<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, 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 August 2, 1999: 6,527,472 shares
<PAGE> 2
ANDOVER BANCORP, INC.
AND SUBSIDIARIES
Index
PART I - FINANCIAL INFORMATION
Page
ITEM 1 Financial Statements
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 June 30, 1999
For the Six Months Ended June 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>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(In thousands)
ASSETS
<S> <C> <C>
Cash and due from banks $ 30,607 $ 29,337
Short-term investments --- 16,100
---------- ----------
Cash and cash equivalents 30,607 45,437
---------- ----------
Assets held for sale, at lower of
cost or market 2,280 11,282
Investments available for sale (amortized
cost of $220,035 in 1999 and $163,399
in 1998) 218,269 165,491
Investments held to maturity (market value
of $77,552 in 1999 and $102,512 in 1998) 77,849 100,920
Loans 1,103,091 1,050,765
Allowance for loan losses (11,274) (10,486)
---------- ----------
Net loans 1,091,817 1,040,279
---------- ----------
Mortgage servicing assets, net 8,735 8,956
Other real estate owned, net 94 252
Premises and equipment, net 9,137 9,255
Accrued interest receivable 8,444 7,432
Stock in FHLBB, at cost 16,628 15,747
Net deferred income taxes receivable 4,733 2,925
Other assets 2,542 2,271
---------- ----------
Total assets $1,471,135 $1,410,247
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 973,288 $ 988,656
Federal Home Loan Bank advances and other borrowings 358,745 283,824
Mortgagors' escrow accounts 2,542 2,819
Income taxes payable 5,903 7,631
Accrued expenses and other liabilities 5,015 6,175
---------- ----------
Total liabilities 1,345,493 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; 6,525,837 and 6,520,012
shares issued in 1999 and 1998, respectively 653 652
Additional paid-in capital 60,572 60,507
Retained earnings 65,518 58,716
Accumulated other comprehensive income (loss) (1,101) 1,267
---------- ----------
Total stockholders' equity 125,642 121,142
---------- ----------
Total liabilities and stockholders' equity $1,471,135 $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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------- -------
1999 1998 1999 1998
---- ---- ---- ----
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans $19,865 $19,366 $39,413 $38,295
Mortgage-backed securities 2,225 3,077 4,673 6,300
Investment securities 2,415 1,844 4,549 3,592
Short-term investments 69 200 201 447
------- ------- ------- -------
Total interest and dividend income 24,574 24,487 48,836 48,634
------- ------- ------- -------
Interest expense:
Deposits 8,478 9,898 17,272 19,767
Federal Home Loan Bank advances and other
borrowings 4,338 4,235 8,372 8,193
------- ------- ------- -------
Total interest expense 12,816 14,133 25,644 27,960
------- ------- ------- -------
Net interest and dividend income 11,758 10,354 23,192 20,674
Credit for loan losses --- (2,250) --- (2,205)
------- ------ ------- -------
Net interest and dividend income
after credit for loan losses 11,758 12,604 23,192 22,879
------- ------- ------- -------
Non-interest income:
Net gains (losses) from sales of assets held
for sale and investments available for sale (7) 192 86 342
Mortgage banking income, net 302 223 519 239
Gains (losses) on real estate operations, net (20) 100 (34) 24
Other income 887 904 1,790 1,847
------- ------- ------- -------
Total non-interest income 1,162 1,419 2,361 2,452
------- ------- ------- -------
Non-interest expense:
Salaries and employee benefits 2,957 3,146 5,284 6,243
Office occupancy and equipment 811 752 1,558 1,407
Data processing 575 493 1,101 1,005
Professional fees 225 202 708 429
Marketing 212 162 424 393
Mortgage banking expense 59 109 185 335
Other operating expense 605 839 1,405 1,571
------- ------- ------- ------
Total non-interest expense 5,444 5,703 10,665 11,383
------- ------ ------- -------
Income before income tax expense 7,476 8,320 14,888 13,948
Income tax expense 2,727 3,070 5,347 4,996
------- ------- ------- -------
Net income $ 4,749 $ 5,250 $ 9,541 $ 8,952
======= ======= ======= =======
Basic earnings per share $0.73 $0.81 $1.46 $1.38
===== ===== ===== =====
Diluted earnings per share $0.71 $0.78 $1.42 $1.34
===== ===== ===== =====
Weighted average shares outstanding - basic 6,525,061 6,477,526 6,523,523 6,470,551
Dilutive impact of stock options 180,602 227,062 181,877 222,123
--------- --------- --------- ---------
Weighted average shares outstanding - diluted 6,705,663 6,704,588 6,705,400 6,692,674
========= ========= ========= =========
</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 Six Months Ended June 30, 1999
(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, 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 --- --- 9,541 --- --- 9,541
Other comprehensive income (loss):
Unrealized holding losses arising
during the period, net of tax
benefit of $1,490 --- --- --- --- (2,368) (2,368)
Realized gains included in net
income, net of taxes of $0 --- --- --- --- --- ---
--------
Total comprehensive income 7,173
Dividends declared and
paid ($0.42 per share) --- --- (2,739) --- --- (2,739)
Stock options exercised 1 65 --- --- --- 66
---- ------- ------- ------ ------- --------
Balance at June 30, 1999 $653 $60,572 $65,518 $ --- $(1,101) $125,642
==== ======= ======= ====== ======= ========
</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,
--------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,541 $ 8,952
Adjustments to reconcile net income to net cash
provided by operating activities:
Credit for loan losses --- (2,205)
Net gains on sales and provisions
for other real estate owned (5) (141)
Net gains from sales of investments available for sale --- (17)
Net gains from sales of assets held for sale (86) (325)
Depreciation and amortization 730 660
Amortization of fees, discounts and premiums, net 336 235
Deferred income taxes (318) 462
(Increase) decrease in:
Assets held for sale 9,088 655
Accrued interest receivable (1,012) (436)
Mortgage servicing assets 1,094 1,182
Other assets (271) (879)
Increase (decrease) in:
Mortgagors' escrow accounts (277) (157)
Accrued income taxes payable (1,728) 1,836
Accrued expenses and other liabilities (1,160) 96
-------- -------
Net cash provided by operating activities 15,932 9,918
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases (76,776) (37,543)
Proceeds from sales --- 3,017
Proceeds from maturities and redemptions 7,063 1,500
Principal repayments 12,806 12,174
Investment and mortgage-backed securities held to maturity:
Purchases --- (10,041)
Proceeds from maturities and redemptions 1,000 ---
Principal repayments 22,032 19,237
Net change FHLB stock (881) ---
Purchases of whole loans (15,708) (13,873)
Purchases of mortgage servicing rights (873) (496)
Net increase in loans (36,062) (37,463)
Capital expenditures on premises and equipment, net (612) (558)
Proceeds from sales of other real estate owned 369 803
-------- -------
Net cash used by investing activities (87,642) (63,243)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits (15,368) 25,011
Net increase (decrease) in other borrowings 37,849 (28,384)
Proceeds from issuance of FHLB advances 55,000 90,000
Principal repayments of FHLB advances (17,928) (25,871)
Dividends paid (2,739) (2,148)
Stock options exercised 66 365
-------- -------
Net cash provided by financing activities 56,880 58,973
-------- -------
Net increase (decrease) in cash equivalents (14,830) 5,648
Cash and cash equivalents, at beginning of period 45,437 35,736
-------- -------
Cash and cash equivalents, at end of period $ 30,607 $41,384
======== =======
Statement continued on next page.
</TABLE>
4
<PAGE> 7
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED,
JUNE 30,
--------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 25,757 $ 26,856
Income taxes 5,893 2,597
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 23,108 25,133
Transfer of loans to other real estate owned 206 504
</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, 1998. 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. The Company
merged Andover Bank NH with and into Andover Bank effective upon the
close of business June 30, 1999.
6
<PAGE> 9
ANDOVER BANCORP, INC. AND SUBSIDIARIES
ANALYSIS OF NET YIELD ON EARNING ASSETS
(Unaudited)
<TABLE>
<CAPTION>
QUARTERS ENDED JUNE 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 $ 5,949 $ 69 4.65% $ 14,705 $ 200 5.46%
Investment securities (1)(2) 147,945 2,415 6.55 111,485 1,844 6.63
Mortgage-backed securities (1) 138,559 2,225 6.44 187,625 3,077 6.58
---------- ------- ---------- -------
Total investments 292,453 4,709 6.46 313,815 5,121 6.55
---------- ------- ---------- -------
Residential loans (1) (3) 762,398 12,861 6.77 752,995 13,313 7.09
Commercial real estate loans (3) 164,493 3,593 8.76 142,310 3,146 8.87
Construction and land loans 62,536 1,396 8.95 36,728 945 10.32
---------- ------- --------- -------
Total real estate loans 989,427 17,850 7.24 932,033 17,404 7.49
Consumer loans (3) 59,056 1,164 7.91 66,262 1,398 8.46
Commercial loans and leases (3) 43,026 851 7.93 23,301 564 9.71
---------- ------- ---------- -------
Total loans 1,091,509 19,865 7.30 1,021,596 19,366 7.60
---------- ------- ---------- -------
Total interest-earning assets 1,383,962 24,574 7.12% 1,335,411 24,487 7.35%
------- -------
Allowance for loan losses (11,187) (12,634)
Other assets 59,680 54,840
---------- ----------
Total assets $1,432,455 $1,377,617
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 101,244 $ 195 0.77% $ 86,564 $ 210 0.97%
Money market deposit accounts 96,412 661 2.75 100,987 709 2.82
Savings accounts 211,675 1,691 3.20 169,498 1,565 3.70
Certificates of deposit 468,342 5,931 5.08 516,109 7,414 5.76
---------- ------- ---------- -------
Total interest-bearing deposits 877,673 8,478 3.87 873,158 9,898 4.55
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements and
Federal Funds purchases 36,548 350 3.84 17,066 224 5.26
Federal Home Loan Bank advances 289,888 3,988 5.52 280,331 4,011 5.74
---------- ------- ----------- -------
Total borrowed funds 326,436 4,338 5.33 297,397 4,235 5.71
---------- ------- ---------- -------
Total interest-bearing liabilities 1,204,109 12,816 4.27% 1,170,555 14,133 4.84%
---------- ------- ---------- --------
Demand deposits 94,754 87,771
Other liabilities 10,263 9,932
---------- ----------
Total liabilities 1,309,126 1,268,258
Stockholders' equity 123,329 109,359
---------- ----------
Total liabilities and stock-
holders' equity $1,432,455 $1,377,617
========== ==========
Net interest income $11,758 $10,354
======= =======
Interest rate spread 2.85% 2.51%
==== ====
Net yield on earning assets 3.41% 3.11%
==== ====
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 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>
Interest-earning assets:
Short-term investments $ 8,594 $ 201 4.72% $ 16,364 $ 447 5.51%
Investment securities (1)(2) 141,989 4,549 6.46 108,090 3,592 6.70
Mortgage-backed securities (1) 144,371 4,673 6.53 190,017 6,300 6.69
---------- ------- ---------- -------
Total investments 294,954 9,423 6.44 314,471 10,339 6.63
---------- ------- ---------- -------
Residential loans (1) (3) 759,294 25,637 6.81 741,424 26,298 7.15
Commercial real estate loans (3) 159,128 7,052 8.94 142,217 6,313 8.95
Construction and land loans 59,013 2,656 9.08 35,264 1,796 10.27
---------- ------- --------- -------
Total real estate loans 977,435 35,345 7.29 918,905 34,407 7.55
Consumer loans (3) 59,987 2,360 7.93 66,781 2,848 8.60
Commercial loans and leases (3) 42,457 1,708 8.11 21,706 1,040 9.66
---------- ------- ---------- -------
Total loans 1,079,879 39,413 7.36 1,007,392 38,295 7.67
---------- ------- ---------- -------
Total interest-earning assets 1,374,833 48,836 7.16% 1,321,863 48,634 7.42%
------- -------
Allowance for loan losses (11,119) (12,712)
Other assets 54,798 52,635
---------- ----------
Total assets $1,418,512 $1,361,786
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 96,688 $ 376 0.78% $ 83,970 $ 410 0.98%
Money market deposit accounts 96,251 1,317 2.76 103,760 1,479 2.87
Savings accounts 206,794 3,288 3.21 161,743 2,934 3.66
Certificates of deposit 475,057 12,291 5.22 519,922 14,944 5.80
---------- ------- ---------- -------
Total interest-bearing deposits 874,790 17,272 3.98 869,395 19,767 4.58
---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements and
Federal Funds purchases 32,936 683 4.18 12,180 313 5.18
Federal Home Loan Bank advances 282,492 7,689 5.49 277,129 7,880 5.73
---------- ------- ---------- -------
Total borrowed funds 315,428 8,372 5.35 289,309 8,193 5.71
---------- ------- ---------- -------
Total interest-bearing liabilities 1,190,218 25,644 4.34% 1,158,704 27,960 4.87%
---------- ------- ---------- -------
Demand deposits 95,024 85,717
Other liabilities 11,657 9,766
---------- ----------
Total liabilities 1,296,899 1,254,187
Stockholders' equity 121,613 107,599
---------- ----------
Total liabilities and stock-
holders' equity $1,418,512 $1,361,786
========== ==========
Net interest income $23,192 $20,674
======= =======
Interest rate spread 2.82% 2.55%
==== ====
Net yield on earning assets 3.40% 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 91 days in the second quarter of both years and 181 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 JUNE 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 Banks' continued ability to originate quality loans, fluctuations of
interest rates, real estate market conditions in the Banks' lending areas,
general and local economic conditions, the Banks' continued ability to attract
and retain deposits, the Company's 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 $4.7 million, or $0.71 per diluted share, for
the quarter ended June 30, 1999 as compared to net income of $5.3 million, or
$0.78 per diluted share, in the corresponding quarter of 1998. The second
quarter's results for 1998 included a pre-tax credit for loan losses of
approximately $2.2 million. Andover's annualized return on average assets
decreased to 1.33% for the second quarter of 1999 compared to 1.53% in the
second quarter of 1998. The annualized return on average stockholders' equity
decreased to 15.45% in the second quarter of 1999 from 19.26% in the second
quarter of 1998.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $11.8
million for the second quarter of 1999 as compared to $10.4 million for the same
period in 1998. This increase resulted from growth in earning assets exceeding
interest-bearing liabilities as well as an improved net interest margin. The 30
basis point increase in the net yield on earning assets to 3.41% for the second
quarter of 1999 compared to 3.11% in the corresponding quarter of 1998, was due
primarily to a 57 basis point decline on the rates paid on the interest-bearing
liabilities, partially offset by a 23 basis point decline in the yield on the
interest-earning assets. The overall decline in market interest rates has led to
continued pressure on the yield on earning assets while providing opportunities
to lower the Company's 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
8
<PAGE> 11
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.
There was no provision for loan losses for the second quarter of 1999 versus a
credit for loan losses of $2.3 million 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 second 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 half of
1999, the total loan portfolio increased by 5.0%. In addition, nonaccrual loans
decreased 9.8% from year-end 1998 and delinquent loans decreased by 28.5 %
during the same period. In 1998 non accruing loans declined over 23% during the
second quarter and almost 36% since year-end 1997. Total overdue loans declined
over several quarters and decreased by 26% at June 30, 1998 from year end 1997.
Net recoveries totaled $120,000 for the second quarter of 1999 as compared to
charge-offs of $35,000 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 $7,000
in the second quarter of 1999 as compared to net gains of $192,000 in the second
quarter of 1998.
Mortgage banking income totaled $302,000 in the second quarter of 1999 versus
income of $222,000 in the comparable quarter in 1998. The increase in 1999
resulted from a partial reversal of the valuation allowance amounting to
$175,000 versus a provision for the valuation allowance of $120,000 in the
second quarter of 1998. For the six months of 1999 a partial reversal was
recorded in the amount of $175,000 versus a provision of $540,000 in the first
half of 1998. During the second quarter of 1999, mortgage interest rates rose,
increasing the value of servicing rights and making it unnecessary to maintain
the same level of valuation allowance. The second quarter of 1998 was marked by
high pre-payment levels and declining mortgage interest rates which negatively
impact the value of mortgage servicing rights since future expected income is
curtailed. Amortization expense totaled $623,000 and $483,000, respectively, for
the quarters ended June 30, 1999 and 1998. Charge-offs totaled $100,000 and
$275,000 for the second quarter of 1999 and 1998, respectively. If interest
rates decline, 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 totaled $813.8
million and $879.2 million, respectively, at June 30, 1999 and 1998.
9
<PAGE> 12
The following table summarizes the activity in the valuation allowance on
mortgage servicing assets for the quarters and six months ended June 30, 1999
and 1998:
<TABLE>
<CAPTION>
QUARTERS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 835 $ 655 $1,125 $ 400
Provision (credit) for valuation
allowance (175) 120 (175) 540
Charge-offs (100) (275) (390) (440)
----- ----- ------ -----
Balance at end of period $ 560 $ 500 $ 560 $ 500
===== ===== ====== =====
</TABLE>
Losses of $20,000 on real estate operations were recognized in the second
quarter of 1999 the majority of which were operating costs of $17,000, as
compared to gains of $100,000 in the second quarter of 1998, resulting primarily
from a negative provision for the valuation allowance in the amount of $107,000.
Other income totaled $887,000 in the second quarter of 1999 as compared to
$904,000 in the second quarter of 1998 primarily due to lower loan fees
partially offset by an increase in deposit fees.
NON-INTEREST EXPENSE. Non-interest expenses decreased by $259,000, or 5.4%, to
$5.4 million in the second quarter of 1999 from $5.7 million in the second
quarter of 1998. The efficiency ratio (a ratio that measures operating expenses
as a percentage of operating income) decreased from 49.7% in the second quarter
of 1998 to 42.1% in the comparable period of 1999. The reduction in non-interest
expense was attributable to declines in other operating expenses, salaries and
employee benefits and mortgage banking expense.
Salaries and employee benefits, the largest component of non-interest expense
decreased $189,000, or 6.0%, from $3.1 million to $3.0 million due to a
reduction in pension expenses. Partially offsetting this decrease were increased
costs associated with an increased number of employees, enhanced benefits and
merit salary increases.
Office occupancy and equipment expenses increased 7.8% or $59,000 for the second
quarter of 1999 versus the corresponding period of 1998, primarily due to
increased depreciation of equipment.
Data processing expenses increased from the second quarter of 1998 to the
corresponding quarter in 1999 by 16.6% or $82,000. 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 in alternative delivery
systems, such as the telephone, automated teller machines and personal computers
continue to increase.
Professional fees increased $23,000 to $225,000 in the second quarter of 1999
from $202,000 in the second quarter of 1998 due to increased legal and corporate
consulting fees. Some of these costs relate to the merger of ABNH into the Bank
and are therefore, non-recurring expenses.
Marketing expenses increased 30.9% from 1998 to $212,000 in the second quarter
of 1999 due to a rise in the level of advertised promotions.
Mortgage banking expenses decreased 45.9% or $50,000 in the second quarter of
1999 versus 1998's second quarter due to reduced costs associated with a lower
serviced loan portfolio.
10
<PAGE> 13
Other operating expenses decreased 27.9% from the second quarter of 1998 to
$605,000 in the corresponding quarter in 1999 due to a reduction in telephone
and miscellaneous costs.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $2.7 million
and $3.1 million on its financial statement earnings for the second quarters of
1999 and 1998, respectively. The effective tax rate for the second quarter of
1999 was 36.5%, as compared to 36.9% for the corresponding period in 1998.
FINANCIAL CONDITION
Total assets increased from $1,410.2 million at December 31, 1998 to $1,471.1
million at June 30, 1999. Increases in investments available for sale and the
loan portfolio were funded by the growth experienced in the FHLB advances during
the first half of 1999.
LOANS. The following table shows the composition of the Company's loan portfolio
at June 30, 1999 and December 31, 1998. The balances shown in the table are net
of unadvanced funds and deferred loan origination fees and costs.
6/30/99 12/31/98
------- ---------
(In thousands)
Real estate loans:
Residential $ 753,982 $ 740,009
Commercial 181,278 163,999
Construction and land 63,729 56,568
---------- ----------
Total real estate loans 998,989 960,576
---------- ----------
Consumer loans 59,640 61,851
Commercial loans and leases 44,462 28,338
---------- ----------
Total loans $1,103,091 $1,050,765
========== ==========
Total loans increased $52.3 million during the first six months of 1999 to
$1,103.1 million at June 30, 1999, primarily due to increases in the residential
real estate and commercial 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 half of 1998 and 1999, residential loan
originations totaled $177.5 million and $125.7 million, respectively.
Residential loan balances increased only $14.0 million during the first six
months of 1999 primarily due to the heavy refinancings as well as securitization
of certain fixed-rate loans, regular amortization and loan prepayments.
Outstanding corporate loans, comprised of commercial real estate, commercial,
construction and land loans and lease loans, increased $40.6 million during the
first half 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 $92.1 million and $73.0 million, respectively, for the six
months ended June 30, 1999 and 1998.
Consumer loan balances decreased by approximately 7% on an annualized basis, to
$59.6 million at June 30, 1999, primarily due to payoffs of the home equity loan
balances and second mortgages resulting from the strong first mortgage refinance
activity.
11
<PAGE> 14
RISK ELEMENTS. The following table shows the composition of non-performing
assets at June 30, 1999 and December 31, 1998:
6/30/99 12/31/98
------- --------
(Dollars in thousands)
Nonaccruing loans $2,923 $3,240
Other real estate owned 94 252
------ ------
Total non-performing assets $3,017 $3,492
====== ======
Total non-performing assets as a
percentage of total assets 0.2% 0.2%
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 June 30, 1999,
approximately $995,000, or 33.0%, of non-performing assets were secured by
properties located in Lawrence, consisting primarily of mixed-use commercial and
multi-family properties, as compared to approximately $1.4 million at December
31, 1998.
At June 30, 1999, total impaired loans were $1.9 million, of which $456,000 had
related allowances of $26,000 and $1.4 million which did not require a related
allowance. During the six months ended June 30, 1999, the average recorded value
of impaired loans was $2.1 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 June 30, 1999
and December 31, 1998:
6/30/99 12/31/98
------- --------
(Dollars in thousands)
Residential real estate $ 840 $ 932
Commercial real estate 1,514 2,023
Commercial loans and leases 553 255
Consumer 16 30
------- -------
Total nonaccrual loans $ 2,923 $ 3,240
======= =======
Allowance for loan losses $11,274 $10,486
======= =======
Allowance for loan losses as a
percentage of nonaccruing loans 385.70% 323.64%
Allowance for loan losses as a
percentage of total loans 1.02% 1.00%
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, 1999 and 1998:
<TABLE>
<CAPTION>
QUARTERS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $11,154 $12,593 $10,486 $12,521
Credit for loan losses --- (2,250) --- (2,205)
Charge-offs:
Residential real estate (10) (27) (98) (177)
Commercial real estate --- (273) (20) (536)
Construction and land --- --- --- ---
Commercial loans and leases --- --- (15) ---
Consumer (2) (4) (3) (6)
------ ------- ------ -------
Total charge-offs (12) (304) (136) (719)
------ ------- ------ -------
Recoveries:
Residential real estate 7 32 11 35
Commercial real estate 76 86 615 274
Construction and land --- 40 --- 235
Commercial loans and leases 46 105 282 153
Consumer 3 6 16 14
------- ------- ------ -------
Total recoveries 132 269 924 711
------- ------- ------ -------
Net recoveries (charge-offs) 120 (35) 788 (8)
------- ------- ------ -------
Balance at end of period $11,274 $10,308 $11,274 $10,308
======= ======= ======= =======
Ratio of annualized net
(charge-offs) recoveries to average
loans outstanding 0.04% (0.01)% 0.15% (0.00)%
</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 June 30, 1999, the Company's total investment portfolio
amounted to $296.1 million for an increase of $13.6 million from December 31,
1998. The increase in the first half 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 $76.8 million. However, these purchases were offset by
principal repayments in the mortgage-backed portfolio and a lower Federal Funds
sold position.
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, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
6/30/99 12/31/98
------- --------
(In thousands)
<S> <C> <C>
SHORT-TERM INVESTMENTS $ --- $ 16,100
======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
U.S. government and federal agency obligations $ 79,345 $ 62,556
Other bonds and obligations 63,126 37,561
-------- --------
Total bonds and obligations 142,471 100,117
-------- --------
GNMA mortgage-backed securities 28,523 35,884
FHLMC participation certificates 21,888 26,981
FNMA pass-through certificates 11,885 2,509
Collateralized mortgage obligations 13,502 ---
-------- --------
Total mortgage-backed securities 75,798 65,374
-------- --------
Total investments available for sale $218,269 $165,491
======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations $ 8,516 $ 8,526
Other bonds and obligations 3,529 4,545
-------- --------
Total bonds and obligations 12,045 13,071
-------- --------
FHLMC participation certificates 22,021 30,207
FNMA pass-through certificates 27,851 35,435
GNMA mortgage-backed securities 2,170 2,576
Collateralized mortgage obligations 13,302 19,080
Other asset-backed securities 460 551
-------- --------
Total mortgage-backed securities 65,804 87,849
-------- --------
Total investments held to maturity $ 77,849 $100,920
======== ========
Total investments $296,118 $282,511
======== ========
</TABLE>
The following table shows the gross unrealized gains and losses by major
categories of securities as of June 30, 1999:
<TABLE>
<CAPTION>
UNREALIZED UNREALIZED
GAINS LOSSES
----- ------
(In thousands)
<S> <C> <C>
INVESTMENTS AVAILABLE FOR SALE:
U.S. government and federal agency obligations $ 348 $ (527)
Other bonds and obligations 103 (1,308)
Mortgage-backed securities 239 (621)
------ -------
Total investments available for sale $ 690 $(2,456)
------ -------
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations $ --- $ (35)
Other bonds and obligations 45 (4)
Mortgage-backed securities 499 (802)
------ -------
Total investments held to maturity 544 (841)
------ -------
Total unrealized gains and losses $1,234 $(3,297)
====== =======
</TABLE>
At June 30, 1999, the Company's net unrealized loss on investments available for
sale amounted to $1.8 million, a fair value decrease of $3.9 million from an
unrealized gain of $2.1 million at December 31, 1998. At June 30, 1999, the
Company's net unrealized loss on investments held to maturity totaled $297,000,
for a decrease of $1.9 million from an unrealized gain of $1.6 million at
December 31, 1998. The changes in the net unrealized gains on the total
investment portfolio from year-end 1998 were primarily due to an increase in
market interest rates at the end of the first half of 1999.
14
<PAGE> 17
DEPOSITS AND BORROWED FUNDS. Total deposits decreased $15.4 million to $973.3
million at June 30, 1999 from $988.7 million at December 31, 1998. This decrease
was most pronounced in certificates of deposits which declined by $25.1 million.
In addition, demand deposits decreased by $8.8 million during the first six
months of 1999. Offsetting these decreases, however, were increases of $12.9
million or 6.5% in savings accounts and $5.5 million or 5.4% in NOW accounts
during the first half of 1999. The decline in the transactional balances
resulted from the high level of refinancing activity which caused the custodial
accounts and legal conveyances accounts to be higher at year-end 1998. The
decline in the certificates of deposits during the first six months reflects the
continued shift from longer maturity term deposits into core deposits without
fixed maturities.
The following table shows the composition of the Company's deposits at June 30,
1999 and December 31, 1998:
6/30/99 12/31/98
------- --------
(In thousands)
Demand deposit accounts $ 94,249 $103,029
NOW accounts 108,181 102,635
Money market deposit accounts 96,395 96,332
Savings accounts 212,218 199,304
Certificates of deposit 462,245 487,356
-------- --------
Total deposits $973,288 $988,656
======== ========
In order to fund the growth in total assets, the Banks offset the decline in
deposits with increased borrowings. Federal Home Loan Bank advances increased
$55.9 million from December 31, 1998 to $323.4 million at June 30, 1999.
Securities sold under agreements to repurchase and Federal Funds purchased
increased $19.0 million to $35.4 million at June 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 subsidiaries.
In the second quarter of 1999, the Company made payments of dividends to its
stockholders in the amount of $1.4 million. In July, 1999, the Company declared
a dividend in the amount of $1.4 million, payable in the third quarter of 1999.
The Banks have 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 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 $6.0 million to $15.9 million in the
first six months of 1999, as compared to $9.9 million in the corresponding
period of 1998, primarily due to a decrease in assets held for sale as well as
higher net income before the credit for loan losses in 1998. Cash flows used by
investing activities increased by $24.4 million to $87.6 million for the six
months ended June 30, 1999, as compared to $63.2 million during the equivalent
period last year. This increase was mainly attributable to purchases of
securities available for sale. Cash flows provided by financing activities
decreased $2.1 million for the six months ended June 30, 1999 to $56.9 million,
as compared to $59.0 million in the equivalent period in 1998. The
15
<PAGE> 18
financing activity decline was due to a change in the mix of financing sources,
with a decline in deposits offset by an increase in borrowed funds.
At June 30, 1999, the Company had home equity, reserve credit and commercial
unadvanced lines of credit totaling $96.2 million. Outstanding commitments to
originate loans totaled $38.6 million. Unadvanced portions of construction and
land loans amounted to $31.2 million. Standby letters of credit were $3.2
million. Loans sold with recourse totaled $1.3 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 June 30, 1999:
<TABLE>
<CAPTION>
LEVERAGE CAPITAL RATIO RISK-BASED CAPITAL RATIO
---------------------- ------------------------
TIER 1 TIER 1 TOTAL
------ ------ -----
<S> <C> <C> <C>
Andover Bancorp, Inc. 8.85% 13.67% 14.88%
Andover Bank 8.19% 12.69% 13.92%
Andover Bank NH 9.98% 15.97% 16.83%
</TABLE>
Current minimum regulatory requirements as of June 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 June 30, 1999, the most recent notification
from the FDIC categorized the Banks as well capitalized under the prompt
corrective action provisions. Therefore, the Banks are entitled to pay the
lowest deposit premium possible.
YEAR 2000 READINESS DISCLOSURE. The statements in the following section include
"Year 2000 readiness disclosure" within the meaning of the Year 2000 Information
and Readiness Disclosure Act.
This section contains certain statements that are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1993, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The 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.
The Company started its Year 2000 initiative in early 1997. The Company has
completed its assessment of Year 2000 issues, developed a plan, tested its
various software
16
<PAGE> 19
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 substantially completed the remediating,
testing and returning to production all of its critical applications. Testing of
the Company's non-critical applications will continue throughout 1999 and will
be completed prior to any anticipated impact of the Year 2000 issue on its
operating systems.
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.
The Company will continue to utilize both internal and external resources to
update, or replace, develop and test all software information systems and
hardware components for Year 2000 modifications. Included in other noninterest
expenses are charges incurred in connection with the modification or replacement
of software and hardware in order for the Company's computer systems to properly
recognize the Year 2000 expenses. The expenses incurred and hardware capitalized
totaled approximately $150,000 and $200,000 for the quarter and six months ended
June 30, 1999, respectively, and $450,000 over the course of the project
incurred to date. The Company expects that the majority of the costs that will
be incurred (as discussed below) will be to replace or upgrade existing hardware
and software which will be capitalized and amortized in accordance with the
Company's existing accounting policy while miscellaneous consulting, maintenance
and modification costs will be expensed as incurred.
The Company continues to evaluate the estimated costs associated with achieving
Year 2000 readiness based on its experience to date. Based on current estimates,
the remaining costs of its efforts to achieve Year 2000 readiness are not
expected to exceed $200,000. 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 Banks' primary source of revenue, is affected
by changes in interest rates as well as fluctuations in the level and duration
of assets and liabilities on the Company's balance sheet.
The mortgage servicing assets are assessed for impairment on a quarterly basis.
In 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 additional 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 consolidated financial statements of the
Company as of and for the year ended December 31, 1998.
18
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 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 $9.5 million, $1.42 per diluted share, for the
six months ended June 30, 1999, compared to net income of $9.0 million, $1.34
per diluted share, in the corresponding period of 1998.
The financial performance in the first six months of 1999 was positively
impacted by a $1.1 pre-tax gain due to the curtailment of the defined benefit
plan. The six months' results for 1998 included a pre-tax credit for loan losses
of approximately $2.2 million. The pension curtailment combined with the rise in
net interest and dividend income resulted in an increase in Andover's annualized
return on average assets to 1.36% for the first six months of 1999 as compared
to 1.33% in the comparable period of 1998. The annualized return on average
stockholders' equity decreased to 15.82% in the first six months of 1999 from
16.78% in the comparable period of 1998.
NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $23.2
million for the first half of 1999, as compared to $20.7 million for the same
period in 1998 an increase of 12.2%. The 25 basis point increase in the net
yield on earning assets to 3.40% for the first six months of 1999, compared to
3.15% in 1998, was primarily due to a 53 basis point decline in the rate paid on
interest-bearing liabilities due to lower market interest rates.
PROVISION (CREDIT) FOR LOAN LOSSES. There were no provisions for loan losses in
the first half of 1999. Among the factors used to determine that no provision
for loan losses was appropriate were the continued improvement in loan quality,
as well as management's assessment of changes in trends and conditions.
Nonaccruing loans decreased by 28.5% during the first six months of 1999 while
overdue loans decreased by 9.8% over the same time period.
The decline in the delinquencies and nonaccruing loans was notable starting in
March of 1998, which, when combined with the lowest level of quarterly additions
to non-performing assets during the second quarter of 1998, contributed to
management's assessment of the appropriateness of the allowance for loan losses.
Based on the foregoing, the Company recorded a credit for loan losses in the
amount of $2.2 million in the first half of 1998.
NON-INTEREST INCOME. Andover recorded gains from non-interest sources of $2.4
million for the first six months of 1999, as compared to $2.5 million in the
corresponding period of 1998. Net gains from sales of assets held for sale and
investments available for sale totaled $86,000 in 1999 as compared to $342,000
in the same period of 1998.
Mortgage banking income totaled $519,000 during the first six months of 1999 as
compared to income of $239,000 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. Total amortization and provisions
amounted to $1.1 million for the first six months of 1999 as compared to $1.7
million for the respective period in 1998.
19
<PAGE> 22
Charge-offs totaled $390,000 and $440,000 for the six months periods ending June
30, 1999 and 1998, respectively.
Losses on real estate operations totaled $34,000 during the first six months of
1999 as compared to gains of $24,000 in the corresponding period of 1998. A
large component of the loss on real estate operations during the first six
months of both 1999 and 1998 was comprised of operating costs associated with
acquiring, maintaining and disposing of other real estate owned and totaled
$40,000 and $118,000, respectively. Included in the results for 1998 was a
negative provision for the valuation of other real estate owned totaling
$107,000.
Other income remained stable amounting to $1.8 million in the first six months
of both 1999 and 1998.
NON-INTEREST EXPENSE. Non-interest expenses decreased 6.3% to $10.7 million in
the first six months of 1999 primarily due to a decrease in salaries and
employee benefits. Salaries and benefits decreased 15.4% to $5.3 million in 1999
due to the curtailment of the defined benefit pension plan which resulted in a
pre-tax gain of $1.1 million. Office occupancy and equipment increased 10.7% to
$1.6 million in 1999 primarily due to higher depreciation of equipment. Data
processing expenses increased 9.6% to $1.1 million as a result of higher loan
and deposit base resulting from the Company's growth. Professional fees
increased 65.0% to $708,000 in 1999 from $429,000 in 1998 due to increased legal
and corporate consulting fees. A portion of these costs relates to the merger of
ABNH into the Bank and a portion relates to the curtailment of the defined
benefit plan. Marketing expenses increased 7.9% to $424,000 primarily due to
increased advertising. Mortgage banking expenses decreased 44.8% due to a lower
level of residential mortgage loan originations and refinances. Other operating
expenses decreased 10.6% to $1.4 million primarily due to reduced telephone
costs, printing expenses and other miscellaneous costs.
INCOME TAX EXPENSE. The Company recorded an income tax expense of $5.3 million
and $5.0 million on its financial statement earnings for the first six months of
1999 and 1998, respectively. The effective tax rate was 35.9% and 35.8% for 1999
and 1998, respectively.
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.
August 2, 1999
/s/ Gerald T. Mulligan
--------------------------------------
Gerald T. Mulligan
President and
Chief Executive Officer
August 2, 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 10-Q
FINANCIAL STATEMENTS DATED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH 10-Q 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> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 30,607
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 2,280
<INVESTMENTS-CARRYING> 77,849
<INVESTMENTS-MARKET> 77,552
<LOANS> 1,103,091
<ALLOWANCE> 11,274
<TOTAL-ASSETS> 1,471,135
<DEPOSITS> 973,288
<SHORT-TERM> 0
<LIABILITIES-OTHER> 13,460
<LONG-TERM> 358,745
0
0
<COMMON> 653
<OTHER-SE> 124,989
<TOTAL-LIABILITIES-AND-EQUITY> 1,471,135
<INTEREST-LOAN> 39,413
<INTEREST-INVEST> 9,423
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 48,836
<INTEREST-DEPOSIT> 17,272
<INTEREST-EXPENSE> 25,644
<INTEREST-INCOME-NET> 23,192
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 86
<EXPENSE-OTHER> 10,665
<INCOME-PRETAX> 14,888
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,541
<EPS-BASIC> 1.46
<EPS-DILUTED> 1.42
<YIELD-ACTUAL> 3.40
<LOANS-NON> 2,923
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 10,486
<CHARGE-OFFS> 136
<RECOVERIES> 924
<ALLOWANCE-CLOSE> 11,274
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
