<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-16358
ANDOVER BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2952665
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
61 MAIN STREET, ANDOVER, MA 01810
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (978)749-2000
------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(Title of Class)
PREFERRED STOCK PURCHASED RIGHTS
(Title of Class)
Indicate by check mark whether: the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sale price for the Registrant's Common
Stock on March 1, 1999, as reported by NASDAQ, was $198,142,564.50.
The number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practicable date, is:
Class: Common Stock, par value $0.10 per share
Outstanding as of March 1, 1999: 6,523,212 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Andover Bancorp, Inc. Definitive Notice of Annual Meeting
and Proxy Statement for the 1999 Annual Meeting of Shareholders are incorporated
by reference into Part III of Form 10-K.
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FORM 10-K
CROSS REFERENCE INDEX
Annual
Report
Page
PART I
Item 1 Business...........................................................2
Item 2 Properties.........................................................8
Item 3 Legal Proceedings..................................................9
Item 4 Submission of Matters to a Vote of Security Holders................9
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder
Matters............................................................9
Item 6 Selected Consolidated Financial Data..............................10
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................11
Item 7A Quantitative and Qualitative Disclosures About Market Risk........27
Item 8 Financial Statements and Supplementary Data................(See Item
14 below)
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................Non-
Applicable
PART III
The information called for by Part III (Items 10 through 13) is incorporated
herein by reference from Andover's Definitive Notice of Annual Meeting and Proxy
Statement for the 1999 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements-
Independent Auditors' Report.....................................35
Consolidated Balance Sheets as of December 31, 1998 and 1997.....36
Consolidated Statements of Operations for each of the years
ended December 31, 1998, 1997 and 1996...........................37
Consolidated Statements of Changes in Stockholders' Equity
for each of the years ended December 31, 1998, 1997 and 1996.....38
Consolidated Statements of Cash Flows for each of the years
ended December 31, 1998, 1997 and 1996........................39-40
Notes to Consolidated Financial Statements....................41-64
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(2) All financial statement schedules are omitted because they are not
applicable, the data is not significant, or the required
information is shown elsewhere in this report.
(b) Reports on Form 8-K. There were no reports filed on Form 8-K
during the three months ended December 31, 1998.
(c) List of Exhibits
Exhibits to the Form 10-K have been included only with the copies
of the Form 10-K filed with the SEC. Upon request to Shareholder
Relations, Andover Bancorp, Inc., 61 Main Street, Andover,
Massachusetts 01810, copies of the individual exhibits will be
furnished upon payment of a reasonable fee.
EXHIBIT NO. DESCRIPTION OF EXHIBITS
- ----------- -----------------------
3.1 Restated Certificate of Incorporation of Andover (incorporated
herein by reference to Exhibit 3.1 to Post-Effective Amendment No.
1 to Andover's Registration Statement on Form S-4, No. 33-11891
filed on March 5, 1987).
3.2 By-laws of Andover, as amended and restated, January 23, 1997
(incorporated herein by reference to Exhibit 3.2 to Andover's Form
10-K for the fiscal year ended December 31, 1996).
4.1 Specimen of Andover Bancorp, Inc. common stock certificate
(incorporated herein by reference to Exhibit 4 to Andover's
Registration Statement on Form S-4, Registration No. 33-11891,
filed on February 11, 1987).
4.2 Shareholder Rights Agreement between Andover Bancorp, Inc. and
BankBoston (incorporated herein by reference to an Exhibit to
Andover's Current Report on Form 8-K filed on January 22, 1999).
10.1 Employment Agreement between Andover, Andover Bank and Gerald T.
Mulligan, dated May 16, 1991 (incorporated herein by reference to
Exhibit 10.1 to Andover's Form 10-K for the fiscal year ended
December 31, 1991).
10.2 Special Termination Agreement between Andover, Andover Bank and
Gerald T. Mulligan, dated May 16, 1991, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.2 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.3 Special Termination Agreement between Andover, Andover Bank and
Joseph F. Casey, dated December 17, 1992, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.3 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.4 Special Termination Agreement between Andover, Andover Bank and
Michael J. Ecker, dated December 17, 1992, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.4 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.5 Special Termination Agreement between Andover, Andover Bank and
John R. Heerwagen, dated December 17, 1992, as amended and
restated through January 23, 1997 (incorporated herein by
reference to Exhibit 10.5 to Andover's Form 10-K for the fiscal
year ended December 31, 1996).
10.6 Special Termination Agreement between Andover, Andover Bank and
Octavio C. Bolivar dated January 24, 1994, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.6 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
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10.7 Andover Savings Bank Employees' Stock Ownership Plan and Trust
Agreement and Amendment No. 1 (incorporated herein by reference to
Exhibit 10(c) to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1987).
10.8 Andover Bancorp, Inc. Stock Option Plan dated May 8, 1986, as
amended May 22, 1986, January 29, 1987, and November 2, 1987
(incorporated herein by reference to Exhibit 10(h) to Andover's
Annual Report on Form 10-K for the fiscal year ended December 31,
1987).
10.9 Special Termination Agreement between Andover, Andover Bank and
Raymond P. Smith, dated December 12, 1995, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.9 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.10 Andover Bancorp, Inc. 1995 Stock Incentive Plan, dated February
16, 1995 (incorporated herein by reference to Exhibit 10.11 to
Andover's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.11 Deferred Compensation Plan for Directors of Andover Bancorp, Inc.
and its Subsidiaries, effective July 1, 1993, as amended and
restated, February 22, 1996 (incorporated herein by reference to
Exhibit 10.12 to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.12 Andover Bancorp, Inc. Special Termination Plan, effective January
23, 1997 (incorporated herein by reference to Exhibit 10.12 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
11 The computation of per share earnings can be readily determined
from the material contained in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1998.
12 As the Company does not have any debt securities registered under
Section 12 of the Securities Act of 1933, no ratio of earnings to
fixed charges appears in this Annual Report on Form 10-K.
13 Andover Bancorp, Inc. 1998 Annual Report, which, except for those
portions expressly incorporated herein by reference, is furnished
only for the information of the Securities and Exchange Commission
and is not deemed to be filed.
21 The Company has two subsidiaries, Andover Bank and Andover Bank
NH. Andover Bank is a Massachusetts savings bank in stock form
while Andover Bank NH is a New Hampshire guaranty savings bank in
stock form. Both subsidiaries are included in the Consolidated
Financial Statements filed in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1998.
23.1 Consent of KPMG Peat Marwick LLP.
27 Financial Data Schedule
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ANDOVER BANCORP, INC.
March 17, 1999 By: /s/ Gerald T. Mulligan
-----------------------------
Gerald T. Mulligan, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
Signature Title Date
/s/ Gerald T. Mulligan President, Chief March 17, 1999
- ------------------------- Executive Officer and
Gerald T. Mulligan Director (Principal
Executive Officer)
/s/ Joseph F. Casey Chief Financial Officer March 17, 1999
- ------------------------- and Treasurer (Principal
Joseph F. Casey Financial and Accounting
Officer)
/s/ Thomas F. Caffrey Director March 17, 1999
- -------------------------
Thomas F. Caffrey
/s/ Naomi A. Gardner Director March 17, 1999
- -------------------------
Naomi A. Gardner
/s/ Cornelius J. Mccarthy Director March 17, 1999
- -------------------------
Cornelius J. McCarthy
/s/ Clifford E. Elias Director March 17, 1999
- -------------------------
Clifford E. Elias
/s/ Robert J. Scribner Director March 17, 1999
- -------------------------
Robert J. Scribner
/s/ Fred P. Shaheen Director March 17, 1999
- -------------------------
Fred P. Shaheen
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<PAGE> 6
EXHIBITS TO FORM 10-K
ANDOVER BANCORP, INC.
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT PAGE NO.
- ----------- ---------------------- --------
3.1 Restated Certificate of Incorporation of Andover
(incorporated herein by reference to Exhibit 3.1 to
Post-Effective Amendment No. 1 to Andover's Registration
Statement on Form S-4, No. 33-11891 filed on March 5,
1987). --
3.2 By-laws of Andover, as amended and restated, January 23,
1997 (incorporated herein by reference to Exhibit 3.2 to
Andover's Form 10-K for the fiscal year ended December 31,
1996). --
4.1 Specimen of Andover Bancorp, Inc. common stock certificate
(incorporated herein by reference to Exhibit 4 to
Andover's Registration Statement on Form S-4, Registration
No. 33-11891, filed on February 11, 1987). --
4.2 Shareholder Rights Agreement between Andover Bancorp, Inc.
and BankBoston (incorporated herein by reference to an
Exhibit to Andover's Current Report on Form 8-K (filed
January 22, 1999). --
10.1 Employment Agreement between Andover, Andover Bank and
Gerald T. Mulligan, dated May 16, 1991 (incorporated
herein by reference to Exhibit 10.1 to Andover's Form 10-K
for the fiscal year ended December 31, 1991). --
10.2 Special Termination Agreement between Andover, Andover
Bank and Gerald T. Mulligan, dated May 16, 1991, as
amended and restated through January 23, 1997
(incorporated herein by reference to Exhibit 10.2 to
Andover's Form 10-K for the fiscal year ended December 31,
1996). --
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<PAGE> 7
10.3 Special Termination Agreement between Andover, Andover
Bank and Joseph F. Casey, dated December 17, 1992, as
amended and restated through January 23, 1997
(incorporated herein by reference to Exhibit 10.3 to
Andover's Form 10-K for the fiscal year ended December 31,
1996). --
10.4 Special Termination Agreement between Andover, Andover
Bank and Michael J. Ecker, dated December 17, 1992, as
amended and restated through January 23, 1997
(incorporated herein by reference to Exhibit 10.4 to
Andover's Form 10-K for the fiscal year ended December 31,
1996). --
10.5 Special Termination Agreement between Andover, Andover
Bank and John R. Heerwagen, dated December 17, 1992, as
amended and restated through January 23, 1997
(incorporated herein by reference to Exhibit 10.5 to
Andover's Form 10-K for the fiscal year ended December 31,
1996). --
10.6 Special Termination Agreement between Andover, Andover
Bank and Octavio C. Bolivar, dated January 24, 1994 as
amended and restated, January 23, 1997 (incorporated
herein by reference to Exhibit 10.6 to Andover's Form 10-K
for the fiscal year ended December 31, 1996). --
10.7 Andover Savings Bank Employees' Stock Ownership Plan and
Trust Agreement and Amendment No. 1 (incorporated herein
by reference to Exhibit 10(c) to Andover's Annual Report
on Form 10-K for the fiscal year ended December 31, 1987). --
10.8 Andover Bancorp, Inc. Stock Option Plan dated May 8, 1986,
as amended May 22, 1986, January 29, 1987 and November 2,
1987 (incorporated herein by reference to Exhibit 10(h) to
Andover's Annual Report on Form 10-K for the fiscal year
ended December 31, 1987). --
10.9 Special Termination Agreement between Andover, Andover
Bank and Raymond P. Smith, dated December 12, 1995, as
amended and restated, January 23, 1997 (incorporated
herein by reference to Exhibit 10.9 to Andover's Form 10-K
for the fiscal year ended December 31, 1996). --
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<PAGE> 8
10.10 Andover Bancorp, Inc. 1995 Stock Incentive Plan, dated
February 16, 1995 (incorporated herein by reference to
Exhibit 10.11 to Andover's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995). --
10.11 Deferred Compensation Plan for Directors of Andover
Bancorp, Inc. and its Subsidiaries, effective July 1,
1993, as amended and restated, February 22, 1996
(incorporated herein by reference to Exhibit 10.12 to
Andover's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995). --
10.12 Andover Bancorp, Inc. Special Termination Plan, effective
January 23, 1997 (incorporated herein by reference to
Exhibit 10.12 to Andover's Form 10-K for the fiscal year
ended December 31, 1996). --
11 The computation of per share earnings can be readily
determined from the material contained in the Annual
Report on Form 10-K for the fiscal year ended December 31,
1998. --
12 As the Company does not have any debt securities
registered under Section 12 of the Securities Act of 1933,
no ratio of earnings to fixed charges appears in this
Annual Report on Form 10-K. --
13 Andover Bancorp, Inc. 1998 Annual Report, which, except
for those portions expressly incorporated herein by
reference, is furnished only for the information of the
Securities and Exchange Commission and is not deemed to be
filed. 9
21 The Company has two subsidiaries, Andover Bank and Andover
Bank NH. Andover Bank is a Massachusetts savings bank in
stock form while Andover Bank NH is a New Hampshire
guaranty savings bank in stock form. Both subsidiaries are
included in the Consolidated Financial Statements filed in
the Annual Report on Form 10-K for the fiscal year ended
December 31, 1998. --
23.1 Consent of KPMG Peat Marwick LLP. 85
-8-
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EXHIBIT 13
Andover Bancorp, Inc.
1998 ANNUAL REPORT
[Picture of Londonderry and Salem, New Hampshire]
<PAGE> 2
[NEW HAMPSHIRE PICTURE]
Andover Bancorp, Inc. is the multi-bank holding company parent of Andover
Bank and Andover Bank NH. Andover Bank is a Massachusetts-chartered bank
organized in 1834 and headquartered in Andover, MA approximately 25 miles north
of downtown Boston. Andover Bank operates 10 banking offices in Andover,
Lawrence, Methuen, North Andover, and Tewksbury, MA and through an affiliate,
Andover Bank NH, in Londonderry and Salem, NH.
The Company has obtained regulatory approval to merge Andover Bank NH with
and into Andover Bank. This merger is anticipated to occur in the second quarter
of 1999 with the two banking offices of Andover Bank NH remaining in full
operation as branches of Andover Bank.
CONTENTS
- --------------------------------------------------------------------------------
President's Message i
Business 2
Market for the Company's Common Stock 9
Selected Consolidated Financial Data 10
Management's Discussion and Analysis 11
Independent Auditors' Report 35
Consolidated Financial Statements 36
Notes to Consolidated Financial Statements 41
Cover illustration features
Londonderry and Salem, New Hampshire
<PAGE> 3
DEAR SHAREHOLDERS:
I am pleased to report that Andover Bancorp achieved record earnings in 1998.
This represents the fifth straight year of earnings growth for the Company. The
economy and interest rates have, of course, been favorable over the period.
Nonetheless, we believe that these record earnings validate the Company's
fundamental operating strategy to offer progressive banking products, sales and
service excellence, and an unmatched commitment to our community.
EARNINGS
For the years ended December 31,
[GRAPH]
1995 $ 9,338
1996 $12,479
1997 $13,206
1998 $17,386
The 1998 earnings of $17.4 million represented a 32 percent increase over 1997
earnings. Return on average assets for 1998 was 1.27 percent and return on
average shareholders' equity was 15.64 percent. These traditional measures of
bank profitability increased by 20 percent and 18 percent, respectively, over
1997 levels. Based on these superior results, dividends paid to shareholders in
1998 increased by 28 percent to $.69 per share.
DIVIDENDS
For the years ended December 31,
[GRAPH]
1995 $.30
1996 $.40
1997 $.54
1998 $.69
(1) Adjusted for 25% stock split (Q2/98)
The earnings increase this past year was attributable, by and large, to loan
growth. Significant growth occurred in outstanding residential mortgages,
commercial real estate mortgages, and construction and land loans. In addition,
Andover Capital Group, our equipment leasing subsidiary, added $13 million in
lease financings and $6 million in secured equipment loans. Net loans increased
from $966 million, as of December 31, 1997, to $1,040 million, as of
December 31, 1998. The positive earnings effect of this growth more than offset
a net margin decline that affected most, if not all, banks
================================================================================
CUSTOMER SERVICE
-----------------------------------
To sustain our commitment to technology, growth and customer service, we
recently relocated our Telephone Sales and Service Center to new, expanded
facilities right here in Andover. This move was necessitated by an unprecedented
increase in call volume - a clear indication that customers and non-customers
alike enjoy not only the convenience of telephone banking but more specifically,
the personal service offered by our knowledgeable and dedicated staff. Our Sales
and Service Representatives provide a growing number of customers with the high
quality, convenient service that they deserve. Coupled with the availability of
PC and automated telephone banking services, Andover Banks' customers are able
to enjoy the latest in banking technology without sacrificing personal customer
service.
[PICTURE / Telephone Center]
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COMMERCIAL BANKING
------------------------------------
Since its inception in 1976, Salem Radiology has emerged as a leader in
advanced medical diagnostic technology. When it came time for them to expand,
Andover Bank was there to answer the call. By providing financing to the Salem
Radiology Real Estate and Equipment Company, Andover Bank made possible the
construction of an expanded facility on the grounds of Holy Family Hospital in
Methuen. It serves as the home to Merrimack Valley MRI, General Electric's
national showsite for MRI imaging equipment, and Merrimack Valley PET, a
state-of-the art nuclear medicine diagnostic site. This new facility allowed
these two groups to acquire the technology that will enable them to provide
unmatched quality care for the entire community. Andover Bank is proud of its
role in providing state-of-the-art medical technology to its community.
[PICTURE / MRI imaging equipment]
================================================================================
during the past year of falling interest rates.
Lending personnel throughout the organization were extremely busy financing real
estate purchases and construction, refinancing existing loans, and originating
new loans. The Commercial Banking Department closed over $88 million in
corporate loans. The Construction Lending Department closed over $51 million in
construction and land development loans. Most impressively of all, however, the
Residential Mortgage areas of Andover Bank closed $352 million in home mortgage
loans. This was a residential loan production record for Andover Bank.
LOAN GROWTH
For the years ended December 31,
[GRAPH]
1997 1998
Construction & Land loans $ 31,800 $ 51,852
Corporate Loans & Leases $ 52,279 $101,696
Residential Real Estate Loans $236,556 $352,269
Beyond the story of loan growth is continued good news on loan quality.
Contributing to the record earnings of the past year was a non-recurring $1.7
million recapture from the loan loss reserve. Upon a review of the amount set
aside to protect against future possible loan losses, the Company reconsidered
the original reserve amounts. One important factor in determining the proper
amount of loan loss reserves is the condition of the various loan portfolios.
Tremendous strides have been made in reducing problem and delinquent loans to
minimal levels.
In addition to the good news regarding non-performing assets, loan
delinquencies, which precede a loan becoming non-performing, were also at
historically low levels and contributed to the reduction of our loan loss
reserve. Thus, we believe that we are adequately protected for the risks
inherent in our present loan portfolio.
There is yet one more matter on which I would like to report. The Directors and
Employees of Andover Bancorp believe that we should serve the interests of our
shareholders while also serving the needs of our customers and local
communities. We believe that the
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<PAGE> 5
interests of both are not only compatible but complementary.
For these reasons, we are especially gratified that in 1998, after careful
examination of the Bank's services and lending record in our local communities,
the Massachusetts Commissioner of Banks awarded Andover Bank an "Outstanding"
rating for its performance under the Community Reinvestment Act. This
recognition explicitly acknowledges the commitment of all areas of the Bank to
meet the needs of our entire community. We seek to provide banking and credit
services so as to promote the economic vitality of our communities and their
residents. That our state regulator recognizes our efforts with the highest
examination rating possible is validation for past activity and a spur for
continued excellence.
Indeed, in all areas of the Company, we are invigorated by the successes of 1998
and committed to success in 1999 and beyond. We believe that a strong balance
sheet, with solid capital and reserves, and an efficient operation are linchpins
to strong earnings over the long term. We believe that seeking prudent means to
expand and grow our franchise, through acquisition, new branches, new product or
business lines, and other means, will help provide earnings growth. Finally, we
believe our commitment to our community and our focus on customer service will
continue to find relevance in the banking market and enhance an already strong
banking franchise.
On behalf of the Board of Directors, I wish to thank our Shareholders, both new
and old, for their support and confidence during 1998 and into the new year. I
would also like to thank the Employees of the organization for their dedication
and efforts in achieving the record results of the past year.
Very truly yours,
/s/ Gerald T. Mulligan
Gerald T. Mulligan
President and Chief Executive Officer
================================================================================
HOME FINANCING
----------------------
As the leading mortgage lender in the Merrimack Valley, Andover Bank has
helped thousands of families make their dream of home ownership a reality. Our
knowledgeable mortgage origination staff is dedicated to providing the best
possible service. Maureen Newton, one of our Mortgage Bankers, works closely
with buyers like Louis and Jackie Isenburg to arrange for home financing. In
fact, the Isenburg's were so happy with Andover Bank they recommended us to
their daughter and grandson. So now, three generations are enjoying home
ownership with the help of Andover Bank.
[PICTURE / Maureen Newton, Mortgage Banker
Louis and Jackie Isenburg, home financing customers]
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<PAGE> 6
COMMUNITY SUPPORT
--------------------------
The Lawrence Family Development Charter School was founded by a coal ition
of Latino-American parents and community organizations in 1995, based on the
belief that the education of children is the shared responsibility of families,
schools and communities. Having financed renovations to an existing building as
well as construction of new classrooms, Andover Bank is proud to be a part of
the school's growth. In addition, Jose Cabrera, an Andover Bank Vice President,
has been an integral part of the school's success. As Treasurer of its Board of
Trustees since its inception, Jose's continuing active involvement with the
Lawrence Family Development Charter School is yet another example of Andover
Bank's commitment to the communities it serves.
[PICTURE / Lawrence Family Development Charter School Students]
================================================================================
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
PERCENTAGE
1997 1998 CHANGE
---------- ---------- ----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Total assets $1,322,745 $1,410,247 + 7%
Loans, net 966,302 1,040,279 + 8
Deposits 946,982 988,656 + 4
Stockholders' equity 107,079 121,142 + 13
Non-performing assets 8,255 3,492 - 58
OPERATING DATA:
Net interest and dividend income $ 38,705 $ 42,231 + 9%
Provision (credit) for loan losses 983 (1,705) -273
Gains (losses) on real estate operations (971) 14 +101
Non-interest expense 21,986 22,577 + 3
Pre-tax income 20,494 25,545+ 25
Net income 13,206 17,386 + 32
PER SHARE DATA:(1)
Basic earnings per share $ 2.05 $ 2.68 + 31%
Diluted earnings per share 1.99 2.60 + 31
Dividends declared 0.54 0.69 + 28
Book value at end of period 16.58 18.58 + 12
Book value(2) 16.40 18.39 + 12
SELECTED FINANCIAL RATIOS:
Return on average assets 1.06% 1.27%
Return on average equity(2) 13.24 15.64
Net yield on average earning assets 3.22 3.18
Efficiency ratio 49.95 49.37
</TABLE>
BOOK VALUE PER SHARE(1)(2)
AT DECEMBER 31,
[GRAPH]
1995 $13.37
1996 $14.89
1998 $16.40
1998 $18.39
(1) Adjusted for 25% stock split (Q2/98)
(2) Excludes the effect of SFAS N0. 115
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-16358
ANDOVER BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2952665
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
61 MAIN STREET, ANDOVER, MA 01810
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (978)749-2000
------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(Title of Class)
PREFERRED STOCK PURCHASED RIGHTS
(Title of Class)
Indicate by check mark whether: the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sale price for the Registrant's Common
Stock on March 1, 1999, as reported by NASDAQ, was $198,142,564.50.
The number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practicable date, is:
Class: Common Stock, par value $0.10 per share
Outstanding as of March 1, 1999: 6,523,212 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Andover Bancorp, Inc. Definitive Notice of Annual Meeting
and Proxy Statement for the 1999 Annual Meeting of Shareholders are incorporated
by reference into Part III of Form 10-K.
<PAGE> 8
PRELIMINARY NOTE IN REGARD TO FORWARD-LOOKING STATEMENTS. This annual
report on Form 10-K contains forward-looking statements. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects", "intends" and similar
expressions are intended to identify forward-looking statements. In addition,
the costs, timing and effectiveness of Year 2000 compliance are forward-looking
statements. You should not rely on forward-looking statements, because they
involve known and unknown risks, uncertainties and other factors, some of which
are beyond the control of the Company. These expressed or implied important
risks, uncertainties and other factors may cause the Company's actual results,
performance or achievements to differ materially from those expressed or implied
by such forward-looking statements. These factors include, without limitation,
those set forth below under the caption "Certain Factors That May Affect Future
Results".
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS. The following important
factors, among others, could cause actual results, performance or achievements
of the Company to differ materially from those expressed or implied by
forward-looking statements made in this annual report on Form 10-K or presented
elsewhere by management from time to time. Defined terms used elsewhere in this
annual report have the same meanings herein as therein. A number of
uncertainties exist that could affect the Company's future operating results,
performance or achievements including, without limitation, the Banks' (as
defined below) continued ability to originate quality loans, fluctuation of
interest rates, real estate market conditions in the Banks' lending areas,
general and local economic conditions, the Banks' continued ability to attract
and retain deposits, the Company's (as defined below) ability to control costs,
new accounting pronouncements, 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.
PART I
ITEM 1. BUSINESS
GENERAL
Andover Bancorp, Inc. ("Andover" or the "Company") is a Delaware
corporation that was organized in 1987. Although Andover has corporate authority
to engage in any activity permitted by the Delaware General Corporation Law,
Andover's primary activity is to act as the holding company for Andover Bank
(the "Bank") and Andover Bank NH ("ABNH") (collectively the "Banks").
The Bank is a Massachusetts-chartered savings bank which was incorporated
in 1834 and is headquartered in Andover, Massachusetts. On May 8, 1986, Andover
Bank converted from mutual to stock form. Deposits at the Bank are insured by
the Federal Deposit Insurance Corporation ("FDIC") up to $100,000 per separately
insured account and by the Depositors Insurance Fund, Inc. ("DIF") for that
portion of deposits in excess of $100,000.
ABNH is a de novo guaranty savings bank chartered in September, 1995 and
headquartered in Salem, New Hampshire. Deposits at ABNH are insured by the FDIC
up to $100,000 per separately insured account. The Company has obtained the
regulatory approvals necessary to merge ABNH with and into Andover Bank. This
merger is anticipated to occur on April 1, 1999, with the two banking offices of
ABNH remaining in full operation as branches of Andover Bank.
The Banks are engaged principally in the business of attracting deposits
from the general public and investing in residential and commercial real estate
loans, in construction, consumer, and corporate loans, and in various
securities. Emphasis is placed on both retail and corporate banking. Retail
activities, an important source of franchise value to the Banks, consist of
branch operations, home mortgage and consumer lending, and mortgage banking. The
Banks offer a variety of retail products through branch offices, automated
teller machines ("ATMs"),
-2-
<PAGE> 9
its telephone call center and product specialists. Corporate banking activities
consist primarily of commercial real estate, construction, land and commercial
lending. These are conducted primarily through loan officers and product
specialists.
The Company's financial performance in 1998 was positively impacted by a
credit for loan losses of $1.7 million, a lower effective tax rate and an
increase in net interest income partially offset by an increase in non-interest
expenses.
The Company's financial performance in 1997 reflects an increase in net
interest income, non-interest income and a reduction in the provision for loan
losses on real estate operations, partially offset by an increase in
non-interest expenses.
MARKET AREA
The Bank's market area is centered in Andover, Massachusetts, approximately
25 miles north of downtown Boston. The Bank operates banking offices in the
towns of Andover, Lawrence, Methuen, North Andover and Tewksbury, which serve
those towns as well as surrounding communities in northeastern Massachusetts and
in southern New Hampshire. ABNH's primary market area is comprised of
communities in southern New Hampshire and operates banking offices in Salem and
Londonderry, New Hampshire. Andover Capital Group, Inc., a subsidiary of Andover
Bank, offering commercial equipment leasing and financing, is located in Boston
with the entire Northeast as its primary market area.
LENDING ACTIVITIES
General. Lending is the principal business of the Banks and loans represent
the largest portion of the Banks' assets. At December 31, 1998, the Banks' loan
portfolio, prior to the allowance for loan losses, amounted to $1,050.8 million
or 74.5% of total assets. The Banks' loan portfolio increased 7.3% during 1998
resulting from higher loan originations and purchases.
The primary lending activity has been the origination of first mortgage
loans for the purchase or refinance of residential properties in Andover's
primary market area and adjacent communities. Such loans are generally viewed as
the least vulnerable to major economic changes. They provide a relatively stable
source of interest income in the loan portfolio. They also provide a significant
source of fee income when they are sold in the secondary mortgage market and
serviced by the Bank. The Bank is an active servicer of residential loans for
investors in the secondary mortgage market.
The Banks originate a variety of other loans for consumer purposes. These
include home equity, second mortgage, and personal loans, among others, and
constitute an additional source of interest income in the loan portfolio. The
consumer lending activities of the Banks complement their home mortgage
activities and position them as full service retail lenders. The retail lending
activities of the Banks complement their retail deposit gathering activities and
strengthen their overall retail franchise in their market areas. At December 31,
1998, retail loans totaled $801.9 million or 76.3% of total loans.
The Banks also originate non-retail or corporate loans, such as commercial
real estate, commercial, construction and land loans and lease financing.
Historically, these types of loans have generated higher yields and returns than
retail loans, but also involve additional risk. See "Risk Elements". Corporate
loans have also been viewed as a means of maintaining a diversified loan and
asset portfolio. At December 31, 1998, corporate loans amounted to $248.9
million, or 23.7% of total loans.
Residential Mortgage Loans. Residential mortgage loans totaling $740.0
million represented 70.4% of the total loan portfolio at December 31, 1998. An
additional $11.3 million in residential mortgage loans was held for sale at that
date. During 1998, the Bank purchased from other banks and correspondent
origination firms $22.9 million of locally originated residential whole loans.
-3-
<PAGE> 10
Nearly all of the loans in the residential mortgage portfolio are secured
by homes located in Massachusetts or in southern New Hampshire. According to
internal policy, the majority of these loans are written to be eligible for sale
in the secondary mortgage market, primarily to the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA").
Residential mortgage loans include both fixed and variable rate mortgages with
original terms of 5 to 30 years. The Bank remains an active seller of originated
home mortgages in the secondary market.
Commercial Real Estate Loans. At December 31, 1998, commercial real estate
loans totaled $158.4 million, representing 15.1% of total loans. Approximately
$40.9 million, or 25.8% of these loans, are secured by apartment buildings and
multi-family residential properties. The balance of the commercial real estate
portfolio is secured by commercial facilities, including office, mixed use,
retail or light manufacturing properties, small shopping centers, and various
other types of commercial real estate. Commercial real estate loans generally
amortize over a period of 15 to 25 years. Variable interest rates on such loans
are generally set at a margin above either the one-year Treasury index or the
prime rate as published in the Wall Street Journal and are subject to periodic
adjustment. Commercial real estate loans with fixed interest rates are set at a
margin above the Federal Home Loan Bank advance rate.
Construction and Land Loans. Construction and land loans totaled $56.6
million at December 31, 1998, representing 5.4% of total loans. At that date,
amounts committed to but not yet advanced in connection with such loans totaled
an additional $28.6 million. At December 31, 1998, outstanding construction
loans totaled $30.8 million and outstanding land loans (including loans for
unimproved land and land development) totaled $25.8 million. The majority of the
construction loans are for residential development of detached single-family
homes. Construction and land loans generally have a term of two years, although
the Banks typically are entitled to review and adjust the interest rate at the
end of the first year. The interest rate generally is set at a margin above the
prime rate as published in the Wall Street Journal.
Consumer Loans. Consumer loans totaled $61.9 million at December 31, 1998,
representing 5.9% of total loans. Home equity loans constitute the greatest
portion of the Banks' consumer lending activity and totaled $44.5 million at
December 31, 1998. At that date, unadvanced amounts relating to home equity
loans totaled an additional $71.3 million. Home equity loans are offered both in
fixed-rate and adjustable form with varying terms of three to ten years. The
adjustable rate loans are generally tied to the prime rate as published in the
Wall Street Journal. Home equity loans are subject to the same general
underwriting standards as residential first mortgage loans.
Commercial Loans. At December 31, 1998, commercial loans totaled $34.0
million, or approximately 3.2% of total loans. The interest rate on commercial
loans generally varies at a margin above the prime rate as published in the Wall
Street Journal. Commercial loans may be secured in whole or in part by real
estate unrelated to the principal purpose of the loan or secured by inventories
and receivables and are ordinarily guaranteed by the principals of the borrower.
Commercial loans with fixed interest rates are set at a margin above the Federal
Home Loan Bank advance rate.
Andover Capital Group, Inc., a subsidiary of the Company offering
commercial equipment leasing and financing as an additional financing option for
corporate customers, had approximately $10.0 million and $1.0 million
outstanding in leases included in the commercial loan portfolio at December 31,
1998 and 1997, respectively. Additionally, there was another $4.9 million of
secured equipment loans included in the commercial loan portfolio at December
31, 1998.
Loan Origination. Mortgage loans originate from a number of sources. These
include realtor, builder and customer referrals, direct advertising and
participation in home shows and other events. The Banks employ a number of
mortgage loan originators who maintain regular contact with real estate firms
and other sources of business and who respond to general mortgage inquiries.
These mortgage specialists are assigned specific territories and receive
commissions on closed mortgage loans. Total residential mortgages originated by
the Banks in 1998 amounted to $329.4 million.
Consumer loans are solicited by advertising and by direct mail targeted to
existing deposit and mortgage customers and, from time to time, selected market
area households which have no customer relationship with either
-4-
<PAGE> 11
Bank. The primary origination activity in the consumer loan area relates to home
equity lines of credit, totaling $16.6 million in 1998, while other consumer
loan originations totaled $11.4 million.
Commercial real estate, commercial, construction and land loans and lease
financings are originated from direct solicitation of existing and prospective
customers and from a variety of referral sources. The Banks originated $153.9
million of these corporate loans during 1998.
RISK ELEMENTS
General. Overbuilding and the weakened New England economy and real estate
market were the principal causes for the past deterioration of the loan
portfolio. For further information concerning the composition of the loan
portfolio, nonaccrual loans, impaired loans and the allowance for loan losses,
see Note 4 to the "Consolidated Financial Statements" and Item 7, "Management's
Discussion and Analysis -- Results of Operations -- Financial Condition -- Loans
- -- Risk Elements.".
Non-performing Assets. Non-performing assets consist of nonaccruing loans
and other real estate owned. During 1998, non-performing assets decreased 57.7%
or $4.8 million from 1997 levels, to $3.5 million and amounted to 0.2% of total
assets at year-end. The Company places all loans, regardless of collateral
values, on nonaccrual status when principal or interest is past due 90 days or
more. Loans for which payments are less than 90 days past due are placed on
non-accrual status where there exists serious doubt as to collectibility. At
December 31, 1998, the Bank had $3.2 million in nonaccruing loans and $252,000
in other real estate owned.
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. The Company recorded a credit for loan losses of $1.7 million in
1998 as compared to a provision for loan losses of $983,000 in 1997. Among the
factors used to determine that the credit for loan losses was appropriate was
the continued improvement in loan quality, as well as management's assessment of
changes in trends and conditions.
INVESTMENT ACTIVITIES
The investment portfolio, an important component of Andover's diversified
asset structure, is a source of earnings in the form of interest and dividends,
provides for diversification and is a source of liquidity. Overall, the
portfolio, comprised of mortgage-backed securities, corporate bonds, U.S.
Treasury and federal agency securities and short-term investments, represented
20.0% of total assets, or $282.5 million as of December 31, 1998.
In both 1998 and 1997, the total investment portfolio produced interest and
dividend income of $19.9 million due to the continued reinvestment of the cash
flows. The investment portfolio and the sale of loans generated on sales,
redemptions and the marking of certain securities to market of $670,000 in 1998,
as compared to $422,000 in 1997. For additional information on investments, see
Notes 1, 2 and 3 to the "Consolidated Financial Statements" and Item 7,
"Management's Discussion and Analysis -- Results of Operations -- Financial
Condition -- Investments".
DEPOSITS AND BORROWED FUNDS
The Banks' major sources of funds are deposits, borrowings, principal
payments or payoffs on loans and mortgage-backed securities, and maturities of
investments. Borrowings are generally used to fund long-term assets and
short-term liquidity requirements or to manage interest rate risk. Total
deposits amounted to $988.7 million at December 31, 1998.
The Bank is a member of the Federal Home Loan Bank of Boston ("FHLB") and
is authorized to borrow funds to meet withdrawals of savings deposits or to
expand the loan or investment portfolios. These borrowings are subject to
collateral requirements and borrowing limitations. The Banks also have available
various other sources of funds, including secured borrowings, federal funds
lines of credit from commercial banks and reverse repurchase
-5-
<PAGE> 12
agreements from brokerage firms, FHLMC and FNMA. In addition, the Banks have
overnight repurchase agreements with several corporate customers. The Banks may
also obtain funds from the Federal Reserve Bank of Boston by pledging certain
assets. At December 31, 1998, total borrowings outstanding from these various
sources amounted to $283.8 million.
For additional information concerning the composition and maturity of
deposits and borrowings, see Notes 8, 9 and 10 to the "Consolidated Financial
Statements" and Item 7, "Management's Discussion and Analysis -- Results of
Operations -- Financial Condition -- Deposits -- Borrowings -- Asset and
Liability Management and Market Risk -- Liquidity".
OTHER SERVICES
Investment Services. The Banks make investment and brokerage services
available to their customers through a contract with Liberty Securities
Corporation, an unaffiliated company. A fully licensed broker of Liberty
Securities located at the Bank's headquarters is available for consultation on
investment opportunities, including mutual funds, municipal bonds,
government-backed securities and annuities. The Bank received income of
approximately $87,000 from these services in 1998.
COMPETITION
The Banks' lending and deposit-taking activities are concentrated in the
Central Merrimack Valley and the surrounding communities in northeastern
Massachusetts and southern New Hampshire. The Banks face strong competition both
in originating loans and in attracting deposits. Competition in originating
loans in the Banks' expansive lending area comes primarily from thrift
institutions, commercial banks, mortgage companies, credit unions and consumer
finance companies. The Banks compete for loans principally on the basis of
interest rates and loan fees, the types of loans offered, and the quality of
service and convenience provided to borrowers.
In attracting deposits, the Banks' primary competitors are thrift
institutions, commercial banks, credit unions and mutual funds. The attraction
and retention of deposits depends on the Banks' ability to provide investment
opportunities that satisfy the requirements of depositors with respect to the
rate of return, liquidity, risk, service and other factors. The Banks compete
for these deposits by offering competitive rates, convenient branch locations,
extended business hours, alternative delivery channels and automated teller
machines.
SUPERVISION AND REGULATION
General. The Company and the Banks are heavily regulated. As a multi-bank
holding company, Andover is supervised by the Board of Governors of the Federal
Reserve Board System ("FRB") and it is also subject to the jurisdiction of the
Massachusetts Board of Bank Incorporation. As a Massachusetts-chartered savings
bank, the Bank is subject to regulation and supervision by the FDIC and the
Massachusetts Commissioner of Banks. As a New Hampshire-chartered guaranty
savings bank, ABNH is subject to regulation and supervision of the FDIC and the
New Hampshire Commissioner of Banks.
Federal Deposit Insurance Corporation. The FDIC insures the Bank's deposit
accounts to the $100,000 maximum per separately insured account. The Banks are
subject to regulation, examination, and supervision by the FDIC and to reporting
requirements of the FDIC. The FDIC has adopted requirements setting minimum
standards for capital adequacy and imposing minimum leverage capital ratios. The
Banks exceeded all applicable requirements at December 31, 1998. Furthermore,
under the capital standards established pursuant to the FDIC Improvement Act of
1991, the Banks are currently well-capitalized. For additional information on
regulatory capital ratios, see Note 12 to the "Consolidated Financial
Statements" and Item 7, "Management's Discussion and Analysis -- Financial
Condition -- Capital Resources".
Massachusetts Commissioner of Banks and New Hampshire Commissioner of
Banks. Massachusetts and New Hampshire statutes and regulations govern, among
other things, investment powers, lending powers, deposit activities, maintenance
of surplus and reserve accounts, the distribution of earnings, the payment of
dividends,
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<PAGE> 13
issuance of capital stock, branching, acquisitions and mergers and
consolidations. Massachusetts and New Hampshire banks that do not operate in
accordance with the regulations, policies and directives of the respective
Commissioner of Banks may be subject to sanctions for noncompliance. The
Commissioners may, under certain circumstances, suspend or remove officers or
directors who have violated the law, conducted the Banks' business in a manner
which is unsafe, unsound or contrary to the depositor's interest, or been
negligent in the performance of their duties.
In response to a Massachusetts law enacted in 1996, in 1997 the
Massachusetts Commissioner finalized rules that generally give Massachusetts
banks, and their subsidiaries, many powers equivalent to those of national
banks. The Massachusetts Commissioner also has adopted procedures expediting
branching by strongly capitalized banks.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Under
the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"), different types of interstate transactions and activities are
permitted. Interstate transactions and activities provided for under the law
include: (i) bank holding company acquisitions of separately held banks in a
state other than a bank holding company's home state; (ii) mergers between banks
with different home states, including consolidations of affiliated banks; (iii)
establishment of interstate branches either de novo or by branch acquisition;
and (iv) affiliate banks acting as agents for one another for certain banking
functions without being considered a "branch". In general, subject to certain
limitations, nationwide interstate acquisitions are now permissible,
irrespective of state law limitations other than limitations related to deposit
concentrations and bank age requirements. Interstate mergers generally also are
permissible, and affiliated banks may act as agents for one another. Each of the
transactions and activities must be approved by the appropriate federal bank
regulator, with separate and specific criteria established for each category.
In 1996, Massachusetts enacted interstate banking laws in response to
Riegle-Neal. The laws permit, subject to certain deposit and other limitations,
interstate acquisitions, mergers and branching on a reciprocal basis. The new
interstate banking law is likely to make it easier for out-of-state institutions
to attempt to purchase or otherwise acquire a Massachusetts bank, or to compete
with the Bank in Massachusetts. Similarly, the new laws make it easier for
Massachusetts banks to compete outside the state.
Subsequent to December 31, 1998, the Company received the regulatory
approvals necessary to merge ABNH with and into Andover Bank. This merger is
anticipated to occur April 1, 1999, with the two banking offices of ABNH
remaining in full operation as branches of Andover Bank.
EMPLOYEES
At December 31, 1998, Andover had 274 full-time equivalent employees. None
of the employees of Andover are represented by a collective bargaining group and
management considers relations with its employees to be good.
SUBSIDIARIES
Andover has two direct subsidiaries, the Bank and ABNH. The Bank has four
wholly-owned subsidiaries and one majority-owned subsidiary. Three of its
subsidiaries were organized to hold real property acquired by the Bank by
foreclosure or acceptances of deeds in lieu of foreclosure. The fourth
subsidiary, ASB Development Corp. ("ASB"), has four subsidiaries and holds title
to a portion of Andover's main office, the loan operations building and to other
income producing property. One subsidiary of ASB holds real estate property that
comprises a portion of Andover's main office location. Two other subsidiaries of
ASB were organized as Massachusetts security corporations to take advantage of
beneficial state tax treatment related to the holding of certain investments.
The fourth subsidiary of ASB, Andover Preferred Capital Corporation ("APCC"), is
99 percent owned by ASB and is a Massachusetts business corporation which has
elected to be taxed as a real estate investment trust for federal and
Massachusetts tax purposes. APCC holds mortgage loans which were previously
originated by Andover Bank. The majority-owned subsidiary of the Bank, Andover
Capital Group, Inc., provides commercial equipment leasing and financing. ABNH
has no subsidiaries.
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<PAGE> 14
ITEM 2. PROPERTIES
Andover conducts its business from its main office and other properties
listed below, all of which are considered to be in good condition and adequate
and suitable for the purposes for which they are used. Andover also serves
customers through its affiliation with three Automatic Teller Machine ("ATM")
networks: NYCE(R), EXCHANGE(R) and CIRRUS(R) with over 260,000 ATM locations
worldwide. In addition, the Company has an affiliation with Maestro(R) for its
debit card customers. The following table sets forth certain information
relating to bank premises owned or used by Andover and its subsidiaries in
conducting its business.
OWNED OR
LOCATION LEASED
- -------- --------
ANDOVER BANK
Main Office:
Andover
61 Main Street............................................Owned
31-45 Main Street-Annex...................................Owned
11 Chestnut Street........................................Owned
18-20 Central Street(1)...................................Leased
Branches:
Lawrence
450 Essex Street..........................................Owned
305 South Broadway........................................Owned
Methuen
547 Broadway..............................................Owned
91 Pleasant Valley Street(2)..............................Owned
228 Haverhill Street......................................Owned
North Andover
108 Main Street...........................................Owned
1077 Osgood Street (ATM only)(3)..........................Leased
Tewksbury
995 Main Street...........................................Owned
2171 Main Street(4).......................................Leased
Andover
159 River Road............................................Owned
ANDOVER BANK NH
Main Office:
Salem
130 Main Street(5)........................................Leased
Branch:
Londonderry
62 Nashua Road............................................Owned
ANDOVER CAPITAL GROUP, INC.
One Constitution Plaza, Boston(6)............................Leased
238 Littleton Road, Westford(7)..............................Leased
- ---------------------------
(1) Lease expires January 31, 2004, with a renewal option for an additional four
years.
(2) Land is held under a ground lease which expires December 1, 2006, with
renewal options for an additional 69 years.
(3) Lease expires May 31, 2001, with renewal options for an additional ten
years.
(4) Lease expires January 31, 2000.
(5) Lease expires July 31, 1999, with renewal options for an additional four
years.
(6) Lease expires May 31, 1999.
(7) Lease expires February 14, 2002, with renewal options for an additional two
years.
-8-
<PAGE> 15
ITEM 3. LEGAL PROCEEDINGS
Andover and the Banks are involved in various legal proceedings incidental
to their business, none of which is believed by management to be material to the
financial condition of Andover or the Banks.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
STOCK PRICES AND DIVIDENDS
Andover's Common Stock trades on the Nasdaq National Market tier of The
Nasdaq Stock Market(SM) under the symbol "ANDB". On February 15, 1999, there
were approximately 2,366 holders of record of the 6,523,212 shares of Andover
Common Stock outstanding.
The following table sets forth the comparative market prices per share of
Andover Common Stock based on high and low sale prices as reported on by
Nasdaq(R) and the dividends per share that have been declared by Andover, for
the periods indicated. The per share information has been restated for prior
periods to reflect the Company's 25% stock split distribution in May, 1998.
<TABLE>
<CAPTION>
PRICE DIVIDENDS
----- DECLARED
QUARTER ENDED HIGH LOW PER SHARE
------------- ---- --- ---------
<S> <C> <C> <C> <C>
1996 March 31, 1996.............$15.75 $13.50 $.080
June 30, 1996.............. 18.67 14.25 .100
September 30, 1996......... 17.75 15.25 .100
December 31, 1996.......... 23.40 16.87 .120
1997 March 31, 1997.............$24.20 $19.80 $.120
June 30, 1997.............. 25.40 20.60 .136
September 30, 1997......... 29.40 23.60 .136
December 31, 1997.......... 33.80 26.20 .152
1998 March 31, 1998.............$33.00 $27.40 $.152
June 30, 1998.............. 38.75 31.50 .180
September 30, 1998......... 40.75 25.50 .180
December 31, 1998.......... 35.00 24.75 .180
</TABLE>
The payment of dividends by Andover is subject to the discretion of
Andover's Board of Directors. Holding companies such as Andover engage in no
business other than acting as the holding company of their subsidiaries. The
only funds available to Andover for the payment of dividends are cash and cash
equivalents held at the holding company level, dividends paid by the Banks to
Andover, and borrowings. At December 31, 1998, Andover held $9.3 million in cash
and interest-bearing deposits at the holding company level.
Dividend payments totaled $4.5 million in 1998 and $3.5 million in 1997. On
January 21, 1999, a dividend of $.21 per share was declared, payable on
February 16, 1999.
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<PAGE> 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes selected consolidated financial data of
Andover at or for the periods indicated, and should be read in conjunction with
the consolidated financial statements and related notes thereto included in
Item 8 of this Report.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT BANKING OFFICES DATA)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets ............................. $1,410,247 $1,322,745 $1,204,813 $1,110,847 $1,058,672
Total loans .............................. 1,050,765 978,823 870,035 768,598 645,037
Allowance for loan losses ................ 10,486 12,521 12,229 11,665 12,343
Investments (1) .......................... 282,511 282,567 276,651 285,232 352,685
Assets held for sale ..................... 11,282 5,537 2,220 5,162 2,507
Deposits ................................. 988,656 946,982 824,311 743,205 727,858
Borrowed funds ........................... 283,824 258,732 274,418 272,626 251,185
Stockholders' equity ..................... 121,142 107,079 95,846 85,165 72,522
Non-performing assets .................... 3,492 8,255 12,382 15,785 23,312
Number of banking offices and locations .. 13 13 12 11 10
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT BANKING OFFICES DATA)
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Interest and dividend income ............. $ 97,246 $ 90,752 $ 83,823 $ 76,886 $ 63,585
Interest expense ......................... 55,015 52,047 48,529 44,552 33,421
---------- ---------- ---------- ---------- ----------
Net interest and dividend income ....... 42,231 38,705 35,294 32,334 30,164
Provision (credit) for loan losses ....... (1,705) 983 2,555 1,295 --
Net gains (losses) from sales of assets
held for sale and investments(1) ....... 670 422 (265) 324 (234)
Gains (losses) on real estate
operations, net ........................ 14 (971) (1,542) (2,003) (2,617)
Other income ............................. 3,502 5,307 4,804 4,870 4,007
Merger expense (recovery) ................ -- -- (225) 1,000 --
Non-interest expense ..................... 22,577 21,986 20,045 18,258 17,496
---------- ---------- ---------- ---------- ----------
Income before income tax expense
and extraordinary item ................. 25,545 20,494 15,916 14,972 13,824
Income tax expense ....................... 8,159 7,288 3,264 5,634 4,781
---------- ---------- ---------- ---------- ----------
Income before extraordinary item ......... 17,386 13,206 12,652 9,338 9,043
Extraordinary item ....................... -- -- (173) -- --
---------- ---------- ---------- ---------- ----------
Net income ............................... $ 17,386 $ 13,206 $ 12,479 $ 9,338 $ 9,043
========== ========== ========== ========== ==========
PER SHARE DATA:(2)
Basic earnings per share:
Income per share before extraordinary
item ................................... $ 2.68 $ 2.05 $ 1.98 $ 1.48 $ 1.44
Extraordinary item per share,
net of tax ............................ -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
Net income per share .................... $ 2.68 $ 2.05 $ 1.95 $ 1.48 $ 1.44
========== ========== ========== ========== ==========
Diluted earnings per share:
Income per share before extraordinary
item ................................... $ 2.60 $ 1.99 $ 1.95 $ 1.46 $ 1.42
Extraordinary item per share,
net of tax ... ......................... -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
Net income per share .................... $ 2.60 $ 1.99 $ 1.92 $ 1.46 $ 1.42
========== ========== ========== ========== ==========
Dividends declared ....................... $ 0.69 $ 0.54 $ 0.40 $ 0.30 $ 0.26
Book value at end of period .............. 18.58 16.58 14.94 13.40 11.49
Book value(3) ............................ 18.39 16.40 14.89 13.37 12.22
SELECTED FINANCIAL RATIOS:
Return on average assets ................. 1.27% 1.06% 1.08% 0.87% 0.94%
Return on average equity (3) ............. 15.64 13.24 13.89 11.51 12.36
Average equity as a percentage
of average assets(3) .................... 8.13 8.00 7.76 7.59 7.57
Dividend payout ratio .................... 26.54 27.14 20.83 20.55 18.31
Weighted average interest rate spread .... 2.57 2.67 2.66 2.71 2.91
Net yield on average earning assets ..... 3.18 3.22 3.16 3.14 3.26
Efficiency ratio ......................... 49.37 49.95 49.43 51.76 51.20
</TABLE>
- ---------------
(1) Includes investment securities, mortgage-backed securities and short-term
investments, both available for sale and held to maturity.
(2) The per share data has been restated for periods prior to December 31,
1998, to reflect the 25% stock split.
(3) Excludes the effect of SFAS No. 115.
-10-
<PAGE> 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
General. The Company's results of operations depend to a great extent on
the Banks' net interest income, which is the difference between income earned on
their loan and investment portfolios and the interest paid on their deposits and
borrowed funds, the size of the provisions or credits for loan losses and
operating expenses. Net interest income is primarily affected by the level of
earning assets as a percentage of total assets, the level of interest-bearing
liabilities, yields earned on assets and rates paid on liabilities. Earnings are
also affected by non-interest income which consists primarily of mortgage
banking income, transaction account fees, gains and losses on sales of the
investment portfolio and real estate operations. The levels of operating
expenses and income taxes also affect earnings.
The following is a discussion and analysis of the Company's consolidated
results of operations for the last three years and its financial condition at
the end of fiscal 1998 and 1997. This section is intended to be read in
conjunction with the Consolidated Financial Statements and accompanying
footnotes.
The following also contains forward-looking statements. There are a number
of important risks, uncertainties and other factors that could cause the
Company's actual results, performance or achievements to differ materially from
those expressed or implied by such forward-looking statements. These risks,
uncertainties and other factors include, without limitation, those set forth
under the caption "Certain Factors That May Affect Future Results".
RESULTS OF OPERATIONS
Andover generated net income of $17.4 million or $2.60 per diluted share,
$13.2 million or $1.99 per diluted share and $12.5 million or $1.92 per diluted
share in 1998, 1997 and 1996, respectively. Andover's return on average assets
increased in 1998 to 1.27%, as compared to 1.06% in 1997 and 1.08% in 1996.
Return on average stockholders' equity increased in 1998 to 15.64%, as compared
to 13.24% in 1997 and 13.89% in 1996. The Company's financial performance in
1998 was positively impacted by a credit for loan losses of $1.7 million and an
increase in net interest income. The financial performance in 1997 was impacted
by an increase in total earning assets as well as the net yield on those assets.
The financial performance in 1996 was positively impacted by a one-time gain (in
the form of a tax benefit) of $2.5 million, partially offset by a pre-tax loss
of $1.1 million from the sale of low-yielding investments and the early
extinguishment of debt.
Net Interest and Dividend Income. Net interest and dividend income was
$42.2 million in 1998, $38.7 million in 1997 and $35.3 million in 1996. Net
interest income increased $3.5 million during 1998 and $3.4 million during 1997
as a result of higher average earning asset volumes in both of those years.
Market interest rates have been fairly volatile over the past several years.
During 1998, the difference between longer-term interest rates and shorter-term
interest rates have lessened, thereby creating a flat yield curve. This
continued compression in the margins has been reflected in the declines in both
the interest rate spread of 2.57% and the net yield of 3.18% for 1998. During
1997, the interest rate margin of 3.22% and the interest rate spread of 2.67%
were favorably impacted by the restructure of the balance sheet undertaken in
the latter part of 1996. This restructure enabled the Company to recognize a six
basis point increase in the yield on interest-earning assets while maintaining
only a 5 basis point increase on the rate paid on interest-bearing liabilities.
The amount of foregone interest income from nonaccruing and restructured loans
totaled $514,000 in 1998, $716,000 in 1997 and $909,000 in 1996.
Average earning assets increased 10.5% in 1998 to $1,326.5 million as of
December 31, 1998, and increased 7.4% during 1997 to $1,200.7 million. The
increase in each of the two years was primarily due to higher loan growth
resulting from increased loan originations and purchases.
-11-
<PAGE> 18
The volatility in the interest rates has also impacted the yields earned on
the investment portfolio. The yield on short-term investments decreased 14 basis
points during 1998 to 5.31%, yet increased 21 basis points during 1997 to 5.45%.
The yields earned on investment securities remained flat in 1998 compared to an
increase of 59 basis points to 6.68% in 1997. The yield on mortgage-backed
securities decreased 22 basis points during 1998 to 6.61% and increased 1 basis
point during 1997 to 6.83%. During 1998, there were three decreases in the
federal funds rate totaling 75 basis points while there was an increase of 25
basis points in 1997, all of which impacted the short-term investment yield in a
corresponding manner. The increase in the yield in 1997 on the investment
securities was primarily due to the 1996 balance sheet restructure. The decline
in the yield on mortgage-backed securities reflects the decline in long-term
interest rates since the cash flows generated by the high prepayment activity
were unable to be reinvested at a comparable interest rate.
Total average loans increased $118.9 million during 1998 and $80.9 million
during 1997 primarily due to retained loan originations and whole loan
purchases. The yield on real estate loans decreased 31 basis points in 1998 to
7.45% while increasing two basis points during 1997 to 7.76%. The largest
component of the yield on real estate loans was residential loans. Due to the
compression in the yield curve mentioned above, the biggest impact has been felt
in the residential portfolio as evidenced by the 35 basis point decline in the
average yield during 1998. This was primarily due to the high level of refinance
activity and origination volumes. The yields on the commercial real estate and
construction and land portfolios have been fairly consistent over the past two
years. The yield on consumer loans increased 29 basis points in 1998 to 8.49%
while decreasing 36 basis points during 1997 to 8.20%. The yield on the consumer
loans increased during 1998 as the teaser period on various promotional home
equity products expired. In addition, the impact of the declines in the prime
rate in the fourth quarter of 1998 won't be felt until early 1999. The main
reason for the decline during 1997 is due to the highly-competitive environment
for home equity loans, causing the Banks to offer lower interest rates on this
product. The yield on commercial loans decreased 48 basis points during 1998 to
9.06% and nine basis points during 1997 to 9.54%. The decline in the yield on
commercial loans reflects a decline in the prime rate as well as competitive
pricing pressures. In addition, the yield on the lease financings, included in
the commercial portfolio, was lower than the portfolio, thereby dragging down
the overall yield. The decline in the commercial loan yield during 1997 was
primarily due to competitive pricing as well as a higher proportion of fixed
rate loans.
The rate paid on interest-bearing deposits decreased 14 basis points during
1998 to 4.48% and increased 19 basis points in 1997 to 4.62%. Core deposits,
which include NOW, savings and money market accounts, usually have rates lower
than those paid on certificates of deposit. However, to grow the core deposit
balances, the Banks have offered promotional rates on certain products. The
impact of these promotional rates on the savings rate has been an increase of 21
basis points in 1998 and 98 basis points in 1997. Average balances on these
savings accounts, meanwhile, have grown by $54.6 million and $45.5 million,
respectively, in 1998 and 1997. The Banks have moderated the rates paid on money
market accounts and had a decrease in the rate paid of 14 basis points and an
increase of only 9 basis points, respectively, in 1998 and 1997. However, the
balances maintained in money market accounts have declined in each of those
years as customers have migrated to the savings account promotional products.
The balances maintained in NOW accounts have increased modestly in both years
while the rates have remained fairly stable during that same time period.
Certificate of deposit average balances decreased $7.6 million and the rates
paid decreased 8 basis points during 1998, while increasing $72.7 million and 6
basis points, respectively, in 1997. The decline in the average balances and
rates paid on the certificates of deposit reflect the customers' desire to
migrate out of longer-term deposits into core deposit or short-term maturities.
The Company has continued its reliance on borrowed funds as an alternative
source of funds to deposits in order to grow average earning assets. In 1998,
the average balance of borrowed funds increased $44.2 million while the rate
paid decreased 17 basis points. The decline in the rate paid on borrowed funds
is due to the reduction in market interest rates that was also experienced in
the investment and loan portfolios. During 1997, the Company was successful in
attracting new deposits, therefore, the average balance of borrowed funds
decreased $50.4 million and the rate paid decreased 4 basis points to 5.81%. The
decline in the rate paid in 1997 was partly attributable to the early
extinguishment of $19.1 million of borrowed funds in the third quarter of 1996.
The combination of the factors mentioned above contributed to the ten basis
point decline in the interest rate spread to 2.57% during 1998 and a four basis
point decline in the net yield on earning assets to 3.18%.
-12-
<PAGE> 19
The following table presents an analysis of the average yields earned and rates
paid for the years indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ----------------------------- -----------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
---------- -------- ------- ----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Short-term investments .......... $ 15,760 $ 837 5.31% $ 13,691 $ 746 5.45% $ 10,874 $ 570 5.24%
Investment securities (1)(2) .... 109,920 7,340 6.68 101,491 6,783 6.68 88,347 5,380 6.09
Mortgage-backed securities(1).... 177,276 11,711 6.61 180,889 12,362 6.83 195,137 13,304 6.82
---------- ------- ---------- ------- ---------- -------
Total investments ............. 302,956 19,888 6.56 296,071 19,891 6.72 294,358 19,254 6.54
---------- ------- ---------- ------- ---------- -------
Residential loans ............... 747,430 52,616 7.04 650,089 48,043 7.39 593,867 44,045 7.42
Commercial real estate loans .... 145,352 12,927 8.89 136,234 12,253 8.99 129,548 11,488 8.87
Construction and land loans ..... 39,988 3,964 9.91 32,395 3,237 9.99 25,992 2,465 9.48
---------- ------- ---------- ------- ---------- -------
Total real estate loans(1)(3).. 932,770 69,507 7.45 818,718 63,533 7.76 749,407 57,998 7.74
Consumer loans(3) ............... 65,159 5,531 8.49 64,816 5,317 8.20 55,081 4,717 8.56
Commercial loans(3) ............. 25,602 2,320 9.06 21,074 2,011 9.54 19,255 1,854 9.63
---------- ------- ---------- ------- ---------- -------
Total loans ................... 1,023,531 77,358 7.56 904,608 70,861 7.83 823,743 64,569 7.84
---------- ------- ---------- ------- ---------- -------
Total interest-earning
assets ....................... 1,326,487 97,246 7.33% 1,200,679 90,752 7.56% 1,118,101 83,823 7.50%
---------- ------- ---------- ------- ---------- -------
Allowance for loan losses ......... (11,524) (12,395) (11,846)
Other assets ...................... 52,100 58,383 52,524
---------- ---------- ----------
Total assets .................. $1,367,063 $1,246,667 $1,158,779
========== ========== ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing deposits:
NOW accounts .................... $ 86,028 $ 806 0.94% $ 74,202 $ 740 1.00% $ 66,708 $ 661 0.99%
Money market deposit accounts ... 100,751 2,861 2.84 113,325 3,381 2.98 125,923 3,639 2.89
Savings accounts ................ 176,633 6,256 3.54 122,045 4,060 3.33 76,506 1,800 2.35
Certificates of deposit ......... 510,794 29,214 5.72 518,368 30,070 5.80 445,682 25,592 5.74
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
deposits ..................... 874,206 39,137 4.48 827,940 38,251 4.62 714,819 31,692 4.43
---------- ------- ---------- ------- ---------- -------
Borrowed funds:
Reverse repurchase agreements ... 11,794 578 4.90 9,614 481 5.00 15,062 783 5.20
Federal Home Loan Bank
advances ...................... 269,766 15,300 5.67 227,726 13,315 5.85 272,655 16,054 5.89
---------- ------- ---------- ------- ---------- -------
Total borrowed funds .......... 281,560 15,878 5.64 237,340 13,796 5.81 287,717 16,837 5.85
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
liabilities ................ 1,155,766 55,015 4.76% 1,065,280 52,047 4.89% 1,002,536 48,529 4.84%
---------- ------- ------- -------
Demand deposits ................... 89,051 69,942 57,913
Other liabilities ................. 11,104 11,702 8,465
--------- ---------- ----------
Total liabilities ............. 1,255,921 1,146,924 1,068,914
Stockholders' equity .............. 111,142 99,743 89,865
---------- ---------- ----------
Total liabilities and
stockholders' equity ......... $1,367,063 $1,246,667 $1,158,779
========== ========== ==========
Net interest income ............... $42,231 $38,705 $35,294
======= ======= =======
Interest rate spread .............. 2.57% 2.67% 2.66%
==== ==== ====
Net yield on earning assets ....... 3.18% 3.22% 3.16%
==== ==== ====
</TABLE>
(1) Included in the average balance amounts are the corresponding components of
the assets held for sale, available for sale and held to maturity. The yield
is calculated using interest income divided by the average balance of the
amortized historical cost.
(2) Included in the average balance 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.
-13-
<PAGE> 20
Rate/Volume Analysis. The following table shows the changes in interest
income and interest expense caused by changes in the volume of interest earning
assets and interest bearing liabilities, and changes in interest rates received
and paid, respectively. The change attributable to a mix of volume and rate has
been allocated proportionally to the change due to volume and the change due to
volume and the change due to rate.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1998 COMPARED TO 1997 1997 COMPARED TO 1996
--------------------------------- ----------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
DUE TO DUE TO
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---------- ------- -------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest and Dividend Income
Investments:
Short-term investments ............ $ 110 $ (19) $ 91 $ 153 $ 23 $ 176
Investment securities ............. 563 (6) 557 848 555 1,403
Mortgage-backed securities ........ (244) (407) (651) (974) 32 (942)
------ ------- ------ ------- ------ -------
Total interest and dividends
on investments .................. 429 (432) (3) 27 610 637
------ ------- ------ ------- ------ -------
Loans:
Residential loans ................. 6,935 (2,362) 4,573 4,155 (157) 3,998
Commercial real estate loans ...... 812 (138) 674 600 165 765
Construction and land loans ....... 753 (26) 727 634 138 772
------ ------- ------ ------- ------ -------
Total real estate loans ......... 8,500 (2,526) 5,974 5,389 146 5,535
Consumer .......................... 28 186 214 805 (205) 600
Commercial ........................ 414 (105) 309 174 (17) 157
------ ------- ------ ------- ------ -------
Total interest on loans ......... 8,942 (2,445) 6,497 6,368 (76) 6,292
------ ------- ------ ------- ------ -------
Total interest and dividend
income .......................... 9,371 (2,877) 6,494 6,395 534 6,929
------ ------- ------ ------- ------ -------
Interest Expense
Core deposits ....................... 1,463 279 1,742 989 1,092 2,081
Certificates of deposit ............. (436) (420) (856) 4,214 264 4,478
Reverse repurchase agreements ....... 107 (10) 97 (274) (28) (302)
Federal Home Loan Bank advances ..... 2,395 (410) 1,985 (2,628) (111) (2,739)
------ ------- ------ ------- ------ -------
Total interest expense ............ 3,529 (561) 2,968 2,301 1,217 3,518
------ ------- ------ ------- ------ -------
Net increase (decrease) in net
interest and dividend income ........ $5,842 $(2,316) $3,526 $ 4,094 $ (683) $ 3,411
====== ======= ====== ======= ====== =======
</TABLE>
Provision (Credit) for Loan Losses. The allowance for loan losses is
established through a provision for loan losses charged to the statement of
operations. The allowance is reduced by a credit for loan losses as well as loan
charge-offs. Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet probable losses in the loan portfolio after weighing
various factors. Among the factors management may consider are the quality of
specific loans, risk characteristics of the loan portfolio generally, the level
of nonaccruing loans, current economic conditions, trends in delinquencies,
actual charge-off experience, and the collateral values of the underlying
security. Ultimate loan losses may vary significantly from current estimates and
future additions may be necessary. In addition, regulatory agencies, as an
integral part of the examination process, review the Banks' allowance and may
require the Banks to provide additions to the allowance based on their
assessment, which may differ from management's assessment.
-14-
<PAGE> 21
The credit for loan losses in 1998 was $1.7 million as compared to
provisions for loan losses in 1997 and 1996 amounting to $983,000 and $2.6
million, respectively. Net charge-offs amounted to $330,000 in 1998, $691,000 in
1997 and $2.0 million in 1996. The credit for loan losses in 1998 resulted from
the continued improvement in overall loan quality, as reflected by the 59%
decline in nonaccruing loans, 38% decline in total overdue loans and net
charge-offs of $330,000. The decline in the provision recorded in 1997 from 1996
reflects, among other things, a 33% reduction in non-performing assets and
reduced levels of delinquencies, combined with lower levels of net charge-offs.
While management believes that it has been reasonable in its analysis of
the allowance for loan losses and in estimating the net fair values of other
real estate owned, management is unable to predict the ultimate course of
economy of the extent of its impact on the Company's financial condition. See
"Financial Condition -- Risk Elements" and Notes 1 and 4 to the "Consolidated
Financial Statements".
Non-interest Income. The Company recorded income from non-interest sources
of $4.2 million in 1998, $4.8 million in 1997 and $3.0 million in 1996. The
decrease in 1998 was primarily due to losses relating to mortgage banking
activities, offset by gains on real estate operations and increased fee income
on deposits and loans. The increase of $1.8 million in 1997 was primarily due to
a reduction in the losses on real estate operations, higher fee income on
deposits and an increase in the gains generated by the investment portfolio.
Net gains from sales and redemptions of investments totaled $17,000 in 1998
and $158,000 in 1997, as compared to net losses on sales and redemptions of
$686,000 in 1996. The loss on sale of investments in 1996 was primarily due to
the balance sheet restructuring whereby the Company sold approximately $40
million of low yielding investments at a loss of $870,000 and reinvested the
proceeds in higher yielding assets. See "Financial Condition -- Investments" and
Notes 1 and 3 to the "Consolidated Financial Statements".
The Company recorded net gains from sales of assets held for sale of
$653,000 in 1998, $264,000 in 1997 and $421,000 in 1996. Included in each of the
three years were gains totaling $726,000, $447,000 and $423,000, respectively,
from the capitalization of originated mortgage servicing rights. See "Financial
Condition -- Loans" and Notes 1, 2 and 5 to the "Consolidated Financial
Statements".
Andover may incur gains and losses on the sale of the loans that it
originates. These loans are generally securitized prior to sale in the form of
mortgage-backed securities which are guaranteed by a government agency and are
then held for sale. Because loans held for sale are stated at the lower of cost
or market value and mortgage-backed securities held for sale are stated at fair
value, periods of rising interest rates cause the values of loans and
mortgage-backed securities held for sale to decrease, resulting in a charge to
income. The Company frequently enters into forward delivery contracts to reduce
exposure to this risk from rising interest rates. Forward delivery contracts
may, however, increase exposure to the risk from declining interest rates if
sufficient loans or mortgage-backed securities held for sale bearing interest
rates specified by the contracts are not available to meet the delivery
schedules under the contracts. See Note 17 to the "Consolidated Financial
Statements".
Mortgage banking income represents the gross servicing fee income less
amortization and provisions for the valuation allowance on the mortgage
servicing assets. The Company retains as a service fee a portion of the interest
paid by the borrower. A valuation allowance was established in 1996 and the
provisions charged against earnings totaled $1.5 million, $285,000 and $200,000,
respectively, for the years ended December 31, 1998, 1997 and 1996. In a low
interest rate environment, the underlying residential loans will repay faster
than expected, causing the fair value of the mortgage servicing assets to
decline as well as reduce the gross cash flows collected on a shrinking serviced
portfolio. This prepayment risk results in increased provisions and charge-offs
to the valuation allowance, and thus lower mortgage banking income. Mortgage
banking loss totaled $389,000 in 1998, as compared to mortgage banking income of
$2.0 million in 1997 and $2.1 million in 1996. The gross servicing income has
fluctuated over the past three years but corresponds to the level of average
loans serviced for investors.
-15-
<PAGE> 22
The table below summarizes the Company's results from servicing loans for
investors.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Gross servicing income.................. $ 3,137 $ 4,054 $ 3,523
Amortization............................ (2,061) (1,754) (1,228)
Provisions for valuation allowance...... (1,465) (285) (200)
-------- -------- --------
Net mortgage banking income (loss)...... $ (389) $ 2,015 $ 2,095
======== ======== ========
Average loans serviced for investors.... $887,071 $977,659 $841,598
Year-end loans serviced for investors... $894,432 $971,041 $877,683
</TABLE>
During 1998, 1997 and 1996, the Company purchased mortgage servicing rights
to $184.7 million, $228.8 million and $180.0 million, respectively, in
residential first mortgage loans. These purchased balances are included in the
balance of loans serviced for investors. As part of its long-term business plan,
the Company intends to continue purchasing mortgage servicing to increase the
use of its existing servicing capacity and increase loan servicing revenue when
it is deemed appropriate. The Company also expects to continue selling mortgages
in the secondary market while retaining the servicing rights and therefore,
servicing income related to this activity is accordingly expected to continue
for the foreseeable future. See Notes 1 and 5 to the "Consolidated Financial
Statements".
Gains on real estate operations totaled $14,000 in 1998, compared to losses
of $971,000 in 1997 and $1.5 million in 1996. Real estate operations consist of
provisions for the valuation allowance, operating costs of maintaining other
real estate owned, gains or losses on sales of properties and costs associated
with the foreclosure on nonaccrual properties, less any rental income on other
real estate owned. The Company accounts for other real estate owned at the lower
of cost or estimated net fair value. Declines in value subsequent to foreclosure
or substantive repossession result in a charge to the valuation allowance.
Replenishing the valuation allowance caused by charge-offs taken as a
result of declines in value resulted in a credit of $107,000 in 1998 compared to
a charge of $350,000 and $554,000 to real estate operations in 1997 and 1996,
respectively. Deterioration in the New England real estate market during the
early 1990's led to high levels of other real estate owned and corresponding
administrative costs. Gains on sales of other real estate owned totaled $50,000
in 1998, $110,000 in 1997 and $162,000 in 1996. The costs of foreclosing on
loans, as well as the administrative costs of maintaining the non-performing
assets, correspond with the volume of problem assets and totaled $153,000 in
1998, $757,000 in 1997 and $1.2 million in 1996. See "Financial Condition --
Risk Elements" and Note 1 to the "Consolidated Financial Statements".
Other income totaled $3.9 million, $3.3 million and $2.7 million in 1998,
1997 and 1996, respectively, and was derived primarily from customer service
charges and fees. Deposit account service charges, representing the largest
component of such other income, totaled $2.3 million in 1998, $2.0 million in
1997 and $1.8 million in 1996. Loan late charges and other fees increased during
1998 by $296,000 to $703,000, while remaining fairly stable in 1997 and 1996 at
$407,000 and $437,000, respectively. The fees recognized in 1998 reflect
increases in both appraisal fees and miscellaneous loan fees resulting from the
high level of originations. Rental income increased slightly during 1998 to
$322,000 and increased in 1997 by 31% due to vacant space becoming fully
tenanted. Other income has remained relatively unchanged over the past two years
and totaled $577,000 and $559,000, respectively, for 1998 and 1997 and includes
income from Liberty Securities, IRA, safe deposit and other miscellaneous
charges. See Note 13 to the "Consolidated Financial Statements".
Non-interest Expense. Non-interest expenses increased $591,000 or 2.7% to
$22.6 million in 1998. Non-interest expenses increased $2.2 million or 10.9% to
$22.0 million in 1997. The modest increase in 1998 reflects a higher level of
capitalized loan origination costs resulting from the high level of originations
as well as the Company's continued attempts at cost containment while the
increase in 1997 is primarily due to operating a larger institution. This has
resulted in higher staffing levels, an increased number of branches and
alternative delivery systems, and growth in the number of loans and deposits.
-16-
<PAGE> 23
Salaries and employee benefits, the largest component of non-interest
expense, increased $123,000 to $12.0 million in 1998 and increased $1.5 million
in 1997 to $11.9 million. The increase in 1998 was primarily due to increased
benefits offset by higher levels of capitalized loan origination costs while the
increase in 1997 was primarily due to increased staffing, merit increases and
increased costs associated with the various benefits programs offered by the
Company. See Note 14 to the "Consolidated Financial Statements".
Office occupancy and equipment increased $87,000 to $3.0 million in 1998
and increased $129,000 in 1997 to $2.9 million. The increased in 1998 was
primarily due to increased rental expense resulting from rental increases and
more properties leased from third parties. The increase in 1997 was primarily
due to an increase in real estate taxes, reflecting an increase in the values of
Company owned properties as well as an increase in service maintenance contracts
on various equipment owned by the Company. See Note 6 to the "Consolidated
Financial Statements".
Data processing expenses totaled $2.1 million in 1998, $1.9 million in 1997
and $1.7 million in 1996. Data processing expenses increased $157,000 in 1998
and $267,000 in 1997 due to a higher loan and deposit base resulting from the
purchase of loans and mortgage loan servicing and internally generated loan and
deposit growth. In addition, the introduction of alternative delivery systems,
via customers' computers, debit cards and by a telephone service center, have
caused overall processing costs to increase in each of the two years. The level
of data processing expenses incurred in 1998 and 1997 on behalf of the Company's
effort in its Y2K compliance have not been material. See "Financial Condition -
Year 2000 Readiness Disclosure".
Professional fees, including corporate legal and accounting and auditing
expenses, totaled $940,000 in 1998, $862,000 in 1997 and $1.3 million in 1996.
Professional fees increased $78,000 in 1998 due to increased consulting and
corporate legal expenses. The decline of $466,000 in 1997 was due to a reduction
in various consulting services incurred in conjunction with tax planning
projects undertaken in 1996.
Marketing expenses totaled $831,000 in 1998, $988,000 in 1997 and $976,000
in 1996. Marketing expenses decreased $157,000 in 1998 due to a reduction in the
number of discretionary promotions as compared to being fairly stable over the
prior two years.
Mortgage banking expenses totaled $606,000 in 1998, $430,000 in 1997 and
$406,000 in 1996. Costs included in mortgage banking expenses are commissions
and related expenses paid to the mortgage loan originators, net of any deferred
origination expenses, and costs associated with servicing the portfolio for
outside investors. The expenses increased substantially in 1998 and reflect the
increased volume of originations while increasing modestly in 1997 due to a
larger servicing portfolio.
Other operating expenses totaled $3.1 million in 1998, $3.0 million in 1997
and $2.3 million in 1996. The increases of $127,000 in 1998 and $660,000 in 1997
are primarily due to running a larger organization. This is reflected in more
loan and deposit accounts, higher staffing levels and more branches and
locations in each of the two years. Correspondingly, increases result from
higher postage expenses, office supplies and printing costs as well as telephone
costs and increased contributions. Included in the other operating expense for
1996 is the recovery of $225,000 from the execution termination agreement,
thereby contributing to the significant increase in 1997.
Federal and State Income Tax Expense. The Company recorded tax expenses of
$8.2 million, $7.3 million and $3.1 million in 1998, 1997 and 1996,
respectively, and realized effective tax rates of 32%, 36% and 21%,
respectively. The increase in 1998 was primarily due to an increase in pretax
income offset by $1.1 million tax benefit resulting from the favorable
resolution of several tax issues that had previously been fully reserved
against. The increase of $4.0 million in 1997 was mainly due to a one time
benefit of $2.5 million recorded in 1996, combined with an increase in pretax
income in 1997. Recognition of deferred tax assets and liabilities is based on
the expected future tax consequences of temporary differences between the
financial reporting and tax basis of the Company's assets and liabilities.
Measurement of deferred tax assets and liabilities is based upon the provision
of enacted tax laws and the effects of future changes in tax laws or rates.
-17-
<PAGE> 24
Management believes the existing net deductible temporary differences that
give rise to the net deferred income tax asset will reverse in periods in which
the Company generates net taxable income. For the years ending December 31,
1998, 1997, and 1996, the Company generated taxable income of approximately
$22.1 million, $17.3 million and $9.0 million, respectively. Taxable income
differs from pretax book income primarily as a result of loan losses and
provision for losses on other real estate owned being recognized in a different
period than for book income. The Company recorded a reduction of the valuation
allowance of $328,000 in 1998 and $500,000 in both 1997 and 1996. The amount
recognized in 1998 was due to the expiration of subsidiary net operating loss
carry forwards while the amounts recognized in 1997 and 1996 were due to
increased recoverable federal income taxes.
At December 31, 1998, the net deferred tax asset is supported by
recoverable income taxes of approximately $16.8 million. Management believes
that the net deferred income tax asset at December 31, 1998 will be realized
based upon the significant reduction in the level of non-performing assets over
the past several years. It should be noted, however, that factors beyond
management's control, such as the general state of the economy and real estate
values, can affect future levels of taxable income and that no assurance can be
given that sufficient taxable income will be generated to fully absorb gross
deductible temporary differences.
See Note 11 to the "Consolidated Financial Statements" for further
information.
FINANCIAL CONDITION
Total assets increased $87.5 million, or 6.6%, to $1,410.2 million at
December 31, 1998. The growth in total assets was primarily due to an increase
of $71.9 million in total loans. Total assets at December 31, 1997 amounted to
$1,322.7 million, an increase of $117.9 million or 9.8% from $1,204.8 million at
December 31, 1996, resulting primarily from an increase in total loans of $101.4
million, offset by a modest decline in the investment portfolio.
LOANS
Total loans at December 31, 1998, prior to the allowance for loan losses,
amounted to $1,050.8 million compared with $978.8 million at December 31, 1997,
an increase of $71.9 million or 7.3%, primarily due to internally generated loan
growth combined with purchases of $22.9 million in residential whole loans. At
December 31, 1998, 60.0% of Andover's total loan portfolio consisted of loans
with adjustable rates as compared to 67.3% at December 31, 1997.
The following table shows the composition of the Company's loan portfolio
at the dates indicated. The balances shown are net of unadvanced funds, loan
premiums or discounts and deferred loan origination fees and costs.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------ ---------------- ---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential ............... $ 740,009 70.4% $715,503 73.1% $619,955 71.3% $558,231 72.6% $452,708 70.2%
Commercial ................ 158,377 15.1 142,617 14.6 136,454 15.7 121,909 15.9 108,725 16.8
Construction and land ..... 56,568 5.4 31,499 3.2 35,001 4.0 18,138 2.4 18,021 2.8
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate loans.. 954,954 90.9 889,619 90.9 791,410 91.0 698,278 90.9 579,454 89.8
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Consumer loans:
Home improvement, second
mortgage and home equity
line of credit ........... 55,691 5.3 58,605 6.0 49,670 5.7 43,463 5.6 42,602 6.6
Other consumer ............ 6,160 0.6 9,599 1.0 9,554 1.1 7,707 1.0 9,562 1.5
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer loans .... 61,851 5.9 68,204 7.0 59,224 6.8 51,170 6.6 52,164 8.1
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Commercial loans ............ 33,960 3.2 21,000 2.1 19,401 2.2 19,150 2.5 13,419 2.1
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans ............... 1,050,765 100.0% 978,823 100.0% 870,035 100.0% 768,598 100.0% 645,037 100.0%
===== ===== ===== ===== =====
Allowance for loan losses ... (10,486) (12,521) (12,229) (11,665) (12,343)
---------- -------- -------- -------- --------
Net loans ................. $1,040,279 $966,302 $857,806 $756,933 $632,694
========== ======== ======== ======== ========
</TABLE>
-18-
<PAGE> 25
Total real estate loans increased $65.3 million in 1998 to $955.0 million
at December 31, 1998, primarily due to the increase in real estate loan
originations of $216.0 million. Origination volumes are sensitive to market
rates, particularly in the refinancing arena. As can be determined by the
following table, total loan originations were the highest in 1998, the year with
the lowest interest rates. Total loan originations were strong in 1997 and 1996
due to a favorable interest rate environment while loan originations dropped in
1995 due to the higher interest rates existing during most of that year.
Residential loan originations totaled $329.4 million in 1998, $165.3
million in 1997 and $168.3 million in 1996. These originations are not fully
reflected in loans outstanding due to the securitization, regular amortization
and prepayments of residential real estate loans.
The majority of the Company's residential loans are underwritten to be
eligible for sale in the secondary market. Andover sells most of the eligible
30-year fixed rate loans it originates. A loan which the Company intends to sell
may be sold directly or converted into mortgage-backed securities and sold in
that form. Residential loans sold directly amounted to $6.1 million in 1998,
$3.4 million in 1997 and $1.7 million in 1996. Those sold in the form of
mortgage-backed securities held for sale or available for sale totaled $53.3
million, $24.2 million and $37.7 million, respectively, in 1998, 1997 and 1996.
The portfolio of residential mortgage loans serviced for others totaled $894.4
million at December 31, 1998, compared to $971.0 million at December 31, 1997
and $877.7 million at December 31, 1996.
The following table shows the composition of the Company's loan originations and
loan purchases for the years indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Retail loans:
Residential fixed rate loans .............. $212,248 $ 81,342 $ 89,830 $ 88,990 $ 83,775
Residential variable rate loans ........... 117,146 83,917 78,453 43,138 96,657
-------- -------- -------- -------- --------
Total residential originations .......... 329,394 165,259 168,283 132,128 180,432
-------- -------- -------- -------- --------
Home equity line of credit ................ 16,648 22,527 22,063 10,350 14,614
Other consumer ............................ 11,403 11,988 9,497 8,022 5,723
-------- -------- -------- -------- --------
Total consumer originations ............. 28,051 34,515 31,560 18,372 20,337
-------- -------- -------- -------- --------
Total retail originations .............. 357,445 199,774 199,843 150,500 200,769
-------- -------- -------- -------- --------
Corporate loans:
Commercial real estate loans .............. 64,662 32,858 32,800 17,991 17,745
Construction and land loans ............... 51,852 31,800 41,888 31,543 30,498
Commercial loans .......................... 24,296 18,591 19,732 16,933 10,437
Lease financing ........................... 13,098 830 -- -- --
-------- -------- -------- -------- --------
Total corporate originations ............ 153,908 84,079 94,420 66,467 58,680
-------- -------- -------- -------- --------
Residential whole loan purchases .......... 22,875 71,297 32,474 59,878 --
-------- -------- -------- -------- --------
Total loan originations and purchases ....... $534,228 $355,150 $326,737 $276,845 $259,449
======== ======== ======== ======== ========
</TABLE>
Outstanding commercial loans increased $13.0 million in 1998 to $34.0
million at December 31, 1998. Commercial real estate loans increased $15.8
million in 1998 to $158.4 million at December 31, 1998, while construction and
land loan balances increased $25.1 million to $56.6 million in the same period.
While originations of corporate loans, comprised of commercial real estate,
commercial, construction and land loans and lease financings, are sensitive to
the interest rate environment, the capacity for borrowing, current and
anticipated economic conditions and real estate values have a more critical
role. Origination volume for these loans has increased substantially in 1998,
reflecting stabilizing values and the Company's interest in corporate lending.
However, due to the highly competitive market for these loans, the origination
volume slipped slightly in 1997 but does not represent a reduction in the
Company's interest or capacity for these types of loans. Total originations of
corporate loans were $153.9 million in 1998, $84.1 million in 1997 and $94.4
million in 1996.
-19-
<PAGE> 26
Loans transferred into real estate owned totaled $773,000, $2.1 million and
$1.7 million in 1998, 1997 and 1996, respectively. Commercial real estate,
construction and land, commercial loans and lease financings involve significant
risks compared with single-family residential mortgage and consumer lending. See
Item 1, "Business -- Lending Activities".
Consumer loans outstanding decreased 9.3%, or $6.4 million to $61.9 million
at December 31, 1998, from $68.2 million at year-end 1997. A large component of
the decline during 1998 resulted from the sale of student loans totaling $2.9
million. During 1998, the level of originations for home equity lines of credit
decreased due to the strong first mortgage refinance activity. This refinance
activity also reduced the outstanding balances on the home equity lines as they
would be combined into a single new mortgage. During 1997, the Company continued
to aggressively price its home equity lines of credit and was able to keep
originations of these loans in excess of $20 million in both 1997 and 1996.
Other consumer loans include secured student loans, collateral loans and second
mortgage loans. Originations of consumer loans are also sensitive to changes in
the interest rate environment.
RISK ELEMENTS
The following table shows the composition of non-performing assets at
December 31:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------ ------ ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccruing loans .............. $3,240 $7,849 $10,699 $11,627 $14,516
Other real estate owned ........ 252 406 1,683 4,158 8,796
------ ------ ------- ------- -------
Total non-performing assets $3,492 $8,255 $12,382 $15,785 $23,312
====== ====== ======= ======= =======
Total non-performing assets as a
percentage of total assets ... 0.2% 0.6% 1.0% 1.4% 2.2%
</TABLE>
During 1998, continued progress was made in reducing non-performing assets
with a reduction of $4.8 million or 57.7%, primarily due to a reduction of
nonaccruing loans. Andover had experienced a sharp increase in the level of
non-performing assets and a corresponding rise in foregone income, loan losses
and other costs associated with non-performing assets beginning in 1990 due to
the deteriorating New England real estate market and economy. A significant
portion of Andover's non-performing assets are secured by mixed-use commercial
and multi-family real estate located in Lawrence, Massachusetts. This city had
been especially hard hit with declining real estate values and increasing
vacancies in multi-family, investor-owned properties, which represents the
majority of Andover's collateral on troubled loans in Lawrence. Continued
deterioration in this market area will adversely impact the collectibility of
residential and commercial real estate loans and may result in an increased
level of non-performing assets in 1999. At December 31, 1998, approximately $1.3
million of nonaccruing loans were secured by properties located in Lawrence. A
majority of the remaining accruing loans at year end in Lawrence were secured by
residential properties. The amount of accruing loans secured by properties in
Lawrence totaled approximately $52.4 million at December 31, 1998.
At December 31, 1998, total impaired loans were $2.5 million, of which
$809,000 had related allowances of $94,000 and $1.7 million which did not
require a related impairment allowance. All of the $2.5 million in impaired
loans have been measured using the fair value of the collateral method. During
the period ended December 31, 1998, the average recorded value of impaired loans
was $4.2 million and the related amount of interest income recognized was
$73,000.
The impact of existing non-performing assets on future interest income will
be largely dependent upon converting these assets to earning status, either
through a return to performing status or through foreclosure and subsequent
disposition of the property. It is expected that the level of foreclosures and
related expenses will continue to impact earnings in 1999.
See Notes 1 and 4 to the "Consolidated Financial Statements" for further
information.
-20-
<PAGE> 27
Nonaccruing Loans. Management places loans, regardless of collateral
values, on nonaccrual status when principal or interest is past due 90 days or
more. All previously accrued but uncollected interest is reversed against
current period interest income when a loan is placed on nonaccrual status. When
collection procedures do not bring a loan to performing status, Andover
generally institutes action to foreclose upon the property or to acquire it by
deed in lieu of foreclosure. Loans for which payments are less than 90 days past
due are placed on nonaccrual status where there exists serious doubt as to the
ultimate collectibility of the loan.
The following table shows the composition of nonaccruing loans at
December 31:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Residential real estate ............ $ 932 $ 2,436 $ 2,838 $ 3,037 $ 4,232
Commercial real estate ............. 2,023 4,866 6,901 7,195 8,004
Construction and land .............. -- -- 79 -- 382
Commercial ......................... 255 513 727 1,136 1,381
Consumer ........................... 30 34 154 259 517
------- ------- ------- ------- -------
Total nonaccrual loans ........... $ 3,240 $ 7,849 $10,699 $11,627 $14,516
======= ======= ======= ======= =======
Allowance for loan losses .......... $10,486 $12,521 $12,229 $11,665 $12,343
======= ======= ======= ======= =======
Allowance for loan losses as a
percentage of nonaccruing loans .. 323.6% 159.5% 114.3% 100.3% 85.0%
Allowance for loan losses as a
percentage of total loans ........ 1.0% 1.3% 1.4% 1.5% 1.9%
</TABLE>
During 1998, loans on nonaccrual decreased 58.7% to $3.2 million,
throughout all loan categories. Interest income of approximately $803,000 would
have been recorded in 1998 on nonaccruing loans if those loans had been on a
current basis in accordance with their original terms. Interest income actually
recognized in 1998 on nonaccruing loans amounted to approximately $103,000.
Additionally, another $209,000 in interest payments were received on nonaccruing
loans during 1998 and applied as a reduction of the loan balance instead of as
interest income.
Restructured Loans. A restructured loan is one for which the Bank has
modified the terms to provide a temporary reduction in the rate of interest
below the prevailing market interest rates at the time of modification and, in
most instances, an extension of payments of principal or interest or both due to
the deterioration in the financial position of the borrowers. Restructured loans
are not returned to performing status until the obligation has performed for a
reasonable period of time, its ultimate collectibility is no longer in doubt and
is at a market rate of interest. Restructured loans totaled $1.4 million at
December 31, 1997. There were no restructured loans at December 31, 1998.
Other Real Estate Owned. Andover's other real estate owned has consistently
declined over the last several years as economic conditions improved. The
valuation allowance represents management's estimate of the net fair value of
other real estate owned.
The following table shows the composition of other real estate owned at
December 31:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ----- ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Other real estate owned .......... $293 $ 641 $1,859 $4,571 $9,511
Valuation allowance .............. (41) (235) (176) (413) (715)
---- ----- ------ ------ ------
Total other real estate owned .. $252 $ 406 $1,683 $4,158 $8,796
==== ===== ====== ====== ======
</TABLE>
-21-
<PAGE> 28
All other real estate owned is carried at the lower of the carrying value
of the loan or the net fair value of the property. Initial writedowns to net
fair value are charged to the allowance for loan losses and totaled $172,000 in
1998, $836,000 in 1997 and $890,000 in 1996. Subsequent provisions for loan
losses due to the deterioration in real estate values are charged to real estate
operations. During the second quarter of 1998, a credit provision was taken to
reduce the valuation allowance in the amount of $107,000 while provisions
totaled $350,000 in 1997 and $554,000 in 1996. Gains of $50,000, $110,00 and
$162,000 were recognized on sales of $1.1 million, $3.2 million and $4.0 million
in other real estate owned in 1998, 1997 and 1996, respectively.
Allowance for Loan Losses. The following table summarizes the activity in
Andover's allowance for loan losses during the five years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year .......... $12,521 $12,229 $11,665 $12,343 $13,392
Balance of Acquired Institution ....... -- -- -- -- 1,715
Provision (credit) for loan losses .... (1,705) 983 2,555 1,295 --
Charge-offs:
Residential real estate .......... (223) (767) (822) (1,501) (1,271)
Commercial real estate ........... (739) (920) (2,208) (867) (1,614)
Construction and land ............ -- -- -- (57) (41)
Commercial ....................... (528) (90) (100) (171) (194)
Consumer ......................... (10) (27) (153) (171) (149)
------- ------- ------- ------- -------
Total charge-offs ................ (1,500) (1,804) (3,283) (2,767) (3,269)
------- ------- ------- ------- -------
Recoveries:
Residential real estate .......... 80 27 45 120 4
Commercial real estate ........... 400 142 178 183 141
Construction and land ............ 371 324 588 2 57
Commercial ....................... 289 597 461 461 280
Consumer ......................... 30 23 20 28 23
------- ------- ------- ------- -------
Total recoveries ................. 1,170 1,113 1,292 794 505
------- ------- ------- ------- -------
Net charge-offs ....................... (330) (691) (1,991) (1,973) (2,764)
------- ------- ------- ------- -------
Balance at end of year ................ $10,486 $12,521 $12,229 $11,665 $12,343
======= ======= ======= ======= =======
Ratio of net charge-offs to
average loans outstanding ........... 0.03% 0.08% 0.24% 0.29% 0.48%
</TABLE>
The allowance for loan losses as a percentage of total loans decreased to
1.0% at December 31, 1998, from 1.3% and 1.4% at December 31, 1997 and 1996,
respectively, due to a credit for loan losses taken during 1998. Management
analyzes the adequacy of the allowance for loan losses on a quarterly basis. See
"Results of Operations -- Provision for Loan Losses". Management measures the
adequacy of its allowance for loan losses by assigning loans into risk
categories based on a loan classification system modelled after the bank
regulatory classification system. While management believes that its allowance
for loan losses is adequate to cover potential losses, there are uncertainties
regarding future events. Deterioration in the real estate market or economy may
result in additional nonaccruing loans, charge-offs and a need for provisions
for loan losses to maintain an adequate allowance. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Banks' allowance for loan losses. Such agencies may
require the Banks to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
Allocation of the allowance for loan losses to the various categories of the
portfolio is also made periodically, based on management's judgment in weighing
various factors, including the quality of specific loans, the level of
nonaccruing loans in the various categories, current economic conditions, trends
in delinquencies and prior charge-offs, and the collateral value of the
underlying security. Because the allowance for loan losses is based on various
-22-
<PAGE> 29
estimates, including loan collectibility and real estate values, and includes a
high degree of judgment, subsequent changes in the general economic prospects of
the borrowers may require changes in those estimates.
The changes in the allowance allocated to each category of loan directly
corresponds to the level of nonaccrual loans and adversely classified loans as
well as the level of outstanding loans. Andover historically has experienced
lower losses in its residential mortgage loan portfolio and, therefore,
allocations applicable to this portfolio are lower.
The following table summarizes the allocation of the allowance for loan
losses at December 31:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------------------- ------------------- ------------------- ------------------- -------------------
LOAN LOAN LOAN LOAN LOAN
CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
AS A % OF AS A % OF AS A % OF AS A % OF AS A % OF
TOTAL TOTAL TOTAL TOTAL
AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN AMOUNT LOAN
LOAN CATEGORY ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO ALLOCATED PORTFOLIO
- ------------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
Residential ................ $ 2,341 71% $ 2,399 73% $ 2,154 71% $ 1,794 73% $ 1,855 70%
Commercial ................. 4,425 15 5,526 15 5,952 16 7,381 16 7,633 17
Construction and land....... 1,256 5 697 3 802 4 549 2 971 3
------- --- ------- --- ------- --- ------- --- ------- ---
Total real estate ........ 8,022 91 8,622 91 8,908 91 9,724 91 10,459 90
Consumer ..................... 365 6 421 7 392 7 344 7 478 8
Commercial ................... 990 3 821 2 848 2 1,201 2 1,113 2
Unallocated .................. 1,109 -- 2,657 -- 2,081 -- 396 -- 293 --
------- --- ------- --- ------- --- ------- --- ------- ---
Totals .................. $10,486 100% $12,521 100% $12,229 100% $11,665 100% $12,343 100%
======= === ======= === ======= === ======= === ======= ===
</TABLE>
Notwithstanding the foregoing allocations, the entire allowance for loan
losses is available to absorb charge-offs in any category of loans.
INVESTMENTS
Andover's investment portfolio totaled $282.5 million as of December 31,
1998, and $282.6 million as of December 31, 1997. The Company manages the
investment portfolio in accordance with an investment policy adopted by the
Board of Directors. The primary objectives are to provide interest and dividend
income, to ensure adequate liquidity and achieve an acceptable asset/liability
gap position while diversifying the asset mix. The investment portfolio is also
evaluated in comparison to returns that are earned by the loan portfolio.
The primary component of the total investment portfolio is mortgage-backed
securities, which accounted for 54.2% of total investments at December 31, 1998.
The remaining portion of the total investment portfolio consists of U.S.
government and federal agency obligations, corporate bonds, short-term
investments in federal funds sold, and other investment grade securities. U.S.
government and federal agency obligations represent the fastest growing
component of the investment portfolio and totaled 25.2% as of December 31, 1998,
as compared to 15.6% at year end 1996.
All of the mortgage-backed securities represent undivided interests in
pools of mortgages which have been formed into pass-through securities and sold
to investors by the Government National Mortgage Association ("GNMA"), the
Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National
Mortgage Association ("FNMA"). Securities issued by GNMA, a wholly-owned U.S.
government corporation, are fully guaranteed as to the timely payment of
principal and interest. Securities issued by FHLMC and FNMA, government
sponsored corporations, carry each corporation's guarantee as to the timely
payment of interest and the ultimate payment of principal. Cash flows from the
underlying mortgages of all mortgage-backed securities are passed through to
Andover in the form of monthly payments of interest, scheduled principal
amortization, and prepayments of mortgage balances. These securities, therefore,
have unpredictable cash flows. Due to the strong refinance market experienced in
1998, principal repayments on all mortgaged-backed securities in the investment
portfolio totaled $60.4 million in 1998 as compared to $33.3 million in 1997.
The approximate market value of
-23-
<PAGE> 30
adjustable rate mortgage-backed securities included in the investment portfolio
totaled $39.0 million at December 31, 1998.
The carrying amount of callable securities included in investments
available for sale and investments held to maturity totaled $30.2 million and
$5.5 million, respectively, as of December 31, 1998.
The following table sets forth information regarding the carrying amounts
of the investment portfolio at December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
SHORT-TERM INVESTMENTS ............................. $ 16,100 $ 14,150 $ 25,600
======== ======== ========
INVESTMENTS AVAILABLE FOR SALE (AT MARKET):
U.S. government and federal agency obligations ..... $ 62,556 $ 55,777 $ 41,740
Other bonds and obligations ........................ 37,561 14,573 14,993
-------- -------- --------
Total bonds and obligations ...................... 100,117 70,350 56,733
-------- -------- --------
GNMA mortgage-backed securities .................... 35,884 27,793 27,526
FHLMC participation certificates ................... 26,981 36,805 25,103
FNMA pass-through certificates ..................... 2,509 4,106 4,763
-------- -------- --------
Total mortgage-backed securities ................... 65,374 68,704 57,392
-------- -------- --------
Total investments available for sale ............. $165,491 $139,054 $114,125
======== ======== ========
INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST):
U.S. government and federal agency obligations ..... $ 8,526 $ 10,001 $ 1,448
Other bonds and obligations ........................ 4,545 7,106 9,686
-------- -------- --------
Total bonds and obligations ...................... 13,071 17,107 11,134
-------- -------- --------
FHLMC participation certificates ................... 30,207 49,217 63,639
FNMA pass-through certificates ..................... 35,435 48,835 57,192
GNMA mortgage-backed securities .................... 2,576 3,383 3,899
Collateralized mortgage obligations ................ 19,080 10,021 --
Other asset-backed securities ...................... 551 800 1,062
-------- -------- --------
Total mortgage-backed securities ................... 87,849 112,256 125,792
-------- -------- --------
Total investments held to maturity ............... $100,920 $129,363 $136,926
======== ======== ========
Total investments ................................ $282,511 $282,567 $276,651
======== ======== ========
</TABLE>
Debt securities are classified as held to maturity only when there is
positive intent and ability to hold them to maturity. Such securities are
recorded at amortized cost. Trading securities are debt and equity securities
held principally for the purpose of selling in the near term. The Company does
not have any securities designated as trading securities. Such securities are
recorded at fair value, with unrealized gains and losses recorded in earnings.
Investments available for sale are any debt or equity security not classified as
either held to maturity or trading securities. Investments available for sale
are recorded at their fair value with changes in fair values recorded as a
separate component of stockholders' equity, net of related income taxes.
See Notes 1, 2 and 3 to the "Consolidated Financial Statements" for further
information.
There was an increase in the total unrealized gain of $221,000 in the
investment portfolio, from a net unrealized gain of $3.5 million at December 31,
1997 to $3.7 million at December 31, 1998, resulting from a decrease in market
interest rates. Changes in interest rates and their impact on the unrealized
gain or loss in the investment portfolio are not material factors in the
Company's overall investment strategy. This is largely due to the fact that
neither the changes nor their impact can be controlled by the Company.
Additionally, investment purchases are often match funded by long-term advances
in order to achieve a consistent spread on a particular investment.
-24-
<PAGE> 31
The following table presents unrealized gains and losses by major
categories of securities at December 31, 1998. The net unrealized gains of $2.1
million on investments available for sale is included in stockholders' equity,
net of applicable income taxes at December 31, 1998. At that date, Andover's net
unrealized gains on investments held to maturity amounted to $1.6 million.
<TABLE>
<CAPTION>
UNREALIZED UNREALIZED
GAINS LOSSES
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
INVESTMENTS AVAILABLE FOR SALE:
U.S. government and federal agency obligations... $1,063 $ --
Other bonds and obligations ..................... 567 --
Mortgage-backed securities ...................... 626 (164)
------ -----
Total investments available for sale .......... 2,256 (164)
------ -----
INVESTMENTS HELD TO MATURITY:
U.S. government and federal agency obligations .. $ 141 $ --
Other bonds and obligations ..................... 91 --
Mortgage-backed securities ...................... 1,406 (46)
------ -----
Total investments held to maturity ............ $1,638 $ (46)
====== =====
Total unrealized gains and losses ............. $3,894 $(210)
====== =====
</TABLE>
The following table presents an analysis of the maturity distribution and
average yields of investments available for sale and held to maturity at
December 31, 1998. Callable investments available for sale and investments held
to maturity are shown in the periods corresponding to their scheduled maturity
without regard to call dates. Mortgage-backed securities are shown in the
periods corresponding to scheduled principal amortization computed based on
their weighted average maturities and weighted average rates without regard to
prepayments.
<TABLE>
<CAPTION>
LENGTH OF TIME TO MATURITY
------------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
YEAR BUT YEARS BUT
WITHIN WITHIN WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-------------- --------------- -------------- -------------- ---------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- -------- ----- ------- ----- ------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Short-term investments ........ $16,100 4.90% $ -- .--% $ -- .--% $ -- .--% $ 16,100 4.90%
======= ==== ======== ==== ======= ==== ======= ==== ======== ====
Investments available for sale:
Total bonds and obligations .. $17,643 5.63% $ 66,744 6.57% $13,147 6.23% $ 2,583 6.23% $100,117 6.35%
Total mortgage-backed
securities .................. 2,162 6.61 10,217 6.62 17,190 6.63 35,805 6.20 65,374 6.40
------- ---- -------- ---- ------- ---- ------- ---- -------- ----
Total investments
available for sale .......... $19,805 5.74% $ 76,961 6.58% $30,337 6.46% $38,388 6.20% $165,491 6.37%
======= ==== ======== ==== ======= ==== ======= ==== ======== ====
Investments held to maturity:
Total bonds and obligations .. $ 2,014 6.10% $ 11,057 6.45% $ -- .--% $ -- .--% $ 13,071 6.40%
Total mortgage-backed
securities .................. 4,009 6.89 34,891 6.71 31,001 6.98 17,948 6.96 87,849 6.86
------- ---- -------- ---- ------- ---- ------- ---- -------- ----
Total investments held
to maturity ................. $ 6,023 6.63% $ 45,948 6.65% $31,001 6.98% $17,948 6.96% $100,920 6.80%
======= ==== ======== ==== ======= ==== ======= ==== ======== ====
Total investments ............. $41,928 5.54% $122,909 6.60% $61,338 6.72% $56,336 6.44% $282,511 6.44%
======= ==== ======== ==== ======= ==== ======= ==== ======== ====
</TABLE>
-25-
<PAGE> 32
DEPOSITS
Total deposits increased $41.7 million during 1998 to $988.7 million at
December 31, 1998, and increased $122.7 million during 1997. The fastest growing
component in each of the past two years has been in the savings account
balances. The growth of $49.7 million and $52.9 million for 1998 and 1997,
respectively, has been primarily due to the introduction of a tiered savings
product offering customers a premium rate on balances in excess of $50,000. This
premium product represents more than half of the savings account balances. The
growth in the balances of demand deposits and NOW accounts reflects the high
levels of activity resulting from the refinance activity in the residential
mortgages. The decline in each of the past two years in money market accounts is
primarily due to a shift in customer preference for the premium savings account.
In the current low interest rate environment, depositors are shifting from
longer maturity term deposits into core deposit accounts without fixed
maturities or into shorter maturity term deposits. The Bank believes that this
trend will continue into 1999 as long as interest rates remain at these
relatively low rates.
See Note 8 to the "Consolidated Financial Statements" for further
information.
The following table reflects the balance of deposit accounts of Andover at
each date indicated and the weighted average interest rates at December 31:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- --------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
PERCENT AVERAGE PERCENT AVERAGE PERCENT AVERAGE
OF INTEREST OF INTEREST OF INTEREST
AMOUNT TOTAL RATE AMOUNT TOTAL RATE AMOUNT TOTAL RATE
-------- ------- -------- -------- ------- -------- -------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand deposit accounts ......... $103,029 10.4% .--% $ 79,501 8.4% .--% $ 60,245 7.3% .--%
NOW accounts .................... 102,635 10.4 0.79 85,917 9.1 1.02 75,297 9.1 1.01
Money market deposit accounts ... 96,332 9.7 2.77 104,353 11.0 2.96 116,019 14.1 2.90
Savings accounts ................ 199,304 20.2 3.19 149,607 15.8 3.61 96,690 11.8 2.87
Variable rate certificates ...... 4,463 0.5 4.31 5,182 0.5 5.43 8,459 1.0 5.24
Fixed rate certificates ......... 482,893 48.8 5.53 522,422 55.2 5.89 467,601 56.7 5.80
-------- ----- -------- ----- -------- -----
Total deposits ................ $988,656 100.0% 3.72% $946,982 100.0% 4.27% $824,311 100.0% 4.18%
======== ===== ==== ======== ===== ==== ======== ===== ====
</TABLE>
Deposits are derived from customers who work or reside in the Company's
market area and surrounding communities, and from businesses located in that
area.
The following table presents Andover's outstanding time certificates in
denominations of $100,000 and over, with remaining maturities at December 31:
<TABLE>
<CAPTION>
REMAINING TERM TO MATURITY 1998 1997 1996
-------------------------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Three months or less.................. $21,612 $15,085 $15,662
Over three months to six months....... 24,751 7,413 7,793
Over six months to twelve months...... 23,114 23,953 23,215
Over twelve months.................... 17,711 38,675 25,136
------- ------- -------
$87,188 $85,126 $71,806
======= ======= =======
</TABLE>
-26-
<PAGE> 33
BORROWINGS
Total borrowings increased $25.1 million during 1998 to $283.8 million at
December 31, 1998, from $258.7 million at December 31, 1997 and decreased $15.7
million during 1997. While the Banks continue to rely on borrowed funds as an
alternative source of funds to grow interest earning assets, due to the success
in generating deposits, the ratio of total borrowings to total assets continues
to drop and represents 20% of total assets, down from a high of almost 25% at
year end 1995. The weighted average rate on the total borrowed funds dropped to
5.39% at December 31, 1998, from 5.82% at December 31, 1997. This decline
reflects the overall decline in market interest rates experienced during 1998.
The amount of callable advances included in total borrowings totaled $125.0
million as of December 31, 1998. These advances are callable at the discretion
of the FHLB of Boston, starting in 1999 and at regular intervals thereafter.
During the third quarter of 1996, the Bank elected early prepayment of
$19.1 million of above market interest rate FHLB advances as part of a balance
sheet restructuring. The Bank incurred a pre-tax loss of $298,000, or $173,000
net of tax, on this transaction; however, by repurchasing new advances, the Bank
was able to reduce the effective rate from approximately 8.20% down to less than
6.00%.
See Notes 9 and 10 to the "Consolidated Financial Statements" for further
information.
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
The Banks' earnings are largely dependent on its net interest income, which
is the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. The Company seeks to reduce its exposure to
changes in interest rates, or market risk, through active monitoring and
management of its interest rate risk exposure. The policies and procedures for
managing both on and off balance sheet activities are established by Andover's
asset/liability management committee (ALCO). The Board of Directors reviews and
approves the ALCO policy annually and monitors related activities on an ongoing
basis.
Market risk is the risk of loss from adverse changes in market prices and
rates. The Banks' market risk arises primarily from interest rate risk inherent
in its lending and deposit taking activities.
The main objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on the Company's net interest income
and preserve capital, while adjusting the Company's asset/liability structure to
obtain the maximum yield-cost spread on that structure. The Company relies
primarily on its asset/liability structure to control interest rate risk.
However, a sudden and substantial increase in interest rates may adversely
impact earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the same
basis.
The following two tables reflect different methods of disclosing the
Company's exposure to a change in interest rates and its potential impact on the
Company's net interest income. The gap analysis uses estimated prepayments,
contractual maturities and next repricing dates while the market risk analysis
excludes the next repricing dates. The interest rate sensitivity of the
Company's assets and liabilities in both tables would vary substantially if
different assumptions were used or if actual experience differs from the
assumptions provided.
One method used to measure the interest rate risk exposure is the Company's
gap analysis, which involves comparing the difference between assets and
liabilities that mature or reprice during a given period of time. These
differences are a primary component of the risk to net interest income. A gap is
considered positive when the amount of interest sensitive assets exceeds the
amount of interest sensitive liabilities, and is considered negative when the
amount of interest sensitive liabilities exceeds the amount of interest
sensitive assets.
-27-
<PAGE> 34
The following table illustrates the Company's gap position, or the
estimated maturity and repricing structure of its interest sensitive assets and
interest sensitive liabilities, at December 31, 1998.
<TABLE>
<CAPTION>
1-180 181-365 >1-3 >3-5 5+
DAYS DAYS YEARS YEARS YEARS TOTAL
-------- -------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest sensitive assets:
Fixed rate securities .................... $ 24,915 $ 47,788 $ 87,366 $ 44,454 $ 23,226 $ 227,749
Variable rate securities ................. 44,582 10,180 -- -- -- 54,762
Fixed rate loans ......................... 40,305 37,913 128,106 94,337 119,151 419,812
Variable rate loans ...................... 179,790 133,898 195,323 84,226 34,476 627,713
Other interest sensitive assets .......... 27,029 -- -- -- -- 27,029
-------- -------- -------- -------- -------- ----------
Total interest sensitive assets ........ 316,621 229,779 410,795 223,017 176,853 1,357,065
Interest sensitive liabilities:
NOW accounts ............................. 9,997 4,729 16,370 12,298 59,241 102,635
Savings and money market
deposit accounts ........................ 55,291 53,364 91,685 16,581 78,715 295,636
Certificates of deposit .................. 249,643 131,415 93,647 12,651 -- 487,356
Total borrowed funds ..................... 76,761 21,342 58,639 45,110 81,972 283,824
-------- -------- -------- -------- -------- ----------
Total interest sensitive liabilities ... 391,692 210,850 260,341 86,640 219,928 1,169,451
-------- -------- -------- -------- -------- ----------
Net interest rate sensitivity gap ......... $(75,071) $ 18,929 $150,454 $136,377 $(43,075) $ 187,614
======== ======== ======== ======== ======== ==========
Cumulative net interest rate
sensitivity gap .......................... $(75,071) $(56,142) $ 94,312 $230,689 $187,614
======== ======== ======== ======== ========
Cumulative net interest rate
sensitivity gap as a percentage
of total assets .......................... (5.3)% (4.0)% 6.7% 16.4% 13.3%
AT DECEMBER 31, 1997:
Cumulative net interest rate
sensitivity gap .......................... $(18,072) $(23,210) $(50,901) $ 45,705 $148,612
======== ======== ======== ======== ========
Cumulative net interest rate
sensitivity gap as a percentage
of total assets .......................... (1.4)% (1.8)% (3.8)% 3.5% 11.2%
</TABLE>
The balance of interest sensitive asset and liability accounts has been
allocated among the various periods using common industry techniques and market
consensus data. Fixed rate residential mortgage loans are shown in the table in
the time period corresponding to scheduled principal amortization and
anticipated prepayments using annual conditional prepayment rates that vary from
11.9% to 13.8% at December 31, 1998, as compared with 8.8% to 10.5% at December
31, 1997. Mortgage-backed securities are allocated using annual conditional
prepayment rates of 21.2% to 46.9% at December 31, 1998, versus 7.7% to 20.7% at
December 31, 1997. All other loans and securities, certificates of deposit and
borrowed funds are allocated to the period in which the rates could be next
adjusted or to their final contractual maturity for the fixed rate instruments.
Substantially all of the callable advances from the FHLB are allocated according
to their contractual maturity due to the unlikelihood of their being called by
the FHLB given current market interest rates. Other interest sensitive assets
include assets held for sale and FHLB stock. Nonaccruing loans have been
excluded from both the gap analysis and the market risk analysis.
A substantial portion of the savings, money market and NOW accounts are
considered core deposits by management and, therefore, relatively insensitive to
interest rates. In addition, any future changes to the interest rates paid on
these accounts are at the sole discretion of management. Despite the foregoing
factors, these deposits have been allocated between each time period based on
the Banks' own historical experience, or decay rates, in determining the deposit
runoff.
-28-
<PAGE> 35
Another method used to measure interest rate risk is the market risk
analysis. The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 1998.
<TABLE>
<CAPTION>
EXPECTED MATURITY DATE AS OF DECEMBER 31, 1998
----------------------------------------------
FAIR VALUE
AT
1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98
---- ---- ---- ---- ---- ---------- ----- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest sensitive assets:
Fixed rate securities............. $ 72.7 $ 47.7 $ 39.7 $ 19.0 $ 25.4 $ 23.2 $ 227.7 $ 229.3
Average interest rate........... 6.64% 6.71% 6.70% 6.74% 6.54% 6.49% 6.64%
Variable rate securities.......... $ 29.6 $ 8.4 $ 6.4 $ 3.5 $ 1.9 $ 5.0 $ 54.8 $ 54.8
Average interest rate........... 5.41% 6.02% 6.03% 6.03% 6.03% 6.50% 5.66%
Fixed rate retail loans........... $ 61.2 $ 53.2 $ 47.9 $ 36.8 $ 36.7 $116.1 $ 351.9 $ 359.2
Average interest rate........... 7.16% 7.18% 7.20% 7.13% 7.13% 7.11% 7.15%
Variable rate retail loans........ $ 92.4 $ 77.8 $ 67.8 $ 51.5 $ 40.7 $119.0 $ 449.2 $ 451.7
Average interest rate........... 7.17% 7.16% 7.16% 7.20% 7.24% 7.07% 7.19%
Fixed rate corporate loans........ $ 17.1 $ 14.0 $ 12.9 $ 10.4 $ 10.4 $ 3.1 $ 67.9 $ 64.5
Average interest rate........... 8.52% 8.51% 8.47% 8.42% 8.42% 8.03% 8.46%
Variable rate corporate loans..... $ 38.9 $ 45.0 $ 30.4 $ 21.6 $ 12.5 $ 30.2 $ 178.6 $ 184.2
Average interest rate........... 8.77% 8.78% 8.30% 8.31% 8.19% 9.76% 8.78%
Other interest sensitive assets... $ 27.0 -- -- -- -- -- $ 27.0 $ 27.1
Average interest rate.......... 6.59% -- -- -- -- -- 6.59%
------ ------ ------ ------ ------ ------ -------- --------
Total interest sensitive assets... $338.9 $246.1 $205.1 $142.8 $127.6 $296.6 $1,357.1 $1,370.8
====== ====== ====== ====== ====== ====== ======== ========
Interest sensitive liabilities:
NOW accounts...................... $ 14.7 $ 8.7 $ 7.7 $ 6.1 $ 6.1 $ 59.3 $ 102.6 $ 102.6
Average interest rate........... 0.79% 0.79% 0.79% 0.79% 0.79% 0.79% 0.79%
Savings & money market
deposit accounts............... $108.6 $ 49.7 $ 42.0 $ 8.3 $ 8.3 $ 78.7 $ 295.6 $ 295.6
Average interest rate........... 3.37% 3.61% 3.73% 2.09% 2.09% 2.08% 3.05%
Certificates of deposit........... $381.1 $ 69.9 $ 23.8 $ 6.3 $ 6.3 -- $ 487.4 $ 491.9
Average interest rate........... 5.52% 5.36% 5.86% 5.91% 5.91% -- 5.52%
Total borrowed funds.............. $ 98.1 $ 45.0 $ 3.6 $ 29.6 $ 15.5 $ 92.0 $ 283.8 $ 293.5
Average interest rate........... 5.37% 5.59% 6.05% 5.80% 5.80% 5.10% 5.39%
------ ------ ------ ------ ------ ------ -------- --------
Total interest sensitive
liabilities .................... $602.5 $173.3 $ 77.1 $ 50.3 $ 36.2 $230.0 $1,169.4 $1,186.6
====== ====== ====== ====== ====== ====== ======== ========
AS OF DECEMBER 31, 1997:
Total interest sensitive
assets.......................... $343.2 $191.6 $177.6 $138.1 $ 97.4 $327.0 $1,274.9 $1,281.8
====== ====== ====== ====== ====== ====== ======== ========
Total interest sensitive
liabilities..................... $593.7 $254.8 $ 79.6 $ 51.4 $ 57.0 $ 89.7 $1,126.2 $1,129.0
====== ====== ====== ====== ====== ====== ======== ========
</TABLE>
Market risk sensitive instruments are generally defined as on and off
balance sheet derivatives and other financial instruments. Expected maturities
are contractual maturities adjusted for prepayments of principal. The Company
uses certain assumptions to estimate fair values and expected maturities. For
interest sensitive assets, expected maturities are based upon contractual
maturity, projected repayments and prepayments of principal using the same
ratios used for the gap analysis presented above. However, as mentioned above,
the market rise analysis excludes repricing features on all interest sensitive
assets. Retail loans include residential and consumer loans while corporate
loans are comprised of commercial real estate, commercial, construction and land
loans and leases. For interest sensitive liabilities, the same decay rates and
contractual maturities used for the gap analysis are used for the market risk
analysis. The only difference between the two analyses on the interest sensitive
liabilities are the callable features on the FHLB advances, the market risk
analysis uses the advances contractual maturity dates in all cases.
-29-
<PAGE> 36
The following table reflects the scheduled maturities of selected loans at
December 31, 1998:
<TABLE>
<CAPTION>
ONE OVER
LESS THAN THROUGH FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
--------- ---------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Construction and land loans ......... $34,781 $21,787 $ -- $56,568
Commercial loans .................... 13,210 10,777 -- 23,987
------- ------- ------- -------
$47,991 $32,564 $ -- $80,555
======= ======= ======= =======
</TABLE>
Of the loans maturing after one year, $21.8 million, or 66.9%, have fixed
rates and $10.8 million, or 33.1%, have floating or variable rates.
LIQUIDITY
The Company's primary source of funds is dividends from its bank
subsidiaries. Dividends from the Bank to the Company totaled $9.5 million in
1998, $7.0 million in 1997 and $4.5 million in 1996. ABNH has been limited in
its ability to pay dividends during its initial years of operation and did not
pay any dividends to the Company for the years ended 1996 through 1998.
The Company made payments of dividends to stockholders in the amount of
$4.5 million, $3.5 million and $2.6 million, respectively, for the years ended
December 31, 1998, 1997 and 1996.
The goal of the Company's liquidity management process is to assess funding
requirements so as to efficiently meet the cash needs of borrowers and
depositors, while also providing funds for attractive investment opportunities.
The Banks have a diverse base of funding. Sources of liquidity include
maturation, amortization and prepayment of the investment and loan portfolios.
Another source of liquidity is funds purchased from other banks, the sale of
securities under repurchase agreements, customer repurchase agreements, and
borrowings from the FHLB, of which Andover Bank is a voluntary member. The Banks
may also obtain funds from the Federal Reserve Bank of Boston by pledging
certain assets.
At December 31, 1998, the Company had home equity, reserve credit and
commercial unadvanced lines of credit totaling $91.7 million. Outstanding
commitments to originate loans totaled $26.2 million. Unadvanced portions of
construction and land loans amounted to $28.6 million. Standby letters of credit
were $2.9 million. Loans sold with recourse totaled $1.9 million. Management
believes that its sources of liquidity are sufficient to meet these commitments
if and as called upon.
See Notes 9, 10, 12, 16 and 17 to the "Consolidated Financial Statements"
for further information.
Cash flows provided by operating activities increased by $6.2 million to
$20.3 at December 31, 1998, and decreased by $4.6 million to $14.0 million at
December 31, 1997. The change in 1998 was primarily attributable to an increase
in net income coupled with a credit for loan losses. The change in 1997 was
primarily due to a reduced provision for loan losses and an increase in assets
held for sale. Cash flows used by investing activities decreased by $54.7
million to $73.9 million during 1998 and increased $46.8 million during 1997 to
$128.6 million. The increase in 1998 was due to a reduction in the purchases of
whole loans. The increase in 1997 was attributable to a reduction in sales of
investments available for sale combined with a $38.8 million increase in whole
loans purchased during the year. Cash flows provided by financing activities
decreased by $40.9 million to $63.3 million during 1998 due to a smaller
increase in deposits. The increase of $23.2 million to $104.2 million during
1997 was mainly attributable to an increase in total deposits.
-30-
<PAGE> 37
CAPITAL RESOURCES
At December 31, 1998, the Company reported total capital of $121.1 million,
or 8.6% of total assets as compared to $107.1 million, or 8.1% at December 31,
1997. The Company and the Banks continue to maintain capital ratios in excess of
all applicable regulatory minimums.
The capital position of banks and bank holding companies are regulated by
various Federal and state agencies. The following table presents regulatory
capital ratios under current regulatory and risk-based capital requirements as
of December 31, 1998:
<TABLE>
<CAPTION>
LEVERAGE CAPITAL RATIO RISK BASED CAPITAL RATIO
---------------------- ------------------------
TIER 1 TIER 1 TOTAL
------ ------ -----
<S> <C> <C> <C>
Andover Bancorp, Inc................... 8.7% 14.2% 15.4%
Andover Bank........................... 7.9 13.0 14.3
Andover Bank NH........................ 9.0 13.3 14.1
</TABLE>
Current minimum regulatory requirements as of December 31, 1998 were 4.0%
for the leverage ratio and 4.0% and 8.0%, respectively, for the Tier 1 and total
risk based capital ratios. Under the FDIC's prompt corrective action regulations
promulgated pursuant to the FDIC Improvement Act of 1991, the Banks have
sufficient capital to be considered "well capitalized". Therefore, the Banks are
entitled to pay the lowest deposit premium possible.
See Item 1, "Business -- Supervision and Regulation" and Note 12 to the
"Consolidated Financial Statements" for further information.
IMPACT OF INFLATION
The Consolidated Financial Statements and related consolidated financial
data presented herein have been prepared in accordance with generally accepted
accounting principles which require the measurement of financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The
primary impact of inflation on operations of Andover is reflected in increased
operating costs. Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the price of
goods and services.
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
-31-
<PAGE> 38
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 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 in accordance with its original plan as of December 31, 1998.
Testing of the Company's non-critical applications will continue into 1999 and
will be completed prior to any anticipated impact of the Year 2000 issue on its
operating systems.
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 $250,000 for the year ended December 31, 1998. The Company
expects that the majority of the costs that will be incurred (as discussed
below) will be to replace or upgrade existing hardware and software which will
be capitalized and amortized in accordance with the Company's existing
accounting policy while miscellaneous consulting, maintenance and modification
costs will be expensed as incurred.
The Company continues to evaluate the estimated costs associated with
achieving Year 2000 readiness based on its experience to date. Based on current
estimates, the remaining costs of its efforts to achieve Year 2000 readiness are
not expected to exceed $400,000. 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.
-32-
<PAGE> 39
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 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 Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), 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 is effective for
financial statements issued for all quarters of all fiscal years beginning after
June 15, 1999. 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.
-33-
<PAGE> 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report............................................. 35
Consolidated Balance Sheets as of December 31, 1998 and 1997............. 36
Consolidated Statements of Operations for each of the years
ended December 31, 1998, 1997 and 1996................................. 37
Consolidated Statements of Changes in Stockholders' Equity for
each of the years ended December 31, 1998, 1997 and 1996............... 38
Consolidated Statements of Cash Flows for each of the years
ended December 31, 1998, 1997 and 1996................................. 39-40
Notes to Consolidated Financial Statements............................... 41-64
-34-
<PAGE> 41
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
ANDOVER BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of Andover
Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Andover
Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
Boston, Massachusetts
January 14, 1999
/s/ KPMG PEAT MARWICK LLP
----------------------------------
KPMG Peat Marwick
-35-
<PAGE> 42
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash and due from banks (note 17) ............................................. $ 29,337 $ 21,586
Short-term investments (note 3) ............................................... 16,100 14,150
---------- ----------
Cash and cash equivalents ................................................... 45,437 35,736
---------- ----------
Assets held for sale, at lower of cost or market (note 2) ..................... 11,282 5,537
Investments available for sale (amortized costs of $163,399 in 1998
and $137,175 in 1997) (notes 3, 9 and 10) ................................... 165,491 139,054
Investments held to maturity (market value $102,512 in 1998 and
$130,947 in 1997) (notes 3, 9 and 10) ....................................... 100,920 129,363
Loans (notes 4 and 10) ........................................................ 1,050,765 978,823
Allowance for loan losses (note 4) ............................................ (10,486) (12,521)
---------- ----------
Net loans ................................................................ 1,040,279 966,302
---------- ----------
Mortgage servicing assets, net (note 5) ....................................... 8,956 9,500
Other real estate owned, net .................................................. 252 406
Premises and equipment, net (note 6) .......................................... 9,255 9,593
Accrued interest receivable ................................................... 7,432 7,567
Stock in FHLB of Boston, at cost (notes 7 and 10) ............................. 15,747 15,747
Net deferred income taxes receivable (note 11) ................................ 2,925 1,832
Other assets .................................................................. 2,271 2,108
---------- ----------
Total assets ........................................................ $1,410,247 $1,322,745
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (note 8) ........................................................ $ 988,656 $ 946,982
Securities sold under agreements to repurchase (note 9) .................. 16,332 10,171
Federal Home Loan Bank advances (note 10) ................................ 267,492 248,561
Mortgagors' escrow accounts .............................................. 2,819 2,478
Income taxes payable (note 11) ........................................... 7,631 2,250
Accrued expenses and other liabilities ................................... 6,175 5,224
---------- ----------
Total liabilities ................................................... 1,289,105 1,215,666
---------- ----------
Commitments and contingencies (notes 6 and 17)
Stockholders' equity (notes 12 and 14):
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; 6,520,012 and 6,459,898 shares issued in 1998
and 1997, respectively ................................................. 652 517
Additional paid-in capital ............................................... 60,507 59,619
Retained earnings ........................................................ 58,716 45,814
Accumulated other comprehensive income (notes 3 and 11) .................. 1,267 1,129
---------- ----------
Total stockholders' equity .......................................... 121,142 107,079
---------- ----------
Total liabilities and stockholders' equity .......................... $1,410,247 $1,322,745
========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-36-
<PAGE> 43
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Interest and dividend income:
Loans .............................................................. $77,358 $70,861 $64,569
Mortgage-backed securities ......................................... 11,711 12,362 13,304
Investment securities .............................................. 6,320 5,753 4,436
Dividends on equity securities (note 7) ............................ 1,020 1,030 944
Short-term investments ............................................. 837 746 570
------- ------- -------
Total interest and dividend income ............................... 97,246 90,752 83,823
------- ------- -------
Interest expense:
Deposits (note 8) .................................................. 39,137 38,251 31,692
Federal Home Loan Bank advances .................................... 15,300 13,315 16,054
Securities sold under agreements to repurchase ..................... 578 481 783
------- ------- -------
Total interest expense ........................................... 55,015 52,047 48,529
------- ------- -------
Net interest and dividend income ................................. 42,231 38,705 35,294
Provision (credit) for loan losses (note 4) .......................... (1,705) 983 2,555
------- ------- -------
Net interest and dividend income after provision
(credit) for loan losses ....................................... 43,936 37,722 32,739
------- ------- -------
Non-interest income:
Net gains from sales of assets held for sale (note 2) .............. 653 264 421
Net gains (losses) from sales and redemptions
of investments available for sale (note 3) ....................... 17 158 (686)
Mortgage banking income (loss), net (note 5) ....................... (389) 2,015 2,095
Gains (losses) on real estate operations, net ...................... 14 (971) (1,542)
Other income (note 13) ............................................. 3,891 3,292 2,709
------- ------- -------
Total non-interest income ........................................ 4,186 4,758 2,997
------- ------- -------
Non-interest expense:
Salaries and employee benefits (note 14) ........................... 12,009 11,886 10,346
Office occupancy and equipment (note 6) ............................ 2,972 2,885 2,756
Data processing .................................................... 2,090 1,933 1,666
Professional fees .................................................. 940 862 1,328
Marketing .......................................................... 831 988 976
Mortgage banking expense ........................................... 606 430 406
Other operating expense ............................................ 3,129 3,002 2,342
------- ------- -------
Total non-interest expense ....................................... 22,577 21,986 19,820
------- ------- -------
Income before income tax expense and extraordinary item .......... 25,545 20,494 15,916
Income tax expense (note 11) ......................................... 8,159 7,288 3,264
------- ------- -------
Income before extraordinary item ................................. 17,386 13,206 12,652
Extraordinary item, net of tax (notes 10 and 11) ..................... -- -- (173)
------- ------- -------
Net income ....................................................... $17,386 $13,206 $12,479
======= ======= =======
Average number of common shares outstanding, basic ................... 6,482 6,434 6,381
Average number of common shares outstanding, diluted ................. 6,697 6,629 6,503
Basic earnings per share:
Income per share before extraordinary item ......................... $ 2.68 $ 2.05 $ 1.98
Extraordinary item per share, net of tax ........................... -- -- (0.03)
------- ------- -------
Net income per share ............................................... $ 2.68 $ 2.05 $ 1.95
======= ======= =======
Diluted earnings per share:
Income per share before extraordinary item ......................... $ 2.60 $ 1.99 $ 1.95
Extraordinary item per share, net of tax ........................... -- -- (0.03)
------- ------- -------
Net income per share ............................................... $ 2.60 $ 1.99 $ 1.92
======= ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-37-
<PAGE> 44
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
ADDITIONAL COMPRE- STOCK-
COMMON PAID-IN RETAINED TREASURY HENSIVE HOLDERS'
STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
------ ---------- -------- -------- ----------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ................ $ 515 $ 71,515 $26,183 $(13,247) $ 199 $ 85,165
Comprehensive income:
Net income ................................ -- -- 12,479 -- -- 12,479
Other comprehensive income, net of tax:
Unrealized holding gains arising during
the period, net of taxes of $215 ........ -- -- -- -- 929 929
Realized losses included in net
income, net of taxes of $(141) .......... -- -- -- -- (827) (827)
--------
Total comprehensive income .............. 12,581
Dividends declared and paid
($0.40 per share) ....................... -- -- (2,553) -- -- (2,553)
Stock options exercised (note 14) ......... -- 41 -- 612 -- 653
Stock dividend ............................ -- (12,334) -- 12,334 -- --
------- -------- ------- -------- ------ --------
Balance at December 31, 1996 ................ 515 59,222 36,109 (301) 301 95,846
Comprehensive income:
Net income ................................ -- -- 13,206 -- -- 13,206
Other comprehensive income, net of tax:
Unrealized holding gains arising during
the period, net of taxes of $493 ........ -- -- -- -- 726 726
Realized gains included in
net income, net of taxes of $56 ......... -- -- -- -- 102 102
--------
Total comprehensive income .............. 14,034
Dividends declared and paid
($0.54 per share) ....................... -- -- (3,501) -- -- (3,501)
Stock options exercised (note 14) ......... 2 397 -- 301 -- 700
------- -------- ------- -------- ------ --------
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, net of tax:
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 (note 14) ......... 5 1,018 -- -- -- 1,023
------- -------- ------- -------- ------ --------
Balance at December 31, 1998 ................ $ 652 $ 60,507 $58,716 $ -- $1,267 $121,142
======= ======== ======= ======== ====== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-38-
<PAGE> 45
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................... $ 17,386 $ 13,206 $ 12,479
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision (credit) for loan losses ............................. (1,705) 983 2,555
Net (gains) losses on sales and provisions
for other real estate owned .................................. (157) 240 392
Net (gains) losses from sales and redemptions of
investments available for sale ............................... (17) (158) 686
Net gains from sales of assets held for sale ................... (653) (264) (421)
Depreciation and amortization .................................. 1,362 1,397 1,396
Amortization of fees, discounts and premiums, net .............. 541 405 412
Deferred income taxes .......................................... (1,168) (1,008) (618)
(Increase) decrease in:
Assets held for sale ......................................... (5,092) (3,053) 1,232
Accrued interest receivable .................................. 135 (403) --
Mortgage servicing assets .................................... 3,110 1,592 741
Other assets ................................................. (163) 1,371 (664)
Increase (decrease) in:
Mortgagors' escrow accounts .................................. 341 184 (1,232)
Accrued income taxes payable ................................. 5,381 (320) 1,181
Accrued expenses and other liabilities ....................... 951 (150) 438
--------- --------- ---------
Net cash provided by operating activities ................. 20,252 14,022 18,577
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment and mortgage-backed securities available for sale:
Purchases .................................................... (60,624) (50,979) (100,311)
Proceeds from sales .......................................... 3,017 14,658 86,641
Proceeds from maturities and redemptions ..................... 4,000 3,000 6,023
Principal repayments ......................................... 26,989 9,889 8,174
Investment and mortgage-backed securities held to maturity:
Purchases .................................................... (15,058) (18,571) (2,991)
Proceeds from maturities and redemptions ..................... 10,000 2,500 6,000
Principal repayments ......................................... 33,416 23,449 27,008
Net change FHLB stock .......................................... -- -- (2,576)
Purchases of whole loans ....................................... (22,875) (71,297) (32,474)
Purchases of mortgage servicing assets ......................... (2,566) (3,086) (2,138)
Net increase in loans .......................................... (50,215) (40,454) (76,855)
Capital expenditures on premises and equipment, net ............ (1,024) (796) (2,053)
Proceeds from sales of other real estate owned ................. 1,084 3,182 3,958
Capital expenditures on other real estate owned ................ -- (54) (128)
--------- --------- ---------
Net cash used by investing activities ..................... (73,856) (128,559) (81,722)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits ....................................... 41,674 122,671 81,106
Net increase (decrease) in securities sold
under agreements to repurchase ............................... 6,161 7,338 (6,379)
Proceeds from issuance of FHLB advances ........................ 310,100 293,514 450,469
Principal repayments of FHLB advances .......................... (291,169) (316,538) (442,298)
Dividends paid ................................................. (4,484) (3,501) (2,553)
Stock options exercised ........................................ 1,023 700 653
--------- --------- ---------
Net cash provided by financing activities ................. 63,305 104,184 80,998
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ................ 9,701 (10,353) 17,853
Cash and cash equivalents, beginning of year ........................ 35,736 46,089 28,236
--------- --------- ---------
Cash and cash equivalents, end of year .............................. $ 45,437 $ 35,736 $ 46,089
========= ========= =========
</TABLE>
Statement continued on next page.
-39-
<PAGE> 46
ANDOVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest ........................................................... $55,191 $52,129 $48,787
Income taxes ....................................................... 4,010 7,866 3,355
Cash received during the year for:
Income taxes ....................................................... 397 -- 585
Supplemental noncash investing and financing activities:
Conversion of real estate loans to mortgage-backed
securities held for sale or investments available for sale ............ 53,300 24,068 37,676
Transfer of loans to other real estate owned ............................ 773 2,091 1,747
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-40-
<PAGE> 47
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Andover Bancorp, Inc. (the "Company") is a Delaware corporation and the
holding company of Andover Bank and Andover Bank NH (collectively the "Banks").
Andover Bank (the "Bank") is a state-chartered savings bank with its
headquarters located in Andover, Massachusetts. Andover Bank NH ("ABNH") is a
guaranty savings bank chartered in September 1995, and headquartered in Salem,
New Hampshire. The Company provides a variety of loan and deposit services to
its customers through 13 locations. The Company is supervised by the Board of
Governors of the Federal Reserve System ("FRB") and it is also subject to the
jurisdiction of the Massachusetts Board of Bank Incorporation, while the Bank is
subject to regulation and supervision by the Federal Deposit Insurance
Corporation ("FDIC") and the Massachusetts Commissioner of Banks (the
"Commissioner"). The Bank's deposits are insured by the FDIC and the Depositors
Insurance Fund, Inc. ("DIF"). ABNH is subject to regulation and supervision of
the FDIC and the New Hampshire Commissioner of Banks. ABNH's deposits are
insured by the FDIC.
The accounting and reporting policies of Andover Bancorp, Inc. and
subsidiaries conform with generally accepted accounting principles and general
practices within the banking industry. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and income and expenses for the period. Actual results could differ
significantly from those estimates. Material estimates that are particularly
susceptible to change relate to the allowance for loan loss and the valuation of
mortgage servicing assets. The following is a summary of the more significant
accounting policies.
Principles of Consolidation
The consolidated financial statements include the accounts of Andover
Bancorp, Inc. and its subsidiaries, including its principal subsidiaries Andover
Bank and Andover Bank NH. All intercompany accounts and transactions have been
eliminated in consolidation. Certain amounts in the prior years' financial
statements have been reclassified to conform with the current year's
presentation for comparative purposes. Such reclassifications had no effect on
net income. In addition, the Company is reporting its results as one operating
segment.
Mortgage Banking Activities
Loans held for sale in the secondary market are stated at the lower of
aggregate amortized cost or market value. Market value is estimated based on
outstanding investor commitments or, in the absence of such commitments, current
investor yield requirements. Net unrealized losses, if any, are provided for in
a valuation allowance by charges to operations. When loans are sold, a gain or
loss is recognized to the extent that the sale proceeds exceed or are less than
the carrying amount of the loans. Gains and losses are determined using the
specific identification method.
Since 1996, the Company has recognized a servicing asset based on an
allocation of the carrying amount of the assets sold between the asset sold and
the servicing obligation and other retained interests using the relative fair
value of the assets sold to the interests retained. These capitalized mortgage
loan servicing rights are a significant component of the net gains from sales of
assets held for sale income category.
Mortgage loan servicing rights purchased or originated are amortized
against mortgage banking income using a method which approximates the level
yield method in proportion to, and over the period of, estimated net servicing
income. Prepayment experience on each mortgage servicing asset is reviewed
periodically, and, when actual prepayments exceed estimated prepayments, the
balance of the mortgage servicing asset is adjusted by a charge to the valuation
allowance. On a regular basis, the mortgage servicing assets are assessed for
impairment based on the fair value of such rights. The fair value is estimated
using market prices when available or, alternatively, using a valuation model
that calculates the present value of future servicing asset cash flows using
discount rates and prepayment assumptions that management believes market
participants would use. Any impairment in the fair value of those mortgage
servicing assets is recognized by a charge to the valuation allowance. The risk
characteristics of the underlying loans used to measure impairment of originated
and purchased mortgage loan servicing rights include the loan type, interest
rate, loan origination date, term to maturity and geographic location.
-41-
<PAGE> 48
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
Investments
Investments include short-term, available for sale, held to maturity and
trading. Debt securities are classified as held to maturity only when there is
positive intent and ability to hold them to maturity. Such securities are
recorded at amortized cost, adjusted for amortization of premiums and accretion
of discounts and adjusted as necessary for estimated prepayments. Trading
securities are debt and equity securities held principally for the purpose of
selling in the near term. Such securities are recorded at fair value, with
unrealized gains and losses recorded in earnings. Investments available for sale
are any debt and equity securities not classified as either held to maturity or
trading securities. Such investments are recorded at fair value with changes in
fair value recorded as a separate component of stockholders' equity, net of the
related income tax effect. Originated mortgage loans converted to
mortgage-backed securities to be sold are classified as trading. Gains and
losses on sales of investment and mortgage-backed securities are recognized
using the specific identification method. Premiums and discounts on investment
and mortgage-backed securities are amortized or accreted into income by use of
the level-yield method. The yields on mortgage-backed securities are affected by
prepayments and changes in interest rates. If a decline in fair value below the
amortized cost basis of an investment or mortgage-backed security is judged to
be other than temporary, the cost basis of the security is written down to fair
value. The amount of the writedown is included as a charge against gain on sale
of securities. Short-term investments with original maturities of 90 days or
less are carried at cost, which approximates market value.
Loans
Accrual of interest income on loans and amortization of net deferred loan
fees are discontinued when loan payments are 90 days or more past due or earlier
when concern exists as to the ultimate collection of principal or interest. When
loans are placed on nonaccrual status, the interest receivable on the loan is
reversed against interest income of the current period. Non-performing loans are
generally not returned to performing status until the obligation is brought
current, the loan becomes well-secured and in the process of collection and, in
either case, when concern no longer exists as to the collectibility of principal
or interest. Interest received on nonaccruing loans is either applied against
principal or reported as income according to management's judgment as to the
collectibility of principal.
Loan origination fees and related direct incremental loan origination costs
are deferred and amortized over the life of the related loans as yield
adjustments using the level yield method. When loans are sold or paid off, the
unamortized fees and costs are recognized to income. Purchased loan discounts
and premiums are amortized or accreted into income over the weighted average
repricing term of the underlying loans.
Allowance for Loan Losses
The Banks maintain an allowance for probable losses that are inherent in
their loan portfolios. The allowance is increased by provisions charged to
operating expense and by recoveries of previously charged-off loans. The
allowance is decreased as loans are charged-off.
The allowance is an amount that management believes will be adequate for
loan losses based on evaluations of collectibility and prior loss experience,
changes in the nature and volume of the loan portfolio, overall portfolio
quality, specific problem loans and current and anticipated economic conditions
that may affect the borrower's ability to pay. A substantial portion of the
Banks' loans are secured by real estate in Massachusetts and New Hampshire.
Accordingly, the ultimate collectibility of a substantial portion of the Bank's
loan portfolio is susceptible to changes in market conditions in these areas.
Management believes the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Banks' allowance for loan
losses. Such agencies may require the Banks to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination.
-42-
<PAGE> 49
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
Impaired loans are commercial, commercial real estate, and individually
significant mortgage and consumer loans for which it is probable that the
Company will not be able to collect all amounts due according to the contractual
terms of the loan agreement. The definition of "impaired loans" is not the same
as the definition of "nonaccrual loans", although the two categories overlap.
Nonaccrual loans include impaired loans and are those on which the accrual of
interest is discontinued when collectibility of principal or interest is
uncertain or payments of principal or interest have been contractually past due
90 days. The Company may choose to place a loan on nonaccrual status due to
payment delinquency, while not classifying the loan as impaired due to
insignificant payment delays and insignificant shortfalls in payment amounts.
Factors considered by management in determining impairment include payment
status and collateral value. The amount of impairment for these types of
impaired loans is determined by the difference between the present value of the
expected cash flows related to the loan, using the original contractual interest
rate and its recorded value, or, as a practical expedient in the case of
collateral dependent loans, the difference between the fair value of the
collateral and the recorded amount of the loans. When foreclosure is probable,
impairment is measured based on the fair value of the collateral. Loan
restructurings at below current market rates are reported as impaired loans and
impairment is measured as described above using the loan's pre-modification rate
of interest. Income received on impaired loans is recognized in income similar
to nonaccrual loans.
Other Real Estate Owned
Other real estate owned is comprised of properties acquired through
foreclosure proceedings, acceptance of a deed in lieu of foreclosure or when the
Bank is in possession of the collateral. Real estate owned is recorded at the
lower of the carrying value of the loan or the net fair value of the property.
Losses arising from the acquisition of such properties are charged against the
allowance for loan losses. Operating expenses, net of related income, and any
provisions to increase the valuation allowance are charged to real estate
operations. Subsequent declines in net fair value are charged-off to the
valuation allowance while gains and losses upon disposition are reflected in
real estate operations. Management believes the allowance is adequate to provide
for potential losses. However, future additions to the valuation allowance may
be necessary based on changes in economic conditions.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation or amortization is computed on the straight-line method over the
lesser of the estimated useful lives of the assets or over the terms of their
respective leases for leasehold improvements. It is the Company's general
practice to charge the cost of maintenance and repairs to operations when
incurred; major expenditures for improvements are capitalized and depreciated.
Income Taxes
Income taxes are accounted for using the asset and liability method of
accounting. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax basis and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The valuation allowance
related to deferred tax assets is recognized when, in management's judgment, it
is more likely than not that all, or a portion of, such deferred tax assets will
not be realized.
-43-
<PAGE> 50
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
Employee Benefits
The Company accounts for pension and postretirement benefits on the net
periodic cost method for financial reporting purposes. This method recognizes
the compensation cost of any employee's benefit over that employee's approximate
service period.
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 132, "Employers' Disclosures About Pensions and Other
Postretirement Benefits" ("SFAS 132"). SFAS 132 amends disclosure requirements
related to pension and other postretirement benefits previously required under
SFAS No. 87, 88 and 106. SFAS 132 does not change the measurement or recognition
of these plans. See footnote 14 for the expanded disclosures required by SFAS
132.
The Company continues to follow APB Opinion No. 25 "Accounting for Stock
Issued to Employees" as permitted by Statement of Financial Accounting Standards
No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"). For companies
that elect to continue using APB 25, SFAS 123 requires disclosure of the pro
forma effect of using the fair value method of accounting for stock-based
compensation that is encouraged by SFAS 123. See footnote 14 for the expanded
disclosures required by SFAS 123 regarding pro forma net income and earnings per
share.
Earnings Per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128
replaces the existing accounting rules for computing earnings per share and
makes the new rules comparable to international standards. Basic earnings per
share excludes common stock equivalents and is computed by dividing net income
by the weighted average number of common shares outstanding for the period.
Diluted earnings per share gives effect to all potential dilutive common shares
using the average market price of the Company's common stock for the period plus
the weighted average number of common shares outstanding for the equivalent
period of time. All prior period earnings per share have been restated to comply
with SFAS 128.
Additionally, all earnings per share, dividends and share information have
been retroactively adjusted for the periods prior to June 30, 1998 to reflect a
25% stock split distributed in May, 1998.
A reconciliation of the common shares outstanding for the three years ended
December 31, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Average number of common shares outstanding, basic................ 6,482 6,434 6,381
Dilutive impact of stock options.................................. 215 195 122
----- ----- -----
Average number of common shares outstanding, diluted.............. 6,697 6,629 6,503
</TABLE>
The numerator in the earnings per common share calculation is net income,
as reported, for both the basic and dilutive calculations.
-44-
<PAGE> 51
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(2) ASSETS HELD FOR SALE
The composition of assets held for sale at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans.............................. $11,282 $11,314 $5,537 $5,624
======= ======= ====== ======
</TABLE>
Proceeds from sales, realized and net unrealized gains and losses on assets
held for sale for the years ended December 31, follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Proceeds from sales.......................... $60,082 $27,732 $39,839
Realized gains on sales...................... 870 498 829
Realized losses on sales..................... 217 260 382
Net unrealized gains (losses)................ -- 26 (26)
</TABLE>
Included in the realized gains on sales are the capitalized originated
mortgage servicing rights of $726,000, $447,000 and $423,000, respectively, for
each of the three years ended December 31.
(3) INVESTMENTS
The amortized cost and approximate fair value of the investment portfolio
at December 31 follow:
<TABLE>
<CAPTION>
1998 1997
------------------------------------------- -------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
-------- ---------- ---------- ----- --------- ---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SHORT-TERM INVESTMENTS:
Federal funds sold ................... $ 16,100 $ -- $ -- $ 16,100 $ 14,150 $ -- $ -- $ 14,150
======== ====== ===== ======== ======== ====== ===== ========
INVESTMENTS AVAILABLE FOR SALE:
U.S. government and federal
agency obligations ................. $ 61,493 $1,063 $ -- $ 62,556 $ 54,869 $ 912 $ (4) $ 55,777
Other bonds and obligations .......... 36,994 567 -- 37,561 14,405 168 -- 14,573
FHLMC participation certificates ..... 26,465 516 -- 26,981 36,329 476 -- 36,805
FNMA pass-through certificates ....... 2,538 -- (29) 2,509 4,012 94 -- 4,106
GNMA mortgage-backed securities ...... 35,909 110 (135) 35,884 27,560 236 (3) 27,793
-------- ------ ----- -------- -------- ------ ----- --------
$163,399 $2,256 $(164) $165,491 $137,175 $1,886 $ (7) $139,054
======== ====== ===== ======== ======== ====== ===== ========
INVESTMENTS HELD TO MATURITY:
U.S. government and federal
agency obligations ................. $ 8,526 $ 141 $ -- $ 8,667 $ 10,001 $ 46 $ -- $ 10,047
Other bonds and obligations .......... 4,545 91 -- 4,636 7,106 86 (2) 7,190
FHLMC participation certificates ..... 30,207 658 -- 30,865 49,217 837 (37) 50,017
FNMA pass-through certificates ....... 35,435 632 (19) 36,048 48,835 724 (213) 49,346
GNMA mortgage-backed securities ...... 2,576 74 -- 2,650 3,383 81 -- 3,464
Collateralized mortgage obligations .. 19,080 42 (23) 19,099 10,021 75 -- 10,096
Other asset-backed securities ........ 551 -- (4) 547 800 -- (13) 787
-------- ------ ----- -------- -------- ------ ----- --------
$100,920 $1,638 $ (46) $102,512 $129,363 $1,849 $(265) $130,947
======== ====== ===== ======== ======== ====== ===== ========
Total investments .................. $280,419 $3,894 $(210) $284,103 $280,688 $3,735 $(272) $284,151
======== ====== ===== ======== ======== ====== ===== ========
</TABLE>
-45-
<PAGE> 52
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
Proceeds from sales, realized gains and losses on investments available for
sale for the years ended December 31, follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Proceeds from sales........................................... $ 3,017 $14,658 $86,641
Realized gains on sales and redemptions....................... 17 199 236
Realized losses on sales and redemptions...................... -- 41 922
</TABLE>
There were no sales of investments held to maturity in 1998, 1997 and 1996.
The amortized cost and fair value of mortgage-backed and asset-backed
securities available for sale and held to maturity at December 31 follow:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------- -----------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
-------------------- ------------------- -------------------- -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ----- --------- ----- --------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed and asset-backed
securities........................ $64,912 $65,374 $87,849 $89,209 $67,901 $68,704 $112,256 $113,710
======= ======= ======= ======= ======= ======= ======== ========
</TABLE>
The amortized cost and fair value of adjustable rate investments available for
sale and held to maturity by type at December 31 follow:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------- -----------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
-------------------- ------------------- -------------------- -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ----- --------- ----- --------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FHLMC participation certificates .... $ 594 $ 617 $ -- $ -- $ 881 $ 925 $ -- $ --
FNMA pass-through certificates ...... 2,538 2,509 -- -- 4,012 4,106 2,869 2,951
GNMA mortgage-backed securities ..... 35,909 35,884 -- -- 27,560 27,793 -- --
------- ------- ----- ----- ------- ------- ------ ------
$39,041 $39,010 $ -- $ -- $32,453 $32,824 $2,869 $2,951
======= ======= ===== ===== ======= ======= ====== ======
</TABLE>
The carrying amounts of callable securities included in investments
available for sale and investments held to maturity totaled $30,200,000 and
$5,521,000 in 1998 and $37,038,000 and $10,001,000 in 1997, respectively.
The maturity distribution of investments available for sale and held to
maturity at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------- --------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY AVAILABLE FOR SALE HELD TO MATURITY
-------------------- -------------------- -------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ----- --------- ----- --------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Within 1 year .............. $ 19,670 $ 19,805 $ 6,023 $ 6,099 $ 6,622 $ 6,673 $ 8,160 $ 8,241
1 to 5 years ............... 75,485 76,961 45,948 46,529 77,743 78,945 39,043 39,489
5 to 10 years .............. 29,931 30,337 31,001 31,604 21,168 21,429 44,739 45,334
Over 10 years .............. 38,313 38,388 17,948 18,280 31,642 32,007 37,421 37,883
-------- -------- -------- -------- -------- -------- -------- --------
$163,399 $165,491 $100,920 $102,512 $137,175 $139,054 $129,363 $130,947
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
- ----------
Maturities of mortgage-backed securities are based on contractual maturities
with scheduled amortization. Actual maturities will differ from contractual
maturities due to prepayments.
-46-
<PAGE> 53
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
Securities pledged at December 31 follow:
<TABLE>
<CAPTION>
SECURITIES SOLD
CUSTOMER UNDER AGREEMENTS
GOVERNMENT DEPOSITS REPURCHASE AGREEMENTS TO REPURCHASE
------------------- ---------------------- ------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ----- --------- ----- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
AT DECEMBER 31, 1998
FHLMC participation certificates .......................... $500 $ 508 $ -- $ -- $ -- $ --
GNMA mortgage-backed securities available for sale ........ -- -- 10,746 10,698 -- --
U.S. government obligations available for sale ............ -- -- -- -- 10,088 10,087
AT DECEMBER 31, 1997
Fixed rate bonds available for sale ....................... 999 1,024 -- -- -- --
GNMA mortgage-backed securities available for sale ........ -- -- 8,994 9,019 -- --
U.S. government obligations available for sale ............ -- -- -- -- 5,035 5,119
</TABLE>
(4) LOANS
The Company's lending activities are conducted principally in eastern
Massachusetts and southern New Hampshire. The Company grants single-family and
multi-family residential loans, commercial real estate loans, commercial loans
and a variety of consumer loans. In addition, the Company grants loans for the
construction of residential homes, commercial real estate properties and for
land development. The ability and willingness of the single-family residential
and consumer borrowers to honor their repayment commitments is generally
dependent on the level of overall economic activity within the borrowers'
geographic areas and real estate values. The ability and willingness of
commercial real estate, commercial and construction loan borrowers to honor
their repayment commitments are generally dependent on the health of the real
estate economic sector in the borrowers' geographic areas and the general
economy.
The composition of loans, shown net of unadvanced funds, loan premiums or
discounts and deferred loan origination fees and costs, at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Real estate loans:
Residential ................................... $ 740,009 $715,503
Commercial .................................... 158,377 142,617
Construction and land ......................... 56,568 31,499
---------- --------
Total real estate loans .................. 954,954 889,619
---------- --------
Consumer loans:
Home improvement, second mortgage and
home equity line of credit .................. 55,691 58,605
Personal ...................................... 2,557 3,161
Guaranteed education .......................... 326 3,086
Collateral .................................... 3,277 3,352
---------- --------
Total consumer loans ..................... 61,851 68,204
---------- --------
Commercial loans ................................... 23,987 20,170
Lease financing .................................... 9,973 830
---------- --------
Total commercial loans ................... 33,960 21,000
---------- --------
Total loans .............................. 1,050,765 978,823
Allowance for loan losses .......................... (10,486) (12,521)
---------- --------
Net loans ................................ $1,040,279 $966,302
========== ========
</TABLE>
-47-
<PAGE> 54
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
An analysis of the allowance for loan losses for the years ended December
31, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year...................... $12,521 $12,229 $11,665
Provision (credit) for loan losses................ (1,705) 983 2,555
Charge-offs....................................... (1,500) (1,804) (3,283)
Recoveries........................................ 1,170 1,113 1,292
------- ------- -------
Balance at end of year............................ $10,486 $12,521 $12,229
======= ======= =======
</TABLE>
The balance of loans on nonaccrual status because of delinquency or other
problem characteristics amounted to $3,240,000 and $7,849,000 at December 31,
1998 and 1997, respectively.
The reduction in interest income for the years ended December 31,
associated with nonaccrual loans, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Interest income in accordance
with original loan terms....................... $ 803 $1,191 $1,566
Interest income recognized........................ (103) (130) (315)
Interest income applied as a
reduction in loan balance....................... (209) (359) (342)
----- ------ ------
Foregone interest income..................... $ 491 $ 702 $ 909
===== ====== ======
</TABLE>
The components of impaired loans at December 31 follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Total impaired loans.............................. $2,504 $6,356 $9,122
Impaired loans with reserve....................... 809 2,476 2,686
Impaired loan reserve............................. 94 280 516
Impaired loans without reserve.................... 1,695 3,880 6,436
Impaired loans average balance.................... 4,184 7,653 10,680
Interest income recognized........................ 73 199 242
Interest income that would have
been recognized under original terms............ 458 738 919
</TABLE>
The impaired loan reserve represents an allocation from the existing
allowance for loan losses. At December 31, 1998, the Company had no restructured
loans outstanding.
A summary of the activity with respect to loans made to directors and
officers and their related interests whose total aggregate loan balances
exceeded $60,000 during the years ended December 31, follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Balance at beginning of year............................... $1,703 $1,537
New loans granted.......................................... 1,140 396
Retirement/reduction of directors and officers............. (175) ---
Repayment of principal..................................... (779) (230)
------ ------
Balance at end of year..................................... $1,889 $1,703
====== ======
</TABLE>
-48-
<PAGE> 55
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
The outstanding balances of loans to directors and principal officers
included above totaled $878,000 and $496,000, respectively, at December 31, 1998
and 1997. Loans included above were made in the Bank's ordinary course of
business, on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons, and did not involve more than the normal risk of collectibility.
(5) MORTGAGE SERVICING ASSETS
A summary of the components of the mortgage servicing assets, including the
valuation allowance, for the years ended December 31, follows:
<TABLE>
<CAPTION>
MORTGAGE
SERVICING VALUATION
EXCESS RIGHTS ALLOWANCE TOTAL
------ --------- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance as of December 31, 1995 ................ $ 2,303 $ 4,306 $ -- $ 6,609
Purchased and capitalized ...................... 264 2,561 -- 2,825
Amortization ................................... (360) (868) -- (1,228)
Provision for valuation allowance .............. -- -- (200) (200)
------- ------- ------- -------
Balance as of December 31, 1996 ................ 2,207 5,999 (200) 8,006
Purchased and capitalized ...................... -- 3,533 -- 3,533
Amortization ................................... (360) (1,394) -- (1,754)
Provision for valuation allowance .............. -- -- (285) (285)
Charge-offs .................................... -- (85) 85 --
------- ------- ------- -------
Balance as of December 31, 1997 ................ 1,847 8,053 (400) 9,500
Purchased and capitalized ...................... -- 3,292 -- 3,292
Amortization ................................... (420) (1,641) -- (2,061)
Provision for valuation allowance .............. -- -- (1,465) (1,465)
Charge-offs .................................... (310) (740) 740 (310)
------- ------- ------- -------
Balance as of December 31, 1998 ................ $ 1,117 $ 8,964 $(1,125) $ 8,956
======= ======= ======= =======
</TABLE>
At December 31, 1998, 1997 and 1996 mortgage loans partially or wholly
owned by others and serviced by the Company amounted to approximately
$894,432,000, $971,041,000 and $877,683,000, respectively, and are not reflected
in the accompanying consolidated financial statements because they are not
assets of the Company. During 1998, 1997 and 1996, the Company purchased
mortgage servicing rights to $184.7 million, $228.8 million and $180.0 million,
respectively, in residential first mortgage loans. These purchased balances are
included in the loans serviced for others reflected above. Gains resulting from
the capitalization of originated mortgage servicing rights are included in net
gains on assets held for sale. Amortization of the mortgage servicing assets and
the provisions for the valuation allowance are included as a reduction of
mortgage banking income.
-49-
<PAGE> 56
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(6) PREMISES AND EQUIPMENT
The composition of premises and equipment at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Land and buildings ................................. $11,823 $11,809
Furniture, fixtures and equipment .................. 4,261 3,321
Leasehold improvements ............................. 282 192
Construction in progress ........................... 23 41
------- -------
16,389 15,363
Less: accumulated depreciation ..................... (7,134) (5,770)
------- -------
$ 9,255 $ 9,593
======= =======
</TABLE>
Rent expense was $231,000, $126,000 and $108,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. Rental income on portions of the
Company owned and occupied premises totaled $322,000, $319,000 and $244,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.
A summary of future minimum rental expense and income under non-cancellable
operating leases at December 31, 1998 follows:
<TABLE>
<CAPTION>
MINIMUM MINIMUM
RENTAL RENTAL
EXPENSE INCOME
------- -------
(IN THOUSANDS)
<S> <C> <C>
1999 ............................................... $221 $317
2000 ............................................... 204 167
2001 ............................................... 201 87
2002 ............................................... 144 4
2003 ............................................... 139 --
Thereafter ......................................... 142 --
</TABLE>
(7) STOCK IN FEDERAL HOME LOAN BANK OF BOSTON
As a voluntary member of the Federal Home Loan Bank ("FHLB") of Boston, the
Bank is required to invest in $100 par value stock of the FHLB of Boston in the
amount of 1% of its outstanding home loans or 5% of its outstanding advances
from the FHLB of Boston, whichever is higher. As and when such stock is
redeemed, the Bank would receive from the FHLB of Boston an amount equal to the
par value of the stock. At its discretion, the FHLB of Boston may declare
dividends on this stock. Such dividends, which are included in dividend income
on equity securities, amounted to $1,008,000, $1,020,000 and $934,000 for the
years ended December 31, 1998, 1997 and 1996, respectively.
-50-
<PAGE> 57
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(8) DEPOSITS
The composition of deposits at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
-------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Non-interest bearing:
Demand deposit accounts......................... $103,029 .--% $ 79,501 .--%
Interest bearing:
NOW accounts.................................... 102,635 0.79 85,917 1.02
Money market deposit accounts................... 96,332 2.77 104,353 2.96
Savings accounts................................ 199,304 3.19 149,607 3.61
Variable rate certificates...................... 4,463 4.31 5,182 5.43
Fixed rate certificates......................... 482,893 5.53 522,422 5.89
-------- --------
Total deposits............................. $988,656 3.72% $946,982 4.27%
======== ==== ======== ====
</TABLE>
Time certificates in excess of $100,000 at December 31, 1998 and 1997
amounted to $87,188,000 and $85,126,000, respectively.
A summary of interest expense on deposits for the years ended December 31,
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Now accounts......................................... $ 806 $ 740 $ 661
Money market deposit accounts........................ 2,861 3,381 3,639
Savings accounts..................................... 6,256 4,060 1,800
Certificates of deposit.............................. 29,214 30,070 25,592
------- ------- -------
Total interest expense on deposits.............. $39,137 $38,251 $31,692
======= ======= =======
</TABLE>
Interest forfeitures resulting from early withdrawals from certificates of
deposit are credited to interest expense on deposits. Interest forfeitures
amounted to $172,000, $148,000 and $128,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
The average interest rate on time certificates at December 31, 1998, by the
earlier of its repricing or period of maturity, follows:
<TABLE>
<CAPTION>
AVERAGE
AMOUNT RATE
------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Maturity in:
1999............................................... $380,563 5.52%
2000............................................... 70,163 5.35
2001............................................... 23,976 5.86
2002............................................... 10,069 6.03
2003............................................... 2,585 5.44
--------
$487,356 5.52%
======== ====
</TABLE>
Included in the table above are variable rate time certificates, the majority of
which mature in 1999.
-51-
<PAGE> 58
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(9) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). These agreements are treated as financings, and
the obligations to repurchase securities sold are reflected as a liability in
the consolidated balance sheets and the securities underlying the agreements
remain in the asset accounts. The securities underlying the agreements are held
by third parties as custodian. In addition, the Banks have established overnight
corporate customer repurchase agreements whereby collateral is set aside by the
Banks' custodian and the rates paid approximate short term deposit or market
interest rates (see note 3).
Information concerning securities sold under agreements to repurchase for
the years ended December 31, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Outstanding at December 31...................................... $16,332 $10,171 $ 2,833
Outstanding collateral:
Amortized cost............................................... 20,834 14,029 5,222
Fair value................................................... 20,785 14,138 5,166
Average balance outstanding during the year..................... 11,794 9,614 15,062
Maximum outstanding at any month-end............................ 19,981 21,752 36,499
Weighted average rate at year-end............................... 4.65% 5.17% 4.35%
Weighted average rate during the year........................... 4.90% 5.00% 5.20%
</TABLE>
The repurchase agreements outstanding at December 31, 1998 matured on
January 1 and January 21, 1999. The reverse repurchase agreements outstanding at
December 31, 1997 matured on January 1 and February 11, 1998 while those
outstanding at December 31,1996 matured on January 1, 1997.
The Bank has established reverse repurchase lines of credit with various
lenders totaling $310.0 million. These lines would be subject to the amount of
securities available for collateralization purposes.
(10) FEDERAL HOME LOAN BANK ADVANCES
A summary of Federal Home Loan Bank advances at December 31 follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------- ---------------------
WEIGHTED WEIGHTED
SCHEDULED REDEEMED AT AVERAGE SCHEDULED AVERAGE
MATURITY INITIAL CALL DATE(1) RATE(2) MATURITY RATE
--------- -------------------- --------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Within 1 year......................... $ 81,769 $156,769 5.52% $143,570 5.73%
Over 1 year to 2 years................ 55,048 80,048 5.34 39,269 6.09
Over 2 years to 3 years............... 3,590 18,590 6.05 20,048 6.06
Over 3 years to 5 years............... 45,110 10,110 5.80 33,199 5.93
Over 5 years.......................... 81,975 1,975 5.21 12,475 5.93
-------- -------- --------
$267,492 $267,492 5.44% $248,561 5.85%
======== ======== ==== ======== ====
</TABLE>
- ----------
(1) Callable FHLB advances are shown in the respective periods assuming that
the callable debt is redeemed at the initial call date while all other
advances are shown in the periods corresponding to their scheduled maturity
date.
(2) Weighted average rate based on scheduled maturity dates.
In accordance with an agreement with the FHLB of Boston, the Bank is
required to maintain qualified collateral, as defined by the FHLB, as collateral
for its advances. This collateral is primarily composed of the Bank's investment
in the FHLB stock, its residential mortgage and investment portfolios not
otherwise pledged (see notes 3, 7 and 9). The Bank has the capacity to borrow an
additional $526.0 million in advances from the FHLB of Boston as of December 31,
1998, subject to the amount of qualifying collateral available.
-52-
<PAGE> 59
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(11) FEDERAL AND STATE INCOME TAXES
The current and deferred components of income tax expense (benefit) for the
years ended December 31, follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current income tax expense:
Federal.......................................................... $ 8,440 $7,447 $3,520
State.......................................................... 887 843 361
---------- -------- --------
9,327 8,290 3,881
--------- ------- -------
Deferred income tax expense (benefit):
Federal........................................................... (1,107) (389) (8)
State........................................................... 267 (113) (109)
Change in valuation allowance.................................... (328) (500) (500)
-------- -------- --------
(1,168) (1,002) (617)
------- ------- --------
Income tax expense before extraordinary item.......................... 8,159 7,288 3,264
Federal and state tax effect of extraordinary item................. --- --- (125)
----------- ---------- --------
Total income tax expense.......................................... $8,159 $7,288 $3,139
====== ====== ======
</TABLE>
The causes of the difference between the total expected income tax expense
computed by applying the Federal statutory rate to income before income taxes
and the reported income tax expense for the years ended December 31, follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Federal income tax expense at statutory rate........................... $8,941 $7,173 $5,571
Tax effect of:
State tax, net of federal benefit before valuation allowance,
excluding state impact of law change......................... 750 475 589
Adjustment of deferred tax liabilities............................ (1,100) --- ---
Federal and state benefit of adjustment to deferred taxes
resulting from change in federal tax law................... --- --- (2,500)
Change in valuation allowance.................................... (328) (500) (500)
Other, net....................................................... (104) 140 104
-------- -------- --------
Income tax expense before extraordinary item........................... $8,159 $7,288 $3,264
====== ====== ======
Effective income tax rate before extraordinary item.................. 31.9% 35.6% 20.5%
==== ==== ====
</TABLE>
The existing net deductible temporary differences that give rise to the net
deferred income tax asset are expected to reverse in periods in which the
Company will generate net taxable income. At December 31, 1998, the net deferred
tax asset is supported by recoverable income taxes of approximately $16.8
million. It should be noted, however, that factors beyond management's control,
such as the general state of the economy and real estate values, can affect
levels of taxable income and that no assurance can be given that sufficient
taxable income will be generated to fully absorb gross deductible temporary
differences.
-53-
<PAGE> 60
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
The components of the net deferred taxes receivable for the years ended
December 31, follow:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses............................................................. $ 3,593 $4,010
Unrealized losses on writedown of other real estate owned............................. 102 37
Deferred benefits..................................................................... 854 722
Depreciation.......................................................................... 135 278
Excess mortgage servicing fees........................................................ 668 156
Other................................................................................. 89 502
------- ------
Gross deferred assets.............................................................. 5,441 5,705
Valuation allowance................................................................... --- (328)
------- ------
Net deferred tax assets before deferred tax liabilities.................................. 5,441 5,377
------- ------
Deferred tax liabilities:
Deferred expenses..................................................................... 1,491 2,465
Security valuation adjustments on investments available for sale...................... 825 750
Miscellaneous security valuation adjustments.......................................... 22 225
Other................................................................................. 178 105
------- ------
Gross deferred liabilities......................................................... 2,516 3,545
------- ------
Net deferred income taxes receivable..................................................... $ 2,925 $1,832
======= ======
</TABLE>
(12) STOCKHOLDERS' EQUITY
Preferred Stock
In connection with the Company's adoption of a Shareholder Rights Plan on
January 21, 1999, the Company established a series of 100,000 shares of
preferred stock designated as Series A Junior Participating Cumulative Preferred
Stock, par value $0.10 per share ("Series A Stock") and declared a dividend of
one Preferred Stock Purchase Right (the "Right") for each outstanding share of
the Company's Common Stock held of record as of February 16, 1999.
Pursuant to the Shareholder Rights Plan, each Right entitles the holder to
purchase a unit consisting of one one-thousandth of a share of Series A Stock,
par value $0.10 per share, at an initial cash exercise price of $130.00 per
unit, subject to adjustment. The Rights are not exercisable and remain attached
to all outstanding shares of Common Stock until the earliest of (i) ten calendar
days following a public announcement that a person or group of affiliated or
associated persons (an "Acquiring Person") has acquired beneficial ownership of
15% or more of the outstanding shares of Common Stock (the date of said
announcement being referred to as the "Stock Acquisition Date"), (ii) ten
business days following the commencement of a tender offer or exchange offer
that could result in a person or group becoming an Acquiring Person or (iii) the
declaration by the Board of Directors that a person is an "Adverse Person", as
such term is defined in the Shareholder Rights Plan.
In the event that a Stock Acquisition Date occurs or the Board of Directors
determines that a person is an Adverse Person, each holder of a Right will be
entitled to receive upon exercise that number of units of Series A Stock having
a market value of two times the exercise price of the Right. In the event that,
at any time following the Stock Acquisition Date, (i) the Company is acquired in
a merger or other business combination transaction or (ii) 50% or more of the
Company's assets or earning power is sold, each holder of a Right shall
thereafter have the right to receive, upon exercise, common stock of the
acquiring company having a market value equal to two times the exercise price of
the Right. The Rights have no voting or dividend privileges and, until they
become exercisable, have no dilutive effect on the earnings of the Company. The
Rights expire on February 16, 2009.
The holders of Series A Stock would be entitled to a preference with
respect to dividends and liquidation.
Retained Earnings
The Company may not declare or pay cash dividends on its common stock if
the effect thereof would cause its net worth to be reduced below regulatory net
worth requirements or if such declaration and payment would otherwise violate
regulatory requirements.
On April 23, 1998, the Company declared a 25% stock split to be distributed
on May 18, 1998. All earnings per share, dividends and share information prior
to June 30, 1998, has been retroactively adjusted to reflect this stock split.
-54-
<PAGE> 61
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
The Banks are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Banks' financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Banks
must meet specific capital guidelines that involve quantitative measures of the
Banks' assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Banks' capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Banks to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to risk
weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes that as of December 31, 1998, the Banks
meet all capital adequacy requirements to which they are subject.
As of December 31, 1998, the most recent notification from the FDIC
categorized the Banks as well capitalized under the prompt corrective action
provisions. To be categorized as well capitalized, the Banks must maintain total
capital risk-based, Tier 1 capital risk-based, and Tier 1 capital leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes would cause a change in the Banks'
categorization.
The Company's and both Banks' actual capital amounts and ratios in addition
to the minimum capital requirements and well capitalized capital requirements at
December 31 follow:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
MINIMUMS PROMPT CORRECTIVE
ACTUAL ADEQUACY ACTION PROVISIONS
---------------------- ---------------------------- ------------------------------
(DOLLARS IN THOUSANDS)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
AS OF DECEMBER 31, 1998
- -----------------------
Risk-based capital ratios:
Total capital
<S> <C> <C> <C> <C> <C> <C>
Andover Bancorp, Inc.............. $130,361 15.4% $67,675 >8.0% $84,594 >10.0%
- -
Andover Bank...................... 111,872 14.3 62,705 >8.0 78,381 >10.0
- -
Andover Bank NH................... 8,707 14.1 4,953 >8.0 6,191 >10.0
- -
Tier 1 capital
Andover Bancorp, Inc.............. 119,875 14.2 33,837 >4.0 50,756 >6.0
- -
Andover Bank...................... 102,074 13.0 31,352 >4.0 47,029 >6.0
- -
Andover Bank NH................... 8,234 13.3 2,476 >4.0 3,714 >6.0
- -
Leverage capital ratio:
Tier 1 capital
Andover Bancorp, Inc.............. 119,875 8.7 54,997 >4.0 68,746 >5.0
- -
Andover Bank...................... 102,074 7.9 51,695 >4.0 64,619 >5.0
- -
Andover Bank NH................... 8,234 9.0 3,659 >4.0 4,574 >5.0
- -
AS OF DECEMBER 31, 1997
- -----------------------
Risk-based capital ratios:
Total capital
Andover Bancorp, Inc.............. $115,474 15.0% $61,435 >8.0% $76,794 >10.0%
- -
Andover Bank...................... 103,677 14.4 57,676 >8.0 72,095 >10.0
- -
Andover Bank NH................... 7,801 16.1 3,866 >8.0 4,832 >10.0
- -
Tier 1 capital
Andover Bancorp, Inc.............. 105,875 13.8 30,718 >4.0 46,076 >6.0
- -
Andover Bank...................... 94,665 13.1 28,838 >4.0 43,257 >6.0
- -
Andover Bank NH................... 7,403 15.3 1,933 >4.0 2,899 >6.0
- -
Leverage capital ratio:
Tier 1 capital
Andover Bancorp, Inc.............. 105,875 8.2 51,901 >4.0 64,877 >5.0
- -
Andover Bank...................... 94,665 7.7 48,892 <4.0 61,115 >5.0
- -
Andover Bank NH................... 7,403 8.7 3,402 >4.0 4,252 >5.0
- -
</TABLE>
-55-
<PAGE> 62
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(13) OTHER INCOME
Components of other income for the years ended December 31, follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Deposit account service charges and other fees......................... $2,289 $2,007 $1,792
Loan late charges and other fees..................................... 703 407 437
Rental income........................................................ 322 319 244
Other................................................................ 577 559 236
-------- -------- --------
$3,891 $3,292 $2,709
====== ====== ======
</TABLE>
(14) EMPLOYEE BENEFITS
Pension Plan and Postretirement Benefits Other Than Pensions
The Company sponsors a non-contributory defined benefit pension plan that
covers all employees who meet specified age and length of service requirements,
which is administered by Northeast Retirement Services, Inc. The plan provides
for benefits to be paid to eligible employees at retirement based primarily upon
their years of service with the Company and compensation levels near retirement.
Contributions to the plan are funded currently and reflect benefits attributed
to employees' service to date, as well as services expected to be earned in the
future. In addition, the Bank provides health care and life insurance benefits
for certain eligible retired employees and dependents. Certain changes in the
items shown below are not recognized as they occur, but are amortized
systematically over subsequent periods.
As amended by SFAS 132, the components of the pension plan and the
postretirement benefits plan for the years ended October 31, and December 31,
respectively, follow:
<TABLE>
<CAPTION>
PENSION PLAN OTHER BENEFITS PLAN
--------------------- ------------------------
1998 1997 1998 1997
---- ---- ---- ----
(IN THOUSANDS)
CHANGE IN BENEFIT OBLIGATION
<S> <C> <C> <C> <C>
Benefit obligation at beginning of year.................... $ 5,946 $4,992 $ 333 $ 248
Service cost............................................... 702 564 ------- ---
Interest cost.............................................. 418 364 21 22
Actuarial loss (gain)...................................... 536 256 42 97
Benefits paid.............................................. (242) (230) (36) (34)
------- ------ ------- ------
Benefit obligation at end of year.......................... $ 7,360 $5,946 $ 360 $ 333
======= ====== ======= =====
CHANGE IN PLAN ASSETS
Fair value at beginning of year............................ $ 5,194 $4,269 $ --- $ ---
Actual return on plan assets............................... 426 777 --- ---
Company contribution....................................... 482 378 --- ---
Benefits paid.............................................. (242) (230) --- ---
------- ------ ------- -------
Fair value at end of year.................................. $ 5,860 $5,194 $ --- $ ---
======= ====== ======= =======
RECONCILIATION OF THE FUNDING STATUS
Transition assets.......................................... $ 168 $ 182 $ --- $ ---
Deferred gain (loss)....................................... (149) 426 7 13
Prepaid (accrued) expense.................................. (1,519) (1,360) (367) (346)
------- ------ ------- -----
Funded status.............................................. $(1,500) $ (752) $ (360) $(333)
======= ====== ======= =====
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost............................................... $ 702 $ 564 $ --- $ ---
Interest cost.............................................. 418 364 21 22
Expected return on plan assets............................. (467) (384) --- ---
Transition obligation...................................... (14) (14) --- ---
Actuarial loss (gain)...................................... 2 (4) --- (1)
------- ------ ------- -------
Net periodic benefit cost.................................. $ 641 $ 526 $ 21 $ 21
======= ====== ======= =======
</TABLE>
-56-
<PAGE> 63
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
Assumptions used to develop the net periodic benefit obligation follow:
<TABLE>
<CAPTION>
PENSION PLAN OTHER BENEFITS PLAN
-------------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Discount rate.............................................................. 6.50% 7.00% 6.00% 7.00%
Rate of increase in compensation levels.................................... 4.75% 4.75% --- ---
Assumptions used to develop the net periodic benefit cost follow:
Discount rate............................................................... 6.50% 7.00% 6.00% 7.00%
Rate of increase in compensation levels..................................... 4.75% 4.75% --- ---
Expected long-term rate of return on assets................................. 9.00% 9.00% --- ---
</TABLE>
The net periodic benefit cost for the pension plan and other benefits plan
totaled $587,000 and $17,000, respectively, for the year ended December 31,
1996.
On February 18, 1999, the Board of Directors of the Company voted to
terminate the defined benefit pension plan. This termination is subject to
regulatory approvals and is expected to generate a pretax gain of approximately
$1.4 million in 1999.
Stock Option Plans
The Company has stock options issued under two separate plans for the
benefit of certain officers and non-employee directors. The first plan, the 1986
Stock Option Plan, had 750,000 shares of authorized but unissued common stock.
All but 4,500 shares were granted prior to the Plan's expiration in 1996. A
second plan, the Stock Incentive Plan, was adopted in 1995 with 311,418 shares
of authorized but unissued common stock. The exercise price of any option
granted will be equal to the fair market value of the Common Stock on the date
the option is granted. Stock options are exercisable over various periods
commencing on the date of the grant and in no event later than ten years after
the date of the grant.
A summary of stock option activity for the years ended December 31,
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------- ---------------------- ---------------------
WTD. AVG. WTD.AVG. WTD. AVG.
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year.............. 505,388 $14.92 488,370 $12.59 420,776 $10.74
Granted.................................. 69,575 34.50 59,750 30.50 132,000 16.57
Exercised................................ (60,114) 11.64 (42,732) 10.05 (62,156) 8.64
Forfeited................................ (2,250) 27.67 --- --- (2,250) 9.81
------- ------- -------
Outstanding at end of year.................... 512,599 17.91 505,388 14.92 488,370 12.59
======= ======= =======
Exercisable at end of year.................... 495,098 18.00 475,637 14.89 450,870 12.44
======= ======= =======
Shares reserved for future grants............. 170,081 237,406 297,156
======= ======= =======
</TABLE>
A summary of options outstanding and exercisable by price range as of
December 31 follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C>
OUTANDING WTD. AVG. EXERCISABLE
RANGE OF AS OF REMAINING WTD. AVG. AS OF WTD. AVG.
EXERCISE PRICES 12/31/98 CONTRACTUAL LIFE EXERCISE PRICE 12/31/98 EXERCISE PRICE
--------------- -------- ---------------- -------------- -------- --------------
$ 2.1667 - $ 6.7500.............. 42,297 3.6 $ 5.4795 42,297 $ 5.4795
$ 6.7600 - $11.7500.............. 73,527 5.4 $ 10.0011 73,527 $10.0011
$11.7600 - $14.2500.............. 153,500 6.2 $13.9937 146,000 $13.9934
$14.2600 - $22.0000.............. 125,075 7.3 $16.7843 116,075 $16.9162
$28.0000 - $34.8000.............. 118,200 9.5 $33.5525 117,199 $33.6000
------- -------
512,599 6.9 $17.9094 495,098 $17.9996
======= === ======== ======= ========
</TABLE>
-57-
<PAGE> 64
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
The Company applies APB Opinion No. 25 in accounting for stock options and,
accordingly, no compensation expense has been recognized in the financial
statements. Had the Company determined compensation expense based on the fair
value at the grant date for its stock options under SFAS 123, the Company's net
income would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net income as reported.............................................. $17,386 $13,206 $12,479
Pro forma net income................................................ 16,807 12,803 12,156
Earnings per common share as reported (basic)....................... 2.68 2.05 1.95
Pro forma earnings per common share (basic)......................... 2.59 1.99 1.91
Earnings per common share as reported (diluted)..................... 2.60 1.99 1.92
Pro forma earnings per common share (diluted)....................... 2.51 1.93 1.87
</TABLE>
Pro forma net income reflects only options granted since 1995, therefore,
the full impact of calculating the compensation expense for stock options under
SFAS 123 is not reflected in the pro forma net income amounts provided above
since options granted prior to January 1, 1995 are not considered. The per share
weighted average fair value of stock options granted during 1998, 1997 and 1996
was $10.07, $8.28 and $3.67, respectively, on the date of grant. These fair
values were determined using the Black Scholes option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Expected dividend yield............................................. 2.75% 3.00% 3.00%
Risk-free interest rate............................................. 4.87% 5.84% 6.65%
Expected volatility................................................. 30.00% 25.00% 25.00%
Expected life (years)............................................... 6.70 7.00 6.20
</TABLE>
Employee Stock Ownership Plan
The Company maintains an Employee Stock Ownership Plan (the "ESOP") that
covers all employees who meet specified age and length of service requirements.
Contributions are made for the purchase of additional shares of Company stock
and accordingly, a charge to salaries and employee benefits expense is recorded.
During 1997, the Company changed the fiscal year end of the ESOP to October 31,
1997 to coincide with the fiscal year end of the defined benefit pension plan.
Approximately 11,552 shares of common stock were purchased in the open market
during 1998 at an average price of $32.32 per share, which when combined with
forfeited shares are allocated to participants proportionately to their gross
wages. In 1997 and 1996, 15,316 and 21,095 shares were purchased at an average
price of $24.45 and $15.37 per share, respectively. Contributions by the Bank to
the ESOP for participants for the years ended October 31, 1998 and 1997 and the
year ended December 31, 1996 were $375,000, $385,000 and $325,000, respectively.
Thrift Incentive Plan
The Company has an employee tax deferred thrift incentive plan (401K) under
which individual employee contributions to the plan are matched within certain
limitations by the Banks. All employees who meet specified age and length of
service requirements are eligible to participate in the 401K plan. The amounts
matched by the Banks are included in salaries and employee benefits expense. The
amounts matched for the years ended December 31, 1998, 1997 and 1996 were
$94,000, $71,000 and $54,000, respectively.
Officers Incentive Compensation Plan
The Incentive Compensation Plan provides for the payment of bonuses to
officers under certain circumstances based upon the Company's pre-tax earnings
adjusted for gains or losses from sales of assets, targeted returns on assets
and the individual's accomplishment of established goals and objectives. Amounts
are to be allocated to participants as determined by the Company's Compensation
and Option Committee based on the recommendation of the President and subject to
approval by its Board of Directors.
In 1998, 1997 and 1996, $490,000, $318,000 and $293,000, respectively, was
charged to salaries and employee benefits expense under this plan.
-58-
<PAGE> 65
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
Executive Officer Employment and Termination Agreements
The Company maintains an employment agreement with its President and Chief
Executive Officer, The employment agreement generally provides for the continued
payment of specified compensation and benefits for specified periods after
termination, unless the termination is for "cause" as defined in the employment
agreement. In addition, the Company has entered into special termination
agreements with its President and Chief Executive Officer and certain other
executives which provide for the payment, under certain circumstances, of
lump-sum amounts upon termination following a "change of control" which is
generally defined to mean a person or group acquiring ownership of 25% or more
of the shares of the Company.
Deferred Compensation Plan
The Company has adopted a deferred compensation plan for its directors
whereby a non-employee director can elect to defer earned fees to future years
with benefits commencing at retirement. In 1996, this unfunded plan was amended
to allow the directors to change their deferred compensation account to
equivalent stock units in the Company's common stock, permit distribution upon
retirement to be paid in shares of common stock, or to choose to receive
interest credits based on an equivalent rate on a term certificate of deposit.
The deferred compensation attributed to the directors for the years ended
December 31, 1998, 1997 and 1996 totaled $107,800, $88,900 and $54,300,
respectively. In 1998, 3,270 equivalent stock units were allocated at an average
price of $32.80, in 1997, 4,277 equivalent stock units were allocated at an
average price of $23.93 and in 1996, 11,529 equivalent stock units were
allocated at an average price of $16.10.
(15) FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets and liabilities that are not
considered financial assets or liabilities include real estate acquired by
foreclosure, the deferred income tax asset, office properties and equipment,
core deposits and other intangibles. In addition, the tax ramifications related
to the realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in any of the
estimates. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company. The estimated fair value amounts
have been determined by using available quoted market information or other
appropriate valuation methodologies.
The fair value estimates provided are made at a specific point in time,
based on relevant market information and the characteristics of the financial
instrument. The estimates do not provide for any premiums or discounts that
could result from concentrations of ownership of a financial instrument. Because
no active market exists for a portion of the Company's financial instruments,
certain fair value estimates are based on subjective judgments regarding current
economic conditions, risk characteristics of the financial instruments, future
expected loss experience, prepayment assumptions, and other factors. The
resulting estimates involve uncertainties and therefore cannot be determined
with precision. Changes made to any of the underlying assumptions could
significantly affect the estimates.
Financial instruments actively traded in a secondary market have been
valued at December 31 using quoted available market prices follow:
<TABLE>
<CAPTION>
1998 1997
-------------------------- ----------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------ ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets held for sale......................................$ 11,282 $ 11,314 $ 5,537 $ 5,624
Investments available for sale............................ 165,491 165,491 139,054 139,054
Investments held to maturity.............................. 100,920 102,512 129,363 130,947
</TABLE>
-59-
<PAGE> 66
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
The fair values at December 31 of financial instruments with stated
maturities have been estimated by discounting cash flows with a discount rate
approximately equal to the current market rate for similar instruments follow:
<TABLE>
<CAPTION>
1998 1997
------------------------------ ---------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------ ---------- ------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans receivable, net...................................$1,040,279 $1,059,566 $966,302 $976,150
Mortgage servicing assets........................... 8,956 10,036 9,500 10,488
Fixed rate certificates............................... 482,893 487,410 522,422 525,322
Federal Home Loan Bank advances....................... 267,492 277,184 248,561 248,435
</TABLE>
The fair values at December 31 of financial instruments with no maturity or
short-term maturities that approximate their carrying amounts are as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------------- -------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------ ---------- ------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash and due from banks................................... $29,337 $29,337 $ 21,586 $ 21,586
Short-term investments................................... 16,100 16,100 14,150 14,150
Accrued interest receivable............................. 7,432 7,432 7,567 7,567
Stock in FHLB............................................ 15,747 15,747 15,747 15,747
Demand deposit accounts................................... 103,029 103,029 79,501 79,501
NOW accounts.............................................. 102,635 102,635 85,917 85,917
Regular savings accounts.................................. 199,304 199,304 149,607 149,607
Money market deposit accounts............................ 96,332 96,332 104,353 104,353
Variable rate certificates.............................. 4,463 4,463 5,182 5,182
Securities sold under agreements to repurchase........... 16,332 16,332 10,171 10,171
Mortgagors' escrow accounts............................ 2,819 2,819 2,478 2,478
</TABLE>
The following methods and assumptions were used to estimate fair value of
each class of financial instrument for which it is practicable to estimate fair
value. The fair values for investments available for sale and held to maturity
are based on quoted bid prices received from securities dealers. Commitments to
originate loans and forward commitments to sell loans have been considered in
the value of assets held for sale. Loans are estimated by discounting
contractual cash flows adjusted for prepayment estimates and using discount
rates approximately equal to current market rates on loans with similar
characteristics and maturities. The incremental credit risk for non-performing
loans has been considered in the determination of the fair value of loans.
Excess servicing is based on the present value of the estimated cash flows using
a current risk rate and taking into consideration estimated prepayments. Fixed
rate certificates and Federal Home Loan Bank advances are based on the
discounted value of contractual cash flows. The discount rates used are
representative of approximate rates currently offered on instruments with
similar remaining maturities. The fair values for cash and short-term
investments approximate their carrying amounts because of the short maturity of
these instruments. The fair values of accrued interest receivable, variable rate
certificates, securities sold under agreements to repurchase and mortgagors'
escrow accounts approximate their carrying amounts because of the short-term
nature of these financial instruments. The fair value of stock in the Federal
Home Loan Bank of Boston equals its carrying amount as reported in the balance
sheet because this stock is redeemable only at full par by the FHLB. The fair
values of demand deposit accounts, NOW accounts, regular savings accounts and
money market accounts are equal to their respective carrying amounts since they
are equal to the amounts payable on demand at the reporting date. The Company's
commitments for unused lines and outstanding standby letters of credit and
unadvanced portions of loans are at floating rates and, therefore, there is no
fair value adjustment.
-60-
<PAGE> 67
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(16) CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The following are the condensed financial statements for Andover Bancorp,
Inc., referred to as the "Parent Company" for purposes of this Note only, as of
December 31 follow:
BALANCE SHEETS
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
ASSETS
<S> <C> <C>
Cash and interest-bearing deposits in subsidiaries......................................$ 9,348 $ 3,611
Investment in subsidiaries, at equity.................................................... 111,573 103,272
Other assets.......................................................................... 377 349
------------ ------------
Total assets....................................................................$121,298 $107,232
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accrued income taxes............................................................$ 2 $ 2
Accrued expenses................................................................. 154 151
----------- ------------
Total liabilities........................................................... 156 153
----------- ------------
Total stockholders' equity............................................................... 121,142 107,079
--------- ---------
Total liabilities and stockholders' equity......................................$121,298 $107,232
======== ========
</TABLE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Dividends from bank subsidiaries.............................................$ 9,500 $ 7,000 $4,500
Interest income from deposits in subsidiaries.............................. 173 94 74
---------- --------- --------
Total operating income................................................. 9,673 7,094 4,574
Non-interest expenses...................................................... 402 334 240
---------- --------- -------
Income before income tax expense and
equity in net income of subsidiaries..................................... 9,271 6,760 4,334
Income tax expense........................................................ 48 21 93
---------- ---------- --------
Income before equity in net income of subsidiaries.......................... 9,223 6,739 4,241
Equity in net income of subsidiaries........................................ 8,163 6,467 8,238
--------- -------- --------
Net income....................................................................$17,386 $13,206 $12,479
======= ======= =======
</TABLE>
The Parent Company's statements of changes in stockholders' equity are
identical to the consolidated statements of changes in stockholders' equity and
therefore are not presented here.
-61-
<PAGE> 68
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
Cash flows from operating activities:
<S> <C> <C> <C>
Net income............................................................... $17,386 $13,206 $12,479
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiaries....................... (8,163) (6,467) (8,238)
Increase in other assets................................................. (28) (347) ---
Increase in other liabilities............................................ 3 5 51
------- ------- -------
Net cash provided by operating activities........................... 9,175 6,397 4,292
------- ------- -------
Cash flows from investing activities:
Investments in subsidiary................................................ --- (3,000) (1,000)
------- ------- -------
Net cash used by investing activities............................... --- (3,000) (1,000)
------- ------- -------
Cash flows from financing activities:
Stock options exercised.................................................. 1,023 700 653
Dividends paid to stockholders........................................... (4,484) (3,501) (2,553)
------- ------- -------
Net cash used by financing activities............................... (3,461) (2,801) (1,900)
------- ------- -------
Net increase in cash and interest-bearing
deposit in subsidiaries.................................................... 5,737 596 1,392
Cash and interest-bearing deposits in subsidiaries at
beginning of year.......................................................... 3,611 3,015 1,623
------- ------- -------
Cash and interest bearing deposits in subsidiaries at
end of year................................................................ $ 9,348 $ 3,611 $ 3,015
======= ======= =======
Supplemental cash flow information: Cash paid during the year for:
Income taxes........................................................ $ 48 $ 21 $ 13
</TABLE>
In the fourth quarter of 1998, the Board of Directors of the Company
approved a stock repurchase program. As of December 31, 1998, the Company had
not repurchased any shares of stock.
(17) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, COMMITMENTS AND
CONTINGENCIES
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to originate loans, standby letters of
credit, recourse arrangements on assets sold, and forward commitments to sell
loans. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amounts recognized in the Consolidated
Balance Sheets. The contract or notional amounts of those instruments reflect
the extent of involvement the Company has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters of
credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. For forward commitments to sell loans and mortgage-backed
securities, the contract or notional amounts do not represent exposure to credit
loss. The Company monitors the credit risk of its forward commitments through
credit approvals, limits, and monitoring procedures.
-62-
<PAGE> 69
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
Financial instruments with off-balance sheet risk at December 31 follow:
<TABLE>
<CAPTION>
CONTRACT OR
NOTIONAL AMOUNT
---------------
1998 1997
---- ----
(IN THOUSANDS)
Financial instruments whose contract amounts represent credit risk:
Commitments to originate loans:
<S> <C> <C>
Fixed rate loans.........................................................................$14,272 $15,993
Adjustable rate loans................................................................... 11,957 20,976
-------- ---------
Total commitments to originate loans................................................. 26,229 36,969
Unadvanced lines of home equity and reserve lines of credit............................. 76,343 77,391
Unadvanced lines on commercial loans.................................................... 15,354 12,671
Unadvanced portions of construction and land loans...................................... 28,602 21,300
Standby letters of credit.............................................................. 2,860 2,367
Loans sold with recourse............................................................... 1,892 2,777
Financial instruments whose notional or contract amounts exceed the amount of
credit risk:
Forward commitments to sell loans and mortgage-backed securities.........................$10,000 $ 7,820
</TABLE>
Commitments to originate loans, unused lines of credit, and unadvanced
portions of loans are agreements to lend to a customer provided there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since a portion of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on management's credit
evaluation of the borrower. Collateral held varies but may include accounts
receivable, inventory, equipment and real estate. Standby letters of credit are
conditional commitments issued by the Company to guarantee the performance by a
customer to a third party. The credit risk in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company has retained credit risk on certain residential mortgage loans
sold with recourse prior to June, 1990. Accordingly, the Company has retained
the risk of loss resulting from any foreclosures on such loans.
Forward commitments to sell loans or mortgage-backed securities are
contracts which the Company enters into for the purpose of reducing the interest
rate risk associated with originating loans for sale. In order to fulfill a
forward commitment, the Company typically exchanges its current production of
loans for mortgage-backed securities through FNMA or FHLMC which are then
delivered to a national securities firm at a future date at prices or yields
specified by the contracts. Risks may arise from the possible inability of the
Company to originate loans to fulfill these contracts, in which case the Company
would normally purchase securities in the open market to deliver against the
contract. Unrealized gains and losses on contracts used for the Company's closed
loans and pipeline of loans expected to close are considered in adjusting
carrying values of the loans held for sale to the lower of cost or market.
As a nonmember of the Federal Reserve System, the Company is required to
maintain certain reserve requirements or vault cash and/or deposits with the
Federal Reserve Bank of Boston. The amount of this reserve requirement, included
in "Cash and due from banks", was $1,141,000 and $998,000 at December 31, 1998
and 1997, respectively.
A number of legal claims against the Company arising in the normal course
of business were outstanding at December 31, 1998. Management, after reviewing
these claims with legal counsel, is of the opinion that the resolution of these
claims will not have a material effect on the Company's financial position.
-63-
<PAGE> 70
ANDOVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998, 1997 and 1996
(18) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarterly earnings per share is calculated by dividing quarterly net income
by the average shares outstanding each quarter. Therefore, the sum of the
quarters may not equal the net earnings per common share for the year. A
discussion of the difference between basic and diluted earnings per share is
presented in footnote 1. The per share data has been restated for 1997 and the
first quarter of 1998 to reflect a 25% stock split distributed on May 18, 1998.
Summaries of consolidated operating results on a quarterly basis for the
years ended December 31, follow:
<TABLE>
<CAPTION>
1998 QUARTERS
---------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
<S> <C> <C> <C> <C>
Interest and dividend income................................... $24,147 $24,487 $24,430 $24,182
Interest expense............................................... 13,827 14,133 13,917 13,138
------- -------- ------- -------
Net interest and dividend income............................... 10,320 10,354 10,513 11,044
Provision (credit) for loan losses............................. 45 (2,250) (a) 400 100
Gains/(losses) on real estate operations....................... (76) 100 13 (23)
Non-interest income............................................ 1,109 1,319 850 894
Non-interest expense........................................... 5,680 5,703 5,625 5,569
------- -------- ------- -------
Income before income tax expense............................... 5,628 8,320 5,351 6,246
Income tax expense............................................. 1,926 3,070 878 (b) 2,285
------- -------- ------- -------
Net income..................................................... $ 3,702 $ 5,250 $ 4,473 $ 3,961
======= ======== ======= =======
Basic earnings per common share................................ $ 0.57 $ 0.81 $ 0.69 $ 0.61
======= ======== ======= =======
Diluted earnings per common share.............................. $ 0.55 $ 0.78 $ 0.67 $ 0.59
======= ======== ======= =======
Dividends declared per share................................... $ 0.15 $ 0.18 $ 0.18 $ 0.18
======= ======== ======= =======
1997 QUARTERS
---------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Interest and dividend income................................... $21,965 $22,283 $22,759 $23,745
Interest expense............................................... 12,486 12,798 13,107 13,656
------- ------- ------- -------
Net interest and dividend income............................... 9,479 9,485 9,652 10,089
Provision for loan losses...................................... 330 223 130 300
Losses on real estate operations............................... (357) (228) (235) (151)
Non-interest income............................................ 1,350 1,504 1,503 1,372
Non-interest expense........................................... 5,168 5,556 5,520 5,742
------- ------- ------- -------
Income before income tax expense............................... 4,974 4,982 5,270 5,268
Income tax expense............................................. 1,766 1,800 1,922 1,800
------- ------- ------- -------
Net income..................................................... $ 3,208 $ 3,182 $ 3,348 $ 3,468
======= ======= ======= =======
Basic earnings per common share................................ $ 0.50 $ 0.49 $ 0.52 $ 0.54
======= ======= ======= =======
Diluted earnings per common share.............................. $ 0.49 $ 0.48 $ 0.50 $ 0.52
======= ======= ======= =======
Dividends declared per share................................... $ 0.12 $ 0.14 $ 0.14 $ 0.15
======= ======= ======= =======
</TABLE>
(a) Includes a credit for loan losses due to significant improvement in
non-performing assets and loan delinquencies.
(b) Includes a tax benefit of $1.1
million due to the favorable resolution of several tax issues.
-64-
<PAGE> 71
FORM 10-K
CROSS REFERENCE INDEX
PART 1
Item 1 Business............................................................2
Item 2 Properties..........................................................8
Item 3 Legal Proceedings...................................................9
Item 4 Submission of Matters to a Vote of Security Holders.................9
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters.................................................9
Item 6 Selected Consolidated Financial Data...............................10
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations................................11
Item 7A Quantitative and Qualitative Disclosures About
Market Risk........................................................27
Item 8 Financial Statements and Supplementary Data.................(See Item
14 below)
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..............................Non-
Applicable
PART III
The information called for by Part III (Items 10 through 13) is incorporated
herein by reference from Andover's Definitive Notice of Annual Meeting and Proxy
Statement for the 1999 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements-
Independent Auditors' Report.....................................35
Consolidated Balance Sheets as of December 31, 1998 and 1997.....36
Consolidated Statements of Operations for each of the
years ended December 31, 1998, 1997 and 1996.....................37
Consolidated Statements of Changes in Stockholders' Equity
for each of the years ended December 31, 1998, 1997 and 1996.....38
Consolidated Statements of Cash Flows for each of the
years ended December 31, 1998, 1997 and 1996..................39-40
Notes to Consolidated Financial Statements....................41-64
-65-
<PAGE> 72
(2) All financial statement schedules are omitted because they are
not applicable, the data is not significant, or the required
information is shown elsewhere in this report.
(b) Reports on Form 8-K. There were no reports filed on Form 8-K
during the three months ended December 31, 1998.
(c) List of Exhibits
Exhibits to the Form 10-K have been included only with the copies
of the Form 10-K filed with the SEC. Upon request to Shareholder
Relations, Andover Bancorp, Inc., 61 Main Street, Andover,
Massachusetts 01810, copies of the individual exhibits will be
furnished upon payment of a reasonable fee.
EXHIBIT NO. DESCRIPTION OF EXHIBITS
3.1 Restated Certificate of Incorporation of Andover (incorporated
herein by reference to Exhibit 3.1 to Post-Effective Amendment
No. 1 to Andover's Registration Statement on Form S-4 No.
33-11891 filed on March 5, 1987).
3.2 By-laws of Andover, as amended and restated, January 23, 1997
(incorporated herein by reference to Exhibit 3.2 to Andover's
Form 10-K for the fiscal year ended December 31, 1996).
4.1 Specimen of Andover Bancorp, Inc. common stock certificate
(incorporated herein by reference to Exhibit 4 to Andover's
Registration Statement on Form S-4, Registration No. 33-11891,
filed on February 11, 1987).
4.2 Shareholder Rights Agreement between Andover Bancorp, Inc.
and BankBoston (incorporated herein by reference to an Exhibit to
Andover's Current Report on Form 8-K filed January 22, 1999).
10.1 Employment Agreement between Andover, Andover Bank and Gerald T.
Mulligan, dated May 16, 1991 (incorporated herein by reference to
Exhibit 10.1 to Andover's Form 10-K for the fiscal year ended
December 31, 1991).
10.2 Special Termination Agreement between Andover, Andover Bank and
Gerald T. Mulligan, dated May 16, 1991, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.2 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.3 Special Termination Agreement between Andover, Andover Bank and
Joseph F. Casey, dated December 17, 1992, as amended and restated
through January 23, 1997 (incorporated herein by reference to
Exhibit 10.3 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.4 Special Termination Agreement between Andover, Andover Bank and
Michael J. Ecker, dated December 17, 1992, as amended and
restated through January 23, 1997 (incorporated herein by
reference to Exhibit 10.4 to Andover's Form 10-K for the fiscal
year ended December 31, 1996).
10.5 Special Termination Agreement between Andover, Andover Bank and
John R. Heerwagen, dated December 17, 1992, as amended and
restated through January 23, 1997 (incorporated herein by
reference to Exhibit 10.5 to Andover's Form 10-K for the fiscal
year ended December 31, 1996).
10.6 Special Termination Agreement between Andover, Andover Bank and
Octavio C. Bolivar dated January 24, 1994, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.6 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
-66-
<PAGE> 73
10.7 Andover Savings Bank Employees' Stock Ownership Plan and Trust
Agreement and Amendment No. 1 (incorporated herein by reference
to Exhibit 10(c) to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1987).
10.8 Andover Bancorp, Inc. Stock Option Plan dated May 8, 1986, as
amended May 22, 1986, January 29, 1987, and November 2, 1987
(incorporated herein by reference to Exhibit 10(h) to Andover's
Annual Report on Form 10-K for the fiscal year ended December 31,
1987).
10.9 Special Termination Agreement between Andover, Andover Bank and
Raymond P. Smith, dated December 12, 1995, as amended and
restated, January 23, 1997 (incorporated herein by reference to
Exhibit 10.9 to Andover's Form 10-K for the fiscal year ended
December 31, 1996).
10.10 Andover Bancorp, Inc. 1995 Stock Incentive Plan, dated February
16, 1995 (incorporated herein by reference to Exhibit 10.11 to
Andover's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.11 Deferred Compensation Plan for Directors of Andover Bancorp, Inc.
and its Subsidiaries, effective July 1, 1993, as amended and
restated, February 22, 1996 (incorporated herein by reference to
Exhibit 10.12 to Andover's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.12 Andover Bancorp, Inc. Special Termination Plan, effective January
23, 1997 (incorporated herein by reference to Exhibit 10.12 to
Andover's Form 10-K for the fiscal year ended December 31, 1996).
11 The computation of per share earnings can be readily determined
from the material contained in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1998.
12 As the Company does not have any debt securities registered under
Section 12 of the Securities Act of 1933, no ratio of earnings to
fixed charges appears in this Annual Report on Form 10-K.
13 Andover Bancorp, Inc. 1998 Annual Report, which, except for those
portions expressly incorporated herein by reference, is furnished
only for the information of the Securities and Exchange
Commission and is not deemed to be filed.
21 The Company has two subsidiaries, Andover Bank and Andover Bank
NH. Andover Bank is a Massachusetts savings bank in stock form
while Andover Bank NH is a New Hampshire guaranty savings bank in
stock form. Both subsidiaries are included in the Consolidated
Financial Statements filed in the Annual Report on Form 10-K for
the fiscal year ended December 31, 1998.
23.1 Consent of KPMG Peat Marwick LLP.
-67-
<PAGE> 74
NOTES
-68-
<PAGE> 75
SHAREHOLDER INFORMATION
TRANSFER AGENT AND REGISTRAR
Our Transfer Agent is responsible for our shareholder records, issuance of stock
certificates, distribution of our dividend and the IRS Form 1099 and
administration of our dividend reinvestment and stock purchase program. Your
requests as shareholders, concerning these matters, are most efficiently
answered by corresponding directly with BankBoston, NA at the following address:
BankBoston, NA
c/o Equiserve Limited Partnership
PO Box 8040
Boston, MA 02266
781*575*3001 800*730*4001
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN/GENERAL INFORMATION
Shareholders may obtain a brochure containing a detailed description of the Plan
or other general shareholder information by corresponding directly with Andover
Bancorp, Inc. at the following address:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
KPMG Peat Marwick LLP
99 High Street
Boston, MA 02110
FORM 10-K
An additional copy of Andover's 1998 Annual Report on Form 10-K, as filed with
the Securities and Exchange Commission pursuant to the Securities and Exchange
Act of 1934, may be obtained without charge by contacting:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
FDIC COMPLIANCE
A copy of this report is being made available to the public on request as
required by the Federal Deposit Insurance Corporation ("FDIC"). The contents of
this report have not been reviewed or confirmed for the accuracy or relevance by
the FDIC. A copy of Management's Report on the effectiveness of the Company's
internal control structure over financial reporting, and the Independent
Accountants' Report of KPMG Peat Marwick LLP thereon, may be obtained without
charge by contacting:
Andover Bancorp, Inc., Shareholder Relations
PO Box 2005
Andover, MA 01810
978*749*2216
================================================================================
ANDOVER BANK DIRECTORS
Thomas F. Caffrey*
Paul J. Donahue, Sr.
Clifford E. Elias*
John E. Fenton Jr.
Naomi A. Gardner*
Frank D. Goldstein
Cornelius J. McCarthy*
Gerald T. Mulligan*
Irving E. Rogers, III
Robert J. Scribner*
Fred P. Shaheen*
*ALSO DIRECTORS OF ANDOVER BANCORP, INC.
ANDOVER BANK NH DIRECTORS
John P. Bachini
Joseph F. Casey
John D. Collins
George J. Khoury
Gerald T. Mulligan
Raymond P. Smith
Marie S. Tucarella
ANNUAL MEETING
The Annual Meeting of the Shareholders of Andover
Bancorp, Inc. will be held
at 10 a.m. on Thursday,
April 29, 1999 at the
Andover Town House,
20 Main Street, Andover, Massachusetts.
<PAGE> 76
[NEW HAMPSHIRE PICTURE]
<TABLE>
<CAPTION>
ANDOVER BANK Member FDIC/DIF
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
MAIN OFFICE 450 Essex Street 547 Broadway 91 Pleasant Valley Street 995 Main Street
61 Main Street Lawrence, MA 01840 Methuen, MA 01844 Methuen, MA 01844 Tewksbury, MA 01876
Andover, MA 01810
305 South Broadway 228 Haverhill Street 108 Main Street 2171 Main Street
159 River Road Lawrence, MA 01843 Methuen, MA 01844 North Andover, MA 01845 Tewksbury, MA 01876
Andover, MA 01810
ANDOVER BANK NH Member FDIC
- ------------------------------------------------------------------------------------------------------------------------------------
Main Office 62 Nashua Road (Rt. 102)
130 Main Street Londonderry, NH 03053
Salem, NH 03079
ANDOVER CAPITAL GROUP, INC.
- ------------------------------------------------------------------------------------------------------------------------------------
238 Littleton Road, Westford, MA 01886
TELEPHONE SALES & SERVICE CENTER
1 800 2CALL AB
</TABLE>
0685-AR-99
<PAGE> 1
KPMG PEAT MARWICK LLP
99 High Street Telephone 617 988 1000 Telefax 617 988 0800
Boston, MA 02110-2371
Exhibit 23.1
INDEPENDENT AUDITORS CONSENT
The Board of Directors and Stockholders
ANDOVER BANCORP, INC.:
We consent to incorporation by reference in Registration Statement No. 33-21975
on Form S-8 of Andover Bancorp, Inc. of our report dated January 14, 1999,
relating to the consolidated balance sheets of Andover Bancorp, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1998, which report
is included herein.
/s/ KPMG PEAT MARWICK LLP
Boston, Massachusetts
March 9, 1999
[KPMG LOGO]
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS DATED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 29,337
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 16,100
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 11,282
<INVESTMENTS-CARRYING> 100,920
<INVESTMENTS-MARKET> 102,512
<LOANS> 1,050,765
<ALLOWANCE> 10,486
<TOTAL-ASSETS> 1,410,247
<DEPOSITS> 988,656
<SHORT-TERM> 16,332
<LIABILITIES-OTHER> 16,625
<LONG-TERM> 267,492
0
0
<COMMON> 652
<OTHER-SE> 120,490
<TOTAL-LIABILITIES-AND-EQUITY> 1,410,247
<INTEREST-LOAN> 77,358
<INTEREST-INVEST> 19,888
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 97,246
<INTEREST-DEPOSIT> 39,137
<INTEREST-EXPENSE> 55,015
<INTEREST-INCOME-NET> 42,231
<LOAN-LOSSES> (1,705)
<SECURITIES-GAINS> 670
<EXPENSE-OTHER> 22,577
<INCOME-PRETAX> 25,545
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,386
<EPS-PRIMARY> 2.68
<EPS-DILUTED> 2.60
<YIELD-ACTUAL> 3.18
<LOANS-NON> 3,240
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 12,521
<CHARGE-OFFS> 1,500
<RECOVERIES> 1,170
<ALLOWANCE-CLOSE> 10,486
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
