to efficiently meet
the cash needs of borrowers and depositors, while also providing funds for
attractive investment opportunities.
The Company's primary source of funds is dividends from its bank subsidiaries.
ABNH will be limited in its ability to pay dividends until the fourth quarter of
1998. In the second quarter of 1998, the Company paid dividends to its
stockholders in the amount of $1.2 million. In July, 1998, the Company declared
a dividend in the amount of $1.2 million, payable in the third quarter of 1998.
The Banks have a diverse base of funding sources including customer deposits,
borrowed funds, repayments and amortization of the loan and investment
portfolios. A portion of the Banks' deposits represent core deposits, which
management believes are relatively insensitive to fluctuations in interest
rates. Sources of borrowed funds include funds purchased from other banks,
customer repurchase agreements, the sale of securities under repurchase
agreements and, in the case of the Bank, borrowings from the FHLB, of which the
Bank is a voluntary member. The Banks may also obtain funds from the Federal
Reserve Bank of Boston by pledging certain assets.
Cash flows provided by operations increased $2.9 million to $9.9 million in the
first six months of 1998, as compared to $7.1 million in the corresponding
period of 1997 due
15
<PAGE> 18
primarily to the credit for loan losses taken in the second quarter of 1998.
Cash flows used by investing activities increased by $15.6 million to $63.2
million for the six months ended June 30, 1998, as compared to $47.7 million
during the equivalent period last year. This increase was mainly attributable to
higher loan originations and loan purchases. Cash flows provided by financing
activities increased $17.7 million for the six months ended June 30, 1998 to
$59.0 million, as compared to $41.3 million in the equivalent period in 1997 due
to the increase in the FHLB advances during 1998, offset by a smaller increase
in deposits over 1997's amounts.
At June 30, 1998, the Company had home equity, reserve credit and commercial
unadvanced lines of credit totalling $93.4 million. Outstanding commitments to
originate loans totalled $44.2 million. Unadvanced portions of construction and
land loans amounted to $22.3 million. Standby letters of credit were $2.4
million. Loans sold with recourse totalled $2.2 million. Management believes
that its sources of liquidity are sufficient to meet these commitments if and as
called upon.
CAPITAL RESOURCES. The following table presents regulatory capital ratios under
current Tier 1 leverage capital and risk-based capital requirements as of June
30, 1998:
Leverage Capital Ratio Risk-Based Capital Ratio
---------------------- ------------------------
Tier 1 Tier 1 Total
------ ------ -----
Andover Bancorp, Inc. 8.2% 13.9% 15.1%
Andover Bank 8.0% 13.6% 14.8%
Andover Bank NH 8.9% 14.3% 15.1%
Current minimum regulatory requirements for the Bank and the Company as of June
30, 1998 were 4.0% for the Tier 1 leverage capital ratio and 4.0% and 8.0%,
respectively, for the Tier 1 and total risk-based capital ratios. As a de novo
bank, Andover Bank NH is obligated to maintain a minimum Tier 1 leverage capital
ratio of 8% until September 30, 1998. As of June 30, 1998, the most recent
notification from the FDIC categorized the Banks as well capitalized under the
prompt corrective action provisions. Therefore, the Banks are entitled to pay
the lowest deposit premium possible.
YEAR 2000 UPDATE. The Company will continue to utilize both internal and
external resources to update, or replace, develop and test all software
information systems for Year 2000 modifications. Included in other noninterest
expenses are charges incurred in connection with the modification or replacement
of software and hardware in order for the Company's computer systems to properly
conform with the Year 2000 compliance. The expenses incurred and hardware
capitalized totalled approximately $80,000 for the first six months of 1998. The
Company expects that the majority of the costs that will be incurred (as
disclosed below) will be to replace or upgrade existing hardware and software
which will be capitalized and amortized in accordance with the Company's
existing accounting policy while miscellaneous consulting, maintenance and
modification costs will be expensed as incurred.
The Company has completed its assessment of Year 2000 issues, developed a plan,
begun testing its various software information systems and arranged for the
required resources to complete its necessary remediation efforts. The Company
plans to complete the changes and testing on the critical information systems
for the Year 2000 project by December 31, 1998. Testing of the Company's
non-critical applications will continue into 1999 and will be completed prior to
any anticipated impact on its operating systems. The total remaining cost of the
Year 2000 project is estimated at $250,000 to $400,000; however, it is not
anticipated that material incremental costs will be incurred in any single
period.
The cost 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
16
<PAGE> 19
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. Since
the Company outsources all of its major date processing systems, it is working
closely with all of its vendors and service providers 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 or third party vendors 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 their respective Year 2000 compliance responsibilities.
RECENT ACCOUNTING DEVELOPMENTS. In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes new accounting and reporting standards for derivative instruments.
SFAS No. 133 requires that an entity recognize all derivatives as either assets
or liabilities and measure those instruments at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Early application is encouraged but restatement of prior periods is prohibited.
SFAS No. 133 is not expected to have a material impact on the consolidated
financial statements.
17
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998
--------------------------------------
This quarterly report contains certain statements that are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements as a result, among other factors, of the risk factors
set forth in the Company's filings with the Securities and Exchange Commission
and of changes in general economic conditions, changes in interest rates and
changes in the assumptions used in making such forward-looking statements.
RESULTS OF OPERATIONS
GENERAL. Net income amounted to $9.0 million, $1.34 per diluted share, for the
six months ended June 30, 1998, compared to net income of $6.4 million, $0.97
per diluted share, in the corresponding period of 1997.
The financial performance in the first six months of 1998 was positively
impacted by an increase in net interest income and a credit for loan losses.
This combination led to an increase in Andover's annualized return on average
assets to 1.33% for the first six months of 1998 as compared to 1.06% in the
comparable period of 1997. The annualized return on average stockholders' equity
increased to 16.78% in the first six months of 1998 from 13.24% in the
comparable period of 1997.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $20.7
million for the first six months of 1998, as compared to $19.0 million for the
same period in 1997, an increase of 9.0%. The 10 basis point decline in the net
yield on earning assets to 3.15% for the first six months of 1998, compared to
3.25% in 1997, was primarily due to a 28 basis point decline in the yield on
residential real estate loans due to lower market interest rates and higher
refinance activity.
PROVISION (CREDIT) FOR LOAN LOSSES. The Company recorded a credit for loan
losses for the first six months of 1998 of $2.2 million as compared to a
provision for loan losses of $553,000 for the same period of 1997. Among the
factors used to determine that the credit for loan losses was appropriate was
the continued improvement in loan quality, as well as management's assessment of
changes in trends and conditions. Nonaccruing loans decreased by 36% during the
first six months of 1998 while overdue loans decreased by 26% over the same time
period. In addition, net charge-offs totalled only $8,000 during the first six
months of 1998 as compared to $251,000 in the first six months of 1997.
NON-INTEREST INCOME. Andover recorded gains from non-interest sources of $2.5
million for the first six months of 1998, as compared to $2.3 million in the
corresponding period of 1997. Net gains from sales of assets held for sale and
investments available for sale totalled $342,000 in 1998 as compared to $170,000
in the same period of 1997.
Mortgage banking income totalled $239,000 during the first six months of 1998 as
compared to $1.2 million in the corresponding period of 1997 due to a decline in
the Company's servicing portfolio resulting from significant prepayments and
refinances. Additionally, there was an increase in the amortization expense of
$86,000 and provisions charged to earnings for the valuation allowance on
mortgage servicing assets totalling $540,000 for the first six months of 1998
over the corresponding period in 1997.
Gains on real estate operations totalled $24,000 during the first six months of
1998 as compared to losses of $585,000 in the corresponding period of 1997. A
large component of the loss on real estate operations during the first six
months of both 1998 and 1997 was comprised of operating costs associated with
acquiring, maintaining and disposing of
18
<PAGE> 21
other real estate owned and totalled $117,000 and $416,000, respectively.
Included in the results for 1998 was a negative provision for the valuation of
other real estate owned totalling $107,000 as compared to provisions of $200,000
incurred during the corresponding period in 1997.
Other income totalled $1.8 million in the first six months of 1998, for an
increase of $349,000, or 23.3%, from $1.5 million recorded in the first six
months of 1997. The majority of the increase is due to an increase in deposit
and loan service fees resulting from a higher deposit and loan base.
NON-INTEREST EXPENSE. Non-interest expenses increased 6.1% to $11.4 million in
the first six months of 1998 primarily due to an increase in salaries and
employee benefits. Salaries and benefits increased 6.3% to $6.2 million in 1998
due to increased personnel and salary merit increases and the related taxes
thereon. Data processing expenses increased 17.0% to $1.0 million as a result of
a higher loan and deposit base resulting from the Company's growth. Marketing
expenses decreased 20.6% to $393,000 primarily due to a decreased number of
discretionary promotions. Mortgage banking expenses increased due to the
significant increase in residential mortgage loan originations and refinances.
Office occupancy and equipment, professional fees and deposit insurance premiums
remained relatively the same for the first six months of 1998 as compared to the
corresponding period in 1997. Other operating expenses increased 8.5% to $1.6
million primarily due to increased general overhead expenses from operating a
larger institution.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $5.0 million
and $3.6 million on its financial statement earnings for the first six months of
1998 and 1997, respectively. The effective tax rate was 35.8% for both 1998 and
1997.
19
<PAGE> 22
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
Not Applicable
ITEM 2 Changes in Securities and Use of Proceeds
Not Applicable
ITEM 3 Defaults Upon Senior Securities
Not Applicable
ITEM 4 Submission of Matters to a Vote of Security Holders
Incorporated by reference to Andover's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 1998.
ITEM 5 Other Information
The Securities and Exchange Commission recently adopted
certain amendments to its rules governing the submission by
shareholders of proposals intended to be presented at
meetings of shareholders. These amendments, which became
effective on June 29, 1998, included granting the Company
the right to exercise discretionary voting authority with
respect to certain shareholder proposals that the Company
did not have notice of within a specified time period prior
to the meeting. Due to the "advance notice" provisions
contained in the Company's By-laws, the amendments relating
to discretionary voting authority will not affect the timing
or treatment of shareholder proposals intended to be
presented at the Company's 1999 Annual Meeting of
Shareholders.
Thus, as disclosed in the Company's 1998 Proxy Statement,
any shareholder proposals submitted pursuant to Rule 14a-8
promulgated under the Securities Exchange Act of 1934, as
amended ("Exchange Act Rule 14a-8"), and intended to be
presented at the Company's 1999 Annual Meeting of
Shareholders must be received in writing by the Company at
its principal executive offices on or before November 24,
1998 for inclusion in the proxy statement and form of proxy
to be distributed by the Board of Directors in connection
with such meeting. Any shareholder proposals intended to be
presented at the Company's 1999 Annual Meeting, other than
shareholder proposals submitted pursuant to Exchange Act
Rule 14a-8, must be filed with the Secretary of the Company
at least 60 days, but not more than 150 days, prior to the
date of the scheduled annual meeting; provided, however,
that if less than 70 days' notice or prior public disclosure
of the date of the scheduled annual meeting is given or
made, notice by the shareholder must be so delivered or
received not later than the close of business on the tenth
day following the earlier of the day on which such notice of
the date of the scheduled meeting was mailed or the day on
which such public disclosure was made.
It is currently anticipated that the Company's 1999 Annual
Meeting will be held on April 29, 1999. Accordingly, any
shareholder proposals intended to be presented at such
meeting, other than shareholder proposals submitted pursuant
to Exchange Act Rule 14a-8, must be filed with the Secretary
of the Company not later than February 28, 1999 and not
earlier than November 30, 1998.
ITEM 6 Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
20
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANDOVER BANCORP, INC.
August 6, 1998 /s/ Gerald T. Mulligan
----------------------
Gerald T. Mulligan
President and
Chief Executive Officer
August 6, 1998 /s/ Joseph F. Casey
----------------------
Joseph F. Casey
Chief Financial Officer
and Treasurer
21
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS DATED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 25,084
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 16,300
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 5,207
<INVESTMENTS-CARRYING> 120,095
<INVESTMENTS-MARKET> 121,671
<LOANS> 1,029,669
<ALLOWANCE> 10,308
<TOTAL-ASSETS> 1,392,342
<DEPOSITS> 971,993
<SHORT-TERM> 16,787
<LIABILITIES-OTHER> 11,727
<LONG-TERM> 277,690
0
0
<COMMON> 518
<OTHER-SE> 113,627
<TOTAL-LIABILITIES-AND-EQUITY> 1,392,342
<INTEREST-LOAN> 38,295
<INTEREST-INVEST> 10,339
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 48,634
<INTEREST-DEPOSIT> 19,767
<INTEREST-EXPENSE> 8,193
<INTEREST-INCOME-NET> 20,674
<LOAN-LOSSES> (2,205)
<SECURITIES-GAINS> 342
<EXPENSE-OTHER> 11,383
<INCOME-PRETAX> 13,948
<INCOME-PRE-EXTRAORDINARY> 13,948
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,952
<EPS-PRIMARY> 1.38
<EPS-DILUTED> 1.34
<YIELD-ACTUAL> 3.15
<LOANS-NON> 5,028
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,314
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<ALLOWANCE-OPEN> 12,521
<CHARGE-OFFS> 719
<RECOVERIES> 711
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<ALLOWANCE-DOMESTIC> 0
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