<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 1999 or
------------------
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the transition period from ____________ to _______________
Commission File Number 0-16358
----------------
ANDOVER BANCORP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 04-2952665
- ------------------------------ -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
61 Main Street, Andover, Massachusetts 01810
- --------------------------------------- ----------
(Address of principal executive office) (Zip Code)
(978) 749-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
The number of shares outstanding of each of the issuer's classes of Common
Stock, as of the latest practicable date is:
Class: Common Stock, par value $0.10 per share
Outstanding as of November 3, 1999: 6,531,772 shares
<PAGE> 2
ANDOVER BANCORP, INC.
AND SUBSIDIARIES
Index
PART I - FINANCIAL INFORMATION
ITEM 1 Financial Statements Page
Consolidated Balance Sheets 1
Consolidated Statements of Operations 2
Consolidated Statements of Changes in
Stockholders' Equity 3
Consolidated Statements of Cash Flows 4-5
Notes to Consolidated Financial
Statements 6
Analysis of Net Yield on Earning Assets 7
ITEM 2 Management's Discussion and Analysis of 8-20
Financial Condition and Results of Operations
For the Quarter Ended September 30, 1999
For the Nine Months Ended September 30, 1999
ITEM 3 Quantitative and Qualitative Disclosure About Market Risk 18
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 21
ITEM 2 Changes in Securities 21
ITEM 3 Defaults upon Senior Securities 21
ITEM 4 Submission of Matters to a Vote of Security Holders 21
ITEM 5 Other Information 21
ITEM 6 Exhibits and Reports on Form 8-K 21
Signatures 22
<PAGE> 3
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(In thousands)
<S> <C> <C>
ASSETS
Cash and due from banks $ 32,755 $ 29,337
Short-term investments 16,900 16,100
----------- -----------
Cash and cash equivalents 49,655 45,437
----------- -----------
Assets held for sale, at lower of
cost or market 1,747 11,282
Investments available for sale (amortized
cost of $210,684 in 1999 and $163,399
in 1998) 208,362 165,852
Investments held to maturity (market value
of $68,860 in 1999 and $102,512 in 1998) 69,471 100,920
Loans 1,103,462 1,050,765
Allowance for loan losses (11,421) (10,486)
----------- -----------
Net loans 1,092,041 1,040,279
----------- -----------
Mortgage servicing assets, net 9,727 8,956
Other real estate owned, net 120 252
Premises and equipment, net 9,063 9,255
Accrued interest receivable 8,713 7,432
Stock in FHLBB, at cost 17,737 15,747
Net deferred income taxes receivable 4,468 2,925
Other assets 2,010 1,910
----------- -----------
Total assets $ 1,473,114 $ 1,410,247
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 972,312 $ 988,656
Other borrowings 37,241 16,332
Federal Home Loan Bank advances 319,742 267,492
Mortgagors' escrow accounts 3,609 2,819
Income taxes payable 6,468 7,631
Accrued expenses and other liabilities 5,254 6,175
----------- -----------
Total liabilities 1,344,626 1,289,105
----------- -----------
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; 6,531,772 and 6,520,012
shares issued in 1999 and 1998, respectively 653 652
Additional paid-in capital 60,629 60,507
Retained earnings 68,670 58,716
Accumulated other comprehensive income (loss) (1,464) 1,267
----------- -----------
Total stockholders' equity 128,488 121,142
----------- -----------
Total liabilities and stockholders' equity $ 1,473,114 $ 1,410,247
=========== ===========
</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 NINE MONTHS ENDED
SEPTEMBER, 30 SEPTEMBER 30,
------------------------ -----------------------
1999 1998 1999 1998
------- ------- ------- -------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans $ 20,260 $ 19,559 $ 59,673 $ 57,854
Mortgage-backed securities 2,191 2,814 6,864 9,114
Investment securities 2,700 1,841 7,249 5,433
Short-term investments 200 216 401 663
----------- ----------- ----------- -----------
Total interest and dividend income 25,351 24,430 74,187 73,064
----------- ----------- ----------- -----------
Interest expense:
Deposits 8,472 9,972 25,744 29,739
Federal Home Loan Bank advances 4,479 3,784 11,971 11,664
Other borrowings 545 161 1,425 474
----------- ----------- ----------- -----------
Total interest expense 13,496 13,917 39,140 41,877
----------- ----------- ----------- -----------
Net interest and dividend income 11,855 10,513 35,047 31,187
Provision (credit) for loan losses -- 400 -- (1,805)
----------- ----------- ----------- -----------
Net interest and dividend income
after provision (credit) for loan
losses 11,855 10,113 35,047 32,992
----------- ----------- ----------- -----------
Non-interest income:
Net gains (losses) on assets held
for sale and investments available for sale (415) 165 (329) 507
Mortgage banking income (loss), net 139 (264) 658 (25)
Gains(losses) on real estate operations, net (18) 13 (52) 37
Other income 920 949 2,710 2,796
----------- ----------- ----------- -----------
Total non-interest income 626 863 2,987 3,315
----------- ----------- ----------- -----------
Non-interest expense:
Salaries and employee benefits 3,138 2,985 8,422 9,228
Office occupancy and equipment 768 774 2,326 2,181
Data processing 608 525 1,709 1,530
Professional fees 254 289 962 718
Marketing 219 211 643 604
Mortgage banking expense 49 124 234 459
Other operating expense 683 717 2,088 2,288
----------- ----------- ----------- -----------
Total non-interest expense 5,719 5,625 16,384 17,008
----------- ----------- ----------- -----------
Income before income tax expense 6,762 5,351 21,650 19,299
Income tax expense 2,240 878 7,587 5,874
----------- ----------- ----------- -----------
Net income $ 4,522 $ 4,473 $ 14,063 $ 13,425
=========== =========== =========== ===========
Basic earnings per share $ 0.69 $ 0.69 $ 2.16 $ 2.07
=========== =========== =========== ===========
Diluted earnings per share $ 0.67 $ 0.67 $ 2.10 $ 2.00
=========== =========== =========== ===========
Weighted average shares outstanding - basic 6,528,611 6,481,421 6,525,237 6,474,214
Dilutive impact of stock options 185,453 221,636 183,151 225,014
----------- ----------- ----------- -----------
Weighted average shares outstanding - diluted 6,714,064 6,703,057 6,708,388 6,699,228
=========== =========== =========== ===========
</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, 1998
and Nine Months Ended September 30, 1999
(Unaudited)
<TABLE>
<CAPTION>
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCK-
COMMON PAID-IN RETAINED COMPREHENSIVE HOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
------ ----------- -------- ------------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 $517 $59,619 $45,814 $1,129 $107,079
Comprehensive income:
Net income --- --- 17,386 --- 17,386
Other comprehensive income:
Unrealized holding gains arising
during the period, net of taxes
of $70 --- --- --- 126 126
Realized gains included in net
income, net of taxes of $5 --- --- --- 12 12
--------
Total comprehensive income 17,524
Dividends declared and
paid ($0.69 per share) (4,484) --- (4,484)
Par value adjustment for stock
split 130 (130) --- --- ---
Stock options exercised 5 1,018 --- --- 1,023
---- ------- ------- ------- --------
Balance at December 31, 1998 652 60,507 58,716 1,267 121,142
Comprehensive income:
Net income --- --- 14,063 --- 14,063
Other comprehensive income (loss):
-
Unrealized holding losses arising
during the period, net of tax
benefit of $1,548 --- --- --- (2,482) (2,482)
Realized losses included in net
income, net of tax benefit of $136 --- --- --- (249) (249)
--------
Total comprehensive income 11,332
Dividends declared and
paid ($0.63 per share) --- --- (4,109) --- (4,109)
Stock options exercised 1 122 --- --- 123
---- ------- ------- ------- --------
Balance at September 30, 1999 $653 $60,629 $68,670 $(1,464) $128,488
==== ======= ======= ======= ========
</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>
NINE MONTHS ENDED,
SEPTEMBER 30,
--------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 14,063 $ 13,425
Adjustments to reconcile net income to net cash
provided by operating activities:
Credit for loan losses -- (1,805)
Net gains on sales and provisions
for other real estate owned (7) (157)
Net (gains) losses from sales of investments available for sale 385 (17)
Net gains from sales of assets held for sale (56) (490)
Depreciation and amortization 1,090 1,012
Amortization of fees, discounts and premiums, net 571 450
Deferred income taxes 140 (909)
(Increase) decrease in:
Assets held for sale 9,591 (487)
Accrued interest receivable (1,281) (431)
Mortgage servicing assets 1,689 2,104
Other assets (100) (258)
Increase (decrease) in:
Mortgagors' escrow accounts 790 621
Accrued income taxes payable (1,163) 3,748
Accrued expenses and other liabilities (921) 99
--------- ---------
Net cash provided by operating activities 24,791 16,905
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases (119,032) (40,180)
Proceeds from sales 28,615 3,017
Proceeds from maturities and redemptions 25,063 2,500
Principal repayments 17,637 19,395
Investment and mortgage-backed securities held to maturity:
Purchases -- (10,041)
Proceeds from maturities and redemptions 1,000 8,500
Principal repayments 30,387 26,321
Net increase in FHLB stock (1,990) --
Purchases of whole loans (18,113) (18,635)
Purchases of mortgage servicing rights (2,460) (1,011)
Net increase in loans (34,017) (31,015)
Capital expenditures on premises and equipment, net (898) (781)
Proceeds from sales of other real estate owned 406 1,010
--------- ---------
Net cash used by investing activities (73,402) (40,920)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits (16,344) 12,194
Net increase in other borrowings 20,909 8,177
Proceeds from issuance of FHLB advances 240,300 242,600
Principal repayments of FHLB advances (188,050) (234,916)
Dividends paid (4,109) (3,314)
Stock options exercised 123 382
--------- ---------
Net cash provided by financing activities 52,829 25,123
--------- ---------
Net increase in cash equivalents 4,218 1,108
Cash and cash equivalents, at beginning of period 45,437 35,736
--------- ---------
Cash and cash equivalents, at end of period $ 49,655 $ 36,844
========= =========
</TABLE>
Statement continued on next page.
4
<PAGE> 7
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED,
SEPTEMBER 30
-------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $38,848 $42,105
Income taxes 7,111 3,025
Cash received during the period for:
Income taxes --- 82
Supplemental noncash investing and financing activities:
Conversion of real estate loans to
assets held for sale 28,236 38,214
Transfer of loans to other real estate owned 267 579
</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
subsidiary, Andover Bank (the "Bank"), presented herein, should be read in
conjunction with the consolidated financial statements of the Company as of
and for the year ended December 31, 1998. Andover Bank is a state chartered
savings bank with its headquarters located in Andover, Massachusetts. 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) MERGER
Andover Bank NH was a wholly-owned, de novo guaranty savings bank chartered
in September, 1995 and headquartered in Salem, New Hampshire. The Company
merged Andover Bank NH with and into Andover Bank as of close of business
on June 30, 1999, with the two banking offices of Andover Bank NH remaining
in full operation as branches of Andover Bank.
6
<PAGE> 9
ANDOVER BANCORP, INC. AND SUBSIDIARIES
ANALYSIS OF NET YIELD ON EARNING ASSETS
(Unaudited)
<TABLE>
<CAPTION>
QUARTERS ENDED SEPTEMBER 30,
1999 1998
------------------------------ --------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(4) BALANCE PAID RATE(4)
------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 15,356 $ 200 5.17% $ 15,349 $ 216 5.58%
Investment securities (1)(2) 169,628 2,700 6.31 110,193 1,841 6.63
Mortgage-backed securities (1) 136,277 2,191 6.38 170,711 2,814 6.54
---------- ------- ---------- -------
Total investments 321,261 5,091 6.29 296,253 4,871 6.52
---------- ------- ---------- -------
Residential loans (1) (3) 752,021 12,705 6.70 753,500 13,251 6.98
Commercial real estate loans (3) 181,695 3,877 8.47 144,720 3,230 8.85
Construction and land loans 67,560 1,562 9.17 41,772 1,042 9.90
---------- ------- --------- -------
Total real estate loans 1,001,276 18,144 7.19 939,992 17,523 7.40
Consumer loans (3) 59,833 1,185 7.86 64,669 1,396 8.56
Commercial loans and leases (3) 45,946 931 8.04 27,482 640 9.24
---------- ------- ---------- -------
Total loans 1,107,055 20,260 7.26 1,032,143 19,559 7.52
---------- ------- ---------- -------
Total interest-earning assets 1,428,316 25,351 7.04% 1,328,396 24,430 7.30%
------- -------
Allowance for loan losses (11,326) (10,376)
Other assets 53,604 51,587
---------- ----------
Total assets $1,470,594 $1,369,607
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 96,229 $ 197 0.81% $ 84,939 $ 212 0.99%
Money market deposit accounts 96,674 676 2.77 98,504 699 2.82
Savings accounts 213,588 1,727 3.21 186,030 1,728 3.69
Certificates of deposit 468,579 5,872 4.97 508,813 7,333 5.72
---------- ------- ---------- -------
Total interest-bearing deposits 875,070 8,472 3.84 878,286 9,972 4.50
---------- ------- ---------- -------
Borrowed funds:
Other borrowings 41,677 545 5.19 12,698 161 5.03
Federal Home Loan Bank advances 325,656 4,479 5.46 267,398 3,784 5.61
----------- ------- ----------- -------
Total borrowed funds 367,333 5,024 5.43 280,096 3,945 5.59
---------- ------- ---------- -------
Total interest-bearing liabilities 1,242,403 13,496 4.31% 1,158,382 13,917 4.77%
---------- ------- ---------- --------
Demand deposits 90,674 86,310
Other liabilities 9,691 11,764
---------- ----------
Total liabilities 1,342,768 1,256,456
Stockholders' equity 127,826 113,151
---------- ----------
Total liabilities and stock-
holders' equity $1,470,594 $1,369,607
========== ==========
Net interest income $11,855 $10,513
======= =======
Interest rate spread 2.73% 2.53%
==== ====
Net yield on earning assets 3.29% 3.14%
==== ====
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1999 1998
---------------------------- -----------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE(4) BALANCE PAID RATE(4)
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments $ 10,809 $ 401 4.96% $ 16,387 $ 663 5.41%
Investment securities (1)(2) 152,835 7,249 6.34 108,798 5,433 6.68
Mortgage-backed securities (1) 141,740 6,864 6.47 183,511 9,114 6.64
---------- ------- ---------- -------
Total investments 305,384 14,514 6.35 308,696 15,210 6.59
---------- ------- ---------- -------
Residential loans (1) (3) 756,733 38,343 6.77 745,494 39,549 7.09
Commercial real estate loans (3) 167,087 10,928 8.74 143,060 9,543 8.92
Construction and land loans 61,981 4,218 9.10 37,457 2,838 10.13
---------- ------- --------- -------
Total real estate loans 985,801 53,489 7.25 926,011 51,930 7.50
Consumer loans (3) 59,929 3,545 7.91 66,069 4,244 8.59
Commercial loans and leases (3) 43,687 2,639 8.08 23,652 1,680 9.50
---------- ------- ---------- -------
Total loans 1,089,417 59,673 7.32 1,015,732 57,854 7.62
---------- ------- ---------- -------
Total interest-earning assets 1,394,801 74,187 7.11% 1,324,428 73,064 7.38%
------- -------
Allowance for loan losses (11,186) (11,925)
Other assets 51,853 51,912
---------- ----------
Total assets $1,435,468 $1,364,415
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 95,012 $ 573 0.81% $ 84,296 $ 622 0.99%
Money market deposit accounts 96,356 5,015 2.77 101,989 4,662 2.86
Savings accounts 209,136 1,993 3.21 169,928 2,179 3.67
Certificates of deposit 472,692 18,163 5.14 516,178 22,276 5.77
---------- ------- ---------- -------
Total interest-bearing deposits 873,196 25,744 3.94 872,391 29,739 4.56
---------- ------- ---------- -------
Borrowed funds:
Other borrowings 40,509 1,425 4.70 12,354 474 5.13
Federal Home Loan Bank advances 293,761 11,971 5.45 273,849 11,664 5.69
---------- ------- ---------- -------
Total borrowed funds 334,270 13,396 5.36 286,203 12,138 5.67
---------- ------- ---------- -------
Total interest-bearing liabilities 1,207,466 39,140 4.33% 1,158,594 41,877 4.83%
---------- ------- ---------- -------
Demand deposits 93,322 85,917
Other liabilities 10,901 10,434
---------- ----------
Total liabilities 1,311,689 1,254,945
Stockholders' equity 123,779 109,470
---------- ----------
Total liabilities and stock-
holders' equity $1,435,468 $1,364,415
========== ==========
Net interest income $35,047 $31,187
======= =======
Interest rate spread 2.78% 2.55%
==== ====
Net yield on earning assets 3.36% 3.15%
==== ====
</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) Included in the average and interest earned amounts is the stock in FHLB of
Boston.
(3) 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 outstanding.
(4) The "Average Yield/Rate" calculation is based on an annualized basis
reflecting 92 days in the third quarter of both years and 273 days in the
year-to-date period of 1999 and 1998.
7
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
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
words "believe", "expect", "anticipate", "intend", "estimate", "assume", "plan",
and other similar expressions which are predictions of or indicate future events
and trends and which do not relate to historical matters identify
forward-looking statements. 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 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,
performance or achievements of the Company to differ materially from those
expressed or implied by forward-looking statements made in this quarterly report
on Form 10-Q or presented elsewhere by management from time to time. Defined
terms used elsewhere in this quarterly report have the same meanings herein as
therein. A number of uncertainties exist that could affect the Company's future
operating results, performance or achievements including, without limitation,
the Bank's continued ability to originate quality loans, fluctuations of
interest rates, real estate market conditions in the Bank's lending areas,
general and local economic conditions, the Bank's continued ability to attract
and retain deposits, the Company's ability to control costs, new accounting
pronouncements, unanticipated delays or expenses in achieving Year 2000
compliance experienced by the Company, its customers or suppliers, and changing
regulatory requirements. You should carefully review all of these factors, and
you should be aware that there may be other factors that could cause these
differences. These forward-looking statements were based on information, plans
and estimates at the date of this report and the Company does not promise to
update any forward-looking statements to reflect changes in underlying
assumptions or factors, new information, future events or other changes.
RESULTS OF OPERATIONS
GENERAL. Net income amounted to $4.5 million, or $0.67 per diluted share, for
the quarter ended September 30, 1999 substantially equivalent to the results for
the third quarter of 1998. The third quarter's results included a pre-tax loss
of $385,000 from the sale of lower yielding investment securities in 1999 versus
an income tax benefit of $1.1 million recognized in 1998. Andover's annualized
return on average assets decreased to 1.22% for the third quarter of 1999
compared to 1.30% in the third quarter of 1998. The annualized return on average
stockholders' equity decreased to 14.04% in the third quarter of 1999 from
15.68% in the third quarter of 1998.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income totaled $11.9
million for the third quarter of 1999 as compared to $10.5 million for the same
period in 1998. This increase resulted from the growth in earning assets
exceeding interest-bearing liabilities as well as an improved net interest
margin. The 15 basis point increase in the net yield on earning assets to 3.29%
for the third quarter of 1999, as compared to 3.14% in the corresponding quarter
of 1998, was due primarily to a 46 basis point decline on the rates paid on the
interest-bearing liabilities, partially offset by a 26 basis point decline in
the yield on the interest-earning assets.
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
8
<PAGE> 11
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 Bank's
allowance and may require the Bank to provide additions to the allowance based
on their assessment, which may differ from management's assessment.
There was no provision for loan losses for the third quarter of 1999 versus a
provision for loan losses of $400,000 in the comparable period of 1998. In
addition to the factors mentioned above, management considered several other
factors in determining that no provision was needed in the third quarter of
1999. These factors include, without limitation, the level and mix of loan
growth, the level of nonaccrual and delinquent loans, the ratio of the allowance
to total loans, as well as charge-offs and recoveries. During the first nine
months of 1999, the total loan portfolio increased by 5.0%. However, nonaccrual
loans decreased 4.1% from year-end 1998 and delinquent loans decreased by 35.2%
during the same period. In 1998, nonaccruing loans declined over 17.3% during
the third quarter while overdue loans continued their decline over several
quarters. Net recoveries totaled $147,000 for the third quarter of 1999 as
compared to net charge offs of $466,000 in 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 losses from sales of loans, investments and
mortgage-backed securities held for sale and available for sale totaled $415,000
in the third quarter of 1999 as compared to net gains of $165,000 in the third
quarter of 1998.
The loss of $415,000 in the third quarter of 1999 was primarily due to the sale
of $27.6 million of certain lower yielding investments at a pre-tax loss of
$385,000. The reinvestment of the sale proceeds is expected to enhance future
earnings.
Mortgage banking income totaled $139,000 in the third quarter of 1999 versus
mortgage banking losses of $264,000 in the comparable quarter in 1998. There was
no provision in 1999 compared to a provision for the valuation allowance of
$500,000 in the third quarter of 1998. The mortgage servicing assets are
assessed for impairment on a quarterly basis. During the third quarter of 1999,
mortgage interest rates rose, thereby increasing the value of the servicing
rights. The third quarter of 1998 was marked by high pre-payment levels and
declining mortgage interest rates which negatively impact the value of mortgage
servicing assets since future expected income is curtailed. Amortization expense
totaled $595,000 and $509,000, respectively, for the quarters ended September
30, 1999 and 1998. Mortgage servicing asset write-downs totaled $60,000 and
$180,000 for the third quarter of 1999 and 1998, respectively. If mortgage
interest rates decline from their current levels, it is possible that provisions
for the valuation allowance may be necessary. Loans serviced for investors
totaled $887.0 million and $857.4 million, respectively, at September 30, 1999
and 1998.
9
<PAGE> 12
The following table summarizes the activity in the valuation allowance for
mortgage servicing assets for the quarters and nine months ended September, 1999
and 1998:
<TABLE>
<CAPTION>
Quarters Ended Nine Months Ended
September 30, September 30,
----------------- --------------------
1999 1998 1999 1998
------ ------ ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 560 $ 500 $ 1,125 $ 400
Provision (credit) for valuation
allowance -- 500 (175) 1,040
Charge-offs (60) (105) (450) (545)
----- ----- ------- -------
Balance at end of period $ 500 $ 895 $ 500 $ 895
===== ===== ======= =======
</TABLE>
Other income totaled $920,000 in the third quarter of 1999 as compared to
$949,000 in the third quarter of 1998 primarily due to lower loan fees partially
offset by an increase in deposit fee income.
NON-INTEREST EXPENSE. Non-interest expenses increased by $94,000, or 1.7%, to
$5.7 million in the third quarter of 1999 from $5.6 million in the third quarter
of 1998. The efficiency ratio (a ratio that measures operating expenses as a
percentage of operating income) decreased from 50.23% in the third quarter of
1998 to 44.29% in the comparable period of 1999 primarily due to higher
operating income. The increase in non-interest expense during the third quarter
of 1999 was attributable to a rise in both salaries and employee benefits and
data processing expenses, partially offset by a decrease in mortgage banking and
other operating expenses.
Salaries and employee benefits, the largest component of non-interest expense,
increased $153,000, or 5.1%, in the third quarter of 1999 to $3.1 million due to
increased costs associated with an increased number of employees as well as a
reduction in deferred costs resulting from fewer residential loan closings
during the current quarter. Partially offsetting this increase was $265,000 in
expenses incurred in 1998 which, due to the pension curtailment in the first
quarter of 1999, were not incurred in 1999. It is expected that a replacement
retirement plan will be in place during the first quarter of 2000 that will
result in recurring charges against earnings.
Data processing expenses increased from the third quarter of 1998 to the
corresponding quarter in 1999 by 15.8% or $83,000. This was primarily due to an
increase in the number of loans serviced by the Company as well as certain
software costs associated with merging Andover Bank NH into Andover Bank and
expenses incurred in preparing for the Year 2000 issue.
Professional fees decreased $35,000 to $254,000 in the third quarter of 1999
from $289,000 in the third quarter of 1998 due to decreased legal fees.
Mortgage banking expenses decreased 60.5% or $75,000 in the third quarter of
1999 versus 1998's third quarter due to reduced costs incurred in conjunction
with the serviced loan portfolio.
Other operating expenses decreased 4.7% from the third quarter of 1998 to
$683,000 in the corresponding quarter in 1999 due to a reduction in corporate
banking insurance and telephone expenses.
Marketing expenses and office occupancy and equipment expenses remained fairly
stable for the third quarters of both 1999 and 1998.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $2.2 million
and $878,000 on its financial statement earnings for the third quarters of 1999
and 1998, respectively. The effective tax rate for the third quarter of 1999 was
33.1%, as
10
<PAGE> 13
compared to 16.4% for the corresponding period in 1998. The lower than
anticipated effective tax rates were due to recognized tax benefits of $225,000
and $1.1 million, respectively, for the quarters ended September 30, 1999 and
1998. The decline in the effective rate in both quarters resulted from the
favorable resolution of various tax issues that had previously been reserved.
FINANCIAL CONDITION
Total assets increased from $1,410.2 million at December 31, 1998 to $1,473.1
million at September 30, 1999. Increases in investments available for sale and
the loan portfolio were funded primarily by borrowings during the first nine
months of 1999.
LOANS. The following table shows the composition of the Company's loan portfolio
at September 30, 1999 and December 31, 1998. The balances shown in the table are
net of unadvanced funds and deferred loan origination fees and costs.
<TABLE>
<CAPTION>
9/30/99 12/31/98
---------- ----------
(In thousands)
<S> <C> <C>
Real estate loans:
Residential $ 746,532 $ 740,009
Commercial 183,270 163,999
Construction and land 64,583 56,568
---------- ----------
Total real estate loans 994,385 960,576
---------- ----------
Consumer loans 60,238 61,851
Commercial loans and leases 48,839 28,338
---------- ----------
Total loans $1,103,462 $1,050,765
========== ==========
</TABLE>
Total loans increased $52.7 million during the first nine months of 1999 to
$1,103.5 million at September 30, 1999, primarily due to increases in the
commercial real estate and the commercial loan and lease portfolios. The
increase in these loan portfolios was aided by the favorable interest rate
environment, high employment and consumer confidence.
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 favorable
interest rates experienced in the first nine months of 1998, mortgage
refinancing volume was heavy resulting in residential loan originations totaling
$242.0 million. Conversely in 1999, residential loan originations totaled $154.4
million due to a decrease in refinancing activity caused by a rise in interest
rates. Residential loan balances increased only $6.5 million during the first
nine months of 1999 primarily due the securitization of certain fixed-rate loans
as well as regular amortization and loan prepayments.
Outstanding corporate loans, comprised of commercial real estate, commercial,
construction and land loans and leases, increased $47.8 million during the first
nine months of 1999. 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 totaled $125.2 million and $110.8 million, respectively, for the
nine months ended September 30, 1999 and 1998. The loan balances do not reflect
the full impact of the strong originations due to loan prepayments and certain
amounts that remain unadvanced as of September 30, 1999.
Consumer loan balances decreased by approximately 3.5% on an annualized basis,
to $60.2 million at September 30, 1999, primarily due to payoffs of the home
equity loan balances and second mortgages resulting from the first mortgage
refinance activity.
11
<PAGE> 14
RISK ELEMENTS. The following table shows the composition of non-performing
assets at September 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
9/30/99 12/31/98
------- --------
(Dollars in thousands)
<S> <C> <C>
Nonaccruing loans $3,106 $3,240
Other real estate owned 120 252
------ ------
Total non-performing assets $3,226 $3,492
====== ======
Total non-performing assets as a
percentage of total assets 0.22% 0.25%
</TABLE>
Significant progress has been made over the past several years in reducing total
non-performing assets. A 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. Continued deterioration in this market area will
adversely impact the collectibility of residential and commercial real estate
loans and may result in an increase in non-performing assets. At September 30,
1999, approximately $1.4 million, or 44.0%, of non-performing assets were
secured by properties located in Lawrence, consisting primarily of mixed-use
commercial and multi-family properties.
At September 30, 1999, total impaired loans were $1.6 million, of which $370,000
had related allowances of $20,000 and $1.3 million which did not require a
related allowance. During the nine months ended September 30, 1999, the average
recorded value of impaired loans was $1.8 million.
NONACCRUING LOANS. Management places loans on nonaccrual status when loan
payments are past due 90 days or more, regardless of collateral values. All
previously accrued but uncollected interest is reversed against current period
interest income when a loan is placed on nonaccrual status. Loans for which
payments are less than 90 days past due are placed on nonaccrual status when
concern exists regarding the ultimate collectibility of the loan.
The following table shows the composition of nonaccruing loans at September 30,
1999 and December 31, 1998:
<TABLE>
<CAPTION>
9/30/99 12/31/98
------- --------
(Dollars in thousands)
<S> <C> <C>
Residential real estate $ 861 $ 932
Commercial real estate 1,741 2,023
Commercial loans and leases 477 255
Consumer 27 30
------- -------
Total nonaccrual loans $ 3,106 $ 3,240
======= =======
Allowance for loan losses $11,421 $10,486
======= =======
Allowance for loan losses as a
percentage of total loans 1.04% 1.00%
</TABLE>
12
<PAGE> 15
ALLOWANCE FOR LOAN LOSSES. The following table summarizes the activity in the
Company's allowance for loan losses for the quarters and nine months ended
September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Quarters Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
1999 1998 1999 1998
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $11,274 $10,308 $10,486 $12,521
Provision (credit) for loan losses --- 400 --- (1,805)
Charge-offs:
Residential real estate --- (5) (97) (182)
Commercial real estate --- (96) (20) (632)
Construction and land --- --- --- ---
Commercial loans and leases --- (510) (15) (510)
Consumer (2) (3) (5) (10)
------ ------- -------- -------
Total charge-offs (2) (614) (137) (1,334)
------ ------- -------- -------
Recoveries:
Residential real estate 3 21 14 56
Commercial real estate 75 55 690 330
Construction and land 19 30 19 265
Commercial loans and leases 48 37 329 190
Consumer 4 5 20 19
------- ------- ------- -------
Total recoveries 149 148 1,072 860
------- ------- ------- -------
Net recoveries (charge-offs) 147 (466) 935 (474)
------- -------- ------- -------
Balance at end of period $11,421 $10,242 $11,421 $10,242
======= ======= ======= =======
Ratio of annualized net
(charge-offs) recoveries to average
loans outstanding 0.05% (0.14)% 0.11% (0.06)%
</TABLE>
Management analyzes the adequacy of the allowance for loan losses on a quarterly
basis. See "Results of Operations - Provision for Loan Losses".
INVESTMENTS. As of September 30, 1999, the Company's total investment portfolio
amounted to $294.7 million for an increase of $11.9 million from December 31,
1998. The increase in the first nine months of 1999 was primarily due to
purchases of various investments available for sale, including U.S. government
and federal agency obligations, corporate and nontaxable bonds and
mortgage-backed securities, totaling $119.0 million. However, these purchases
were offset by principal repayments in the mortgage-backed portfolio as well as
higher maturities and redemptions.
During the third quarter of 1999, approximately $27.6 million of lower yielding
investments were sold at a loss of $385,000. These included U.S. government
obligations and GNMA mortgage-backed securities. The reinvestments of the sale
proceeds is expected to enhance future earnings.
Management continually evaluates its investment alternatives in order to
properly manage the overall balance sheet mix. The timing of purchases, sales
and reinvestment, if any, will be based on various factors including expectation
of movements in market interest rates and loan demand. Notwithstanding these
events, it is the intent of management to grow the earning asset base through
loan originations, loan purchases or investment acquisitions while funding this
growth through a mix of retail deposits, FHLB advances and reverse repurchase
agreements.
13
<PAGE> 16
The following table presents the composition and carrying values of the
investment portfolio at September 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
9/30/99 12/31/98
------- --------
(In thousands)
<S> <C> <C>
SHORT-TERM INVESTMENTS $ 16,900 $ 16,100
======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
Common stocks $ 416 $ 361
U.S. government and federal agency obligations 66,161 62,556
Other bonds and obligations 70,898 37,561
-------- --------
Total bonds and obligations 137,475 100,478
-------- --------
GNMA mortgage-backed securities 25,828 35,884
FHLMC participation certificates 20,346 26,981
FNMA pass-through certificates 11,626 2,509
Collateralized mortgage obligations 13,087 ---
-------- --------
Total mortgage-backed securities 70,887 65,374
-------- --------
Total investments available for sale $208,362 $165,852
======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations $ 8,512 $ 8,526
Other bonds and obligations 3,521 4,545
-------- --------
Total bonds and obligations 12,033 13,071
-------- --------
FNMA pass-through certificates 25,587 35,435
FHLMC participation certificates 19,586 30,207
GNMA mortgage-backed securities 2,015 2,576
Collateralized mortgage obligations 9,833 19,080
Other asset-backed securities 417 551
-------- --------
Total mortgage-backed securities 57,438 87,849
-------- --------
Total investments held to maturity $ 69,471 $100,920
======== ========
Total investments $294,733 $282,872
======== ========
</TABLE>
The following table shows the gross unrealized gains and losses by major
categories of securities as of September 30, 1999:
<TABLE>
<CAPTION>
Unrealized Unrealized
Gains Losses
---------- ----------
(In thousands)
<S> <C> <C>
INVESTMENTS AVAILABLE FOR SALE:
Common stocks $ --- $ ---
U.S. government and federal agency obligations 238 (601)
Other bonds and obligations 91 (1,648)
Mortgage-backed securities 133 (535)
------ -------
Total investments available for sale $ 462 $(2,784)
====== =======
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations $ --- $ (45)
Other bonds and obligations 41 (2)
Mortgage-backed securities 351 (956)
------ -------
Total investments held to maturity $ 392 $(1,003)
====== =======
Total unrealized gains and losses $ 854 $(3,787)
====== =======
</TABLE>
At September 30, 1999, the Company's net unrealized loss on investments
available for sale amounted to $2.3 million, a fair value decline of $4.4
million from an unrealized gain of $2.1 million at December 31, 1998. At
September 30, 1999, the Company's net unrealized loss on investments held to
maturity totaled $611,000, for a decline of $2.2 million from an unrealized gain
of $1.6 million at December 31, 1998. The changes in
14
<PAGE> 17
the net unrealized gains on the total investment portfolio from year-end 1998
were primarily due to an increase in market interest rates during the first nine
months of 1999.
DEPOSITS AND BORROWED FUNDS. Total deposits decreased $16.3 million to $972.3
million at September 30, 1999 from $988.7 million at December 31, 1998. This
decrease was most pronounced in certificates of deposit which decreased by $16.9
million during the first nine months of 1999. In addition, demand deposit
accounts declined by $13.1 million during this period. Partially offsetting
these decreases, however, was an increase of $13.8 million or 6.9% in savings
accounts during the first nine months of 1999. The decline in the certificates
of deposits during the first nine months reflects the continued shift from
longer maturity term deposits into core deposits without fixed maturities. The
decline in the demand deposit balances resulted from the high level of custodial
balances at year-end 1998 due to the refinancing activity.
The following table shows the composition of the Company's deposits at September
30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
9/30/99 12/31/98
------- --------
(In thousands)
<S> <C> <C>
Demand deposit accounts $ 89,905 $103,029
NOW accounts 103,293 102,635
Money market deposit accounts 95,486 96,332
Savings accounts 213,137 199,304
Certificates of deposit 470,491 487,356
-------- --------
Total deposits $972,312 $988,656
======== ========
</TABLE>
In order to fund the growth in total assets experienced during the first nine
months of 1999, the Bank offset the decline in deposits with an increased
reliance on borrowed funds. Federal Home Loan Bank advances increased $52.3
million from December 31, 1998 to $319.7 million at September 30, 1999. Other
borrowings increased $20.9 million to $37.2 million at September 30, 1999.
LIQUIDITY. The goal of the Company's liquidity management process is to assess
its funding requirements so as 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 subsidiary. In
the third quarter of 1999, the Company made payments of dividends to its
stockholders in the amount of $1.4 million. In October, 1999, the Company
declared a dividend in the amount of $1.6 million, payable in the fourth quarter
of 1999.
The Bank has a diverse base of funding sources including customer deposits,
borrowed funds, repayments, prepayments and amortization of the investment and
loan portfolios. A portion of the Bank's 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 Bank may also obtain funds from the Federal
Reserve Bank of Boston by pledging certain assets.
Cash flows provided by operations increased $7.9 million to $24.8 million in the
first nine months of 1999, as compared to $16.9 million in the corresponding
period of 1998, primarily due to a decrease in assets held for sale as well as
higher net income. Cash flows used by investing activities increased by $32.5
million to $73.4 million for the nine months ended September, 1999, as compared
to $40.9 million during the equivalent period last year. This increase was
mainly attributable to a higher level of purchases of securities available for
sale. Cash flows provided by financing activities increased
15
<PAGE> 18
$27.7 million for the nine months ended September 30, 1999 to $52.8 million, as
compared to $25.1 million in the equivalent period in 1998. The financing
activity increase was due to a change in the mix of financing sources, with a
decline in deposits offset by an increase in borrowed funds.
At September 30, 1999, the Company had home equity, reserve credit and
commercial unadvanced lines of credit totaling $99.1 million. Outstanding
commitments to originate loans totaled $37.2 million. Unadvanced portions of
construction and land loans amounted to $26.6 million. Standby letters of credit
were $2.9 million. Loans sold with recourse totaled $1.2 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 regulatory and risk-based capital requirements as of September 30, 1999:
<TABLE>
<CAPTION>
Leverage Capital Ratio Risk-Based Capital Ratio
---------------------- ------------------------
Tier 1 Tier 1 Total
------ ------ -----
<S> <C> <C> <C>
Andover Bancorp, Inc. 8.84% 13.80% 15.01%
Andover Bank 8.52% 13.22% 14.43%
</TABLE>
Current minimum regulatory requirements as of September 30, 1999 were 4.0% for
the leverage capital ratio and 4.0% and 8.0%, respectively, for the Tier 1 and
total risk-based capital ratios. As of September 30, 1999, the most recent
notification from the FDIC categorized the Bank as well capitalized under the
prompt corrective action provisions. Therefore, the Bank is entitled to pay the
lowest deposit premium possible.
YEAR 2000 READINESS DISCLOSURE. The statements in the following section include
"Year 2000 readiness disclosure" within the meaning of the Year 2000 Information
and Readiness Disclosure Act.
This section contains certain statements that are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1993, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"believe", "expect", "anticipate", "intend", "estimate", "assume", "plan", and
other similar expressions which are predictions of or indicate future events and
trends and which do not relate to historical matters identify forward-looking
statements. Forward-looking statements include, without limitation, the
Company's expectations as to when it will complete the modification and testing
phases of its Year 2000 project plan as well as its Year 2000 contingency plans;
its estimated cost of achieving Year 2000 readiness; and the Company's belief
that its internal systems will be Year 2000 compliant in a timely manner. The
Company's readiness for the Year 2000, and the eventual effects of the Year 2000
on the Company may be materially different than currently projected. This may be
due to, among other things, unanticipated delays and expenses in the completion
of the Company's Year 2000 initiative, the availability of qualified personnel
and other information technology resources; the ability to identify and
remediate all date sensitive lines of computer code or to replace embedded
computer chips in affected systems or equipment; the failure of its proposed
contingency plans, if such contingency plans become necessary, to achieve their
desired result and the failure of governmental agencies and third parties with
whom the Company has a significant business relationship to achieve Year 2000
readiness.
The Year 2000 computer software compliance issues affect Andover and many other
financial institutions and companies in the U.S. Historically, certain computer
programs were written using two digits rather than four to define the applicable
years. As a result, software may recognize a date using the two digits "00" as
1900 rather than the year 2000. Computer programs that do not recognize the
proper date could generate erroneous data or cause systems to fail.
16
<PAGE> 19
The Company began its Year 2000 initiative in early 1997. The Company has
completed its assessment of Year 2000 issues, devised a workplan as well as a
contingency plan, tested its various software information systems, hardware
components and non-technology systems and arranged for the required human and
financial resources to complete its necessary remediation efforts. The Company
has completed the remediating, testing and returning to production all of its
critical and non-critical applications as of September 30, 1999.
The Company has considered various contingency plans for its critical
applications, including the possibility of obtaining alternative vendors or
replacement systems. Based on its assessment of their progress to date, the
Company has determined to rely on the ability of the Company's service bureau
and other critical vendors to achieve Year 2000 readiness. This assessment has
included multiple visits with the Company's service bureau, discussions with the
other critical vendors, reviewing each vendor's compliance in meeting its own
targeted deadlines as well as continuously monitoring each vendor by the
Company. In addition, the Company has actively participated in the testing of
its critical applications in conjunction with its significant vendors. However,
contingency plans beyond this reliance on vendor compliance have not been
established in the event that these critical vendors are unable to achieve Year
2000 readiness.
The Company has worked on a number of alternative solutions for their
non-technology systems such as heat, electric and telephone services. This has
involved seeking alternative vendors and sources such as generators to provide
heat in case of an electric failure or cellular phones in lieu of traditional
phone lines. Should the Company's worst case scenario, the loss of electric
power, occur, the Company will have in place an electric generator at its main
office. This will allow the Company to continue to run its core operating
system. Transactions that would be performed at a number of the Company's
locations would then have to be transported to the main office for input. This
would continue until such time as normal electric power is restored. In
addition, two other branch locations have had generators installed to assist in
the processing of transactions if needed.
The Company will continue to utilize both internal and external resources to
ensure Year 2000 readiness. Included in other noninterest expenses are charges
incurred in connection with the modification or replacement of software and
hardware in order for the Company's computer systems to properly recognize the
Year 2000. The expenses incurred and hardware capitalized totaled approximately
$160,000 and $360,000 for the quarter and nine months ended September 30, 1999,
respectively, and approximately $650,000 over the course of the project incurred
to date. The Company expects that the majority of the remaining costs that will
be incurred (as discussed below) will be to replace or upgrade existing hardware
and software which will be capitalized and amortized in accordance with the
Company's existing accounting policy while miscellaneous consulting, maintenance
and modification costs will be expensed as incurred.
The Company continues to evaluate the estimated costs associated with achieving
Year 2000 readiness based on its experience to date. Based on current estimates,
the remaining costs of its efforts to achieve Year 2000 readiness are not
expected to exceed $75,000. However, no assurance can be given that the Company
or the third party vendors to whom the Company outsources its information
systems will solve such issues in a successful and timely fashion or that the
costs of such efforts will not exceed current estimates. If the Company does not
solve such issues, or does not do so in a timely manner, the Year 2000 issue
could have a material adverse impact on the Company's business, future operating
results and financial condition.
Bank regulatory agencies have issued guidance under which they are assessing
Year 2000 readiness. The failure of a financial institution, such as Andover, to
take appropriate action to address Year 2000 issues may result in enforcement
actions which could have a material adverse effect on such institution, result
in the imposition of
17
<PAGE> 20
civil money penalties, or result in the delay of applications seeking to acquire
other entities or otherwise expand the institution's activities.
RECENT ACCOUNTING DEVELOPMENTS. In June 1998, the FASB issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes new accounting and reporting standards for derivative instruments.
SFAS 133 requires that an entity recognize all derivatives as either assets or
liabilities and measure those instruments at fair value. This statement, as
amended by SFAS 137, is effective for financial statements issued for all fiscal
quarters of fiscal years beginning after June 15, 2000. Early application is
encouraged but restatement of prior periods is prohibited. SFAS 133 is not
expected to have a material impact on the consolidated financial statements of
the Company.
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK. The Company's interest rate risk
and asset and liability management are the responsibility of Andover's
Asset/Liability Management Committee (ALCO). The ALCO Committee actively manages
and monitors its interest rate risk exposure and reports its findings to the
Board of Directors of the Company on a regular basis.
Interest rate risk, including mortgage prepayment risk, or market risk, is by
far the most significant non-credit related risk to which the Company is
exposed. Net interest income, the Bank's primary source of revenue, is affected
by changes in interest rates as well as fluctuations in the level and duration
of assets and liabilities on the Company's balance sheet.
The mortgage servicing assets are assessed for impairment on a quarterly basis.
In a low interest rate environment, loans may repay faster than expected,
thereby causing the fair value of the mortgage servicing assets to decline. If
interest rates decline it is possible that provisions for the valuation
allowance on servicing assets may be necessary.
For further information regarding quantitative and qualitative disclosures about
market risk, please refer to the Company's Form 10-K as of and for the year
ended December 31, 1998.
18
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
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 $14.1 million, $2.10 per diluted share, for the
nine months ended September 30, 1999, compared to net income of $13.4 million,
$2.00 per diluted share, in the corresponding period of 1998.
The financial performance in the first nine months of 1999 was positively
impacted by a $1.1 pre-tax gain due to the curtailment of the defined benefit
plan. The nine months' results for 1998 included a pre-tax credit for loan
losses of approximately $1.8 million and a tax benefit of $1.1 million due to
the favorable resolution of several tax issues previously reserved. The pension
curtailment combined with the rise in net interest and dividend income resulted
in an annualized return on average assets of 1.31% for the first nine months of
1999 as compared to 1.32% in the comparable period of 1998. The annualized
return on average stockholders' equity was 15.19% in the first nine months of
1999, for a slight decline from 16.40% in the comparable period of 1998.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $35.0
million for the nine months of 1999, as compared to $31.2 million for the same
period in 1998, an increase of 12.4%. The 21 basis point increase in the net
yield on earning assets to 3.36% for the first nine months of 1999, was
primarily due to a 50 basis point decline in the rate paid on interest-bearing
liabilities.
PROVISION (CREDIT) FOR LOAN LOSSES. There was no provision for loan losses in
the first nine months of 1999 as compared to a credit for loan losses of $1.8
million in the first nine months of 1998. Among the factors used to determine
that no provision for loan losses was appropriate in 1999 were the continued
improvement in loan quality, as well as management's assessment of changes in
trends and conditions. Nonaccruing loans decreased by 4.1% during the first nine
months of 1999 while overdue loans decreased by 35.2% over the same time period.
In addition, loan loss recoveries totaled $935,000 in the first nine months of
1999.
NON-INTEREST INCOME. Andover recorded gains from non-interest sources of $3.0
million for the first nine months of 1999, as compared to $3.3 million in the
corresponding period of 1998. Net losses from sales of assets held for sale and
investments available for sale totaled $329,000 in 1999 as compared to gains of
$507,000 in the same period of 1998. Included in the results of 1999 was a loss
of $385,000 from the sale of certain lower yielding investments available for
sale.
Mortgage banking income totaled $658,000 during the first nine months of 1999 as
compared to losses of $25,000 in the corresponding period of 1998 due to
decreased amortization and a partial reversal of the provision for the valuation
allowance on mortgage servicing assets in 1999. Total amortization and
provisions amounted to $1.7 million for the first nine months of 1999 as
compared to $2.5 million for the respective period in 1998. Charge-offs on
mortgage servicing assets totaled $450,000 and $690,000 for the nine months
periods ending September 30, 1999 and 1998, respectively.
19
<PAGE> 22
Losses on real estate operations totaled $52,000 during the first nine months of
1999 as compared to gains of $37,000 in the corresponding period of 1998.
Included in the results for 1998 was a negative provision for the valuation of
other real estate owned totaling $107,000.
Other income remained relatively stable and amounted to $2.7 million in the
first nine months of 1999 as compared to $2.8 million in 1998.
NON-INTEREST EXPENSE. Non-interest expenses decreased 3.7% to $16.4 million in
the first nine months of 1999 primarily due to a decrease in salaries and
employee benefits. Salaries and benefits decreased 8.7% to $8.4 million in 1999
due to the curtailment of the defined benefit pension plan which resulted in a
pre-tax gain of $1.1 million taken in the first quarter of 1999. This compares
to costs incurred in 1998 of approximately $528,000. It is expected that a
replacement retirement plan that will result in recurring charges against
earnings, will become effective in the first quarter of 2000.
Office occupancy and equipment increased 6.6% to $2.3 million in 1999 primarily
resulting from increased capitalized hardware purchases and related depreciation
expense thereon.
Data processing expenses increased 11.7% to $1.7 million resulting from the
Company's loan base growth as well as expenses incurred relating to both the
merger of Andover Bank NH into Andover Bank and the Year 2000 issue.
Professional fees increased 34.0% to $962,000 in 1999 from $718,000 in 1998 due
to increased legal and corporate consulting fees. A portion of these costs are
non-recurring and relate to the merger of Andover Bank NH into the Bank and the
curtailment of the defined benefit plan.
Marketing expenses increased 6.5% to $643,000 primarily due to increased
advertising.
Mortgage banking expenses decreased 49.0% due to a lower level of residential
mortgage loan originations and refinances.
Other operating expenses decreased 8.7% to $2.1 million primarily due to reduced
corporate insurance costs, telephone costs, printing expenses and other
miscellaneous costs.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $7.6 million
and $5.9 million on its financial statement earnings for the first nine months
of 1999 and 1998, respectively. The effective tax rate was 35.0% and 30.4% for
1999 and 1998, respectively. The lower effective rate in 1998 resulted from a
tax benefit of $1.1 million due to the favorable resolution of several tax
issues that had been previously reserved.
20
<PAGE> 23
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
Not Applicable
ITEM 2 Changes in Securities and Use of Proceeds
Not Applicable
ITEM 3 Defaults Upon Senior Securities
Not Applicable
ITEM 4 Submission of Matters to a Vote of Security Holders
Not Applicable
ITEM 5 Other Information
None
ITEM 6 Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
21
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANDOVER BANCORP, INC.
November 10, 1999 /s/ Gerald T. Mulligan
----------------------
Gerald T. Mulligan
President and
Chief Executive Officer
November 10, 1999 /s/ Joseph F. Casey
-------------------
Joseph F. Casey
Chief Financial Officer
and Treasurer
22
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 10Q
FINANCIAL STATEMENTS DATED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH 10Q FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 32,755
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 16,900
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,747
<INVESTMENTS-CARRYING> 69,471
<INVESTMENTS-MARKET> 68,860
<LOANS> 1,103,462
<ALLOWANCE> 11,421
<TOTAL-ASSETS> 1,473,114
<DEPOSITS> 972,312
<SHORT-TERM> 0
<LIABILITIES-OTHER> 15,331
<LONG-TERM> 356,983
653
0
<COMMON> 0
<OTHER-SE> 127,835
<TOTAL-LIABILITIES-AND-EQUITY> 1,473,114
<INTEREST-LOAN> 59,673
<INTEREST-INVEST> 14,514
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 74,187
<INTEREST-DEPOSIT> 25,744
<INTEREST-EXPENSE> 39,140
<INTEREST-INCOME-NET> 35,047
<LOAN-LOSSES> 0
<SECURITIES-GAINS> (329)
<EXPENSE-OTHER> 16,384
<INCOME-PRETAX> 21,650
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,063
<EPS-BASIC> 2.16
<EPS-DILUTED> 2.10
<YIELD-ACTUAL> 3.36
<LOANS-NON> 3,106
<LOANS-PAST> 0
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<ALLOWANCE-OPEN> 10,486
<CHARGE-OFFS> 137
<RECOVERIES> 1,072
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</TABLE>
