<PAGE> 1
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-16947
PEOPLES HERITAGE FINANCIAL GROUP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Maine 01-0437984
------------------------------ ----------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
One Portland Square, Portland, Maine 04112
--------------------------------------- ----------
(Address of principal executive offices (Zip Code)
(207) 761-8500
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports); and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock as of November
1, 1999 is:
Common stock, par value $.01 per share 102,101,513
- -------------------------------------- -------------
(Class) (Outstanding)
<PAGE> 2
INDEX
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998 3
Consolidated Statements of Income -
Three and Nine Months ended September 30, 1999
and 1998 4
Consolidated Statements of Changes in Shareholders'
Equity - Nine months ended September 30, 1999
and 1998 5
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1999 and 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 33
PART II. OTHER INFORMATION
Item 1. Legal proceedings 33
Item 2. Changes in securities 33
Item 3. Defaults upon senior securities 33
Item 4. Submission of matters to a vote of security holders 33
Item 5 Other information 33
Item 6 Exhibits and reports on Form 8-K 33
Signatures 33
2
<PAGE> 3
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, 1999 December 31,1998
------------------ ----------------
ASSETS (Unaudited)
<S> <C> <C>
Cash and due from banks $ 278,761 $ 415,435
Federal funds sold and other short term investments 183,334 283,878
Securities available for sale, at market value 5,412,505 2,986,131
Securities held to maturity (fair value of $559,572
and $245,555 at September 30, 1999 and
December 31, 1998, respectively) 565,783 245,233
Loans held for sale 98,575 517,754
Loans and leases:
Residential real estate mortgages 1,387,692 2,230,615
Commercial real estate mortgages 1,786,810 1,621,890
Commercial business loans and leases 1,276,754 1,146,242
Consumer loans and leases 2,239,913 2,089,284
----------- -----------
6,691,169 7,088,031
Less: Allowance for loan and lease losses 110,788 110,561
----------- -----------
Net loans and leases 6,580,381 6,977,470
Premises and equipment 140,749 144,574
Goodwill and other intangibles 114,206 124,363
Mortgage servicing rights 48,103 40,088
Bank-owned life insurance 225,329 66,944
Other assets 233,138 248,369
=========== ===========
$13,880,864 $12,050,239
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Regular savings $ 1,282,419 $ 1,284,074
Money market and NOW accounts 2,143,584 2,073,793
Certificates of deposit 3,256,083 3,455,541
Brokered deposits 143,819 257,570
Demand deposits 1,276,536 1,305,737
----------- -----------
Total deposits 8,102,441 8,376,715
Federal funds purchased and securities sold under
repurchase agreements 565,760 591,970
Borrowings from the Federal Home Loan Bank of Boston 4,206,474 1,936,585
Other borrowings 30,542 25,659
Other liabilities 54,739 118,182
----------- -----------
Total liabilities 12,959,956 11,049,111
----------- -----------
Company obligated, mandatory redeemable securities of
subsidiary trust holding solely parent junior
subordinated debentures 68,775 100,000
Shareholders' Equity:
Preferred stock (par value $0.01 per share, 5,000,000
shares authorized, none issued) -- --
Common stock (par value $0.01 per share, 200,000,000
shares authorized, 106,647,439 and 106,647,585
shares issued) 1,066 1,066
Paid-in capital 508,836 509,473
Retained earnings 499,159 447,438
Unearned compensation (1,775) (2,027)
Accumulated other comprehensive income (loss):
Net unrealized loss on securities available for sale (70,752) (1,651)
Treasury stock, at cost (4,575,261 shares and
2,845,731 shares) (84,401) (53,171)
----------- -----------
Total shareholders' equity 852,133 901,128
----------- -----------
$13,880,864 $12,050,239
=========== ===========
See accompanying notes to Consolidated Financial Statements.
</TABLE>
3
<PAGE> 4
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data) (Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------- -------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Interest and dividend income:
<S> <C> <C> <C> <C>
Interest on loans and leases $ 141,610 $ 169,675 $ 436,016 $ 508,114
Interest and dividends on securities 95,131 40,536 231,323 120,390
------------ ------------ ------------ ------------
Total interest and dividend income 236,741 210,211 667,339 628,504
Interest expense:
Interest on deposits 62,185 71,142 190,589 214,087
Interest on borrowed funds 59,753 31,600 144,883 94,177
------------ ------------ ------------ ------------
Total interest expense 121,938 102,742 335,472 308,264
Net interest income 114,803 107,469 331,867 320,240
Provision for loan and lease losses 3,565 3,973 10,695 10,457
------------ ------------ ------------ ------------
Net interest income after provision
for loan and lease losses 111,238 103,496 321,172 309,783
Noninterest income:
Customer services 14,405 10,262 37,955 29,817
Mortgage banking services 3,496 5,445 14,277 22,329
Insurance commissions 4,681 3,362 14,277 9,050
Trust services 3,556 3,060 10,741 9,188
Investment advisory services 1,361 1,249 3,821 2,917
Bank-owned life insurance income 3,067 881 8,385 2,807
Net securities gains 3 1,457 281 3,509
Other noninterest income 1,551 3,240 5,597 8,329
------------ ------------ ------------ ------------
32,120 28,956 95,334 87,946
Noninterest expenses:
Salaries and employee benefits 41,070 40,141 120,410 123,136
Data processing 6,886 6,773 20,985 18,183
Occupancy 6,727 6,409 20,631 20,229
Equipment 5,313 4,619 15,527 15,355
Distributions on securities of subsidiary trust 1,558 2,265 5,129 6,795
Amortization of goodwill and other intangibles 2,933 2,888 8,834 8,664
Telephone 2,888 2,315 8,015 6,239
Advertising and marketing 2,158 2,905 6,812 8,558
Special charges -- -- 33,235 35,374
Other noninterest expenses 9,969 9,981 30,240 35,098
------------ ------------ ------------ ------------
79,502 78,296 269,818 277,631
Income before income tax expense 63,856 54,156 146,688 120,098
Applicable income tax expense 21,275 16,914 49,847 39,204
------------- ------------ ------------ ------------
Net income $ 42,581 $ 37,242 $ 96,841 $ 80,894
============= ============ ============ ============
Weighted average shares outstanding:
Basic 102,841,836 103,319,214 103,427,165 103,529,930
Diluted 103,835,930 105,353,615 104,622,386 105,818,328
Earnings per share:
Basic $ 0.41 $ 0.36 $ 0.94 $ 0.78
Diluted 0.41 0.35 0.93 0.76
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
4
<PAGE> 5
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Compen- Other
Par Paid-in Retained sation Comprehensive Treasury
Value Capital Earnings ESOP Income (Loss) Stock Total
----- ------- -------- ------ ------------ -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1998 $1,066 $509,473 $447,438 ($2,027) ($ 1,651) ($53,171) $901,128
Net income -- -- 96,841 -- -- -- 96,841
Unrealized losses on securities, net of
reclassification adjustment -- -- -- -- (69,101) -- (69,101)
--------
Comprehensive income 27,740
--------
Common stock issued for employee benefit plans -- -- (8,545) -- -- 22,515 13,970
Treasury stock purchased -- -- -- -- -- (53,745) (53,745)
Decrease in unearned compensation -- 1,167 -- 252 -- -- 1,419
Premium on repurchase of trust preferred
securities -- (1,801) -- -- -- -- (1,801)
Payment of fractional shares -- (3) -- -- -- -- (3)
Cash dividends -- -- (36,575) -- -- -- (36,575)
------ -------- -------- ------ ------- ------- --------
Balances at September 30, 1999 $1,066 $508,836 $499,159 ($1,775) ($70,752) ($84,401) $852,133
====== ======== ======== ====== ======= ======= ========
Balances at December 31, 1997 $1,052 $491,034 $379,017 ($3,123) $ 7,938 ($29,663) $846,255
Net income -- -- 80,894 -- -- -- 80,894
Unrealized losses on securities net of
reclassification adjustment -- -- -- -- (1,930) -- (1,930)
--------
Comprehensive income 78,964
--------
Cancellation of treasury shares at acquisition (1) (1,879) -- -- -- 1,880 --
Common stock issued for employee benefit plans 9 8,841 (2,122) (567) -- 12,232 18,393
Treasury stock purchased -- -- -- -- -- (24,457) (24,457)
Decrease in unearned compensation -- 1,029 -- 883 -- -- 1,912
Payment of fractional shares -- (36) -- -- -- -- (36)
Cash dividends -- -- (31,237) -- -- -- (31,237)
------ -------- -------- ------ ------- ------- --------
Balances at September 30, 1998 $1,060 $498,989 $426,552 ($2,807) $ 6,008 ($40,008) $889,794
====== ======== ======== ====== ======= ======= ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE> 6
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
<S> <C> <C>
Net income $ 96,841 $ 80,894
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses 10,695 10,457
Depreciation 14,596 14,439
Amortization of goodwill and other intangibles 8,834 8,664
Net (decrease) increase in net deferred tax liabilities (1,675) 29,304
ESOP and restricted stock expense 1,419 1,912
Net gains realized from sales of securities and consumer loans (281) (3,509)
Net losses realized from sales of loans held for sale (a component of
mortgage banking services) 1,961 15,578
Earnings from bank owned life insurance (8,385) (2,807)
Net (increase) decrease in mortgage servicing rights (8,015) 2,998
Proceeds from sales of loans held for sale 818,247 4,588,189
Residential loans originated and purchased for sale (401,029) (4,690,523)
Net decrease (increase) in interest and dividends receivable and other asset (39,176) (32,787)
Net increase (decrease) in other liabilities 34,954 (44,759)
----------- -----------
Net cash provided (used) by operating activities $ 528,986 $ (21,950)
----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale $ 27,461 $ 388,122
Proceeds from maturities and principal repayments of securities available for sale 1,117,456 780,706
Purchases of securities available for sale (3,435,870) (1,262,284)
Proceeds from maturities and principal repayments of securities held to maturity 66,952 65,201
Purchase of securities held to maturity -- (116,432)
Net (increase) decrease in loans and leases (246,341) 37,180
Purchase of bank owned life insurance (150,000) --
Net additions to premises and equipment (10,771) (10,606)
----------- -----------
Net cash provided (used) by investing activities $(2,631,113) $ (118,113)
----------- -----------
Cash flows from financing activities:
Net (decrease) increase in deposits $ (274,274) $ 207,579
Net increase (decrease) in securities sold under repurchase agreements (26,210) 48,350
Proceeds from Federal Home Loan Bank of Boston borrowings 2,885,000 2,942,790
Payments on Federal Home Loan Bank of Boston borrowings (615,111) (2,741,421)
Net increase (decrease) in other borrowings 4,883 9,769
Repurchase of trust preferred securities (33,026) --
Issuance of stock 13,967 17,027
Purchase of treasury stock (53,745) (24,457)
Dividends paid (36,575) (31,237)
----------- -----------
Net cash provided by financing activities $ 1,864,909 $ 428,400
----------- -----------
Increase (decrease) in cash and cash equivalents $ (237,218) $ 288,337
Cash and cash equivalents at beginning of period 699,313 390,426
----------- -----------
Cash and cash equivalents at end of period $ 462,095 $ 678,763
=========== ===========
</TABLE>
For the nine months ended September 30, 1999 and 1998, interest of $331,327 and
$314,136 and income taxes of $23,927 and $29,802 were paid, respectively.
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE> 7
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(IN THOUSANDS)
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles and predominant
practices within the banking industry. The Company has not changed its
accounting and reporting policies from those disclosed in its 1998 Annual Report
on Form 10-K.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of the consolidated financial
statements have been included. The results of operations and other data for the
nine months ended September 30, 1999 are not necessarily indicative of the
results that may be expected for any other interim period or the entire year
ending December 31, 1999. Certain amounts in the prior periods have been
reclassified to conform to the current presentation.
On January 1, 1999, the Company completed the acquisition of SIS Bancorp, Inc.
("SIS"), which was accounted for under the pooling-of-interests method.
Accordingly, the consolidated financial statements of the Company have been
restated to reflect the acquisition at the beginning of each period presented.
At December 31, 1998, SIS had total assets of $2.0 billion and total
shareholders' equity of $139 million. Effective January 1, 1999, the Company
transferred all securities classified by SIS as "held to maturity" to "available
for sale." This transfer was done to be consistent with the Company's interest
rate risk management policies.
NOTE 2 - OTHER COMPREHENSIVE INCOME
The components of total comprehensive income for the Company are net income and
unrealized gains (losses) on securities available for sale, net of tax. The
following is a reconciliation of comprehensive income for the nine months ended
September 30, 1999 and 1998.
Nine Months Ended
September 30,
-----------------
1999 1998
------- -------
Net income $96,841 $80,894
Other comprehensive income (loss), net of tax
Unrealized gains (losses) on available for sale securities:
Unrealized holding gains (losses) arising during
the period (68,918) 351
Less: reclassification adjustment for gains included in
net income 183 2,281
------- -------
Other comprehensive income, net (69,101) (1,930)
------- -------
Comprehensive income $27,740 $78,964
======= =======
7
<PAGE> 8
NOTE 3 - EARNINGS PER SHARE
The computation of basic and diluted net income per share and weighted average
shares outstanding follow (dollars in thousands, except per share amounts):
Three months ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net income $ 42,581 $ 37,242 $ 96,841 $ 80,894
============ ============ ============ ============
Weighted average shares
outstanding
Basic: 102,841,836 103,319,214 103,427,165 103,529,930
Effect of dilutive
securities:
Stock options 994,094 2,034,401 1,195,221 2,288,398
------------ ------------ ------------ ------------
Diluted 103,835,930 105,353,615 104,622,386 105,818,328
============ ============ ============ ============
Net income per share:
Basic $ 0.41 $ 0.36 $ 0.94 $ 0.78
Diluted 0.41 0.35 0.93 0.76
NOTE 4 - PENDING ACQUISITION
In June 1999, the Company reached a definitive agreement to acquire Banknorth
Group, Inc. ("Banknorth"), a $4.4 billion bank holding company based in
Burlington, Vermont. Under the terms of the agreement, shareholders of Banknorth
will receive 1.825 shares of Peoples Heritage Common Stock for each whole share
of Banknorth Common stock, plus cash in lieu of any fractional share. The
exchange is expected to be tax-free and accounted for as a pooling-of-interests.
The transaction, which is subject to approval by shareholders of both Banknorth
and the Company and various regulatory agencies, is expected to be completed in
the first quarter of 2000.
8
<PAGE> 9
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
SUMMARY
The Company reported net income of $42.6 million, or $0.41 per diluted share,
for the third quarter of 1999. This compares with $37.2 million, or $0.35 per
diluted share, for the third quarter of 1998, representing a 17% increase in per
share earnings.. Return on average equity ("ROE") and return on average assets
("ROA") were 19.62% and 1.23%, respectively, for the third quarter of 1999
compared with 17.23% and 1.27%, respectively, for the third quarter of 1998. Net
income for the first nine months of 1999 was $96.8 million as compared to $80.9
million for the first nine months of 1998. Diluted earnings per share was $0.93
compared to $0.76 per share for the nine months ended September 1999 and 1998,
respectively. ROE and ROA for the first nine months of 1999 were 14.75% and
1.00%, respectively, compared with 12.70% and 0.93% in 1998.
The nine months ended September 30, 1999 included special charges of $33.2
million ($24.1 million post tax) pertaining to the acquisition of SIS Bancorp,
Inc. and discontinuing the correspondent mortgage business. The nine months
ended September 30, 1998 included special charges of $35.4 million ($24.6
million after tax) related to the acquisition of CFX Corporation ("CFX"). (See
Table 5 for more information related to special charges.) Excluding the impact
of special charges, the Company's operating income for the first nine months of
1999 was $120.9 million, or $1.16 per diluted share, and ROE and ROA were 18.42%
and 1.25%, respectively. Operating income for the first nine months of 1998 was
$105.5 million, or $1.00 per diluted share, and ROE and ROA of 16.57% and 1.22%,
respectively. Operating results for the first nine months of 1999 represent a
16% increase in diluted earnings per share from the comparable period last year.
The improved operating results for the third quarter of 1999 over the third
quarter of 1998 were largely due to growth in earning assets levels and strong
fee income coupled with control of operating expenses. Noninterest income
increased 11% compared to the third quarter of 1998 and the efficiency ratio
(noninterest expense excluding distributions on securities of subsidiary trust
and special charges, as a percentage of net interest income and noninterest
income, excluding net securities gains) improved to 53.05% from 56.33%. Selected
quarterly data, ratios and per share data, both as reported and on an operating
basis, are provided in Table 1.
9
<PAGE> 10
TABLE 1 - Selected Quarterly Data
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1999 1999 1998 1998 1998 1998
Third Second First Fourth Third Second First
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net interest income $114,803 $109,126 $107,938 $106,233 $107,469 $106,219 $106,552
Provision for loan and lease losses 3,565 3,565 3,565 3,973 3,973 3,235 3,249
-------- -------- -------- -------- -------- -------- --------
Net interest income after loan and lease loss provision 111,238 105,561 104,373 102,260 103,496 102,984 103,303
Noninterest income (excluding securities transactions) 32,117 33,520 29,416 28,350 27,499 30,272 26,666
Net securities gains 3 260 18 2,395 1,457 2 2,050
Noninterest expenses (excluding special charges) 79,502 79,312 77,769 79,574 78,296 79,873 84,088
Special charges (1) -- -- 33,235 3,798 -- 34,474 900
-------- -------- -------- -------- -------- -------- --------
Income before income taxes 63,856 60,029 22,803 49,633 54,156 18,911 47,031
Income tax expense 21,275 19,263 9,309 17,703 16,914 6,375 15,915
-------- -------- -------- -------- -------- -------- --------
Net income $ 42,581 $ 40,766 $ 13,494 $ 31,930 $ 37,242 $ 12,536 $ 31,116
======== ======== ======== ======== ======== ======== ========
Earnings per share:
Basic $0.41 $0.39 $0.13 $0.31 $0.36 $0.12 $0.30
Diluted 0.41 0.39 0.13 0.30 0.35 0.12 0.29
Operating earnings per share (excluding special charges):
Basic 0.41 0.39 0.36 0.35 0.36 0.35 0.31
Diluted 0.41 0.39 0.36 0.34 0.35 0.35 0.30
Return on average assets (2) 1.23% 1.25% 0.45% 1.07% 1.27% 0.43% 1.10%
Return on average equity (2) 19.62% 18.08% 6.19% 14.21% 17.23% 5.86% 14.79%
Operating ratios:
Return on average assets (excluding special charges) (2) 1.23% 1.25% 1.25% 1.22% 1.27% 1.27% 1.13%
Return on average equity (excluding special charges) (2) 19.62% 18.08% 17.23% 16.13% 17.23% 17.08% 15.06%
Efficiency ratio (3) 53.05% 54.49% 55.17% 57.44% 56.33% 56.84% 61.44%
</TABLE>
(1) Special charges consists of merger-related expenses and one-time charges
related to the discontinuance of the Company's correspondent mortgage
business.
(2) Annualized.
(3) Represents operating expenses, excluding distributions on securities of
subsidiary trust and special charges, as a percentage of net interest
income and noninterest income, excluding net securities gains.
10
<PAGE> 11
RESULTS OF OPERATIONS
NET INTEREST INCOME
The Company's fully taxable equivalent net interest income in the third quarter
of 1999 increased $6.9 million compared to the third quarter of 1998 and $5.7
million compared to the second quarter of 1999. The increase was primarily
attributable to increased levels of average earning assets, offset in part by
narrowing net interest margins. Commercial real estate, commercial business, and
consumer loan product lines all experienced significant growth while residential
real estate loans declined. Residential real estate loans declined largely due
to the Company's discontinuance of the correspondent mortgage business and the
securitization of $633 million of residential loans in a REMIC, which are now
classified as securities held to maturity. Securities increased due primarily to
this securitization and additional investments in agency mortgage-backed
securities. The Company's net interest margin was 3.61% for the third quarter of
1999 compared to 4.05% for the comparable quarter of 1998. The lower margin was
due largely to increased levels of securities as a percent of total assets,
purchases of Bank Owned Life Insurance (the earnings from which are recorded as
noninterest income) and an increase in average borrowings as a percent of total
average funding. Table 2 shows quarterly average balances, net interest income
by category and rates for each quarter in 1999 and 1998. Table 3 shows the
changes in fully taxable equivalent net interest income by category due to
changes in rate and volume. See also "Interest Rate Risk and Asset Liability
Management" below.
The following table sets forth, for the periods indicated, information regarding
(i) the total dollar amount of interest income from interest-earning assets and
the resultant average yields; (ii) the total dollar amount of interest expense
on interest-bearing liabilities and the resultant average cost; (iii) net
interest income; (iv) interest rate spread; and (v) net interest margin. For
purposes of the tables and the following discussion, (i) income from
interest-earning assets and net interest income is presented on a fully-taxable
equivalent basis primarily by adjusting income and yields earned on tax-exempt
interest received on loans to qualifying borrowers and on certain of the
Company's securities to make them equivalent to income and yields earned on
fully-taxable investments, assuming a federal income tax rate of 35%, and (ii)
nonaccrual loans have been included in the appropriate average balance loan
category, but unpaid interest on nonaccrual loans has not been included for
purposes of determining interest income. Average balances are based on average
daily balances during the indicated periods.
11
<PAGE> 12
TABLE 2 - Average Balances, Yields and Rates
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 Third Quarter 1999 Second Quarter
------------------------------------- -------------------------------------
Yield/ Yield/
Average Balance Interest Rate (1) Average Balance Interest Rate (1)
--------------- -------- ------- --------------- -------- -------
Loans and leases (2):
<S> <C> <C> <C> <C> <C> <C>
Residential real estate mortgages $ 1,653,642 30,059 7.27% $ 1,801,616 32,589 7.24%
Commercial real estate mortgages 1,762,761 38,599 8.69 1,689,588 36,952 8.77
Commercial loans and leases 1,267,025 27,045 8.47 1,232,071 26,029 8.47
Consumer loans and leases 2,150,425 46,370 8.55 2,081,520 44,796 8.63
----------- ------- -----------
Total loans and leases 6,833,853 142,073 8.26 6,804,795 140,366 8.27
Securities (3) 5,846,490 94,115 6.43 5,103,801 78,130 6.12
Federal funds sold and other short term investments 77,451 1,052 5.39 189,798 2,331 4.93
----------- ------- -----------
Total earning assets 12,757,794 237,240 7.40 12,098,394 220,827 7.31
------- --------
Nonearning assets 966,829 950,405
----------- -----------
Total assets 13,724,623 $13,048,799
=========== ===========
Interest-bearing deposits:
Regular savings $ 1,289,605 6,548 2.01 $1,268,159 6,428 2.03
NOW and money market accounts 2,141,901 13,175 2.44 2,078,200 12,464 2.41
Certificates of deposit 3,298,215 40,186 4.83 3,391,976 41,725 4.93
Brokered deposits 163,886 2,275 5.51 201,244 2,811 5.60
----------- ------- -----------
Total interest-bearing deposits 6,893,607 62,184 3.58 6,939,579 63,428 3.67
Borrowed funds 4,558,071 59,754 5.20 3,769,847 47,796 5.09
----------- ------- -----------
Total interest-bearing liabilities 11,451,678 121,938 4.22 10,709,426 111,224 4.17
------- --------
Non-interest bearing deposits 1,285,903 1,284,420
Other liabilities (3) 57,185 80,378
Securities of subsidiary trust 68,775 69,987
Shareholders' equity (3) 861,082 904,588
----------- -----------
Total liabilities and shareholders' equity 13,724,623 $13,048,799
=========== ===========
Net earning assets $ 1,306,116 $ 1,388,968
=========== ===========
Net interest income (fully-taxable equivalent) 115,302 109,603
Less: fully-taxable equivalent adjustments (499) (477)
------- --------
Net interest income 114,803 $109,126
======= ========
Net interest rate spread (fully-taxable equivalent) 3.18% 3.14%
Net interest margin (fully-taxable equivalent) 3.61% 3.62%
</TABLE>
(1) Annualized.
(2) Loans and leases include loans held for sale.
(3) Excludes effect of unrealized gains or losses on securities available for
sale.
12
<PAGE> 13
TABLE 2 - Average Balances, Yields and Rates
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 First Quarter 1998 Fourth Quarter
------------------------------------- -------------------------------------
Yield/ Yield/
Average Balance Interest Rate (1) Average Balance Interest Rate (1)
--------------- -------- ------- --------------- -------- -------
Loans and leases (2):
<S> <C> <C> <C> <C> <C> <C>
Residential real estate mortgages $ 2,556,325 $ 47,050 7.36% $ 2,919,838 $ 53,662 7.35%
Commercial real estate mortgages 1,653,097 36,880 9.05 1,611,739 38,667 9.52
Commercial loans and leases 1,139,847 25,784 9.17 1,126,061 24,598 8.67
Consumer loans and leases 2,127,014 45,073 8.59 2,092,081 45,308 8.59
----------- -------- ----------- --------
Total loans and leases 7,476,283 154,787 8.36 7,749,719 162,235 8.33
Securities (3) 3,583,507 54,105 6.05 3,010,073 45,319 5.97
Federal funds sold and other short term investments 186,465 1,820 3.96 167,001 2,233 5.30
----------- -------- ----------- --------
Total earning assets 11,246,255 210,712 7.55 10,926,793 209,787 7.63
-------- --------
Nonearning assets 912,961 898,969
----------- -----------
Total assets $12,159,216 $11,825,762
=========== ===========
Interest-bearing deposits:
Regular savings $ 1,283,505 6,445 2.04 $ 1,283,063 7,198 2.23
NOW and money market accounts 2,036,837 12,006 2.39 2,017,616 13,018 2.56
Certificates of deposit 3,449,865 43,893 5.16 3,484,536 46,997 5.35
Brokered deposits 211,412 2,632 5.05 249,110 3,635 5.79
----------- ----------- --------
Total interest-bearing deposits 6,981,619 64,976 3.77 7,034,325 70,848 4.00
Borrowed funds 2,923,476 37,334 5.18 2,387,353 31,874 5.30
----------- ----------- --------
Total interest-bearing liabilities 9,905,095 102,310 4.19 9,421,678 102,722 4.33
-------- --------
Non-interest bearing deposits 1,235,688 1,308,902
Other liabilities (3) 46,166 103,862
Securities of subsidiary trust 88,000 100,000
Shareholders' equity (3) 884,267 891,320
----------- -----------
Total liabilities and shareholders' equity $12,159,216 $11,825,762
=========== ===========
Net earning assets $ 1,341,160 $ 1,505,115
=========== ===========
Net interest income (fully-taxable equivalent) 108,402 107,065
Less: fully-taxable equivalent adjustments (464) (832)
-------- --------
Net interest income $107,938 $106,233
======== ========
Net interest rate spread (fully-taxable equivalent) 3.36% 3.30%
Net interest margin (fully-taxable equivalent) 3.86% 3.90%
</TABLE>
(1) Annualized.
(2) Loans and leases include loans held for sale.
(3) Excludes effect of unrealized gains or losses on securities available for
sale.
13
<PAGE> 14
TABLE 2 - Average Balances, Yields and Rates
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 Third Quarter 1998 Second Quarter
------------------------------------- -------------------------------------
Yield/ Yield/
Average Balance Interest Rate (1) Average Balance Interest Rate (1)
--------------- -------- ------- --------------- -------- -------
Loans and leases (2):
<S> <C> <C> <C> <C> <C> <C>
Residential real estate mortgages $ 3,272,641 $ 61,006 7.46% $ 3,363,259 $ 62,583 7.44%
Commercial real estate mortgages 1,594,023 38,186 9.50 1,600,841 37,693 9.44
Commercial loans and leases 1,122,187 25,828 9.13 1,090,450 25,418 9.35
Consumer loans and leases 2,006,297 45,011 8.90 2,017,090 44,618 8.87
----------- -------- ----------- --------
Total loans and leases 7,995,148 170,031 8.46 8,071,640 170,312 8.45
Securities (3) 2,583,739 39,833 6.12 2,462,955 38,478 6.27
Federal funds sold and other short term investments 97,657 1,295 5.26 96,298 634 2.64
----------- -------- ----------- --------
Total earning assets 10,676,544 211,159 7.87 10,630,893 209,424 7.90
-------- --------
Nonearning assets 924,025 948,706
----------- -----------
Total assets $11,600,569 $11,579,599
=========== ===========
Interest-bearing deposits:
Regular savings $ 1,306,657 7,960 2.42 $ 1,361,919 8,094 2.38
NOW and money market accounts 1,938,800 11,989 2.45 1,915,109 12,239 2.56
Certificates of deposit 3,437,848 47,046 5.43 3,472,084 47,232 5.46
Brokered deposits 280,012 4,147 5.88 315,289 4,507 5.73
----------- -------- ----------- --------
Total interest-bearing deposits 6,963,317 71,142 4.05 7,064,401 72,072 4.09
Borrowed funds 2,285,054 31,600 5.49 2,215,643 30,323 5.49
----------- -------- ----------- --------
Total interest-bearing liabilities 9,248,371 102,742 4.41 9,280,044 102,395 4.43
-------- --------
Non-interest bearing deposits 1,260,212 1,220,460
Other liabilities (3) 134,455 120,338
Securities of subsidiary trust 100,000 100,000
Shareholders' equity (3) 857,531 858,757
----------- -----------
Total liabilities and shareholders' equity $11,600,569 $11,579,599
=========== ===========
Net earning assets $ 1,428,173 $ 1,350,849
=========== ===========
Net interest income (fully-taxable equivalent) 108,417 107,029
Less: fully-taxable equivalent adjustments (948) (810)
-------- --------
Net interest income $107,469 $106,219
======== ========
Net interest rate spread (fully-taxable equivalent) 3.46% 3.47%
Net interest margin (fully-taxable equivalent) 4.05% 4.03%
</TABLE>
(1) Annualized.
(2) Loans and leases include loans held for sale.
(3) Excludes effect of unrealized gains or losses on securities available for
sale.
14
<PAGE> 15
TABLE 2 - Average Balances, Yields and Rates
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 First Quarter
-------------------------------------
Yield/
Average Balance Interest Rate (1)
--------------- -------- -------
Loans and leases (2):
<S> <C> <C> <C>
Residential real estate mortgages $ 3,388,356 $ 64,971 7.75%
Commercial real estate mortgages 1,596,801 37,644 9.56
Commercial loans and leases 1,015,809 23,143 9.25
Consumer loans and leases 1,972,781 43,671 8.98
----------- --------
Total loans and leases 7,973,747 169,429 8.61
Securities (3) 2,439,674 39,521 6.57
Federal funds sold and other short term investments 90,671 1,290 5.77
----------- --------
Total earning assets 10,504,092 210,240 8.11
--------
Nonearning assets 918,811
-----------
Total assets $11,422,903
============
Interest-bearing deposits:
Regular savings $ 1,372,469 8,470 2.50
NOW and money market accounts 1,809,653 11,524 2.58
Certificates of deposit 3,452,992 46,633 5.48
Brokered deposits 290,177 4,246 5.93
----------- --------
Total interest-bearing deposits 6,925,291 70,873 4.15
Borrowed funds 2,334,920 32,254 5.60
----------- --------
Total interest-bearing liabilities 9,260,211 103,127 4.52
--------
Non-interest bearing deposits 1,123,814
Other liabilities (3) 85,381
Securities of subsidiary trust 100,000
Shareholders' equity (3) 853,497
-----------
Total liabilities and shareholders' equity $11,422,903
============
Net earning assets $ 1,243,881
============
Net interest income (fully-taxable equivalent) 107,113
Less: fully-taxable equivalent adjustments (561)
--------
Net interest income $106,552
========
Net interest rate spread (fully-taxable equivalent) 3.59%
Net interest margin (fully-taxable equivalent) 4.13%
</TABLE>
(1) Annualized.
(2) Loans and leases include loans held for sale.
(3) Excludes effect of unrealized gains or losses on securities available for
sale.
15
<PAGE> 16
The following table presents certain information on a fully taxable equivalent
basis regarding changes in interest income and interest expense of the Company
for the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (1) changes in rate (change in rate multiplied by old volume),
(2) changes in volume (change in volume multiplied by old rate) and (3) changes
in rate/volume (change in rate multiplied by change in volume).
TABLE 3 - Rate Volume Analysis
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended September 30, 1999 vs. 1998
Increase (decrease) due to
---------------------------------------------
Rate & Total
Volume Rate Volume (1) Change
-------- ------- ---------- --------
Interest income:
<S> <C> <C> <C> <C>
Loans and leases $(24,763) $(4,030) $ 835 $(27,958)
Securities 50,330 2,019 1,933 54,282
Federal funds sold and other short term investments (268) 32 (7) (243)
-------- ------- ------ --------
Total interest income 25,299 (1,979) 2,761 26,081
-------- ------- ------ --------
Interest expense:
Interest-bearing deposits
Regular savings (104) (1,350) 42 (1,412)
NOW and money market accts 1,254 (49) (19) 1,186
Certificates of deposit (1,911) (5,199) 250 (6,860)
Brokered deposits (1,721) (261) 110 (1,872)
-------- ------- ------ --------
Total interest-bearing deposits (2,482) (6,859) 383 (8,958)
Borrowed funds 31,454 (1,670) (1,630) 28,154
-------- ------- ------ --------
Total interest expense 28,972 (8,529) (1,247) 19,196
Net interest income (fully taxable equivalent) $ (3,673) $ 6,550 $4,008 $ 6,885
======== ======= ====== ========
</TABLE>
(1) Includes changes in interest income and expense not due solely to volume
or rate changes.
16
<PAGE> 17
NON-INTEREST INCOME
Third quarter non-interest income of $32.1 million increased 11% from the third
quarter of 1998. This increase was due to customer service income (up $4.1
million or 40%), insurance agency commissions (up $1.3 million or 39%), trust
income (up $496 thousand or 16%) and bank owned life insurance income (up $2.2
million or 248%.) These increases were partially offset by a $1.9 million
decline in mortgage banking income due primarily to discontinuance of the
correspondent lending business in the first quarter of 1999. For the nine months
ended September 30, 1999 and 1998, non-interest income amounted to $95.3 million
and $87.9 million, respectively. This 8% increase was attributable to increased
purchases of bank owned life insurance and growth in insurance agency
commissions, which more than offset decreases in mortgage banking income.
Customer services income in the third quarter of 1999 increased 40% from the
third quarter of 1998. For the nine months ended September 30, 1999 and 1998,
customer service income amounted to $38.0 million compared to $29.8 million,
respectively. The increase was primarily attributable to volume driven increases
in checking account fees, ATM fees and expansion of the ATM network.
Insurance commission revenue was $4.7 million for the third quarter of 1999,
compared to $3.4 million for the same period in 1998. For the nine months ended
September 30,1999 and 1998, insurance commissions were $14.3 million and $9.1
million, respectively. The increase primarily relates to the acquisition of
insurance agencies in Massachusetts and New Hampshire in the fourth quarter of
1998, which were accounted for using the purchase method.
Trust income reflects the continued growth in trust assets under management.
Trust income for the third quarter of 1999 was $3.6 million compared to $3.1
million in the third quarter of 1998. For the nine months ended September 30,
1999, trust income was $10.7 million, an increase of 16% or $1.6 million from
the same period in 1998. Assets under management were $3.1 billion and $2.9
billion at September 30, 1999 and 1998, respectively.
Bank-owned life insurance ("BOLI") income was $3.1 million for the third quarter
of 1999, compared to $881 thousand for the same period in 1998. For the nine
months ended September 30, 1999 and 1998, BOLI income was $8.4 million and $2.8
million, respectively. The increase relates to additional purchases of BOLI in
the first quarter of 1999. At September 30, 1999, the cash surrender value of
BOLI was $225 million compared to $67 million at December 31, 1998; the increase
reflecting the purchases and the BOLI income . BOLI covers certain employees of
the Company's bank subsidiaries. Most of the Company's BOLI is invested in the
"general account" of quality insurance companies. All such companies were rated
AA or better by Standard and Poor's at September 30, 1999.
Mortgage banking services income of $3.5 million and $5.4 million provided 11%
and 19% of non-interest income for the quarters ended September 30, 1999 and
1998, respectively. The 36% decrease from the same quarter of last year was due
to a $6.1 million decrease in mortgage sales income resulting primarily from the
discontinuance of the correspondent mortgage lending business in January 1999
and a $4.2 million improvement in net servicing income. This improvement was due
to changes in the valuation adjustment of the mortgage servicing rights and
interest rate floor that hedge them. The amount of loans serviced for others was
$3.8 billion and $5.3 billion at September 30, 1999 and 1998, respectively. See
"Special Charges" below for a discussion of the costs to discontinue the
correspondent mortgage lending business. For the nine months ended September 30,
1999 and 1998, mortgage banking services income was $14.3 million and $22.3
million, respectively. This 36% decrease was due largely to the discontinuance
of the correspondent mortgage lending business in January 1999 and the valuation
of the MSR asset. See Table 4 for a summary of mortgage banking services income
by quarter for 1999 and 1998.
Capitalized mortgage servicing rights amounted to $48.1 million at September 30,
1999, compared to $57.6 million at September 30, 1998. The decrease was due
largely to the sale of mortgage servicing rights totaling $16 million in the
fourth quarter of 1998. See Table 4 for details. Because mortgage servicing
rights are an interest-rate sensitive asset, the value of the Company's mortgage
servicing rights and the related mortgage banking income may be adversely
impacted if mortgage interest rates decline and actual or expected loan
prepayments increase. To mitigate the prepayment risk associated with adverse
changes in interest rates and the resultant impairment to capitalized mortgage
servicing rights and effects on mortgage banking income, the Company has
established a hedge program against a portion of its capitalized mortgage
servicing rights to help protect its value and mortgage banking income.
17
<PAGE> 18
Notwithstanding the foregoing, there can be no assurance that significant
declines in interest rates will not have a material impact on the Company's
mortgage servicing rights and mortgage banking income or that the hedge program
will be successful in mitigating the effects of such a decline.
TABLE 4 - Mortgage Banking Services
(Dollars in thousands)
<TABLE>
<CAPTION>
At or for the Three Months Ended
9/30/99 6/30/99 3/31/99 12/31/98 9/30/98 6/30/98 3/31/98
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Residential mortgages serviced for investors $3,759,247 $3,913,525 $4,328,668 $4,243,181 $5,289,015 $7,374,982 $6,974,292
========== ========== ========== ========== ========== ========== ==========
Mortgage banking services income:
Sales income:
Residential mortgage sales income $ 1,252 $ 2,799 $ 3,313 $ 7,123 $ 8,124 $ 4,596 $ 3,280
Lower of cost or market adjustment -
loans held for sale 731 (1,934) -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total sales income 1,983 865 3,313 7,123 8,124 4,596 3,280
---------- ---------- ---------- ---------- ---------- ---------- ----------
Servicing income:
Residential mortgage servicing income, net 1,189 1,880 1,559 1,137 2,320 3,599 4,087
Change in impairment reserve 1,343 2,382 950 (4,545) (6,182) (359) --
Valuation adjustments - interest rate floor (953) (1,475) (1,600) 200 2,180 -- --
Gain (loss) on sale of capitalized mortgage
servicing rights (66) 2,924 (17) 958 (997) 1,681 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total servicing income 1,513 5,711 892 (2,250) (2,679) 4,921 4,087
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total $ 3,496 $ 6,576 $ 4,205 $ 4,873 $ 5,445 $ 9,517 $ 7,367
========== ========== ========== ========== ========== ========== ==========
Mortgage servicing rights:
Balance at beginning of period $ 47,314 $ 45,266 $ 40,088 $ 57,640 $ 96,056 $ 80,278 $ 60,638
Mortgage servicing rights capitalized
and purchased 2,985 2,747 7,535 6,803 13,940 24,364 35,709
Amortization charged against
mortgage servicing fee income (2,697) (2,736) (2,828) (3,644) (3,161) (3,647) (3,918)
Change in impairment reserve 1,343 2,382 950 (4,545) (6,182) (359) --
Mortgage servicing rights sold (842) (345) (479) (16,166) (43,013) (4,580) (12,151)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at end of period $ 48,103 $ 47,314 $ 45,266 $ 40,088 $ 57,640 $ 96,056 $ 80,278
========== ========== ========== ========== ========== ========== ==========
</TABLE>
18
<PAGE> 19
NON-INTEREST EXPENSE
Excluding special charges, amortization of intangibles and distribution on
securities of subsidiary trust, non-interest expense was $75.0 million and $73.1
million for the quarters ended September 30, 1999 and 1998, respectively, an
increase of 2.6%. The efficiency ratio was 53.05% and 56.33% for the quarters
ended September 30, 1999 and 1998, respectively, excluding special charges,
distributions on securities of subsidiary trust and net securities gains. For
the nine months ended September 30, 1999 and 1998, non-interest expense
excluding special charges, amortization of intangibles and distribution on
securities trust was $222.6 million and $226.8 million, respectively, a decrease
of 1.9%.
Salaries and benefits expense of $41.1 million for the quarter ended September
30, 1999 increased $929 thousand from the same quarter of last year. On a year
to date basis, salaries and benefits expense amounted to $120.4 million in 1999
compared to $123.1 million in 1998. Staff reductions related to the SIS
acquisition and the discontinuance of the correspondent mortgage business were
the primary reasons for this decline.
Data processing expense of $6.9 million for the quarter ended September 30, 1999
remained relatively unchanged from the same quarter a year ago. For the nine
months ended September 30, 1999 and 1998, data processing expense was $21.0
million and $18.1 million, respectively. The 15% increase from last year was due
to new systems initiatives, the costs of year 2000 testing (see "Impact of the
Year 2000" section) and increased transaction volumes.
Occupancy expense of $6.7 million increased $318 thousand from the third quarter
of 1998. For the nine months ended September 30, 1999 and 1998, occupancy
expense was $20.6 million and $20.2 million, respectively. The year to date
increase was due to a $206 thousand loss on the disposition of a branch in the
second quarter of 1999.
The Company had 221 branch offices at September 30, 1999 and 1998.
Equipment expense increased $694 thousand from the third quarter of last year
due to the purchases of new equipment. Advertising and marketing expense
decreased $747 thousand from the third quarter of 1998 due primarily to cost
savings and efficiencies related to the SIS acquisition. For the nine months
ended September 30, 1999 and 1998, equipment expense was $15.5 million and $15.3
million and advertising and marketing expense was $6.8 million and $8.6 million,
respectively.
Amortization of goodwill and other intangibles was $8.8 million for the nine
months ended September 30, 1999 compared to $8.7 for the nine months ended
September 30, 1998. The slight increase was due to the goodwill associated with
the fourth quarter 1998 purchase acquisitions of two insurance agencies.
There were no special charges in the third quarter of 1999 or 1998. Special
charges of $33.2 million pre-tax were incurred during the first nine months of
1999, which included merger-related expenses of $25.9 million incurred in
connection with the acquisition of SIS and $7.4 million related to the
discontinuance of the Company's correspondent mortgage lending business. Special
charges of $34.5 million pre-tax were incurred during the nine months of 1998
related to the acquisition of CFX on April 10, 1998. On an after-tax basis,
special charges amounted to $24.0 million and $24.6 million for the nine months
ended September 30, 1999 and 1998, respectively.
19
<PAGE> 20
The following table summarizes activity related to special charges recorded
from December 31, 1998 through September 30, 1999.
TABLE 5 - SPECIAL CHARGES
(Dollars in thousands)
<TABLE>
<CAPTION>
Special Charges for the Nine Months
ended September 30, 1999
-------------------------------------------------
Discontinuance Plus:
of Correspondent Accrual Less:
Acquisition Mortgage Balance at Cash Non-cash Balance at
of SIS Business Total 12/31/98 Transactions Items Adjustments 9/30/99
------- -------- ------- -------- ------------ ------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Severance costs $11,345 $1,986 $13,331 $ 32 $(12,458) $ 0 $ (39) $ 866
Data processing/systems
integration 5,176 -- 5,176 -- (4,645) -- -- 531
Professional fees 3,314 1,793 5,107 -- (4,663) -- -- 444
Asset write-downs and lease
terminations 4,067 1,293 5,360 -- (613) (2,905) -- 1,842
Customer communications 1,148 -- 1,148 -- (1,939) -- 791 --
Fund charitable foundation 3,000 -- 3,000 -- (3,000) -- -- --
Correspondent losses -- 957 957 -- (1,945) -- 988 --
Other costs 1,821 1,335 3,156 1,131 (2,547) -- (1,740) --
------- ------ ------- ------ -------- ------- ------- ------
Sub-total 29,871 7,364 37,235 $1,163 $(31,810) $(2,905) $ 0 $3,683
====== ======== ======= ======= ======
Pension curtailment gain (3) (4,000) -- (4,000)
------- ------ -------
$25,871(1) $7,364(2) $33,235
======= ====== =======
</TABLE>
(1) On an after-tax basis merger charges amounted to $18,779.
(2) On an after-tax basis charges for discontinuing the correspondent mortgage
business amounted to $5,300.
(3) The pension curtailment gain included in the special charge for the
acquisition of SIS will be recorded as a credit to the merger accrual
account when the SIS pension plan is merged with the PHFG pension plan
(anticipated by the end of 1999).
Other non-interest expenses for the third quarter of 1999 decreased $12 thousand
from the third quarter of 1998. The following table summarizes the principal
components of other non-interest expenses by quarter.
TABLE 6 - OTHER NON-INTEREST EXPENSES
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1999 1999 1998 1998 1998 1998
Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Miscellaneous loan costs $2,149 $ 1,952 $1,934 $1,457 $2,035 $ 2,612 $ 1,264
Postage and freight 1,737 1,771 2,103 1,893 1,542 1,884 1,887
Office supplies 1,546 1,805 1,471 1,706 1,664 2,017 1,773
Deposits and other assessments 862 727 668 651 657 675 705
Collection and carrying costs
of non-performing assets 359 313 701 666 (583) 268 737
Other 3,316 4,714 2,112 2,615 4,666 5,131 6,164
------ ------- ------ ------ ------ ------- -------
Total $9,969 $11,282 $8,989 $8,988 $9,981 $12,587 $12,530
====== ======= ====== ====== ====== ======= =======
</TABLE>
TAXES
The effective tax rate for the third quarter and first nine months of 1999 was
33% and 34%, respectively, compared with 31% and 33%, respectively, for the
comparable periods of 1998.
OTHER COMPREHENSIVE INCOME
FASB Statement No. 130 requires disclosure of "Other comprehensive income."
Unlike net income, "other comprehensive income" includes the after-tax change in
unrealized gains and losses on securities. As a result of an increase in
interest rates in the first nine months of 1999, the unrealized loss on the
Company's securities portfolio increased $69.1 million, net of taxes and gains
and losses realized on sales of securities. At September 30, 1999, unrealized
losses, net of tax, represented 1.3% of securities available for sale. The
Company attempts to balance the interest rate risk of its assets with its
liabilities (see "Interest Rate Risk and Asset Liability Management"). However,
the change in value of its liabilities, which tends to improve in rising
interest rate environments, is not included in "other comprehensive income." The
Company has no current intention to sell any of its available for sale
securities.
20
<PAGE> 21
FINANCIAL CONDITION
LOANS AND LEASES
Total loans and leases (including loans held for sale) averaged $6.8 billion
during the third quarter of 1999, a decrease of $1.2 billion or 14.5% from the
third quarter of 1998. The decrease was primarily in residential real estate
mortgages. Loans as a percent of average earning assets were 54% at September
30, 1999 compared to 75% at September 30, 1998.
Average residential real estate loans (which includes mortgage loans held for
sale) of $1.7 billion during the third quarter of 1999 declined $1.6 billion
from the third quarter of last year. As a result of declining interest rates
during the period, prepayments on residential real estate loans accelerated,
particularly in adjustable rate mortgages. The decline also reflected the $633
million securitization of single-family residential real estate loans into a
real estate investment conduit ("REMIC") in April 1999 now classified as
securities held to maturity. Mortgage loans held for sale amounted to $99
million at September 30, 1999 and $518 million at December 31, 1998. The decline
in loans held for sale was due primarily to discontinuance of the correspondent
mortgage business in the first quarter of 1999.
Average commercial real estate loans of $1.8 billion increased 11% from the
third quarter of last year. The average yield on commercial real estate loans
during the third quarter of 1999 was 8.69%, as compared to 9.50% in the third
quarter of 1998, which is indicative of increased competition and lower
prevailing interest rates.
Commercial loans averaged $1.3 billion during the third quarter of 1999, an
increase of 13% over the third quarter of 1998. The yield on commercial loans
decreased to 8.47% in the second quarter of 1999 from 9.13% in the third quarter
of 1998.
Average consumer loans of $2.2 billion during the third quarter of 1999
increased 7% from the third quarter of 1998. The increase was primarily in
indirect automobile, student and home equity loans. The average yield on
consumer loans declined from 8.90% in the third quarter of 1998 to 8.55% in the
third quarter of 1999.
SECURITIES AND OTHER EARNING ASSETS
The Company's securities portfolio averaged $5.8 billion during the third
quarter of 1999, as compared to $2.6 billion in the third quarter of 1998, and
consisted primarily of mortgage-backed securities, most of which are seasoned 15
year agency securities and U.S. Treasury securities. Other securities consisted
of collateralized mortgage obligations, asset-backed securities and securitized
portfolio loans held in a REMIC and classified as held to maturity.
Substantially all available for sales securities are rated AAA or equivalently
rated. A significant portion of the increase in securities was to replace the
decline in residential real estate loans. The average yield on securities was
6.43% and 6.12% for the quarters ended September 30, 1999 and 1998,
respectively. The increased yield was due in part to the addition of the REMIC
securities which had a weighted average yield of 7.60% and increased the
portfolio yield by 11 basis points in the third quarter of 1999. Securities
available for sale are carried at fair value and had an after-tax unrealized
loss of $70.8 million and $1.7 million at September 30, 1999 and December 31,
1999, respectively. The unrealized loss was 2% of total securities available for
sale at September 30, 1999.
21
<PAGE> 22
ASSET QUALITY
As shown in Table 7, nonperforming assets were $59.3 million at September 30,
1999, or 0.43% of total assets, compared to $70.3 million at September 30, 1998.
The decline was attributable to declines in nonperforming loans in all
categories, particularly commercial real estate loans and consumer loans. The
Company continues to monitor asset quality with regular reviews of its portfolio
in accordance with its lending and credit policies.
The Company's residential loan portfolio accounted for 21% of the total loan
portfolio at September 30, 1999, as compared with 31% at December 31, 1998. The
Company's residential loans are generally secured by single-family homes (one to
four units) and have a maximum loan to value ratio of 80%, unless they are
protected by mortgage insurance. At September 30, 1999, 0.78% of the Company's
residential loans were nonperforming, as compared with 0.44% at December 31,
1998. The increase was due mainly to the securitization of $633 million of
single-family residential loans, as discussed above.
The Company's commercial real estate loan portfolio accounted for 27% of the
total loan portfolio at September 30, 1999 compared to 23% at December 31, 1998.
At September 30, 1999, 0.81% of the Company's commercial real estate loans were
nonperforming, as compared with 1.23% at December 31, 1998.
The Company's commercial business loan portfolio accounted for 19% of the total
loan portfolio at September 30, 1999 and 16% at December 31, 1998. Commercial
business loans are not concentrated in any particular industry, but reflect the
broad-based economies of Maine, New Hampshire, Massachusetts and, to a lesser
extent, Connecticut. The Company's commercial business loans are generally to
small and medium size businesses located within its geographic market area. At
September 30, 1999, 1.39% of the Company's commercial business loans were
non-performing, as compared with 1.38% at December 31, 1998.
The Company's consumer loan portfolio accounted for 33% of the total loan
portfolio at September 30, 1999 and 30% at December 31, 1998. The Company has a
diversified consumer loan portfolio consisting of home equity, automobile,
mobile home, boat and recreational vehicles and education loans. At September
30, 1999, 0.25% of the Company's consumer loans were nonperforming, as compared
with 0.52% at December 31, 1998.
At September 30, 1999, the Company had $13.8 million of accruing loans which
were 90 days or more delinquent, as compared to $22.0 million of such loans at
December 31, 1998. The decrease was primarily attributable to a decrease in
residential real estate loans over 90 days delinquent, which the Company
believes are well secured and in the process of collection.
22
<PAGE> 23
TABLE 7 - NONPERFORMING ASSETS
(Dollars in thousands)
<TABLE>
<CAPTION>
9/30/99 6/30/99 3/31/99 12/31/98 9/30/98 6/30/98 3/31/98
------- ------- ------- -------- ------- ------- -------
Residential real estate loans:
<S> <C> <C> <C> <C> <C> <C> <C>
Nonaccrual loans $10,855 $11,643 $10,124 $ 9,917 $13,976 $10,802 $14,134
------- ------- ------- ------- ------- ------- -------
Commercial real estate loans:
Nonaccrual loans 13,211 14,494 16,657 19,944 20,521 20,398 22,239
Troubled debt restructurings 1,282 1,391 1,110 6 475 1,477 3,298
------- ------- ------- ------- ------- ------- -------
Total 14,493 15,885 17,767 19,950 20,996 21,875 25,537
------- ------- ------- ------- ------- ------- -------
Commercial business loans and leases:
Nonaccrual loans 17,712 18,600 12,694 14,920 15,174 18,409 19,833
Troubled debt restructurings 83 80 40 874 70 71 207
------- ------- ------- ------- ------- ------- -------
Total 17,795 18,680 12,734 15,794 15,244 18,480 20,040
------- ------- ------- ------- ------- ------- -------
Consumer loans and leases:
Nonaccrual loans 5,639 5,531 7,566 10,865 8,887 8,323 10,000
------- ------- ------- ------- ------- ------- -------
Total nonperforming loans:
Nonaccrual loans 47,417 50,268 47,041 55,646 58,558 57,932 66,206
Troubled debt restructurings 1,365 1,471 1,150 880 545 1,548 3,505
------- ------- ------- ------- ------- ------- -------
Total 48,782 51,739 48,191 56,526 59,103 59,480 69,711
------- ------- ------- ------- ------- ------- -------
Other nonperforming assets:
Other real estate owned, net of related reserves 7,764 7,170 7,468 7,030 7,435 7,790 6,270
Repossessions, net of related reserves 2,773 3,411 4,446 3,624 3,786 4,380 4,158
------- ------- ------- ------- ------- ------- -------
Total other nonperforming assets 10,537 10,581 11,914 10,654 11,221 12,170 10,428
------- ------- ------- ------- ------- ------- -------
Total nonperforming assets $59,319 $62,320 $60,105 $67,180 $70,324 $71,650 $80,139
======= ======= ======= ======= ======= ======= =======
Accruing loans which are 90 days overdue $13,764 $17,990 $24,967 $21,962 $ 7,933 $10,078 $ 9,136
======= ======= ======= ======= ======= ======= =======
Total nonperforming loans as a percentage of total loans (1) 0.73% 0.78% 0.68% 0.80% 0.81% 0.82% 0.96%
Total nonperforming assets as a percentage of total assets 0.43% 0.46% 0.48% 0.56% 0.60% 0.62% 0.68%
Total nonperforming assets as a percentage of total loans
and leases (1) and total other nonperforming assets 0.89% 0.94% 0.85% 0.95% 0.96% 0.98% 1.10%
</TABLE>
(1) Total loans and leases are exclusive of loans held for sale.
23
<PAGE> 24
PROVISION/ALLOWANCE FOR LOAN LOSSES
The Company provided $3.6 million for loan and lease losses in the third quarter
of 1999, compared to $4.0 million in the third quarter of 1998. As shown in
Table 8, net charge-offs for the third quarter of 1999 were $3.4 million, or 20
basis points of average loans outstanding, compared to $2.9 million, or 15 basis
points of average loans outstanding, for the third quarter of 1998. Net
charge-offs have continued to decline in 1999 from 25 basis points of average
loans outstanding in the fourth quarter of 1998.
At September 30, 1999, the allowance for loan and lease losses amounted to
$110.8 million or 1.66% of total portfolio loans and leases, as compared to
$111.4 million or 1.52% at September 30, 1998. The ratio of the allowance for
loan and lease losses to nonperforming loans was 227% at September 30, 1999 and
189% at September 30, 1998. Management considers the allowance appropriate and
adequate to cover potential losses inherent in the loan portfolio based on the
current economic environment.
Provisions for loan losses are attributable to management's ongoing evaluation
of the adequacy of the allowance for loan and lease losses, which includes,
among other procedures, consideration of the character and size of the loan
portfolio, such as internal risk ratings and credit concentrations, trends in
nonperforming loans, delinquent loans and net charge-offs, the volume of new
loan originations and other asset quality factors. Although management utilizes
its best judgment in providing for possible losses, there can be no assurance
that the Company will not have to change its provisions for loan and lease
losses in subsequent periods. Changing economic and business conditions in
northern New England, fluctuations in local markets for real estate, future
changes in nonperforming asset trends, large movements in market-based interest
rates or other reasons could affect the Company's future provisions for loans
losses.
24
<PAGE> 25
TABLE 8 - ALLOWANCE FOR LOAN AND LEASE LOSSES
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 Third 1999 Second 1999 First 1998 Fourth 1998 Third 1998 Second 1998 First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Average loans and leases outstanding
during the period (1) $6,833,853 $6,804,795 $7,476,283 $7,744,371 $7,990,408 $8,068,140 $7,973,747
========== ========== ========== ========== ========== ========== ==========
Allowance at beginning of period $ 110,639 $ 110,573 $ 110,561 $ 111,413 $ 110,371 $ 111,507 $ 112,064
Charge-offs:
Real estate mortgages 790 1,982 530 1,169 2,929 2,426 1,518
Commercial business loans and leases 1,043 346 1,137 2,634 717 1,304 601
Consumer loans and leases 3,260 3,904 3,550 3,822 2,868 2,966 3,727
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total loans charged off 5,093 6,232 5,217 7,625 6,514 6,696 5,846
---------- ---------- ---------- ---------- ---------- ---------- ----------
Recoveries:
Real estate mortgages 452 1,402 550 1,142 1,991 1,431 1,186
Commercial business loans and leases 694 688 627 932 889 501 166
Consumer loans and leases 531 643 487 726 703 393 688
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total loans recovered 1,677 2,733 1,664 2,800 3,583 2,325 2,040
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net charge-offs 3,416 3,499 3,553 4,825 2,931 4,371 3,806
Additions charged to operating expenses 3,565 3,565 3,565 3,973 3,973 3,235 3,249
---------- ---------- ---------- ---------- ---------- ---------- ----------
Allowance at end of period $ 110,788 $ 110,639 $ 110,573 $ 110,561 $ 111,413 $ 110,371 $ 111,507
========== ========== ========== ========== ========== ========== ==========
Ratio of net charge-offs to average
loans and leases outstanding
during the period, annualized (1) 0.20% 0.21% 0.19% 0.25% 0.15% 0.22% 0.19%
Ratio of allowance to total loans
and leases at end of period (2) 1.66% 1.67% 1.56% 1.56% 1.52% 1.52% 1.54%
Ratio of allowance to nonperforming
loans at end of period 227% 214% 229% 196% 189% 186% 161%
Ratio of net charge-offs as a
percent of average outstanding
loans, annualized (1):
Real estate mortgages 0.039% 0.067% -0.002% 0.002% 0.076% 0.080% 0.027%
Commercial business loans
and leases 0.109% -0.111% 0.181% 0.603% -0.061% 0.296% 0.174%
Consumer loans and leases 0.503% 0.628% 0.584% 0.587% 0.428% 0.512% 0.625%
</TABLE>
(1) Average loans and leases include portfolio loans and loans held for sale.
(2) Total loans and leases are exclusive of loans held for sale.
25
<PAGE> 26
DEPOSITS
Average deposits of $8.2 billion during the third quarter of 1999 remained
relatively unchanged from the third quarter of 1998. Excluding brokered
deposits, average total deposits increased $72 million compared to the third
quarter of 1998. The ratio of portfolio loans to retail deposits was 84% and 87%
at September 30, 1999 and December 31, 1998, respectively.
Average non-interest bearing deposit accounts of $1.3 billion during the third
quarter of 1999 increased $25.7 million or 2% from the third quarter of 1998.
The increase in these non-interest bearing deposits is consistent with the
Company's marketing of these lower cost accounts.
Average interest-bearing deposit accounts, excluding brokered deposits, of $6.7
billion during the third quarter of 1999 remained relatively unchanged from the
third quarter of 1998. The average rates paid on all deposit types decreased
from 4.05% in the third quarter of 1998 to 3.58% in the third quarter of 1999.
OTHER FUNDING SOURCES
The Company's primary source of funding, other than deposits, are securities
sold under repurchase agreements and advances from the Federal Home Loan Bank of
Boston ("FHLB"). Average FHLB borrowings for the third quarter of 1999 were $4.0
billion, which increased $2.3 billion or 138% from the third quarter of 1998 in
order to fund the growth in earning assets. FHLB collateral consists primarily
of first mortgage loans secured by 1 - 4 family properties, certain unencumbered
securities and other qualified assets. At September 30, 1999, the Company's FHLB
borrowings amounted to $4.2 billion and its additional borrowing capacity was
$1.1 billion.
Average balances for securities sold under repurchase agreements were $560
million and $555 million for the quarters ended September 30, 1999 and 1998,
respectively. These borrowings are secured by mortgage-backed securities and
U.S. Government obligations.
INTEREST RATE RISK AND ASSET-LIABILITY MANAGEMENT
The goal of asset-liability management is the prudent control of market risk,
liquidity and capital. Asset-liability management is governed by policies
reviewed and approved annually by the Company's Board of Directors (the "Board")
and monitored periodically by a committee of the Board. The Board delegates
responsibility for asset-liability management to the Liquidity and Funds
Management Committee ("LFMC"), which is comprised of members of senior
management who set strategic directives that guide the day-to-day
asset-liability management activities of the Company. The LFMC also reviews and
approves all major risk, liquidity and capital management programs.
Market Risk
Market risk is the sensitivity of income to changes in interest rates, foreign
exchange rates, commodity prices and other market-driven rates or prices. The
Company has no trading operations and thus is only exposed to non-trading market
risk.
Interest-rate risk, including mortgage prepayment risk, is by far the most
significant non-credit risk to which the Company in exposed. Interest-rate risk
is the sensitivity of income to changes in interest rates. Changes in interest
rates, as well as fluctuations in the level and duration of assets, affect net
interest income, the Company's primary source of revenue. This risk arises
directly from the Company's core banking activities lending, deposit gathering
and loan servicing. In addition to directly impacting net interest income,
changes in the level of interest rates can also affect (i) the amount of loans
originated and sold by the institution, (ii) the ability of borrowers to repay
adjustable or variable rate loans, (iii) the average maturity of loans, (iv) the
rate of amortization of capitalized mortgage servicing rights and premiums paid
on securities, (v) the amount of unrealized gains and losses on securities
available for sale and (vi) the value of an institution's investment securities
and mortgage loans and the resultant ability to realize gains on the sale of
such assets.
The primary objective of interest-rate risk management is to control the
Company's exposure to interest-rate risk both within limits approved by the
Board of Directors and guidelines established by the LFMC. These limits and
26
<PAGE> 27
guidelines reflect the Company's tolerance for interest-rate risk over both
short-term and long-term horizons. The Company controls interest-rate risk by
identifying, quantifying and, where appropriate, hedging its exposure.
The Company quantifies and measures interest-rate exposures using a model to
dynamically simulate net-interest income under various interest rate scenarios
over 12 months. Simulated scenarios include deliberately extreme interest rate
"shocks" and more gradual interest rate "ramps." Key assumptions in these
simulation analyses relate to behavior of interest rates and spreads, the growth
or shrinkage of product balances and the behavior of the Company's deposit and
loan customers. The most material assumption relates to the prepayment of
mortgage assets (including mortgage loans, securities and mortgage servicing
rights). The risk of prepayment tends to increase when interest rates fall.
Since future prepayment behavior of loan customers is uncertain, the resultant
interest rate sensitivity of loan assets cannot be determined exactly.
Complicating management's efforts to measure interest rate risk is the
uncertainty of the maturity, repricing and/or runoff of some of the Company's
assets and liabilities.
To cope with these uncertainties, management gives careful attention to its
assumptions. For example, many of the Company's interest-bearing deposit
products (e.g. interest checking, savings and money market deposits) have no
contractual maturity and based on historical experience have only a limited
sensitivity to movements in market rates. Because management believes it has
some control with respect to the extent and timing of rates paid on non-maturity
deposits, certain assumptions regarding rate changes are built in to the model.
In the case of prepayment of mortgage assets, assumptions are derived from
published dealer median prepayment estimates for comparable mortgage loans.
The Company manages the interest-rate risk inherent in its core banking
operations primarily using on-balance sheet instruments, mainly fixed-rate
portfolio securities and borrowed fund maturities. When appropriate, the Company
will utilize off-balance sheet interest rate instruments such as interest-rate
swaps, forward-rate agreements, options, options on swaps and exchange traded
futures and options. The Company owns an interest-rate floor with a notional
amount of $10 million, expiring in 2000, which was purchased to protect certain
rate sensitive assets against falling interest rates. The Company has no direct
or contingent liability as a result of these floors.
The Company's policy on interest-rate risk simulation specifies that if interest
rates were to immediately shift up or down 200 basis points, estimated net
interest income for the subsequent 12 months should decline by less than 10%.
The Company was in compliance with this limit at September 30, 1999. The Company
also monitors gradual changes in market interest rates which it believes better
represents its exposure to net interest income. The following table reflects the
estimated percentage exposure of the Company's net interest income for the 12
months following the date indicated assuming a gradual shift in market interest
rates of 100 and 200 basis points, respectively.
<TABLE>
<CAPTION>
200 Basis Point 100 Basis Point 100 Basis Point 200 Basis Point
Rate Decrease Rate Decrease Rate Increase Rate Increase
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
September 30, 1999 -0.82% 1.05% -1.48% -1.74%
===== ==== ===== =====
</TABLE>
The results implied in the above table indicate estimated changes in simulated
net interest income for the subsequent 12 months assuming a gradual shift up or
down in market rates of 100 and 200 basis points across the entire yield curve.
Assuming a downward shift in rates, savings, money market and NOW accounts have
implied interest rate floors and it is assumed that the related interest expense
on these accounts will not decrease in proportion to the downward shift in
rates. Assuming an upward shift in rates of 200 basis points, the simulated
increase in interest income would be less than the simulated increase in
interest expense as the Company's fixed-rate earning assets exceed its
fixed-cost paying liabilities. It should be emphasized, however, that the
results are dependent on material assumptions such as those discussed above.
The Company uses interest rate floors, U.S. Treasury debt instruments and
principal only strips to mitigate the prepayment risk associated with mortgage
servicing rights (see "Non-Interest Income" for further details). At September
30, 1999, the Company had $200 million notional amount in interest rate floors,
$20 million in U.S. Treasury bonds and $20 million in principal only strips. For
mortgage servicing rights, the adverse impact of current movements in interest
rates on expected future cash flows must be recognized immediately through an
adjustment to their carrying value. If interest rates decline, estimated future
fee income from mortgage servicing rights is reduced because of an expected
increase in mortgage prepayments.
27
<PAGE> 28
The following table sets forth the net exposure at September 30, 1999 of the
carrying value of mortgage servicing rights and identified hedging instruments,
assuming an immediate shift by the indicated amount in market interest rates.
<TABLE>
<CAPTION>
200 Basis Point 100 Basis Point 100 Basis Point 200 Basis Point
Rate Decrease Rate Decrease Rate Increase Rate Increase
--------------- --------------- --------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage servicing rights $(19,152) $(8,000) $6,300 $9,576
Interest rate floors 7,500 2,900 (1,100) (1,300)
U.S. Treasury bonds 6,125 2,625 (2,275) (4,025)
Principal only strips 5,676 2,700 (1,700) (2,236)
-------- ------- ------ ------
Net exposure $ 149 $ 225 $1,225 $2,015
======== ======= ====== ======
</TABLE>
The foregoing estimates of the effects of specified changes in interest rates on
the Company's net interest income and the carrying value of its mortgage
servicing rights are based on various assumptions, as discussed above, which
approximate actual experience and which management of the Company considers to
be reasonable. The effects of changes in interest rates on the Company could
vary substantially if different assumptions were used or actual experience
differs from the historical experience on which the assumptions are based.
The most significant factors affecting market risk exposure of net interest
income during 1999 have been (i) the increase in interest rates, (ii) changes in
the composition of mortgage assets and (iii) the increase and diversification of
assets and off-balance sheet interest-rate instruments used to hedge mortgage
servicing rights.
The Company's earnings are not directly and materially impacted by movements in
foreign currency rate or commodity prices. Virtually all transactions are
denominated in the US dollar. Movements in equity prices may have an indirect
but modest impact on earnings by affecting the volume of activity or the amount
of fees from investment-related businesses.
LIQUIDITY
On a parent-only basis, the Company does not have substantial commitments or
debt service requirements. At September 30, 1999, such commitments consisted
primarily of junior subordinated debentures issued to a subsidiary, Peoples
Heritage Capital Trust I, in connection with that subsidiary's issuance of 9.06%
Capital Securities due 2027. The principal sources of funds for the Company to
meet parent-only obligations are dividends from its banking subsidiaries, which
are subject to regulatory limitations. Other sources of funds available to the
Company on a parent-only basis include borrowings from public and private
sources.
For banking subsidiaries of the Company, liquidity represents the ability to
meet both loan commitments and deposit withdrawals. Funds to meet these needs
generally can be obtained by converting liquid assets to cash or by attracting
new deposits or other sources of funding. Many factors affect a bank's ability
to meet liquidity needs, including variations in the markets served, its
asset-liability mix, its reputation and credit standing in the market and
general economic conditions.
In addition to traditional in-market deposit sources, banks have many other
sources of liquidity, including proceeds from maturing securities and loans, the
sale of securities, asset securitizations and other non-relationship funding
sources, such as FHLB borrowings, senior or subordinated debt, commercial paper
and wholesale purchased funds. Management believes that the high proportion of
residential and installment consumer loans in its banks' loan portfolios also
provides a significant amount of contingent liquidity through the conventional
securitization programs that exist today. Management believes that the level of
liquidity is sufficient to meet current and future funding requirements.
28
<PAGE> 29
CAPITAL
At September 30, 1999, shareholders' equity amounted to $852.1 million. In
addition, through a subsidiary trust, the Company had outstanding $68.8 million
of Capital Securities which mature in 2027 and qualify as Tier 1 Capital. The
Company paid a $0.12 per share dividend on its common stock during the third
quarter of 1999. In July 1999, the Company authorized a 4,000,000 share
repurchase program. As of September 30, 1999, the Company repurchased
2.9 million shares for $53.7 million.
Capital guidelines issued by the Federal Reserve Board require the Company to
maintain certain ratios, set forth in Table 9. As indicated in such table, the
Company's regulatory capital currently substantially exceeds all applicable
requirements.
TABLE 9 - Regulatory Capital Requirements
(Dollars in thousands)
<TABLE>
<CAPTION>
For Capital Adequacy
Actual Purposes Excess
----------------- ----------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- -------- -----
As of September 30, 1999:
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk weighted assets) $977,541 11.94% $643,875 8.00% $333,666 3.94%
Tier 1 capital (to risk weighted assets) 875,178 10.69% 321,537 4.00% 553,641 6.69%
Tier 1 leverage capital ratio (to average assets) 875,178 6.36% 550,059 4.00% 325,119 2.36%
As of December 31, 1998:
Total capital (to risk weighted assets) 968,974 13.02% 595,426 8.00% 373,548 5.02%
Tier 1 capital (to risk weighted assets) 875,723 11.76% 297,713 4.00% 578,010 7.76%
Tier 1 leverage capital (to average assets) 875,723 7.50% 467,096 4.00% 408,627 3.50%
</TABLE>
Net risk weighted assets were $8.2 billion and $7.4 billion at September 30,
1999 and December 31, 1998, respectively.
The Company's banking subsidiaries are also subject to federal, and in certain
cases state, regulatory capital requirements. At September 30, 1999, each of the
Company's banking subsidiaries was deemed to be "well capitalized" under the
regulations of the applicable federal banking agency and in compliance with
applicable state capital requirements.
IMPACT OF THE YEAR 2000
The Company recognizes the significant potential impact from what is generally
called the "year-2000" computer problem. This problem results from a computer
programming convention where the specification of year data is truncated to two
digits instead of the literal four digits (i.e., the year "1998" is represented
as "98" and the century indicator of "19" is only assumed or automatically added
after processing is completed). As computer software programs using this
programming convention encounter data with year-2000 dates, they may
misinterpret the resulting "00" year representation as the year "1900" instead
of "2000." Date-based calculations under these conditions could result in
inaccurate results or system failures.
The use of embedded chips into non-information processing applications has also
increased the risk of year-2000 problems in automated control and production
systems where date and calendar programming is involved (e.g., in automated
building environment controls or automated production equipment).
Year-2000 computer software or embedded chip system failures external to the
Company have the potential for negative impacts if they occur "upstream" (at
suppliers, service providers, fiduciary counter-parties, or funding sources) or
"downstream" (at customers or other third-parties).
As with most large financial service providers, the Company relies on a
substantial number of information processing systems to deliver and manage its
financial services products and the year-2000 problem presents a significant
challenge. The Company relies heavily on external sources for computer software,
basic infrastructure services, product-line support services and other goods and
materials. The Company also exchanges a significant volume of
29
<PAGE> 30
data with external parties, including other financial institutions, government
entities, customers and business partners. The extent of the Company's reliance
on external support for its business operations adds to the challenge of getting
"year-2000 ready."
SOLUTION STRATEGY
The Company initiated a formal Year-2000 Readiness Project in 1997. A senior
management committee monitors the project and receives status reports on a
bi-weekly basis. The Board of Directors receives quarterly status updates. A
project team chaired by the Vice President of Technology and made up of a
full-time project coordinator and team leaders from core support and data
processing business units directs the detail readiness effort. Business unit
representatives are involved in assessment, testing and implementation tasks as
required. The Company is using both internal and external resources for various
project tasks.
The project plan has been segregated into five phases and closely follows the
guidelines provided by the Federal Financial Institutions Examination Council
(FFIEC), an inter-agency collaborative sponsored by the Federal Reserve Board,
the Federal Deposit Insurance Corp., the Office of the Comptroller of the
Currency, the Office of Thrift Supervision and the National Credit Union
Administration. The project phases and description are as follows:
Awareness phase - the problem and project effort was initially defined
and senior project sponsorship and support obtained. The project team was formed
and the overall nature of the project effort was communicated to employees and
other important external parties. This phase was initiated in January 1997 and,
except for the on-going customer and community awareness efforts, was completed
in July 1998.
Assessment phase - a system component inventory was conducted across
the Company. This included identifying all internally managed and controlled
hardware, software, networks, unique processing platforms, and external customer
and vendor data processing interdependencies. Various non-information processing
systems such as physical security, elevator, HVAC/building environment and vault
control systems were included in the inventory.
Each system component was rated on its importance to the Company and its
year-2000 compliance status. This assessment was used as a guide for repair or
replacement priority and resource assignments. The Company identified nearly 100
internally controlled or managed systems or system categories as "critical."
Twelve external services or data interfaces are currently considered as
"critical." Assessments of building environment and security control systems
indicated they were a low risk to the Company.
During this phase, a plan to identify material customers (as funds takers, funds
providers or capital market/asset management counterparties), assess their
Year-2000 readiness, evaluate the risks to the Company, and develop appropriate
risk management strategies was formulated. The Assessment phase for Company
systems and external suppliers and servicers was concluded in August 1998.
Renovation phase - a solution strategy was determined and planned for
each system at risk and the strategies were executed. This included re-coding,
hardware and software replacement or upgrade, and other associated changes. For
systems and services supplied by external parties, the Company obtained from
vendors their year-2000 readiness certifications and statements or monitored the
vendor's progress in renovation, internal testing and availability of certified
systems or upgrades. The review of current service contracts for year-2000
implications was also included in this phase.
The Company relies on vendors for over 90% of its software systems and
components, including the core mainframe-based software. The remaining
approximately 10% of software is mainframe-based customized product or in-house
developed micro-computer database applications. The renovation phase commenced
in October 1997 and software upgrades, replacements and other remediation were
completed in June 1999.
Validation Phase - this phase includes developing and executing test
scripts in specific testing environments where system dates can be set ahead and
documenting the results. The validation plans closely follow regulatory
guidances dictating the independent testing of critical systems in the Company's
own test centers even when vendor certifications are available. Testing designs
include unit, integrated (with internal and external systems), point-to-point
and end-to-end testing as appropriate. Business unit management, project
management and internal audit provide final validation of the testing process
and year-2000 readiness.
The testing of critical rated and non-critical rated internal systems and
external servicers and data interfaces, user acceptance and audit review was
completed in June 1999.
30
<PAGE> 31
The Company is communicating with, or otherwise monitoring, the year-2000
readiness progress of significant external providers of infrastructure services
on an on-going basis; the Company does not expect to directly test with these
providers. At this time, the Company is not aware of any material disruption of
infrastructure services which may be likely to occur.
Implementation phase - once systems are validated as year-2000 ready,
repairs, upgrades or replacements are installed into production during this
phase. All critical systems have been validated as Year 2000 ready, or repaired
or replaced as necessary and put into production by June 1999. All non-critical
systems have been validated as Year 2000 ready, or repaired or replaced as
necessary and put into production by June 1999. Also as part of the
implementation phase, the Company conducted systematic analyses regarding core
critical business processes in order to create a Y2K specific Business
Resumption Contingency Plan, an addendum to the already existing Company-wide
Business Recovery Plan focusing on the uniqueness of potential Y2K failure
scenarios. Business processes critical to the Company have been analyzed and
broken down into manual processes or other workaround tasks and fully
documented. A method to evaluate the validity of the Y2K plan has been developed
and was approved by the Board in May 1999. The final Y2K Business Resumption
Contingency Plan received Board approval in the third quarter of 1999. The
Company has also developed an Event Management Plan and strategy to serve as a
master management tool for all tasks necessary to meet the millennium rollover
period, including those necessary for a swift and expedient return from any
alternate operating contingency procedures back to normal operations. The plan
includes preparation tasks, validation procedures, and internal and external
communications protocols, and forms a Y2K "Command Center" consisting of senior
management and Y2K support units to function as communications/coordination
centers for possible event disruptions. The Event Management Plan and strategy
were independently validated in September 1999. The Company is also proactively
working with employees, customers and industry peers, media and the White House
Council on Y2K in efforts to increase awareness and educate customers and the
public with regard to Y2K preparedness and safety.
Ongoing activities include the monitoring and evaluation of internal system
changes for year-2000 risk impacts, the monitoring of material customer, vendor,
and counterparty risk, and the continuing development and implementation of
customer and community awareness efforts.
COST
The Company does not separately track the internal costs incurred for the
year-2000 project, except for the dedicated salary of the project coordinator.
The vast majority of internal costs relates to the payroll cost for staff
assigned to the year-2000 project team and Company personnel assigned to testing
the changes resulting from the Year 2000 effort. The Company has incurred $1.9
million of external expenses in 1999 and anticipates that the incremental cost
of the Year 2000 project will total approximately $2.1 million in 1999. All year
2000 costs are expensed as incurred, and are being funded out of the Company's
operating cash flow.
SUMMARY
Based on the risk assessment, remediation, testing and monitoring efforts to
date, the Company expects substantially all of its critical and important
systems will operate successfully in all material respects through the century
change. Therefore, the Company believes internal system failures are unlikely to
materially adversely affect the Company's operations or financial condition,
although there can be no assurances in this regard. The Company has already
successfully tested with several critical external service providers and will
continue in 1999 to validate and monitor changes in the readiness of its
critical service providers, including the Company's electric power,
telecommunications and transportation service providers. At this time, the
Company believes the most likely "worst case" scenario consists of temporary and
localized disruptions in infrastructure services, which may disrupt the
Company's ability to service customers and/or the ability of external service
providers to service the Company.
The magnitude and scope of the Company's efforts to address the year-2000
problem may be revised periodically as the quality and quantity of knowledge
about the project increases. It should also be noted that this description of
the Company's efforts involves estimates and projections that are subject to
change as work continues and such changes could be substantial.
Pursuant to FFIEC guidelines, the Company is required to develop commercial
credit risk controls to monitor and assess Year 2000 risk. As of September 1999,
the Company had exceeded its target for reviewing commercial loan balances for
year-2000 readiness.
31
<PAGE> 32
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which sets accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the balance
sheet and measure those instruments at fair value. This Statement currently is
scheduled to be effective for the Company for years beginning January 1, 2001.
FORWARD LOOKING STATEMENTS
Certain statements contained herein are not based on historical facts and are
"forward-looking statements" within the meaning of Section 21A of the Securities
Exchange Act of 1934. Forward-looking statements, which are based on various
assumptions (some of which are beyond the Company's control), may be identified
by reference to a future period or periods, or by the use of forward-looking
terminology, such as "may," "will," "believe," "expect," "estimate,"
"anticipate," "continue," or similar terms or variations on those terms or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, those related to the economic environment, particularly in the
market areas in which the Company operates, competitive products and pricing,
fiscal and monetary policies of the U.S. Government, changes in government
regulations affecting financial institutions, including regulatory fees and
capital requirements, changes in prevailing interest rates, acquisitions and the
integration of acquired businesses, credit risk management, asset/liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity.
The Company does not undertake, and specifically disclaims any obligation, to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of events or circumstances
after the date of such statements.
32
<PAGE> 33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in the section captioned "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate Risk
and Asset - Liability Management" is incorporated herein by reference.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which in the aggregate are believed by
management to be immaterial to the financial condition and results of
operations of the Company.
Item 2. Changes in securities - not applicable.
Item 3. Defaults upon senior securities - not applicable.
Item 4. Submission of matters to a vote of security holders - not applicable.
Item 5. Other Information - not applicable.
Item 6. Exhibits and reports on Form 8-K.
(a) Exhibit 27 - Financial Data Schedule.
(b) The Company filed a Current Report on Form 8-K on July 27
and July 28, 1999.
SIGNATURES
Pursuant to the requirements 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.
PEOPLES HERITAGE FINANCIAL GROUP, INC.
Date November 15, 1999 By: /s/ William J. Ryan
-----------------------
William J. Ryan
Chairman, President and
Chief Executive Officer
Date November 15, 1999 By: /s/ Peter J. Verrill
---------------------------
Peter J. Verrill
Executive Vice President,
Chief Operating Officer and
Chief Financial Officer
(principal financial and
accounting officer)
33
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