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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ________________________ to _____________________
Commission file number 1-10506
Essex Bancorp, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 54-1721085
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(State of organization) (I.R.S. Employer
Identification No.)
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
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(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (757) 893-1300
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $.01 Per Share American Stock Exchange
- -------------------------------------- -----------------------
(Title of Class) (Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during 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 |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained to
the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the Registrant's common stock on the
American Stock Exchange on March 20, 1997 held by nonaffiliates of the
Registrant was $2,101,730.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1996 are incorporated by reference into Parts I and II hereof.
Portions of the Proxy Statement for the Annual Meeting to be held on May 29,
1997 are incorporated by reference into Part III hereof.
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Essex Bancorp, Inc.
Annual Report on Form 10-K for the
Year Ended December 31, 1996
Table of Contents
Page
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Part I
Item 1 Business....................................................... 3
Item 2 Properties..................................................... 44
Item 3 Legal Proceedings.............................................. 44
Item 4 Submission of Matters to a Vote
of Security Holders........................................ 45
Part II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters............................ 45
Item 6 Selected Financial Data........................................ 46
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations.................................. 46
Item 8 Financial Statements and
Supplementary Data......................................... 46
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure....................................... 46
Part III
Item 10 Directors and Executive Officers
of the Registrant.......................................... 46
Item 11 Executive Compensation......................................... 47
Item 12 Security Ownership of Certain
Beneficial Owners and Management........................... 48
Item 13 Certain Relationships and
Related Transactions....................................... 48
Part IV
Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K.................................... 49
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PART I
Item 1. Business
Organization and Background
General. The following organizational chart depicts Essex Bancorp, Inc.
and its subsidiaries as of December 31, 1996. It is intended to facilitate the
readers' understanding of the companies discussed in this report. Following the
chart is a glossary of terms which are used throughout this report.
Essex Bancorp, Inc. and Subsidiaries
Organizational Chart
[GRAPHIC OMITTED]
Unless otherwise noted, each company is owned 100% by its parent entity.
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Defined Term Formal Name
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Company Essex Bancorp, Inc., successor to Essex Financial Partners,
L.P. and Essex Bancorp.
Partnership Essex Financial Partners, L.P.
Bancorp Essex Bancorp.
EAC Essex Acquisition Corporation
Bank Essex Savings Bank, F.S.B.
EMC Essex Mortgage Corporation
Essex First Essex First Mortgage Corporation
ECC Essex Capital Corporation
Essex Home Essex Home Mortgage Servicing Corporation
EHADC E H Asset Disposition Corporation
TMS Thrift Management Services, Inc. - General Partner
The Company is a Delaware corporation that is the holding company for the
Bank, a federally-chartered savings bank which operates four branches located in
North Carolina and Virginia. The Company is the successor by merger to the
Partnership, a Delaware limited partnership, which was formed in 1989 in order
to acquire an existing corporation that was the holding company for one of the
Bank's predecessor institutions. The Partnership and Bancorp, the Bank's former
holding company, were merged into the Company in January 1995. The Company is
engaged primarily in the operation of the Bank as a wholly-owned subsidiary. The
Company's other principal operating subsidiaries are Essex First, a wholly-owned
subsidiary of the Bank that is engaged primarily in the origination and sale of
residential mortgage loans, and Essex Home, an indirect subsidiary of the
Company and the Bank that is engaged primarily in the servicing of mortgage
loans owned by the Bank, various governmental agencies and various third party
investors. Because the merger described below did not occur until January 1995,
the financial statements included herein for years prior to 1995 are those of
the Partnership. At December 31, 1996, the Company had total assets of $174.3
million, total liabilities of $159.2 million, including total deposits of $131.0
million, and total shareholders' equity of $15.1 million.
In January 1995, following approval by the holders of the Partnership's
limited partnership units ("LPUs"), both the Partnership and Bancorp were merged
with and into the Company (collectively, the "Merger"), which resulted in a
single holding company structure for the Bank and the other subsidiaries of the
Company. As a result of the consummation of the Merger, each holder of LPUs
received one share of Company common stock ("Common Stock") for every two LPUs
beneficially owned, and the former corporate general partner of the Partnership
received 10,496 shares of Common Stock (which represented 1.0% of the issued and
outstanding Common Stock) in exchange for its general partner's interest. The
Merger was undertaken, among other reasons, in order (i) to eliminate a
cumbersome business structure that no longer provided the originally intended
benefits to the Partnership's unitholders, (ii) to expand the base of potential
investors in the Company by eliminating a complicated and nontraditional holding
company structure, and (iii) to provide the Company with greater access to
public and private equity capital markets. The Company had 1,049,687 shares of
Common Stock outstanding immediately following the Merger. As a consequence of
the Merger, the Company succeeded to all of the assets and liabilities of the
Partnership and Bancorp. In this report, unless the context otherwise requires,
the term "Company" refers to the Partnership prior to the Merger and/or the
Company subsequent to the Merger, in each case including all subsidiaries
thereof.
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Operations of the Partnership Prior to the Merger. The Partnership was the
predecessor to the Company and was formed in 1989 as a publicly-traded master
limited partnership with the issuance of 2,078,382 LPUs priced at $20 per LPU.
The Partnership's former business plan was based on the premise that the thrift
industry was undergoing structural changes similar to those experienced by the
commercial banking industry during the decades of the 1960s and 1970s. These
structural changes were believed to portend the consolidation of the thrift
industry into larger holding company structures characteristic of the commercial
banking industry.
Specifically, the Partnership's goal was to use the proceeds of its public
offering to fund the acquisition of smaller, predominantly undercapitalized
thrift institutions located in the southeastern United States. These thrift
institutions would then be operationally linked through common control by
Bancorp, a multi-state thrift holding company. The bank branch network was
considered to be little more than a platform from which to raise deposits,
largely "mini-jumbo" certificates of deposit in denominations of $25,000 to
$80,000, offering yields typically priced at the top of the deposit market. The
funds provided by these deposits would be used to operate an active secondary
marketing function which would acquire mortgage loans, principally second
mortgage loans in geographically dispersed markets purchased at premiums, in the
secondary market. Pools of loans were then to be aggregated and sold to or
participated among Bancorp's bank subsidiaries.
The Partnership made only three acquisitions, however. The initial
acquisition was of Bancorp and its principal subsidiary, Essex Savings Bank,
Inc. of Elizabeth City, North Carolina, also referred to as the Bank, a $300
million thrift owned by the original corporate general partner of the
Partnership. The Partnership also acquired in 1990 a $65 million thrift
institution based in Emporia, Virginia. The Partnership's acquisition activity
was concluded in May 1990 with the acquisition from the Resolution Trust Company
("RTC") of the former Financial Security Savings & Loan Association of Delray
Beach, Florida, a $107 million thrift institution.
In addition to the $41.6 million in partnership equity raised by the
Partnership, in January 1991 EMC, the Partnership's non-bank mortgage
subsidiary, issued $23.4 million in mortgage servicing backed notes (the "Essex
11's") through a private placement. Proceeds of these notes were used over a
17-month period to acquire purchased mortgage servicing rights ("PMSRs") for
sale on the secondary market. Issuance of the Essex 11's coincided with the
decline in interest rates to their lowest level in 20 years and, not
unexpectedly, the Partnership and its subsidiaries suffered the adverse
financial impact of impairment to the carrying value of the Partnership's PMSR
portfolio, capitalized excess servicing, and loan premiums. Concurrently, the
Partnership also suffered dramatic deterioration in the quality of its loan
portfolio, necessitating substantial additional loan loss reserves and
provisions for losses on foreclosed properties.
In March 1991, as a result of regulatory findings made during the 1990
examination of the Partnership and its subsidiaries, the Office of Thrift
Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the
Commissioner of Savings Institutions for the State of North Carolina imposed a
broadly restrictive supervisory agreement on the operations of the Partnership's
three subsidiary banks. During the second quarter of 1991 the Partnership also
announced the reduction in its dividend per partnership unit to $.25 per quarter
from the prior level of $.40 per unit. Fiscal year 1991 concluded with the Bank
failing its regulatory capital requirements, an event which required the
submission of a capital restoration plan.
During the second quarter of 1992 it became increasingly apparent that EMC
would default on certain terms of the indenture under which the Essex 11's were
issued, and in April 1992 the Partnership announced that the $.25 per unit
dividend declared on March 19, 1992 payable on May 15, 1992 would be delayed as
a result of a lack of liquidity at the Partnership. In response to the serious
deterioration in the financial condition of the Partnership, in May 1992 the
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Investment Committee of the Partnership, a body effectively controlled by
members employed by the Partnership's investment banker, PaineWebber Inc.
("PWI"), acting pursuant to certain provisions of the Agreement of Limited
Partnership, removed the Partnership's corporate general partner.
The change of control of the Partnership was initiated on May 1, 1992 and
was concluded on May 6, 1992 with the installation of an interim corporate
general partner of the Partnership. Following regulatory approval in 1993, TMS
was installed as the permanent corporate general partner of the Partnership. TMS
was controlled by Gene D. Ross, the present president and chief executive
officer of the Company, who had also been the president and chief executive
officer of the interim general partner since the 1992 change in control.
The Partnership's new management undertook four principal courses of
action. First, the Company replaced certain members of its former senior
management with individuals with significant experience in banking and problem
asset rehabilitation. Second, the Company reorganized its risk management and
collections department in order to focus on the early identification of
potential problem assets and the administration, rehabilitation or liquidation
of the Company's nonperforming assets. Third, the Partnership's three separate
savings bank subsidiaries were consolidated into the Bank in May 1993, which
created operating efficiencies and a simplified organizational structure. At the
time of the consolidation, the Bank did not comply with its minimum regulatory
capital requirements. As a result, the Partnership obtained a $3.0 million loan
from PaineWebber Capital Inc. ("PWC"), the proceeds of which were contributed to
the Bank in order to bring the institution into regulatory capital compliance.
This $3.0 million loan was evidenced by a seven-year note (the "Seven-Year
Note") from the Partnership to PWC. Fourth, PWC successfully tendered for and
repurchased at par all of the outstanding Essex 11's. In exchange for the
cancellation of substantially all of the Essex 11's, the Partnership delivered a
ten-year note (the "Ten-Year Note") in the original principal amount of $14.2
million to PWC in May 1993, and PWC received the proceeds of the sale of the
balance of EMC's PMSRs, which was consummated in mid-1993. On October 24, 1994,
the total outstanding principal and interest owed with respect to the Seven- and
Ten-Year Notes and the remaining Essex 11's held by PWC were forgiven in
connection with the settlement of the litigation discussed below.
By the end of 1993, although the Bank had made significant progress in
resolving many of its financial and operational problems, it again fell out of
compliance with its minimum regulatory capital requirements. Management of the
Bank had already concluded that in order to reposition the Bank's activities
along the lines of a more traditional financial institution and in order to
focus the Bank's lending and deposit gathering activities within the Bank's
primary market of North Carolina and Virginia, it would be necessary to sell the
Bank's Florida branches. The sale of the Florida branches to a third party,
which was consummated on June 30, 1994, brought the Bank into compliance with
its minimum regulatory capital requirements.
In December 1993, the Partnership also became a defendant, together with
PaineWebber and others, in certain class action litigation (the "Litigation")
relating to the original offering by the Partnership and the management of the
Partnership and its subsidiaries prior to the 1992 change in control. In
September 1994, the United States District Court for the Eastern District of
Texas entered an order approving a proposed class action settlement (the
"Settlement") of the Litigation. The Settlement substantially improved the
financial condition of the Partnership and its subsidiaries by providing for the
forgiveness by PaineWebber, effective October 24, 1994, of all of the debt
outstanding under the Seven- and Ten-Year Notes and the remaining Essex 11's.
The aggregate amount of such debt totaled approximately $20.7 million at October
24, 1994.
The benefit of the debt forgiveness was offset to some extent by (i)
litigation expenses of approximately $90,000, (ii) the Partnership's
contribution of $1.3 million to a settlement fund established by the defendants
to pay the plaintiffs' attorneys' fees and certain costs associated with
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the Settlement and to make certain payments to the named plaintiffs, and (iii)
the issuance by the Company to former holders of LPUs of a total of $1.0 million
in preferred stock (the "Series A Preferred Stock"). As a result of the
Settlement, the Company also recognized approximately $330,000 of alternative
minimum taxes ("AMT") and the Company's net operating loss ("NOL") carryforwards
were reduced by approximately $20.0 million, resulting in a NOL carryforward of
$20.5 million and a $330,000 AMT carryover at December 31, 1994.
Business Strategy of the Company and the Bank
General. Since the change in management which occurred in May 1992, the
Company's new management achieved substantial progress in addressing its various
financial, regulatory and operating problems. Such achievements included the
consolidation of the Partnership's three savings bank subsidiaries into the
Bank, the restructuring of the Essex 11's, the sale of the Bank's Florida
branches, and the Settlement of the Litigation (which resulted in the
forgiveness of approximately $20.7 million of debt). Nevertheless, due to the
Bank's financial condition and continued losses from operations, the Bank again
failed certain of its minimum regulatory capital requirements at December 31,
1994. Management had already determined that the raising of additional capital
was critical to the Bank's long-term viability and the accomplishment of the
Bank's business objectives, as well as the Bank's compliance with applicable
regulatory capital requirements
Capital Raising Efforts. Following discussions with the Company's
financial advisor, the Board of Directors of the Company (the majority of which
were independent) determined that the most expeditious method of raising capital
was through a private placement offering and unanimously approved a proposed
recapitalization plan. Accordingly, on March 13, 1995, the Company's financial
advisor began distributing a preliminary placement memorandum to a select group
of institutional and accredited investors. A series of meetings was held with
potential investors in order to determine their level of interest. On June 29,
1995, the OTS, the Bank's primary regulator, formally notified the Bank that
unless it raised additional capital by June 30, 1995, the Bank would be subject
to the appointment of a conservator or a receiver, as well as other enforcement
actions. The OTS further advised that if the Bank was unable to provide written
evidence by June 30, 1995 that it had entered into a binding agreement to
recapitalize the Bank, the OTS would transfer the Bank to the RTC, an
instrumentality of the U.S. Government which had the authority to sell and
liquidate depository institutions. Therefore, it was imperative that the Bank
raise capital in order to prevent its imminent seizure by the RTC. In the final
analysis, only one party was able to step forward within the required
time-frame. On June 30, 1995, the Company and the Bank signed an Agreement and
Plan of Reorganization (the "Agreement") with Home Bancorp, Inc. ("Home
Bancorp") and its wholly-owned subsidiary Home Savings Bank, F.S.B. ("Home
Savings"), a Norfolk, Virginia based savings institution. On September 15, 1995,
the Company and the Bank merged with Home Bancorp and Home Savings (the "Home
Acquisition"). After this transaction, the Bank exceeded all of the minimum
regulatory capital requirements imposed by federal law.
The Home Acquisition was accounted for using the purchase method of
accounting and the purchase price was allocated among the assets and liabilities
of Home Bancorp and Home Savings at their fair value, which was $60.1 million
and $52.6 million, respectively, as of September 15, 1995. The excess of cost
over net assets acquired("goodwill") recognized in connection with the Home
Acquisition was approximately $8.6 million.
In exchange for all of the outstanding stock of Home Bancorp, the
stockholders of Home Bancorp received 2,250,000 shares of nonvoting perpetual
preferred stock of the Company with an aggregate redemption and liquidation
value of $15 million and warrants to purchase 7,949,000 shares of the Company's
common stock at a price of $0.9375 per share, which was the price of
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the Company's Common Stock as of June 30, 1995. The warrants are exercisable
beginning in September 1998 and expire in September 2005. The fair market value
of the preferred stock and the warrants was estimated in a third party valuation
to approximate $15.5 million at the time of the Home Acquisition. Following the
completion of the transaction, two representatives designated by Home Bancorp
joined the Boards of Directors of the Company and the Bank, filling existing
vacancies on those Boards.
Development of Full-Service Branches. The original business plan of the
Bank resulted in mostly limited service branches that were designed primarily to
accumulate large deposits in non-transactional accounts by offering attractive
interest rates. Almost all of the Bank's branches were limited service branches,
which received deposits but originated very few loans and had almost no presence
in the communities they served. The consolidation of the Partnership's three
savings bank subsidiaries in 1993, the sale of the Florida branches in 1994, and
the Home Acquisition in 1995, were important initial steps in management's
efforts to reposition the Bank's activities along the lines of a more
traditional savings institution while allowing the Bank to focus its lending and
deposit gathering activities within its primary market of Virginia and North
Carolina.
Not long after the Home Acquisition was assimilated, the Board of
Directors of the Company formed a Strategic Evaluation Committee (the
"Committee") to explore the possibility of further expansion or contraction by
branch sales. It was concluded, with assistance from an independent consultant,
that selling non-strategic bank branches and effectively shrinking the size of
the assets base by approximately 50% was a strategy that ultimately would be in
the best interests of the common and preferred shareholders of the Company.
Accordingly, the Bank sold its branches in Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina and in Norfolk, Portsmouth, Hampton, Newport News and
Grafton, Virginia (collectively, the "Branches") in three separate transactions
over a nine-month period in 1996. The outcome of this strategy is that the
Company has retained the most strategic branches with the greatest potential for
significant market share growth, has approximately 8.7% tangible capital as of
December 31, 1996 and has largely removed goodwill from its balance sheet. See
Note 5 on pages 50 and 51 of the Notes to Consolidated Financial Statements of
the 1996 Annual Report to Stockholders, which is attached hereto as Exhibit 13
and incorporated herein by reference.
During this downsizing period in 1996, the Bank continued its efforts to
position the remaining strategic branches to more nearly conform to the
activities of a traditional savings institution. To that end, the Bank and its
mortgage banking subsidiary introduced a wider range of consumer and mortgage
loan products to attract new business and maximize the potential of its existing
customer base. In addition, in September 1996 the Bank executed a purchase
agreement on a parcel in Suffolk, Virginia with the intent to relocate its
Suffolk branch from a leased facility location to a location with potential for
significant growth.
Expansion of Residential Construction and Consumer Lending. Since 1992,
the Company has begun to emphasize the origination and purchase of residential
construction and consumer loans because of the shorter-term nature of such loans
and the higher yields available thereon when compared to permanent residential
mortgage lending. However, construction and consumer lending is generally
considered to involve a higher level of risk as compared to single-family
residential lending. Notwithstanding the higher risk aspect, the portfolio of
residential construction loans has grown steadily since 1992 without a loss. For
additional information, see "Lending Activities - Construction Loans" and "-
Consumer Loans."
Reduction in Operating Expenses. Historically, the Company's operating
expenses have been high relative to those of other savings institutions of
similar asset size. This has been primarily due to the presence of duplicative
operating procedures and personnel, a high level of professional fees resulting
from the various financial and operating problems of the Partnership, an
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increase in expenses relating to the allocation of resources to the collection
and work-out of nonperforming assets, high levels of provisions for losses on
foreclosed properties and high levels of impairment adjustments relating to
PMSRs, excess servicing fees and loan premiums. Significant reductions have been
made in operating expenses since the change in management which occurred in May
1992. Nevertheless, management continues to evaluate the Bank's personnel needs
and operating requirements in order to identify areas where additional measures
may be taken to reduce costs, and is in the process of implementing additional
cost reductions so that the on-going expense structure is compatible with an
institution that has dramatically downsized during 1996. Although the Bank is
committed to achieving a lower level of operating expenses relative to the
Bank's operations, management recognizes that operating expenses will remain
higher than much of the Bank's peer group due to the relatively low level of
assets of Essex Home.
Reduction of Nonperforming Assets. As previously discussed, the Company's
new management reorganized the Bank's risk management and collections department
and revised its loan underwriting, collection and monitoring procedures in an
effort to reduce the level of nonperforming assets. As a result, nonperforming
assets have declined from $24.8 million or 5.92% of total assets at December 31,
1992 to $5.2 million or 2.99% of total assets at December 31, 1996. In addition,
loans delinquent 30 to 89 days have declined from $7.0 million or 2.66% of total
loans held for investment at December 31, 1992 to $1.5 million or 1.01% of total
loans held for investment at December 31, 1996. Reduced provisions for loan
losses and provisions for losses on foreclosed properties are expected to
contribute to improved operating results. Nevertheless, future additions to the
allowance for loan losses or reductions in the carrying values of foreclosed
properties could become necessary as a result of future increases in
nonperforming assets or for other reasons, including any adjustments required in
connection with future regulatory examinations of the Bank.
Expansion of Subservicing Activities. The Bank is also committed to
securing a reliable source of fee income by providing competitive and profitable
residential mortgage loan servicing and subservicing. Essex Home is a service
corporation subsidiary licensed by the Federal National Mortgage Association
("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and the
Government National Mortgage Association ("GNMA"). Essex Home also services and
subservices loans for approximately 28 other private investors.
In April 1993, Essex Home began a marketing effort to acquire subservicing
contracts as a means of generating loan servicing fees and ancillary income.
Through various networking and referral opportunities and advertising efforts,
Essex Home has successfully attracted other financial institutions and mortgage
banking firms interested in subcontracting their loan servicing function. By
subservicing loans for others, the Bank will be able to utilize more fully its
available resources in a cost efficient and profitable manner. At December 31,
1996, approximately 13,300 loans with an aggregate principal balance of $1.1
billion were serviced or subserviced by Essex Home. However, on February 28,
1997, the Company was notified by its largest subservicing client of its
intention not to renew its contract beyond June 1, 1997. As of December 31,
1996, the Company serviced approximately 7,000 loans totaling $858.9 million for
this client and servicing fee income for 1996 included approximately $409,000
attributable to servicing activities performed for this client. While the
Company's management has intensified its marketing efforts in order minimize the
impact of this loss on the earnings performance of Essex Home and the Company,
no assurances can be made that this significant servicing volume can be replaced
in its entirety in the near term. Management believes, however, that its
marketing efforts will be buoyed by the much-improved capital position of the
Bank, which is deemed a "well-capitalized" institution under the Prompt
Corrective Action provisions of the Federal Deposit Insurance Act. In the
meantime, the Company is examining expenses associated with the servicing of
this client in contemplation of reductions to minimize the loss in servicing fee
income.
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Strengthening of Loan Policies. Since May 1992, the loan underwriting
policies of the Bank have been substantially revised and strengthened with the
objective of reducing the risk profile of the Bank's loan portfolio. In
addition, the Company's loan portfolio has been restructured in order to improve
its asset quality, reduce the risk-weighting of the Bank's assets and minimize
the Company's exposure to interest rate risk. Specifically, the Company has
significantly reduced its portfolio of second mortgage loans while emphasizing
the origination of both construction and permanent loans secured by
single-family residential real estate. Efforts were made to effect these changes
while continuing to be responsive to the borrowing needs in the Bank's markets.
In addition to strengthening the Bank's underwriting policies and procedures,
other measures were taken to improve the Bank's asset quality, including the
formation of a loan committee, further strengthening of the Bank's internal
audit and quality control functions and enhanced loan origination standards and
practices.
Interest Rate Risk Management. Deposit accounts typically adjust more
quickly to changes in market interest rates than mortgage loans because of the
shorter maturities of deposits. As a result, significant increases in interest
rates may adversely affect the Bank's earnings. To reduce the potential
volatility of the Bank's earnings, management has sought to improve the match
between asset and liability maturities and rates, while maintaining an
acceptable interest rate spread. Pursuant to this strategy, the Bank has (i)
emphasized investment in adjustable-rate single-family residential loans or
shorter-term (seven years or less), fixed-rate single-family residential loans;
(ii) sold longer-term (over seven years), fixed-rate single-family residential
loans in the secondary market; (iii) purchased adjustable-rate mortgage-backed
securities; (iv) maintained higher liquidity by holding short-term investments
and cash equivalents; and (v) increased the average maturity of the Bank's
interest-bearing liabilities by utilizing long-term advances and attempting to
attract longer-term retail deposits.
The interest rate sensitivity gap is defined as the difference between
interest-earning assets and interest-bearing liabilities maturing or repricing
with a given time period. As a result of the acquisition of Home Savings, whose
loans were predominantly fixed-rate mortgage loans with maturities in excess of
seven years, and whose deposits were predominantly fixed-rate certificates with
maturities of one year or less, the Bank's one-year interest rate sensitivity
gap amounted to a negative 7.7% of total assets at December 31, 1995. However,
through the balance sheet restructuring that resulted from the sale of branches
during 1996, the Bank was able to significantly improve its one-year interest
rate sensitivity gap to zero as of December 31, 1996. Furthermore, the total
cumulative ratio of interest earning assets to interest-bearing liabilities
increased from 97.2% at December 31, 1995 to 101.4% at December 31, 1996. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset and Liability Management" on pages 27 through 30 of the 1996
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
General
The Company, as a registered savings and loan holding company, is subject
to examination and regulation by the OTS and is subject to various reporting and
other requirements of the Securities and Exchange Commission (the "Commission").
The Bank, as a federally chartered savings bank, is subject to comprehensive
regulation and examination by the OTS, as its chartering authority and primary
regulator, and by the FDIC, which administers the Savings Association Insurance
Fund ("SAIF"), which insures the Bank's deposits to the maximum extent permitted
by law. The Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLB"),
which is one of 12 regional banks which comprise the Federal Home Loan Bank
System. The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System ("Federal Reserve Board") governing reserves required
to be maintained against deposits and certain other matters.
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The principal business of the Company has in the past consisted of
attracting deposits from the general public through its offices (primarily
mini-jumbo certificates of deposit) and using such deposits, together with
advances from the FHLB and other sources of funds, to originate and purchase
mortgage loans secured by first and second liens on single-family residential
real estate. Historically, the Company has also engaged in the origination of
construction loans (including residential development loans), and, to a lesser
extent, commercial real estate loans, commercial business loans and consumer
loans. The Company's principal focus is currently on the origination (through
Essex First) of both construction and permanent single-family residential loans
(of which substantially all fixed-rate single-family residential loans with
terms to maturity in excess of seven years are being sold by Essex First in the
secondary market). Moreover, in order to provide a full range of services to its
customers and in accordance with the Company's asset and liability management
policies, the Company recently has increased its emphasis of the origination of
various types of consumer loans. In addition, the Company generates fee income
by providing to third parties residential mortgage loan servicing and
subservicing through Essex Home. Furthermore, the Company invests in
mortgage-backed securities which are insured or guaranteed by the U.S.
Government and agencies thereof and other similar investments permitted by
applicable laws and regulations.
Lending Activities
General. At December 31, 1996, the Company's net loan portfolio (excluding
loans classified as held for sale) totaled $145.6 million, representing
approximately 83.5% of its $174.3 million of total assets at that date. The
principal categories of loans in the Company's portfolio are residential real
estate loans, which are secured by single-family (one-to-four units) residences;
loans for the construction of single-family properties; commercial real estate
loans, which are secured by multi-family (over five units) residential and
commercial real estate; commercial business loans; and consumer loans.
Substantially all of the Company's mortgage loan portfolio consists of
conventional mortgage loans, which are loans that are neither insured by the FHA
nor partially guaranteed by the VA.
As a federally chartered savings institution, the Bank has general
authority to originate and purchase loans secured by real estate located
throughout the United States. Prior to the change in management which occurred
in May 1992, the Company was engaged primarily in the origination and purchase
of loans secured by second liens (and, to a lesser extent, first liens) on
single-family residential real estate located throughout the continental United
States. The Company has ceased its nationwide lending and currently originates
substantially all of its loans within Virginia and North Carolina. Nevertheless,
the Company continues to purchase from time to time loans secured by properties
located outside of its market area and continues to hold a relatively
diversified portfolio.
Federal regulations permit the Bank to invest without limitation in
residential mortgage loans and up to four times its capital in loans secured by
non-residential or commercial real estate. The Bank is also permitted to invest
in secured and unsecured consumer loans in an amount not exceeding 35% of the
Bank's total assets; however, such 35% limit may be exceeded for certain types
of consumer loans, such as home equity, property improvement and education
loans. In addition, the Bank is permitted to invest up to 20% of its total
assets in secured (by other than real estate) and unsecured loans for
commercial, corporate, business or agricultural purposes, provided that any
investments which in the aggregate total 10% may only be used for small business
loans.
Since the enactment of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), a savings institution generally may not make
loans to one borrower and related entities in an amount which exceeds 15% of its
unimpaired capital and surplus, although loans in an amount equal to an
additional 10% of unimpaired capital and surplus may be made to a
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<PAGE>
borrower if the loans are fully secured by readily marketable securities. See
"Regulation - Regulation of the Bank - General." At December 31, 1996, the
Bank's limit on loans-to-one borrower was $2.5 million. The loans-to-one
borrower limitation may restrict the Bank's ability to do business with certain
existing customers.
At December 31, 1996, the Bank's five largest commercial loans-to-one
borrower and their related entities amounted to $1.4 million, $1.3 million,
$677,000, $430,000 and $307,000. In addition, as of December 31, 1996, the
Bank's largest lines of credit with unaffiliated home builders consisted of one
in the amount of $2.0 million (of which $531,000 had been drawn upon as of such
date), another in the amount of $1.5 million (of which $609,000 had been drawn
upon as of such date), another in the amount of $1.5 million (of which $455,000
had been drawn upon as of such date) and another in the amount of $1.5 million
(of which $252,000 had been drawn upon as of such date). At December 31, 1996,
the $1.4 million loan and the $430,000 loan were classified based on a rating
system adopted by the Company. Refer to "-Asset Quality - Classified Assets" for
a description of the classifications for problem assets.
The $430,000 loan is secured by one improved commercial property and four
residential lots located on the Outer Banks of North Carolina. This loan was
originally an $830,000 portion of a $2.7 million loan made in February 1990. See
"-Lending Activities - Nonperforming Assets" for a discussion of the $1.75
million portion of this loan (referred to as the "Richmond Apartments loan").
The commercial property and residential lots had an aggregate appraised value of
$1.0 million pursuant to appraisals obtained in October 1996 for the commercial
property and December 1994 for the residential lots. Interest is being paid
monthly with principal repayment expected to result from the sale or refinance
of the subject commercial and residential properties. The borrower is currently
marketing the residential lots and commercial properties for sale. As of
December 31, 1996, the loan was classified as substandard.
The $1.4 million group of loans consists of (i) a commercial real estate
loan which was originated in October 1987 in the amount of $1.0 million for the
purpose of refinancing a mini-storage/office facility (76 mini-storage units and
38 office units) located in Virginia Beach, Virginia, and (ii) a line of credit
in the amount of $600,000. The Company occupies approximately 12,000 square feet
of the office facility. The lease payments largely service the principal and
interest on the two loans. The term of the lease coincides with the maturity of
the loans, which are scheduled to mature on December 31, 2001. In addition, as
of December 31, 1996, the Bank and its subsidiaries leased 16 of the
mini-storage units. The property was most recently appraised in November 1992
for $915,000. As of December 31, 1996, the Bank had established a $300,000
specific reserve with respect to the loans and the remaining $1.1 million was
classified as substandard.
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<PAGE>
Loan Portfolio Composition. The following table sets forth information
concerning the Company's loan portfolio (excluding loans held for sale) by type
of loan at the dates indicated:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------
1996 1995 1994
---- ---- ----
$ % $ % $ %
--- --- --- --- --- ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Single-family residential:
First mortgages................ $103,643 70.0% $223,531 82.1% $187,607 77.7%
Second mortgages............... 12,384 8.3 13,398 4.9 18,717 7.8
Construction and development..... 17,190 11.6 15,078 5.5 15,501 6.4
Commercial real estate........... 6,313 4.3 10,611 3.9 11,499 4.8
-------- ----- -------- ----- -------- -----
Total real estate loans........ 139,530 94.2 262,618 96.4 233,324 96.7
Commercial business loans........... 1,915 1.3 2,171 .8 1,824 .8
Consumer loans:
Other............................ 5,828 3.9 6,488 2.4 5,320 2.2
Secured by deposits.............. 842 .6 994 .4 835 .3
-------- ----- -------- ----- -------- -----
Total consumer loans........... 6,670 4.5 7,482 2.8 6,155 2.5
-------- ----- -------- ----- -------- -----
Total Loans.............. 148,115 100.0% 272,271 100.0% 241,303 100.0%
===== ===== =====
Less:
Unearned loan fees and discounts. 8 388 482
Allowance for loan losses........ 2,556 5,251 3,429
--------- --------- ---------
2,564 5,639 3,911
--------- --------- ---------
Net Loans................ $ 145,551 $ 266,632 $ 237,392
========= ========= =========
<CAPTION>
1993 1992
---- ----
$ % $ %
- - - -
Real estate:
Single-family residential:
First mortgages................ $159,398 75.8% $177,442 67.7%
Second mortgages............... 24,851 11.8 54,386 20.7
Construction and development..... 9,137 4.4 8,735 3.3
Commercial real estate........... 10,781 5.1 8,817 3.4
-------- ----- -------- -----
Total real estate loans........ 204,167 97.1 249,380 95.1
Commercial business loans........... 1,946 .9 3,692 1.4
Consumer loans:
Other............................ 2,884 1.4 7,088 2.7
Secured by deposits.............. 1,263 .6 1,987 .8
-------- ----- -------- -----
Total consumer loans........... 4,147 2.0 9,075 3.5
-------- ----- -------- -----
Total Loans.............. 210,260 100.0% 262,147 100.0%
===== =====
Less:
Unearned loan fees and discounts. 440 864
Allowance for loan losses........ 3,039 4,489
-------- --------
3,479 5,353
-------- --------
Net Loans................ $206,781 $256,794
======== ========
</TABLE>
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<PAGE>
The size of the Company's loan portfolio has declined significantly
primarily due to sales of second mortgage loans, the sale of loans in connection
with the sale of the Bank's Florida branches in 1994 and the sale of loans in
connection with the sale of the Branches in 1996. Total loans decreased by an
aggregate of $114.0 million or 43.5% from December 30, 1992 to December 31,
1996. During this period, the Company placed increased emphasis on single-family
first mortgage loans which increased from 67.7% of total loans held for
investment at December 31, 1992 to 70.0% of total loans held for investment at
December 31, 1996. Single-family second mortgage loans declined substantially
during such period from 20.7% of total loans held for investment at December 31,
1992 to 8.3% of total loans held for investment at December 31, 1996. The
decline in second mortgage loans resulted from loan sales undertaken to reduce
the regulatory risk-weighting of the Bank's assets and, thus, improve its
risk-based capital ratio, while at the same time reducing earnings volatility
associated with the amortization of deferred premiums and the increased credit
risk associated with second mortgage loans. Construction loans increased from
$8.7 million or 3.3% of total loans held for investment at December 31, 1992 to
$17.2 million or 11.6% of total loans held for investment at December 31, 1996.
The Company, through Essex First, is currently emphasizing its origination of
construction loans with respect to single-family properties. Commercial real
estate loans increased from 3.4% of total loans held for investment at December
31, 1992 to 4.3% of total loans held for investment at December 31, 1996, while
commercial business loans declined from 1.4% of total loans held for investment
to 1.3% of total loans held for investment at December 31, 1996. Consumer loans
increased from 3.5% of total loans held for investment at December 31, 1992 to
4.5% of total loans held for investment at December 31, 1996. The Company has
begun to emphasize the origination and purchase of various types of consumer
loans and, consequently, expects the balance of such loans to increase.
The following table presents the maturity distribution and interest
sensitivity of selected loan categories (excluding residential mortgage and
consumer loans) at December 31, 1996. Maturities are presented on a contractual
basis. Loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less. Scheduled contractual principal repayments
do not reflect the actual maturities of loans.
<TABLE>
<CAPTION>
Commercial Commercial
Construction Real Estate Business Total
------------ ----------- -------- -----
(dollars in thousands)
<S> <C> <C> <C> <C>
Amounts due:
One year or less $ 16,383 $ 738 $ 655 $ 17,776
After one year through
five years 171 3,010 1,260 4,441
Beyond five years 636 2,565 - 3,201
-------- ------ ------ --------
Total $ 17,190 $6,313 $1,915 $ 25,418
======== ====== ====== ========
Interest rate terms on
amounts due after one
year:
Fixed $ 495 $1,563 $1,126 $ 3,184
======== ====== ====== ========
Adjustable $ 312 $4,012 $ 134 $ 4,458
======== ====== ====== ========
</TABLE>
Origination, Purchase and Sale of Loans. Historically, the Company has
been primarily engaged in attracting deposits from the general public and using
such deposits, together with advances from the FHLB and other sources of funds,
to originate and purchase mortgage loans secured by first and second liens on
single-family residential real estate. Historically, the Company has also
engaged in the origination of construction loans (including residential
development loans), and, to a lesser extent, commercial real estate loans,
commercial business loans and consumer loans. In earlier years, the Bank
operated as a wholesale financial institution and conducted its deposit
gathering activities through a network of limited service branches that were
designed to primarily accumulate large non-transactional deposit accounts. The
Bank's
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<PAGE>
lending activities were not generally conducted through its branch offices.
Instead, substantially all of the Company's loan product was either originated
by Essex First or purchased in the secondary market.
As part of management's efforts to reposition the Bank's activities along
the lines of a more traditional financial institution, the Bank converted its
existing branch offices into full-service retail facilities, which will enable
the Bank to, among other things, increase its origination of both consumer and
mortgage loans directly through its branch network. Nevertheless, substantially
all of the Company's mortgage loan product is expected to continue to be either
originated by Essex First or purchased in the secondary market.
Mortgage Banking Activities. Since 1992, Essex First has significantly
expanded its mortgage banking operations in order to, among other things,
increase the Company's level of loan originations that generate fee income. At
December 31, 1996, Essex First conducted its operations out of four offices,
which are located in Virginia Beach, Richmond, and Chester, Virginia, and
Elizabeth City, North Carolina. Essex First also currently accepts applications
through the Bank's branch office in Emporia, Virginia. During the years ended
December 31, 1996, 1995, and 1994, Essex First originated $104.2 million, $101.8
million, and $116.5 million of loans (consisting primarily of both permanent and
construction loans secured by single-family residential real estate). During
such periods, $29.3 million, $26.3 million, and $33.6 million of such loans,
respectively, were sold by Essex First to the Bank, with the remainder
(excluding construction loans) being sold by Essex First primarily to other
private investors in the secondary market.
Although the majority of the Bank's loan product is currently originated
by Essex First, Essex First was established primarily to increase the volume of
loans being originated for sale to private investors in the secondary market.
Such loan sales generate fee income, while avoiding the interest rate and credit
risk associated with holding long-term fixed-rate mortgage loans in its
portfolio. Loans originated by Essex First for sale in the secondary market are
originated in accordance with terms, conditions and documentation prescribed by
the FHLMC, FNMA and GNMA. However, Essex First does not generally sell mortgage
loans to such government agencies and, instead, sells loans to private investors
in the secondary market. Consequently, loans originated by Essex First for sale
in the secondary market must also comply with any particular requirements of
such private investors. Upon approval of a particular loan, Essex First provides
an independent title company or attorney instructions to close the loan. Loan
proceeds are disbursed and funded at the closing by Essex First. The loan
documents are generally delivered to the private investor within 10 days of the
closing and the price paid by the private investor for purchasing the loan is
generally remitted within five to 10 days after such delivery. Although Essex
First currently sells substantially all non-government conventional loans
without recourse (so that losses incurred as a result of nonperformance with
respect to the loan become the responsibility of the purchaser of the loan as of
the date of the closing), Essex First has in the past occasionally sold
non-government conventional loans in the secondary market with recourse, and may
continue to sell certain government conventional loans in the secondary market
with recourse. However, as of December 31, 1996 there were no loans outstanding
which were previously originated and sold by Essex First in the secondary market
with recourse.
A majority of all residential mortgage loans originated by Essex First for
sale in the secondary market are sold with servicing released to third party
investors. Management anticipates that substantially all of the loans originated
by Essex First and not sold with servicing released to third party investors are
sold to the Bank, which enables the Company to retain the servicing. When loans
are sold with servicing rights released to the buyer, the Company recognizes
current income from receipt of servicing release fees. In the alternative, when
loans are sold with servicing retained, the Company recognizes additional gains
based on the estimated
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<PAGE>
fair value of the servicing retained. For additional information, see "- Loan
Servicing" and "- Loan Fee Income."
Management of the Bank and Essex First believe that "pipeline risk," which
is created by offering loan applicants agreed upon interest rates for a future
closing, is currently being minimized because Essex First's loan originators are
compensated based on the purchase price they receive from the third party
investors purchasing the loans. Therefore, in most cases, the loan originator
will lock-in a purchase price with the third party investor simultaneously with
making the rate commitment to the borrower and therefore eliminate any interest
rate risk. If the loan is not locked-in simultaneously with the commitment to
the borrower, any market movement that occurs prior to the third party investor
locking-in the purchase price is shared by the loan originator and Essex First
for the first 1% of the loan amount, while any additional market movement is
reflected in the loan originator's compensation and not absorbed by Essex First
or the Bank.
Loan Purchases and Sales. The Bank purchases from Essex First
single-family mortgage loans which generally have adjustable rates or a term to
maturity of seven years or less. In addition, the Bank continues to purchase
first mortgage loans secured by single-family residential properties from
selected financial institutions and mortgage banking companies in the secondary
market. Such loans generally consist of ARMs or fixed-rate loans with terms of
five, seven, or to a lesser extent, 15 years. Such loan purchases are secured by
properties located both within and outside the Bank's primary market. Purchased
loans are generally made for immediate delivery. During the years ended December
31, 1995 and 1994, the Bank purchased $50.7 million and $45.7 million of loans,
respectively, from various financial institutions and mortgage banking companies
(other than Essex First) in the secondary market. However, the amount of loans
purchased during 1995 was predominantly attributable to the Home Acquisition.
The Company purchased less than $600,000 of loans in the secondary market during
1996 because of its emphasis on loan sales to accomodate the sale of the
Branches.
At December 31, 1996, 1995, and 1994, loans classified by the Company as
held for sale amounted to $2.5 million, $3.3 million, and $1.5 million,
respectively. Except for loans originated for sale in the secondary market by
Essex First, it is generally management's intention to hold originated and
purchased loans for investment. Under certain circumstances, however, the
Company may sell loans originally acquired for investment in order to address
needs regarding liquidity, regulatory capital, interest rate risk, or other
objectives. During 1996, the Bank sold first mortgage loans totaling $118.3
million in order to provide funds for the sale of the Branches. See Note 5 on
pages 50 and 51 of the Notes to Consolidated Financial Statements of the 1996
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
Loan Underwriting. Applications for all types of loans offered by the Bank
are taken at all of the Bank's branch offices. Applications for residential
mortgage loans are taken at all of Essex First's offices. Residential mortgage
loan applications are generally attributable to referrals from real estate
brokers and builders, existing customers and, to a lesser extent, walk-in
customers. Essex First also obtains applications for residential mortgage loans
through several loan originators who solicit and refer mortgage loan
applications to Essex First. These loan originators are compensated in part on a
commission basis and provide convenient origination services during banking and
nonbanking hours. During 1996, Essex First established a wholesale
construction/permanent ("C/P") lending program. Currently a network of
approximately 40 approved brokers are responsible for originating and processing
C/P loans and submitting them to the Bank for underwriting approval.
Loans purchased by the Bank from Essex First or other financial
institutions and mortgage banking companies in the secondary market are
underwritten by the Bank in accordance with its
16
<PAGE>
underwriting guidelines and procedures (which generally follow FHLMC and FNMA
guidelines) and may be approved by various lending officers of the Bank within
designated limits, which are established and modified from time to time to
reflect an individual's expertise and experience. All loans in excess of an
individual's designated limits are referred to an officer with the requisite
authority. Specifically, when acting individually, the Chief Executive Officer
and the Senior Underwriter are authorized to approve secured loans of up to
$250,000 and unsecured loans of up to $25,000. When the Senior Underwriter acts
together with the Chief Executive Officer, he is authorized to approve secured
loans of up to $500,000 and unsecured loans of up to $50,000. All secured loans
greater than $500,000 but not exceeding $750,000 require approval by the Bank's
loan committee, which consists of the aforementioned officers, the Senior Loan
Officer and the Chief Executive Officer of Essex First. All secured loans
greater than $750,000 and all unsecured loans greater than $50,000 must be
approved by the Bank's loan committee and the Board of Directors of the Bank. In
addition, all loans committed or approved by the Bank's loan committee are
reported to the Board of Directors on a monthly basis. Management of the Bank
believes that its relatively centralized approach to approving loan applications
ensures strict adherence to the Bank's underwriting guidelines while still
allowing the Bank to approve loan applications on a timely basis.
Loan Servicing. Essex Home services or subservices residential real estate
loans owned by the Bank as well as for other private mortgage investors. Loan
servicing includes collecting and remitting loan payments, accounting for
principal and interest, making advances to cover delinquent payments, making
inspections as required of mortgaged premises, contacting delinquent mortgagors,
supervising foreclosures and property dispositions in the event of unremedied
defaults and generally administering the loans. The majority of the funds that
have been escrowed by borrowers for the payment of mortgage related expenses,
such as property taxes and hazard and mortgage insurance premiums, are
maintained in noninterest-bearing accounts at nonaffiliated banks.
Essex Home receives fees for servicing and/or subservicing mortgage loans.
Such fees serve to compensate Essex Home for the costs of performing the
servicing/subservicing function. Other sources of loan servicing revenues
include late charges and other ancillary fees. Servicing and subservicing fees
are collected by Essex Home out of the monthly mortgage payments made by
borrowers. For additional information concerning Essex Home and its servicing
and subservicing portfolio, see "- Loan Fee Income."
Real Estate Lending Standards. Effective March 19, 1993, all financial
institutions were required to adopt and maintain comprehensive written real
estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies adopted by the federal banking
agencies, including the OTS, in December 1992 ("Guidelines"). The Guidelines set
forth, pursuant to the mandates of the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), uniform regulations prescribing standards
for real estate lending. Real estate lending is defined as extensions of credit
secured by liens on interests in real estate or made for the purpose of
financing the construction of a building or other improvements to real estate,
regardless of whether a lien has been taken on the property.
The policies must address certain lending considerations set forth in the
Guidelines, including loan-to-value ("LTV") limits, loan administration
procedures, underwriting standards, portfolio diversification standards, and
documentation, approval and reporting requirements. These policies must also be
appropriate to the size of the institution and the nature and scope of its
operations, and must be reviewed and approved by the institution's board of
directors at least annually. The LTV ratio, which is the total amount of credit
to be extended divided by the appraised value of the property at the time the
credit is originated, must be established for each category of real estate
loans. If not a first lien, the lender must include all senior liens when
17
<PAGE>
calculating this ratio. The Guidelines, among other things, establish the
following supervisory LTV limits: raw land (65%); land development (75%);
construction (commercial, multi-family and nonresidential) (80%); improved
property (85%); and one-to-four family residential (owner occupied) (no maximum
ratio; however any LTV ratio in excess of 90% should require appropriate
mortgage insurance or readily marketable collateral). In most cases, the
Company's loan underwriting guidelines with respect to LTV ratios are more
stringent than the Guidelines set forth above.
Single-Family Residential Real Estate Loans. As part of management's
efforts to reposition the Bank along the lines of a more traditional thrift
institution, the Bank has increased its emphasis on loans secured by first liens
on single-family residential real estate. At December 31, 1996, $103.6 million
or 70.0% of the Company's total loans held for investment consisted of such
loans.
In recent years, the Company has been emphasizing for its portfolio
single-family residential mortgage adjustable-rate loans which provide for
periodic adjustments to the interest rate. The loans currently emphasized by the
Company have 30-year terms and an interest rate which adjusts annually in
accordance with a designated index after a specified period has elapsed.
Depending on the loan product selected by the borrower, this period can range
from one year to seven years. In order to be competitive and generate
production, the ARMs offered by the Company provide for initial rates of
interest below the rates which would prevail when the index used for repricing
is applied. However, the Company underwrites each loan on a basis that is no
less stringent than the underwriting guidelines of the FNMA. The Company has not
engaged in the practice of using a cap on the payments that could allow the loan
balance to increase rather than decrease, resulting in negative amortization.
Approximately 53.7% of the permanent single-family residential loans in the
Company's loan portfolio held for investment at December 31, 1996 had adjustable
interest rates.
The demand for adjustable-rate loans in the Company's primary market area
has been a function of several factors, including the level of interest rates,
the expectations of changes in the level of interest rates and the difference
between the interest rates and loan fees offered for fixed-rate loans and
adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. The Company believes that these risks, which have not had a
material adverse effect on the Company to date, generally are less than the
risks associated with holding fixed-rate loans in an increasing interest rate
environment. In addition, the Company underwrites these loans based on a
borrower's qualification at a fully-indexed interest rate.
The Company continues to originate long-term, fixed-rate loans in order to
provide a full range of products to its customers, but generally only under
terms, conditions and documentation which permit the sale thereof in the
secondary market. Currently, fixed-rate single-family residential loans with
terms to maturity of seven years or less are generally retained in the Company's
portfolio while fixed-rate single-family residential loans with terms to
maturity of over seven years are generally sold in the secondary market as
market conditions permit. At December 31, 1996, approximately 46.3% of the
permanent single-family residential loans held by the Company for investment
consisted of loans which provide for fixed rates of interest. Although these
loans provide for repayments of principal over a fixed period of up to 30 years,
it is the
18
<PAGE>
Company's experience that such loans remain outstanding for a substantially
shorter period of time.
The Company is generally permitted to lend up to 100% of the appraised
value of the real property securing a residential loan (referred to as the LTV
ratio); however, if the amount of a residential loan originated or refinanced
exceeds 90% of the appraised value, the Company is required by federal
regulations to obtain appropriate credit enhancement in the form of either
mortgage insurance or readily marketable collateral. Pursuant to underwriting
guidelines adopted by the Board of Directors, the Company will lend up to 95% of
the appraised value of the property securing a single-family residential loan,
and generally requires borrowers to obtain private mortgage insurance on loans
which have a principal amount that exceeds 80% of the appraised value of the
security property. The extent of coverage is dependent upon the LTV ratio at the
time of origination.
The Company generally requires title insurance insuring the priority of
its mortgage lien, as well as fire and extended coverage casualty insurance in
order to protect the properties securing its residential and other mortgage
loans. Borrowers may be required to advance funds, with each monthly payment of
principal and interest, to a loan escrow account from which the Company makes
disbursements for items such as real estate taxes, hazard insurance premiums and
mortgage insurance premiums as they become due. The properties securing all of
the Company's mortgage loans originated or closed by the Bank and/or Essex First
are appraised by independent appraisers that conform to guidelines established
pursuant to FIRREA and regulations promulgated thereunder.
Home equity line of credit loans have a maximum commitment of five years,
which may be extended within the sole discretion of the Bank, and the interest
rate is set at the Bank's prime rate plus a margin. The Company will lend up to
a 90% LTV ratio and the loan can be secured by a primary or subordinate mortgage
on the property. The Company will originate the loan even if another institution
holds the first mortgage. At December 31, 1996, home equity lines of credit
totaled $677,000 ($344,000 of which had been funded as of such date).
Construction Loans. In recent years, the Company has been increasingly
active in originating loans to construct primarily single-family residences.
These construction lending activities generally are limited to the Company's
primary market, with particular emphasis in the greater Richmond, Virginia
market and the Tidewater, Virginia area. With the success of the
builder/construction program in these areas, the Company is expanding this
program to include counties in northeastern North Carolina. At December 31,
1996, construction loans amounted to $17.2 million or 11.6% of the Company's
total loans held for investment. As of such date, the Company's entire portfolio
of construction loans consisted of loans for the construction of single-family
residences.
The Company offers construction loans to individual borrowers as well as
to local real estate builders, contractors and developers for the purpose of
constructing single-family residences. Substantially all of the Company's
construction lending to individuals is originated on a C/P mortgage loan basis.
C/P loans are made to individuals who hold a contract with a licensed general
contractor to construct their personal residence. The construction phase of the
loan currently provides for monthly payments on an interest only basis at a
designated prime rate (plus 100 basis points) for up to six months. Upon
completion of construction, the loan converts to a permanent loan at either an
adjustable or fixed interest rate, consistent with the Company's policies with
respect to residential real estate financing. Essex First's construction loan
department approves the proposed contractors and administers the loan during the
construction phase. The Company's C/P loan program has been successful due to
its ability to offer borrowers a single closing and, consequently, reduced
costs. At December 31, 1996, the Company's C/P portfolio included 60
construction/permanent loans with an aggregate principal balance of $6.8
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<PAGE>
million (and an additional $7.8 million was subject to legally binding
commitments but had not been advanced as of such date).
The Company also offers construction loans to real estate builders,
contractors and developers in order that they may construct single-family
residences on both a presold and speculative basis. Construction loans to
builders generally have a three-year note with annual renewals throughout the
term, with payments being made monthly on an interest only basis (at 1% to 2%
over a designated prime rate). Upon application, credit review and analysis of
personal and corporate financial statements, the Company will grant builders
lines of credit up to designated amounts. These credit lines may be used for the
purpose of construction of speculative (or unsold) residential properties. The
Company will generally limit the number of homes that may be built by any
individual builder or developer on a speculative basis depending on the
builder's financial strength and total exposure to other lenders. Although at
December 31, 1996, the Company did not have any real estate acquisition and
development loans in its portfolio, the Company may in the future, on a
case-by-case basis, grant a limited amount of real estate acquisition and
development loans. At December 31, 1996, the Company's construction loan
portfolio included 107 loans to 41 different builders with an aggregate
principal balance of $9.0 million (and an additional $28.6 million was subject
to legally binding commitments but had not been advanced as of such date). Of
this $9.0 million of builder loans, approximately $8.0 million consisted of
construction loans for which there were no contracts for sale at the time of
origination.
The Company intends to continue to increase its involvement in
construction lending. Such loans afford the Company the opportunity to increase
the interest rate sensitivity of its loan portfolio. Construction lending is
generally considered to involve a higher level of risk as compared to
single-family residential lending, due to the concentration of principal in a
limited number of loans and borrowers and the effects of general economic
conditions on real estate developers and managers. Moreover, a construction loan
can involve additional risks because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost
(including interest) of the project. The nature of these loans is such that they
are generally more difficult to evaluate and monitor. In addition, speculative
construction loans to a builder are not necessarily pre-sold and thus pose a
greater potential risk to the Company than construction loans to individuals on
their personal residences.
The Company has taken steps to minimize the foregoing risks by, among
other things, limiting its construction lending primarily to residential
properties. In addition, the Company has adopted underwriting guidelines which
impose stringent loan-to-value (80% during the construction phase with respect
to single-family residential real estate), debt service and other requirements
for loans which are believed to involve higher elements of credit risk, by
limiting the geographic area in which the Company will do business and by
working with builders with whom it has established relationships or knowledge
thereof.
Commercial Real Estate Loans. The Company has also originated mortgage
loans secured by multi-family residential and commercial real estate. At
December 31, 1996, $6.3 million or 4.3% of the Company's total loans held for
investment consisted of such loans.
Commercial real estate loans originated by the Company are primarily
secured by office buildings, retail stores, warehouses and general purpose
industrial space. Commercial real estate loans also include multi-family
residential loans, substantially all of which are secured by small apartment
buildings. At December 31, 1996, $1.4 million or 21.8% of the Company's total
commercial real estate loans were comprised of multi-family residential loans.
Although terms vary, commercial real estate loans generally are amortized
over a period of up to 20 years and mature in seven years or less. The Company
will originate these loans either
20
<PAGE>
with fixed interest rates or with interest rates which adjust in accordance with
a designated index, which generally is negotiated at the time of origination.
Loan-to-value ratios on the Company's commercial real estate loans are currently
limited to 80% or lower. As part of the criteria for underwriting commercial
real estate loans, the Company generally imposes a specified debt coverage ratio
(the ratio of net cash from operations before payment of debt service to debt
service). It is also the Company's general policy to seek additional protection
to mitigate any weaknesses identified in the underwriting process. Additional
strength may be provided via mortgage insurance, secondary collateral and/or
personal guarantees from the principals of the borrower.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. The Company attempts to minimize
its risk exposure by limiting the extent of its commercial lending. In addition,
the Company imposes stringent LTV ratios, requires conservative debt coverage
ratios, and continually monitors the operation and physical condition of the
collateral.
Commercial Business Loans. From time to time, and in connection with its
community bank activities, the Company has originated secured or unsecured loans
for commercial, corporate, business and agricultural purposes. However, the
Company's originations of commercial business loans and the total amount of
commercial business loans in its loan portfolio have decreased in recent
periods. At December 31, 1996, $1.9 million or 1.3% of the Company's total loans
held for investment consisted of commercial business loans. The Company's
commercial business loans consist primarily of loans and lines of credit secured
by various equipment, machinery and other corporate assets.
Consumer Loans. Subject to restrictions contained in applicable federal
laws and regulations, the Company is authorized to make loans for a wide variety
of personal or consumer purposes. The Company has recently begun to emphasize
the origination and purchase of consumer loans in order to provide a full range
of financial services to its customers and because such loans generally have
shorter terms and higher interest rates than mortgage loans. At December 31,
1996, $6.7 million or 4.5% of the Company's total loans held for investment
consisted of consumer loans. The consumer loans offered by the Company include
automobile loans, boat and recreational vehicle loans, mobile home loans, home
equity line of credit loans, loans secured by deposit accounts and unsecured
personal loans.
The Company currently offers loans secured by deposit accounts, which
amounted to $842,000 at December 31, 1996. Such loans are originated for up to
90% of the account balance, with a hold placed on the account restricting the
withdrawal of the account balance. At December 31, 1996, the Company's loan
portfolio also included $2.1 million of automobile loans, $475,000 of mobile
home loans and $73,000 of boat and recreational vehicle loans. The Company also
offers home equity lines of credit in amounts up to 90% of the appraised value
of the property, including the amount of any existing prior liens.
Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
many cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of
21
<PAGE>
the underlying security. The remaining deficiency may not warrant further
substantial collection efforts against the borrower.
Loan Fee Income. In addition to interest earned on loans, the Company
receives income through servicing of loans, unamortized loan fees in connection
with loan sales and fees in connection with loan modifications, late payments,
prepayments and for miscellaneous services related to its loans. Income from
these activities varies from period to period with the volume and type of loans
made and competitive conditions.
In connection with its loan origination activities, the Company often
charges loan origination fees that are calculated as a percentage of the amount
borrowed. The Company generally charges a borrower on a single-family home loan
a loan origination fee based on the principal amount of the loan, with the
actual amount being dependent upon, among other things, the interest rate and
market conditions at the time the loan application is taken. These fees are in
addition to appraisal and other fees paid by the borrower to the Company at the
time of the application. The Company's policy is to defer all loan origination
fees net of direct origination costs and amortize those fees over the
contractual lives of the related loans. Amortization of loan fees is included in
interest income. Nevertheless, the predominant portion of the Company's loans
are originated for resale and, consequently, related net loan fees are
recognized as mortgage banking income upon consummation of the loan sales.
When loans are sold with servicing rights released to the buyer, the
Company also recognizes current income from receipt of servicing release fees in
addition to receiving a premium or deducting a discount based on the market
value of the loan, which is dependent upon, among other things, the interest
rate and market conditions at the time the sales price is committed to by the
buyer. Sales prices for loans originated for resale are generally committed to
with a buyer at the time of origination in order to minimize the Company's
interest rate risk. When loans are sold with servicing retained, the Company
recognizes additional gains based on the estimated fair value of the servicing
retained. Recognition of such gains creates originated mortgage servicing rights
("OMSRs") for the Company on a consolidated basis, which are capitalized and
amortized against servicing fee income over the estimated remaining lives of the
related loans. OMSRs amounted to $1.1 million, $1.6 million, and $2.1 million at
December 31, 1996, 1995 and 1994, respectively. For additional information
regarding the Company's servicing assets, see Note 2 of the Notes to
Consolidated Financial Statements on pages 44 through 47 of the 1996 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
Through Essex Home, the Company services loans that are owned by the Bank
and other investors. At December 31, 1992, Essex Home serviced or subserviced
approximately 24,200 loans with principal balances outstanding of $1.4 billion.
At December 31, 1996, approximately 13,300 loans with principal balances of $1.1
billion were serviced or subserviced by Essex Home, a reduction that reflects
the sale of EMC's PMSRs in connection with the restructuring of the Essex 11's.
However, on February 28, 1997, the Company was notified by its largest
subservicing client of its intention not to renew its contract beyond June 1,
1997. As of December 31, 1996, the Company serviced approximately 7,000 loans
totaling $858.9 million for this client and servicing fee income for 1996
included approximately $409,000 attributable to servicing activities performed
for this client. While the Company's management has intensified its marketing
efforts in order minimize the impact of this loss on the earnings performance of
Essex Home and the Company, no assurances can be made that this significant
servicing volume can be replaced in its entirety in the near term. Management
believes, however, that its marketing efforts will be buoyed by the
much-improved capital position of the Bank. In the meantime, the Company is
examining expenses associated with the servicing of this client in contemplation
of reductions to minimize the loss in servicing fee income.
22
<PAGE>
Asset Quality
Delinquent Loans. When a borrower fails to make a required payment on a
loan, the Company attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made on the 15th day after a payment is
due and a late charge is assessed at such time. In most cases, deficiencies are
cured promptly. If a delinquency extends beyond 30 days, the loan and payment
history is carefully reviewed, additional notices are sent to the borrower and
additional efforts are made to collect the loan. While the Company generally
prefers to work with borrowers to resolve such problems, when the account
becomes 90 days delinquent, the Company institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss.
The following table sets forth information concerning the principal
balances and percent of the total loan portfolio held for investment represented
by delinquent loans at the dates indicated:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1996 1995 1994
---------------- ---------------------- -----------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
30-59 days (1)................. $1,156 .78% $2,222 .82% $ 895 .37%
60-89 days (1)................. 335 .23 942 .34 641 .27
90 or more days (1), (2)....... 2,938 1.98 6,258 2.30 7,313 3.03
------ ---- ------ ---- ------ ----
$4,429 2.99% $9,422 3.46% $8,849 3.67%
====== ==== ====== ==== ====== ====
</TABLE>
(1) Includes at December 31, 1996, $185,000, $70,000 and $611,000 of
loans delinquent 30-59 days, 60-89 days and 90 days or more,
respectively, which were acquired in connection the Home
Acquisition. Includes at December 31, 1995, $977,000, $381,000 and
$1.2 million of loans delinquent 30-59 days, 60-89 days and 90 days
or more, respectively, which were acquired in connection with the
Home Acquisition.
(2) Includes $30,000, $177,000, and $539,000 of loans that were accruing
interest at December 31, 1996, 1995, and 1994, respectively.
Nonperforming Assets. All loans are reviewed on a regular basis and are
placed on nonaccrual status based on the loan's delinquency status, an
evaluation of the related collateral, and the borrower's ability to repay the
loan. Generally, loans past due more than 90 days are placed on nonaccrual
status; however, in instances where the borrower has demonstrated an ability to
make timely payments, loans past due more than 90 days are returned to an
accruing status. Such loans may be returned to accruing status, even though the
loans have not been brought fully current, provided two criteria are met: (i)
all principal and interest amounts contractually due (including arrearages) are
reasonably assured of repayment within a reasonable period, and (ii) there is a
sustained period of repayment performance (generally a minimum of six months) by
the borrower. Consumer loans generally are charged-off or fully reserved for
when the loan becomes over 120 days delinquent. When a loan is placed on
nonaccrual status, interest accruals cease and uncollected accrued interest is
reversed and charged against current income. Additional interest income on such
loans is recognized only when received.
In certain circumstances, for reasons related to a borrower's financial
difficulties, the Company may grant a concession to the borrower that it would
not otherwise consider. Such restructuring of troubled debt may include a
modification of loan terms and/or a transfer of assets (or equity interest) from
the borrower to the Company.
If a foreclosure action is instituted with respect to a particular loan
and the loan is not reinstated, paid in full or refinanced, the property is sold
at a foreclosure sale in which the Company may participate as a bidder. If the
Company is the successful bidder, the acquired property is classified as
foreclosed property until it is sold. Properties acquired in settlement of
23
<PAGE>
loans are initially recorded at fair value less estimated cost to sell.
Valuations are periodically performed by management, and an allowance for losses
is established by a charge to operations if the carrying value of a property
exceeds its fair market value less the estimated cost to sell. Costs incurred in
connection with ownership of the property, including interest on senior
indebtedness, are expensed to the extent not previously allowed for in
calculating fair value less estimated cost to sell. Costs relating to the
development or improvement of the property are capitalized to the extent these
costs increase fair value less estimated cost to sell. Sales of foreclosed
properties are recorded under the accrual method of accounting. Under this
method, a sale is not recognized unless the buyer has assumed the risks and
rewards of ownership, including an adequate cash down payment. Until the
contract qualifies as a sale, all collections are recorded as deposits.
In recent periods, foreclosed properties also included loans classified
as in-substance foreclosures. Such loans were identified as in-substance
foreclosures when all of the following had occurred: (i) the borrower had little
or no equity remaining in the underlying collateral, (ii) repayment of the loan
could be expected only from the operation or sale of the collateral, and (iii)
the borrower had formally or effectively abandoned control of the collateral to
the Company or it was doubtful the borrower could rebuild equity in the
collateral or repay the loan in the foreseeable future. During 1993, the Company
adopted SFAS No. 114, which limits loans classified as in-substance foreclosures
to those in which the creditor receives physical possession of the debtor's
assets regardless of whether formal foreclosure proceedings have occurred. As a
result, loans previously classified as in-substance foreclosures were
reclassified during 1993 from foreclosed properties to collateral-dependent real
estate loans. The prior period has also been restated to reflect the
reclassification of in-substance foreclosures, net of allowance for losses, to
collateral-dependent real estate loans.
24
<PAGE>
The following table sets forth information regarding nonperforming assets
held by the Company at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------
1996 1995 1994
---- ---- ----
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Nonaccrual loans, net:
Single-family residential................ $2,513 1.70% $ 2,959 1.09% $ 3,158 1.31%
Construction............................. 220 .15 378 .14 1,253 .52
Commercial............................... 22 .01 2,636 .97 2,306 .96
Consumer................................. 153 .10 108 .04 57 .02
------ ---- -------- ---- -------- ----
Total nonaccrual loans................. 2,908 1.96 6,081 2.24 6,774 2.81
Accruing loans 90 days or more past due..... 30 .02 177 .06 539 .22
Troubled debt restructurings................ 223 .15 143 .05 1,049 .44
------ ---- -------- ---- -------- ----
Total nonperforming loans.............. 3,161 2.13 6,401 2.35 8,362 3.47
Foreclosed properties, net.................. 2,054 1.39 4,856 1.78 5,290 2.19
------ ---- -------- ---- -------- ----
Total nonperforming assets............. $5,215 3.52% $11,257 4.13% $13,652 5.66%
====== ==== ======= ==== ======= ====
Nonperforming loans to total loans.......... 2.13% 2.35% 3.47%
Nonperforming assets to total assets........ 2.99 3.32 4.61
Allowance for loan losses to total loans.... 1.73 1.93 1.42
Allowance for loan losses to nonaccrual
loans.................................... 87.90 86.35 50.62
Allowance for loan losses to nonperforming
loans.................................... 80.86 82.03 41.01
<CAPTION>
1993 1992
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
<S> <C> <C> <C> <C>
Nonaccrual loans, net:
Single-family residential................ $ 4,801 2.28% $10,101 3.85%
Construction............................. 17 .01 7 -
Commercial............................... 513 .25 3,703 1.41
Consumer................................. 93 .04 196 .08
-------- ---- ------- ----
Total nonaccrual loans................. 5,424 2.58 14,007 5.34
Accruing loans 90 days or more past due..... 1,136 .54 139 .05
Troubled debt restructurings................ 2,948 1.40 2,300 .88
-------- ---- ------- ----
Total nonperforming loans.............. 9,508 4.52 16,446 6.27
Foreclosed properties, net.................. 8,582 4.08 8,371 3.20
-------- ---- ------- ----
Total nonperforming assets............. $18,090 8.60% $24,817 9.47%
======= ==== ======= ====
Nonperforming loans to total loans.......... 4.52% 6.27%
Nonperforming assets to total assets........ 4.63 5.92
Allowance for loan losses to total loans.... 1.45 1.72
Allowance for loan losses to nonaccrual
loans.................................... 56.03 32.05
Allowance for loan losses to nonperforming
loans.................................... 31.96 27.30
</TABLE>
25
<PAGE>
Gross interest income that would have been recorded during the years ended
December 31, 1996, 1995, and 1994 if the Company's nonaccrual loans at the end
of such periods had been performing in accordance with their terms during such
periods was $291,000, $678,000, and $406,000, respectively.
The $2.9 million of nonaccrual loans at December 31, 1996 consisted of
$2.5 million of loans secured by single-family residential property, $220,000 of
construction loans (which were secured by residential property), $22,000 of
loans secured by commercial property and $153,000 of consumer loans. The $30,000
of accruing loans 90 days or more past due at December 31, 1996 consisted of one
loan secured by single-family residential property. The $223,000 of troubled
debt restructurings at December 31, 1996 consisted of four loans secured by
single-family residential property, one secured commercial loan and one
unsecured loan.
The Company's decrease in nonaccrual loans during 1996 occurred primarily
in loans secured by commercial property. This $2.6 million decrease was
attributable to the $2.7 million charge-off of a loan made by the Bank in 1990
in the amount of $1.75 million for the purpose of acquiring a 360-unit
low-income apartment complex located in Richmond, Virginia, and renovating 124
unrentable units (the "Richmond Apartments loan"). The loan was modified several
times and the property was sold to a third party which assumed and became the
principal obligor (albeit on a nonrecourse basis) with respect to the $1.75
million loan. In addition to the modification with the Bank, the purchaser
succeeded in gaining the cooperation of the City of Richmond for extensive
renovations to the apartment complex. The Bank received regulatory approval to
utilize its salvage powers and in October 1994 the Bank committed to advance an
additional $1.3 million to finance contemplated improvements, of which $955,000
had been advanced as of December 31, 1995. Therefore, the total balance of loans
to the third party purchaser totaled $2.7 million at December 31, 1995.
Additional funds were advanced during 1996 bringing the loan to $2.8 million
when management concluded that the sale of the apartment complex, which was
intended to be the source of repayment of the Richmond Apartments loan, would
not occur in the foreseeable future and the loan was charged off in its entirety
in 1996.
The Company's $164,000 foreclosed property at December 31, 1996 consisted
of six residential lots, which resulted from a real estate loan which was
originated in 1990 in the amount of $1.1 million and was secured by 14
residential lots located in the Outer Banks of North Carolina. During 1994, the
borrower sold five of the lots which reduced the principal balance of the loan.
Consequently, as of December 31, 1994, the loan balance was reduced to $895,000
and the loan was secured by nine residential lots. On January 3, 1995, the Bank
learned of the principal borrower's death and the loan was placed in nonaccrual
status. The Bank received no principal or interest payments since that time and
foreclosed on the lots in July 1995. The Company has recognized $477,000 of
charge-offs on this credit. During 1996, the Company sold three of the lots.
Subsequent to December, 1996, the Bank has sold an additional five lots and
continues to market the single remaining lot for sale.
During 1996, the Company completed the sale of its largest foreclosed
property at December 31, 1995, which consisted of 2,554 acres of farmland
located in Currituck County, North Carolina. The Company recognized $1.8 million
of charge-offs on this credit that originated in 1990 with an aggregate
principal balance of $3.3 million. Upon completion of the sale, the Company
recognized a gain of $295,000 during 1996.
Also, during 1996 the Company completed the sale of the fourteen
undeveloped lots and eight townhouse pads located in Richmond, Virginia it held
at December 31, 1995 with an aggregate net carrying value of $321,000. This
credit originated in 1988 as a $5.0 million unsecured commercial business loan
to a real estate development and property management company. The loan was
restructured in 1992 and the Bank accepted the property described above, an
interest in the cash flows of a partnership (which had a net carrying value of
$200,000
26
<PAGE>
as of December 31, 1996), whose sole function was to develop and sell a single
tract of land, and $350,000 in cash in consideration for terminating the note.
The Company charged off an aggregate of $4.0 million with respect to the
restructuring. Upon completion of the sale of the remaining lots during 1996,
the Company recognized a gain of $69,000.
In addition, the Company through ECC (a subsidiary of the Bank and EMC) is
a preferred stockholder of Essex Commercial Mortgage Corporation ("ECMC"), a
commercial real estate brokerage firm and an affiliate of the borrower of the
$5.0 million unsecured commercial business loan discussed above. ECC's
investment in ECMC originally amounted to $410,000, prior to a reserve for
potential loss of $40,000 recorded at December 31, 1991. In connection with the
final settlement with the borrower, an agreement was reached to redeem the
preferred stock, the reserve was eliminated and the investment in ECMC was
reduced to $307,500. The majority owner of the borrower has personally endorsed
a note held by ECMC that was made by the borrower. Payments on the note
represent the source of funds for the stock redemption. As further collateral
for the note between ECMC and the borrower, a general partnership interest in an
office/warehouse building was pledged by the borrower. The personal endorsement
and pledged partnership interest are for the sole benefit of ECC and their value
is now limited to $195,000, which was the carrying value of the ECMC preferred
stock at December 31, 1996.
For additional information about the Company's nonperforming assets, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Nonperforming Assets" on pages 15 through 17
and Notes 8 and 9 of the Notes to Consolidated Financial Statements on pages 53
through 55 of the 1996 Annual Report to Stockholders, which is attached hereto
as Exhibit 13 and incorporated herein by reference.
Classified Assets. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified as loss is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted. Another
category designated "special mention" also must be established and maintained
for assets which do not currently expose an insured institution to a sufficient
degree of risk to warrant classification as substandard, doubtful or loss.
Assets classified as substandard or doubtful require the institution to
establish general allowances for loan losses. If an asset or portion thereof is
classified as loss, the insured institution must either establish specific
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss, or charge-off such amount. General loss allowances established
to cover possible losses related to assets classified substandard or doubtful
may be included in determining an institution's risk-based capital, while
specific valuation allowances for loan losses do not qualify as regulatory
capital. Federal examiners may disagree with an insured institution's
classifications and amounts reserved.
In addition to the nonperforming assets discussed above, at December 31,
1996, the Company had classified for regulatory and internal purposes an
additional $2.7 million of assets, $2.2 million of which were classified
substandard, $119,000 of which were classified doubtful and $378,000 of which
were classified loss.
27
<PAGE>
Allowance for Losses on Loans and Foreclosed Properties. An allowance for
loan losses is maintained at a level that management considers adequate to
provide for potential losses based upon an evaluation of the inherent risks in
the loan portfolio. Management's determination of the adequacy of the allowance
is based on an evaluation of the portfolio, past loss experience, current
economic conditions, volume, growth and composition of the portfolio, and other
relevant factors. The allowance is increased by provisions for loan losses which
are charged against income. While management uses the best information available
to make such evaluations, future adjustments to the allowance may be necessary
if economic conditions differ substantially from the assumptions used in making
the evaluations. For additional information, see Notes 8 and 9 of the Notes to
Consolidated Financial Statements on pages 53 through 55 of the 1996 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
The following table sets forth information concerning the activity in the
Company's allowance for loan losses during the years indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans, net of unearned fees and discounts:
Year-end.................................. $148,107 $271,883 $240,821 $209,820 $261,283
Average outstanding during period......... 216,803 251,108 218,806 267,143 298,365
Allowance for loan losses:
Balance, beginning of year................ $ 5,251 $ 3,429 $ 3,039 $ 4,489 $ 5,454
Allowance transferred in connection
with the Home Acquisition............. -- 500 -- -- --
Provision for loan losses................. 1,411 2,477 1,604 1,085 4,569
-------- -------- -------- -------- --------
6,662 6,406 4,643 5,574 10,023
Charge-offs, net of recoveries (1):
Commercial (2)........................ 2,892 644 -- 82 1,660
Real estate - mortgage................ 894 494 1,255 2,248 3,763
Consumer ............................. 320 17 (41) 205 111
-------- -------- -------- -------- --------
Total (2)........................ 4,106 1,155 1,214 2,535 5,534
-------- -------- -------- -------- --------
Balance, end of year...................... $ 2,556 $ 5,251 $ 3,429 $ 3,039 $ 4,489
======== ======== ======== ======== ========
Ratio of net charge-offs to average
outstanding loans (2)........................ 1.89% .46% .55% .95% 1.85%
Allowance for loan losses to year-end
total nonperforming loans.................... 80.86% 82.03% 41.01% 31.96% 27.30%
Allowance for loan losses to year-end
loans, net of unearned fees and discounts.... 1.73% 1.93% 1.42% 1.45% 1.72%
</TABLE>
(1) Recoveries of prior loan charge-offs were not significant for the periods
presented.
(2) Charge-offs during 1996 include the $2.8 million write-off of the Richmond
Apartments loan. Excluding the impact of this charge-off, the ratio of net
charge-offs to average outstanding loans for 1996 was .59%.
28
<PAGE>
The following table sets forth information concerning the allocation of
the Company's allowance for loan losses by loan categories at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- --------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential mortgage $1,636 89.9% $2,607 92.5% 2,068 91.9% $2,080 92.0% $2,895 91.7%
Commercial (1) 505 5.6 1,530 4.7 861 5.6 387 6.0 598 4.8
Consumer 299 4.5 323 2.8 467 2.5 424 2.0 195 3.5
Unallocated 116 -- 791 -- 33 -- 148 -- 801 --
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$2,556 100.0% $5,251 100.0% $3,429 100.0% $3,039 100.0% $4,489 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
(1) Includes commercial real estate and commercial business loans.
The Company also maintains an allowance for losses on foreclosed
properties. The following table sets forth information concerning the activity
in the Company's allowance for losses on foreclosed properties during the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1996 1995 1994
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year............. $199 $ 418 $ 724
Provision for losses on
foreclosed properties.................. (21) 79 1,923
---- ----- -------
178 497 2,647
Charge-offs on foreclosed properties..... 1 (298) (2,229)
---- ----- -------
Balance at end of year................... $179 $ 199 $ 418
==== ===== =======
</TABLE>
Investment Activities
Mortgage-Backed Securities. Mortgage-backed securities (which also are
known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the FHLMC, the
FNMA and the GNMA.
The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 Federal Home Loan Banks and federally-insured savings
institutions. The FHLMC issues participation certificates backed principally by
conventional mortgage loans. The FHLMC guarantees the timely payment of interest
and the ultimate return of principal. The FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for conventional mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are Quasi-Government and U.S. Government-sponsored enterprises,
respectively, these securities are considered to be among the highest quality
investments with minimal credit risks. The GNMA is a government agency within
the Department of Housing and Urban Development which is intended to help
finance government-assisted housing programs. GNMA securities are backed by
FHA-insured and VA-guaranteed loans, and the timely payment of principal and
interest on GNMA securities are guaranteed by the GNMA and backed by the full
faith and credit of the U.S. Government. Because the FHLMC, the FNMA and the
GNMA were established to provide support for low- and middle-income housing,
there are limits to the maximum size of loans that qualify for these
29
<PAGE>
programs. To accommodate larger-sized loans, and loans that, for other reasons,
do not conform to the agency programs, a number of independent companies have
established their own home-loan origination and securitization programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages.
The Company's mortgage-backed securities include collateralized mortgage
obligations ("CMOs"), which include securities issued by entities which have
qualified under the Internal Revenue Code (the "Code") as Real Estate Mortgage
Investment Conduits ("REMICs"). CMOs and REMICs (collectively CMOs) have been
developed in response to investor concerns regarding the uncertainty of cash
flows associated with the prepayment option of the underlying mortgagor and are
typically issued by government agencies, government sponsored enterprises and
special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A CMO can
be collateralized by loans or securities which are insured or guaranteed by the
FNMA, the FHLMC or the GNMA. In contrast to pass-through mortgage-backed
securities, in which cash flow is received pro rata by all security holders, the
cash flow from the mortgages underlying a CMO is segmented and paid in
accordance with a predetermined priority to investors holding various CMO
classes. By allocating the principal and interest cash flows from the underlying
collateral among the separate CMO classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.
Mortgage-backed securities generally increase the quality of the Company's
assets by virtue of the insurance or guarantees that back them, are more liquid
than individual mortgage loans and may be used to collateralize borrowings or
other obligations of the Company.
The following table sets forth the activity in the Company's
mortgage-backed securities portfolio during the periods indicated:
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
------------------------------------------
1996 1995 1994
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year............ $15,650 $18,223 $27,241
Purchases (1)........................... -- -- 4,813
Sales................................... (9,915) (2) -- (9,840)
Repayments.............................. (3,668) (3) (2,724) (4,028)
Amortization............................ (8) (3) (59)
Valuation adjustments................... (154) 154 96
------- ------- -------
Balance at end of year.................. $ 1,905 $15,650 (4) $18,223
======= ======= =======
Weighted average coupon at end
of year.............................. 6.40% 7.25% 7.04%
======= ======= =======
</TABLE>
(1) Includes applicable premiums and discounts.
(2) Represents sale of mortgage-backed securities in connection with the
sale of branches during 1996.
(3) Includes the termination and reclassification of a company-issued
second mortgage REMIC totaling $2.7 million from mortgage-backed
securities to loans.
(4) Includes $13.7 million of mortgage-backed securities classified as
available for sale at December 31, 1995.
30
<PAGE>
The Company's investment in mortgage-backed securities at December 31,
1996 consists solely of a $1.9 million FNMA guaranteed adjustable rate REMIC.
The Company does not currently own and does not anticipate investing in
mortgage-backed securities that would be deemed "high risk" securities pursuant
to OTS Thrift Bulletin 52. The Company's mortgage-backed securities are carried
in accordance with generally accepted accounting principles. See Note 7 of the
Notes to Consolidated Financial Statements on pages 52 through 53 of the 1996
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
Investment Securities. Federally-chartered savings institutions have
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various Federal agencies and of state and
municipal governments, certificates of deposit at federally-insured banks and
savings and loan associations, certain bankers' acceptances and Federal funds.
Subject to various restrictions, federally-chartered savings institutions may
also invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally-chartered savings institutions are otherwise authorized to make
directly.
The Bank's investment securities portfolio is managed by the Treasurer of
the Bank in accordance with a comprehensive investment policy which addresses
strategies, types and levels of allowable investments and which is reviewed and
approved by the Board of Directors on an annual basis and by the Asset and
Liability Management Committee as circumstances warrant. The Bank currently
emphasizes lending activities in order to increase the weighted average yield on
the Bank's interest-earning assets. The Bank's investment securities are carried
in accordance with generally accepted accounting principles. See Note 6 of the
Notes to Consolidated Financial Statements on pages 51 through 52 of the 1996
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
The following table sets forth certain information relating to the
Company's investment securities held for investment at the dates indicated:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------
1996 1995 1994
--------------------- ---------------------- ----------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Government securities...... $1,003 $1,003 $ 1,000 $ 999 $ 3,996 $ 3,929
U.S. Government agency
securities (1)............... 5,000 4,887 6,998 6,841 6,991 6,332
FHLB stock...................... 2,540 2,540 3,603 3,603 4,887 4,887
------ ------ -------- -------- -------- --------
Total (2)................... $8,543 $8,430 $11,601 $11,443 $15,874 $15,148
====== ====== ======= ======= ======= =======
</TABLE>
(1) Of the $5.0 million of U.S. Government agency securities held for
investment at December 31, 1996, $3.0 million consisted of a bond
issued by the FNMA and $2.0 million consisted of a note issued by
the FHLB. The $3.0 million FNMA bond adjusts monthly based on the
11th District cost of funds and qualifies for regulatory liquidity.
The $2.0 million FHLB note adjusts semi-annually based on the yield
of three-year constant maturity treasury notes.
(2) Does not include investment securities classified as available for
sale which consisted of a $9,000, $1.5 million and $828,000
investment in a money market mutual fund at December 31, 1996, 1995
and 1994, respectively.
31
<PAGE>
Information regarding the carrying values, contractual maturities and
weighted average yield of the Company's investment securities held for
investment (excluding FHLB stock) at December 31, 1996 is presented below.
<TABLE>
<CAPTION>
One Year After One to After Five to Over 10
or Less Five Years 10 Years Years Total
------- ---------- -------- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
U.S. Government securities............. $1,003 $ -- $ -- $ -- $1,003
U.S. Government agency securities...... 3,000 2,000 -- -- 5,000
------ ------- ------- -------- ------
Total $4,003 $ 2,000 $ -- $ -- $6,003
====== ======= ======= ======== ======
Weighted average yield................. 4.45% 5.23% --% --% 4.72%
====== ======= ======= ======== ======
</TABLE>
Sources of Funds
General. Deposits are the primary source of the Company's funds for
lending and other investment purposes. In addition to deposits, the Company
derives funds from loan principal repayments, prepayments, advances from the
FHLB and other borrowings. Loan repayments are a relatively stable source of
funds, while deposits inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds from
other sources. They may also be used on a longer term basis for general business
purposes, including asset/liability management.
Deposits. Deposits obtained through bank branch offices of the Company
have traditionally been the principal source of the Company's funds for use in
lending and for other general business purposes. The Company's current deposit
products include regular passbook and statement savings accounts, negotiable
order of withdrawal ("NOW") accounts, money market accounts, fixed-rate,
fixed-maturity retail certificates of deposit ranging in terms from 90 days to
60 months, mini-jumbo (generally $25,000 - $100,000) and jumbo (generally
greater than $100,000) certificates of deposit and individual retirement
accounts.
The Bank had previously operated as a wholesale financial institution
which conducted its deposit gathering activities through a network of limited
service branches that were designed to primarily accumulate large
non-transactional deposit accounts by offering attractive interest rates. The
Bank's prior business strategy consisted of offering a limited number of deposit
products to various businesses and high income and net worth individuals, which
strategy was expected to reduce the Bank's operating costs per transaction. The
Bank was able to attract such accounts (i.e., mini-jumbo certificates of
deposit) by offering rates of interest that were higher than the average rates
paid by the Bank's competitors.
The Bank's deposits are currently obtained primarily from residents in its
primary market area. The principal methods currently used by the Company to
attract deposit accounts include offering a wide variety of services and
accounts and competitive interest rates. The Company utilizes traditional
marketing methods to attract new customers and savings deposits, including print
media advertising. Currently, the Company does not advertise for retail deposits
outside of its local market area or utilize the services of deposit brokers.
Management estimates that as of December 31, 1996, deposit accounts totaling
$4.5 million or 3.5% of the Bank's total deposits were held by nonresidents of
Virginia or North Carolina. These out-of-market deposits include jumbo
certificates of deposits owned largely by financial institutions which totaled
$2.8 million at December 31, 1996, and represented a decline from the $3.9
million of such certificates at December 31, 1995. These jumbo certificates of
deposit were obtained through the posting of deposit rates on national
computerized bulletin boards at no cost to the Company and were not obtained
through deposit brokers.
32
<PAGE>
The following table sets forth the average balances of the Company's
deposits for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------
1996 1995 1994
------------------- ----------------- --------------------
Average Average Average
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(dollars in thousands)
<S> <C> <C> <C>
Noninterest-bearing deposits... $ 1,433 --% $ 1,285 --% $ 927 --%
Interest checking and
passbook savings........... 6,782 3.33 5,465 3.33 5,224 3.32
NOW accounts................... 5,332 2.80 4,859 2.85 4,866 2.73
Money market accounts.......... 21,104 4.50 21,760 4.14 40,429 3.41
Certificates of deposit:
Consumer................... 92,771 5.83 95,363 5.99 51,321 4.90
Mini-jumbo................. 71,269 5.69 90,216 5.60 131,197 4.70
Jumbo...................... 19,670 5.86 28,026 5.46 34,205 4.50
-------- -------- --------
$218,361 $246,974 $268,169
======== ======== ========
</TABLE>
The following table shows the interest rate and maturity information for
the Company's time deposits at December 31, 1996.
<TABLE>
<CAPTION>
Maturity Date
-------------------------------------------------------------------------
One Year Over
or Less 1-2 Years 2-3 Years 3 Years Total
------- --------- --------- ------- -----
(dollars in thousands)
<C> <C> <C> <C> <C> <C>
4.01% to 5.00%............. $ 5,064 $ 15 $ 2 $ - $ 5,081
5.01% to 6.00%............. 48,798 18,531 5,379 2,414 75,122
6.01% to 7.00%............. 7,093 5,934 4,766 3,704 21,497
7.01% to 8.00%............. 307 589 236 2,804 3,936
8.01% to 9.00%............. - 31 - 6 37
------- ------- ------- ------ --------
$61,262 $25,100 $10,383 $8,928 $105,673
======= ======= ======= ====== ========
</TABLE>
The following table shows the Company's certificates of deposit of
$100,000 or more outstanding at the dates indicated:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1996 1995 1994
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
3 months or less........................ $ 2,709 $ 6,638 $ 5,831
Over 3 through 6 months................. 3,505 11,270 9,432
Over 6 through 12 months................ 2,625 12,834 8,836
Over 12 months ......................... 5,919 10,489 10,309
-------- -------- --------
Total.......................... $ 14,758 $ 41,231 $ 34,408
======== ======== ========
</TABLE>
The ability of the Company to attract and maintain deposits and the
Company's cost of funds on these deposit accounts have been, and will continue
to be, significantly affected by economic and competitive conditions.
33
<PAGE>
Borrowings. The Bank is a member of the FHLB System, which consists of 12
regional FHLBs subject to supervision and regulation by the Federal Housing
Finance Board. The FHLBs provide a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB of Atlanta, is required to hold
shares of common stock in that FHLB in an amount at least equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans and
mortgage-backed securities, 3/10 of 1% of total assets at the end of the
calendar year, or 5% of its advances (borrowings) from the FHLB, whichever is
greater. The Bank had a $2.5 million investment in stock of the FHLB at December
31, 1996, which was in compliance with this requirement. At December 31, 1996,
the Bank had $25.7 million of advances outstanding from the FHLB.
The following table presents certain information regarding the Company's
FHLB advances at the dates and for the periods indicated:
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
-------------------------------------------------
1996 1995 1994
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at end of period.................. $25,690 $29,833 $58,952
Weighted average interest rate
at end of period..................... 6.14% 6.00% 5.97%
Maximum amount outstanding
at any month's end................... $29,833 $59,952 $97,387
Average amount outstanding
during the period.................... $27,137 $46,617 $50,034
Weighted average interest rate
during the period.................... 5.99% 6.00% 5.54%
</TABLE>
The outstanding FHLB advances at December 31, 1996 mature as follows:
December 31,
1996
----
(in thousands)
1997.................................... 16,144
1998.................................... 7,138
1999.................................... 1,808
2000.................................... 600
-------
$25,690
=======
The Company's notes payable amounted to $96,000, $120,000, and $2.7
million at December 31, 1996, 1995, and 1994, respectively. Notes payable at
December 31, 1996 and 1995 consisted solely of a note payable to the former
president of Home Bancorp and Home Savings. The note accrues interest at 9.50%
per annum. The note is due in five equal annual installments, plus accrued
interest thereon. The decrease in notes payable from December 31, 1994 to
December 1995 was attributable to the $2.5 million of notes payable to PWC,
which were forgiven effective September 15, 1995 in connection with the Home
Acquisition. Also, in March 1995, EMC's credit facility was paid in full through
a sale to a third party of substantially all of the underlying collateral and
through the forgiveness of debt totaling approximately $262,000.
The Company's subordinated capital notes amounted to $628,000 and $616,000
at December 31, 1995 and 1994, respectively. During 1989 and 1990, one of the
Bank's predecessor savings institutions sold $3.3 million of subordinated
capital notes with a ten-year maturity. The notes were issued in minimum
denominations of $2,500 at interest rates ranging between 11.5% and 12.0%. In
July 1993, the Bank redeemed $2.8 million of the subordinated
34
<PAGE>
capital notes. In August 1996, the Bank redeemed the remaining subordinated
capital notes at par in their entirety.
Competition
The Company faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions and commercial
banks located in Virginia and North Carolina, including many large financial
institutions which have greater financial and marketing resources available to
them. In addition, the Company has faced additional significant competition for
investors' funds from short-term money market securities and other corporate and
government securities. The ability of the Company to attract and retain savings
deposits depends on its ability to generally provide a rate of return, liquidity
and risk comparable to that offered by competing investment opportunities.
The Company experiences strong competition for real estate and other loans
principally from other savings institutions, commercial banks, mortgage banking
companies, insurance companies and other institutional lenders. The Company
competes for loans principally through the interest rates and loan fees it
charges and the efficiency and quality of services it provides borrowers.
Competition may increase as a result of the continuing reduction of restrictions
on the interstate operations of financial institutions.
Employees
As of December 31, 1996, the Company employed 102 full-time employees and
12 part-time employees.
Regulation of the Company
General. The Company is a savings and loan holding company within the
meaning of the Home Owners' Loan Act ("HOLA"). As such, the Company is subject
to OTS regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a qualified
thrift lender ("QTL") test, then such unitary holding company also shall become
subject to the activities restrictions applicable to multiple savings and loan
holding companies and, unless the savings association requalifies as a QTL
within one year thereafter, shall register as, and become subject to, the
restrictions applicable to, a bank holding company. See "- Regulation of the
Bank - Qualified Thrift Lender Test."
35
<PAGE>
Limitations on Transactions with Affiliates. Transactions between savings
associations and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings association is any company or
entity which controls, is controlled by or is under common control with the
savings association. In a holding company context, the parent holding company of
a savings association (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings association or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such association's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the association or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings association, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the association's
loans to one borrower limit (generally equal to 15% of the institution's
unimpaired capital and surplus). Section 22(h) also requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons
and also requires prior board approval for certain loans. In addition, the
aggregate amount of extensions of credit by a savings association to all
insiders cannot exceed the association's unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive
officers. At December 31, 1996, the Bank was in compliance with the above
restrictions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings association or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings association, other than
a subsidiary savings association, or of any other savings and loan holding
company.
Regulation of the Bank
General. The OTS has extensive authority over the operations of savings
associations. As part of this authority, savings associations are required to
file periodic reports with the OTS and are subject to periodic examinations by
the OTS and the FDIC. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
36
<PAGE>
FIRREA imposed limitations on the aggregate amount of loans that a savings
association could make to any one borrower, including related entities. See "-
Lending Activities - General" for a discussion of such limitations.
The OTS' enforcement authority over all savings associations and their
holding companies was substantially enhanced by FIRREA. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. FIRREA significantly
increased the amount of and grounds for civil money penalties. FIRREA requires,
except under certain circumstances, public disclosure of final enforcement
actions by the OTS.
Insurance of Accounts. The deposits of the Bank are insured up to $100,000
per insured member (as defined by law and regulation) by the SAIF administered
by the FDIC and are backed by the full faith and credit of the United States
Government. As insurer, the FDIC is authorized to conduct examinations of, and
to require reporting by, FDIC-insured institutions. It also may prohibit any
FDIC-insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious threat to the FDIC. The FDIC also has the
authority to initiate enforcement actions against savings associations, after
giving the OTS an opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
The FDIA, as amended on December 31, 1991, required the FDIC to promulgate
regulations which establish a risk-based assessment system, and gave the FDIC
the authority to promulgate regulations governing the transition from a
fixed-rate assessment system to a risk-based assessment system. Under FDIC
regulations, institutions are assigned to one of three capital groups - "well
capitalized," "adequately capitalized" and "undercapitalized" which are defined
in the same manner as the regulations establishing the prompt corrective action
system under Section 38 of the FDIC, as discussed under "-Prompt Corrective
Action" below. These three groups are then divided into subgroups which are
based on supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Effective January 1, 1997,
assessment rates for SAIF-insured institutions range (except as described below)
from 0 basis points of insured deposits for well-capitalized institutions with
minor supervisory concerns to 27 basis points of insured deposits for
undercapitalized institutions with substantial supervisory concerns. In
addition, an additional assessment approximating 6.5 basis points will be added
to the regular SAIF-assessment until December 31, 1999 in order to cover
Financing Corporation ("FICO") debt service payments.
Both the SAIF and the Bank Insurance Fund ("BIF"), the deposit insurance
fund that covers most commercial bank deposits, are statutorily required to be
recapitalized to a ratio of 1.25% of insured reserve deposits. The BIF has
achieved the required reserve ratio, and as a result, the FDIC reduced the
average deposit insurance premium paid by BIF-insured banks to a
37
<PAGE>
level substantially below the average premium paid by savings institutions.
Banking legislation was enacted on September 30, 1996 to eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions. The
legislation provided that all insured depository institutions with
SAIF-assessable deposits as of March 31, 1995 pay a special one-time assessment
to recapitalize the SAIF. Pursuant to this legislation, the FDIC promulgated a
rule that established the special assessment necessary to recapitalize the SAIF
at 65.7 basis points of SAIF-assessable deposits held by affected institutions
as of March 31, 1995. However, as a result of the Bank's financial condition, on
November 8, 1996, the Bank was notified by the FDIC that its application for
exemption had been approved. As a result, the Bank was exempt from paying the
special one-time assessment (which would have amounted to $1.8 million).
Instead, the Bank will continue to pay future assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995. Therefore, as of
December 31, 1996, the Bank's annual assessment for deposit insurance was 30
basis points of insured deposits as opposed to 6.4 basis points of insured
deposits (the assessment rate for "well capitalized" savings institutions).
Another component of the SAIF recapitalization plan provides for the
merger of the SAIF and the BIF on January 1, 1999, provided no insured
depository institution is a savings association on that date. If legislation is
enacted which required the Bank to convert to a bank charter, the Company would
become a bank holding company subject to the more restrictive activity limits
imposed on bank holding companies unless special grandfather provisions are
included in the legislation. The Company does not believe that its activities
would be materially affected in the event that it was required to become a bank
holding company.
Regulatory Capital Requirements. Federally insured savings associations
are required to maintain minimum levels of regulatory capital. Pursuant to
FIRREA, the OTS has established capital standards applicable to all savings
associations. These standards generally must be as stringent as the comparable
capital requirements imposed on national banks. The OTS also is authorized to
impose capital requirements in excess of these standards on individual
associations on a case-by-case basis.
Current OTS capital standards require savings associations to satisfy
three different capital requirements. Under these standards, savings
associations must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8.0% of "risk-weighted" assets. For purposes of the regulation, core
capital generally consists of common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets, with only a limited exception
for purchased mortgage servicing rights. Both core and tangible capital are
further reduced by an amount equal to a savings association's debt and equity
investments in subsidiaries engaged in activities not permissible to national
banks (other than subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). A savings association is allowed to
include both core capital and supplementary capital in the calculation of its
total capital for purposes of the risk-based capital requirement, provided that
the amount of supplementary capital does not exceed the savings association's
core capital. Supplementary capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included as
core capital; subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for repossessed assets or loans more
than 90 days past due. Single-family residential first mortgage loans which are
not past-due or non-
38
<PAGE>
performing and which have been made in accordance with prudent underwriting
standards are assigned a 50% level in the risk-weighting system, as are certain
privately-issued mortgage-backed securities representing indirect ownership of
such loans. Off-balance sheet items also are adjusted to take into account
certain risk characteristics.
An association which is not in capital compliance or which is otherwise
deemed to require more than normal supervision, such as the Bank, is subject to
restrictions on its ability to grow pursuant to OTS Regulatory Bulletin 3a-1. In
addition, a provision of the HOLA generally provides that, among other
restrictions, the Director of OTS must restrict the asset growth of savings
institutions not in regulatory capital compliance, subject to a limited
exception for growth not exceeding interest credited.
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations,
termination of federal deposit insurance and the appointment of a conservator or
receiver. The OTS' capital regulation provides that such actions, through
enforcement proceedings or otherwise, could require one or more of a variety of
corrective actions. For additional information, see "- Prompt Corrective
Action."
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its interest rate risk component from total
capital for purposes of calculating its risk-based capital requirement. As a
result, such an institution will be required to maintain additional capital in
order to comply with the risk-based capital requirement. The final rule was
effective January 1, 1994. However, the date that institutions are first
required to deduct the interest rate risk component has been postponed
indefinitely until a final rule is published by the OTS. Pursuant to the rule,
the Bank would have not been subject an interest rate risk component as of
December 31, 1996.
At December 31, 1996, the Bank's actual capital ratios and the minimum
requirements under FIRREA were as follows (dollars in thousands):
Minimum
Actual Requirement Excess
------ ----------- ------
Tangible capital $15,090 8.66% $2,613 1.5 $12,477
Core capital 15,090 8.66 5,227 3.0 9,863
Risk-based capital 16,495 14.73 8,959 8.0 7,536
For further information regarding the Bank's actual capital ratios and
minimum requirements under FDICIA, see Note 21 of the Notes to Consolidated
Financial Statements on pages 65 through 66 of the 1996 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference. At December 31, 1996, the Bank exceeded its core capital and
risk-based capital requirements under FDICIA.
Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
FDICIA, each federal banking agency is required to implement a system of prompt
corrective action for institutions which it regulates. The federal banking
agencies, including the OTS, adopted substantially similar regulations to
implement Section 38 of the FDIA, effective as of December 19, 1992. Under the
regulations, an institution is deemed to be (i) "well capitalized" if it has
total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio
of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital
39
<PAGE>
ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0%
under certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less
than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital
ratio that is less than 3.0% or a Tier I leverage capital ratio that is less
than 3.0% and does not meet the definition of "critically undercapitalized," and
(v) "critically undercapitalized" if it has a ratio of tangible equity to total
assets that is equal to or less than 2.0%. Section 38 of the FDIA and the
regulations promulgated thereunder also specify circumstances under which a
federal banking agency may reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category (except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized). At
December 31, 1996, the Bank was considered a "well capitalized" institution
under the prompt correction action provisions of FDIA.
Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required minimum
liquid asset ratio is 5%. The Bank has consistently exceeded such regulatory
liquidity requirement and, at December 31, 1996, had a liquidity ratio of 7.26%.
Liquid assets for purposes of this ratio include specified short-term
assets (e.g., cash, certain time deposits, certain banker's acceptances and
short-term United States Government obligations), and long-term assets (e.g.,
United States Government obligations of more than one and less than five years
and state agency obligations with a maximum term of two years). The regulations
governing liquidity requirements include as liquid assets debt securities hedged
with forward commitments obtained from, or debt securities subject to repurchase
agreements with, members of the Association of Primary Dealers in United States
Government Securities or banks whose accounts are insured by the FDIC, debt
securities directly hedged with a short financial future position, and debt
securities that provide the holder with a right to redeem the security at par
value, regardless of the stated maturities of such securities. FIRREA also
authorized the OTS to designate as liquid assets certain mortgage-related
securities with less than one year to maturity. Short-term liquid assets
currently must constitute at least 1% of an association's average daily balance
of net withdrawable deposit accounts and current borrowings. Monetary penalties
may be imposed upon associations for violations of liquidity requirements.
Qualified Thrift Lender Test. All savings associations are required to
meet a QTL test set forth in Section 10(m) of HOLA and regulations of the OTS
thereunder in order to avoid certain restrictions on their operations. A savings
association that does not meet the QTL test set forth in the HOLA and
implementing regulations must either convert to a bank charter or comply with
the following restrictions on its operations: (i) the association may not engage
in any new activity or make any new investment, directly or indirectly, unless
such activity or investment is permissible for a national bank; (ii) the
branching powers of the association shall be restricted to those of a national
bank; (iii) the association shall not be eligible to obtain any advances from
its FHLB; and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the association ceases to be a QTL, it must cease
any activity and not retain any investment not permissible for a national bank
and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations).
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<PAGE>
Under recent legislation and applicable regulations, any savings
institution is a QTL if (i) it qualifies as a domestic building and loan
association under Section 7701(a)(19) of the Code (which generally requires that
at least 60% of the institution's assets constitute housing-related and other
qualifying assets) or (ii) at least 65% of the institution's "portfolio assets"
(as defined) consist of certain housing and consumer-related assets on a monthly
average basis in at least nine out of every 12 months. At December 1996, the
Bank was in compliance with the QTL test.
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions from
associations meeting at least their minimum capital requirements, so long as
such associations notify the OTS and receive no objection to the distribution
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making any capital
distributions.
Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the association's ratio of total
risk-based capital to assets exceeds the ratio of its fully phased-in capital
requirement to assets. "Fully phased-in capital requirement" is defined to mean
an association's capital requirement under the statutory and regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association.
Tier 2 associations, which are associations that before and after the
proposed distribution meet or exceed their minimum capital requirements, may
make capital distributions during any calendar year up to 75% of net income over
the most recent four-quarter period.
In order to make distributions under these safe harbors, Tier 1 and Tier 2
associations must submit written notice to the OTS 30 days prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. In addition, a Tier 1 association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination.
Tier 3 associations, which are associations that do not meet current
minimum regulatory capital requirements, or that have capital in excess of
either their fully phased-in capital requirement or minimum capital requirement
but which have been notified by the OTS that they will be treated as Tier 3
associations because they are in need of more than normal supervision, cannot
make any capital distribution without obtaining OTS approval prior to making
such distributions. Due to the Bank requiring more than normal supervision, it
currently is a Tier 3 institution for purposes of the regulation dealing with
capital distributions.
On December 5, 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, institutions
would be permitted to only make capital distributions that would not result in
their capital being reduced below the level required to remain "adequately
capitalized," as defined above under "- Prompt Corrective Action." Because the
Bank is a subsidiary of a holding company, the proposal would require the Bank
to continue to provide notice to the OTS of its intent to make a capital
distribution.
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<PAGE>
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of 12 regional FHLBs that administers the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB in an amount equal to at least 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar obligations at the beginning
of each year. At December 31, 1996, the Bank had $2.5 million in FHLB stock,
which was in compliance with this requirement.
As a result of FIRREA, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to affordable
housing programs through direct loans or interest subsidies on advances targeted
for community investment and low- and moderate-income housing projects. These
contributions have adversely affected the level of FHLB dividends paid and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future. For the years ended December
31, 1996, 1995, and 1994, dividends paid by the FHLB to the Bank totaled
approximately $221,000, $293,000, and $276,000, respectively.
Federal Reserve System. The FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At December 31, 1996, the
Bank was in compliance with applicable requirements. However, because required
reserves must be maintained in the form of vault cash or a noninterest-bearing
account at a Federal Reserve Bank, the effect of this reserve requirement is to
reduce an institution's earning assets.
Safety and Soundness. Effective August 9, 1995, the federal banking
regulatory agencies jointly implemented Interagency Guidelines Establishing
Standards for Safety and Soundness ("Guidelines") for all insured depository
institutions relating to internal controls, information systems and audit
systems, loan documentation, credit underwriting, interest rate risk exposure,
asset growth, compensation, fees and benefits, and employment contracts and
other compensation arrangements of executive officers, employees, directors and
principal stockholders of insured depository institutions that would prohibit
compensation and benefits and arrangements that are excessive or that could lead
to a material financial loss for the institution. In addition, the federal
banking regulatory agencies adopted asset quality and earnings standards, which
became effective October 1, 1996. If an insured depository institution fails to
meet any of its prescribed standards as described above, it may be required to
submit to the appropriate federal banking agency a compliance plan specifying
the steps that will be taken to cure the deficiency and the time within which
these steps will be taken. If an institution fails to submit an acceptable plan
or fails to implement the plan, the appropriate federal banking agency will
require the institution or holding company to correct the deficiency and until
corrected, may impose restrictions on the institution or holding company,
including any of the restrictions applicable under the prompt corrective action
provisions of FDICIA. The Bank does not currently meet some of the standards for
earnings. Accordingly, the Bank may be required to file a safety and soundness
compliance plan.
Taxation
Federal Taxation. The Company and its subsidiaries are subject to those
rules of federal income taxation generally applicable to corporations under the
Code. The Company and its principal subsidiary, the Bank, as members of an
affiliated group of corporations within the meaning of Section 1504 of the Code,
file a consolidated federal income tax return, which has the
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<PAGE>
effect of eliminating or deferring the tax consequences of inter-company
transactions and distributions, including dividends, in the computation of
consolidated taxable income.
In addition to regular corporate income tax, corporations are subject to
an alternative minimum tax which generally is equal to 20% of alternative
minimum taxable income (taxable income, increased by certain tax preference
items and determined with adjustments to certain regular tax items). The
adjustments which are generally applicable include an amount equal to a
percentage of the amount by which a financial institution's adjusted current
earnings (generally alternative minimum taxable income computed without regard
to this adjustment and prior to reduction for alternative tax net operating
losses) exceeds its alternative minimum taxable income without regard to this
adjustment. Alternative minimum tax paid can be credited against regular tax due
in later years. See Note 14 of the Notes to Consolidated Financial Statements on
pages 58 through 59 of the 1996 Annual Report to Stockholders, which is attached
hereto as Exhibit 13 and incorporated herein by reference.
State Taxation. The Commonwealth of Virginia imposes a tax at the rate of
6.0% on the combined "Virginia taxable income" of the Bank, EMC and its
subsidiaries. Virginia taxable income is equal to federal taxable income with
certain adjustments. Significant modifications include the subtraction from
federal taxable income of interest or dividends on obligations or securities of
the United States that are exempt from state income taxes, and a recomputation
of the bad debt reserve deduction on reduced modified taxable income.
Because consolidated or combined income tax returns are not allowed under
North Carolina law, the Bank and its subsidiaries that conduct business in North
Carolina are separately subject to an annual corporate income tax of 7.75% of
their federal taxable income as computed under the Code, subject to certain
prescribed adjustments. In addition to the state corporate income tax, the Bank
and its subsidiaries are subject to an annual state franchise tax, which is
imposed at a rate of .15% applied to the greater of the Company's and the Bank's
respective (i) capital stock, surplus, and undivided profits, (ii) investments
in tangible property in North Carolina; or (iii) appraised valuation of property
in North Carolina.
Furthermore, the Company is separately subject to income taxes and an
annual state franchise tax in Delaware.
43
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Item 2. Properties
The following table sets forth information with respect to offices of the
Company and its subsidiaries as of December 31, 1996.
<TABLE>
<CAPTION>
Lease Date Total Net Book
Owned/ Expiration Date Acquired/ Office Value at
Location Leased Including Options Leased Square Ft. (1)12/31/96 (2)
- -------- ------ ----------------- ------ --------------------------
<S> <C> <C> <C> <C> <C>
The Company
Executive Office:
The Koger Center Leased 01/31/02 10/96 7,328 $22,533
Building 9, Suite 200
Norfolk, VA 23502
The Bank
Main Office:
400 W. Ehringhaus Street Owned -- 11/78 3,805 213,983
Elizabeth City, NC 27906
Branch Offices:
520 South Main Street Owned -- 05/86 6,517 699,797
Emporia, VA 23847
1401 Gaskins Road Leased 09/07/98 05/95 5,876 --
Richmond, VA 23233
1455 N. Main Street Leased 12/31/99 09/95 1,200 --
Suffolk, VA 23434
12599 Warwick Boulevard Owned(4) -- 09/95 1,794 274,809
Newport News, VA 23606
3511 High Street Owned(5) -- 09/95 3,739 214,676
Portsmouth, VA 23707
Essex First
The Koger Center Leased 01/31/02 10/96 5,554 --
Building 9, Suite 200
Norfolk, VA 23502
1401 Gaskins Road Leased(3) 09/07/98 05/95 3,078 --
Richmond, VA 23233
2430 Southland Drive, 3rd Floor Leased 05/31/98 06/93 2,000 --
Chester, VA 23831
400 W. Ehringhaus Street Leased(3) -- 07/94 750 --
Elizabeth City, NC 27906
Essex Home
2420 Virginia Beach Blvd. Leased 12/31/01 12/91 11,950 12,057
Virginia Beach, VA 23454
</TABLE>
(1) Total office square feet excludes leased common area.
(2) Consists of the net book value of land and buildings if owned, or
leasehold improvements if leased.
(3) Leased or subleased from the Bank.
(4) Branch was vacated in October 1995 because of its proximity to an existing
branch. It is currently under contract for sale.
(5) Branch was vacated in September 1996 in connection with the sale of the
Branches. It is currently being marketed for sale.
Item 3. Legal Proceedings
The Company and its subsidiaries are 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 of the Company.
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<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the stockholders of the Company
through the solicitation of proxies, or otherwise, during the fourth quarter of
the year ended December 31, 1996.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Common Stock is currently traded on the AMEX under the symbol "ESX."
The information contained on page 70 of the 1996 Annual Report to Stockholders,
which is attached hereto as Exhibit 13, under the caption "Stock Price
Information," is incorporated herein by reference.
As of March 20, 1997, there were 1,053,379 shares of Common Stock
outstanding, which were held by approximately 2,600 persons. The number of
persons holding shares of Common Stock reflects an estimate of the number of
persons or entities holding their stock in nominee or "street" name through
various brokerage firms or other entities.
Dividends
Neither the Company nor its predecessor (the Partnership) has declared any
capital distributions since the fourth quarter of 1991. Due to its financial
condition, its recent results of operations and regulatory restrictions on the
payment of dividends imposed on the Company and the Bank, the Company does not
anticipate the payment of dividends on the Common Stock in the foreseeable
future.
The Company's ability to pay dividends on the Common Stock will depend
primarily on the receipt of dividends from the Bank. While the completion of the
Home Acquisition resulted in the termination of the supervisory agreements the
Company and the Bank had entered into with the OTS, the Boards of Directors of
the Company and the Bank have undertaken, as required by the OTS, to continue to
implement and adhere to the spirit of the provisions of the agreements.
Therefore, the Bank is currently precluded from making dividend payments to the
Company.
In connection with the Home Acquisition, the Company issued 2,250,000
shares of nonvoting perpetual preferred stock with an aggregate redemption and
liquidation value of $15 million in exchange for all of the outstanding stock of
Home Bancorp. The 2,125,000 shares of Series B preferred stock bear a cumulative
annual dividend rate of 9.5% (based on redemption value) and the 125,000 shares
of Series C preferred stock bear a cumulative annual dividend rate of 8.0%
(based on redemption value). The Series C preferred stock is senior to Series B
preferred stock with respect to the payment of dividends, and the holders of the
Series C preferred stock may, in their discretion, from time to time in whole or
in part, elect to convert such shares of Series C preferred stock into a like
amount of Series B preferred stock. At December 31, 1996, dividends and accrued
interest thereon in arrears on the Series B and Series C preferred stock were
$1,729,472 and $85,418, respectively.
Also in connection with the Home Acquisition, the stockholders of Home
Bancorp received warrants to purchase 7,949,000 shares of Common Stock at a
price of $0.9375 per share, which was the price of the Common Stock as of June
30, 1995. The warrants are exercisable beginning in September 1998 and expire in
September 2005.
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<PAGE>
Item 6. Selected Financial Data
The selected financial data for the five years ended December 31, 1996,
which appears on page 12 of the 1996 Annual Report to Stockholders attached
hereto as Exhibit 13, is incorporated by reference in this Form 10-K Annual
Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information contained on pages 13 through 33 of the 1996 Annual Report
to Stockholders, which is attached hereto as Exhibit 13, under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The consolidated balance sheets of the Company as of December 31, 1996 and
1995 and the related consolidated statements of operations, shareholders'
equity, partners' capital (deficit) and cash flows for each of the years in the
three-year period ended December 31, 1996, along with the related notes to
consolidated financial statements and the report of Price Waterhouse LLP,
independent accountants, are incorporated herein by reference from pages 34
through 69 of the Company's 1996 Annual Report to Stockholders, which is
attached hereto as Exhibit 13.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding the directors of the Company is included in the
Company's Proxy Statement for the Annual Meeting to be held on May 29, 1997
under the heading "Election of Two Directors for a Term of Three Years" on pages
3 through 6 and the information included therein is incorporated herein by
reference.
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<PAGE>
Set forth below is information with respect to the executive officers of
the Company and its subsidiaries who do not serve as directors.
Earl C. McPherson 43 President and Chief Executive Officer of Essex
First and Executive Vice President of Loan
Production and Secondary Marketing of the Bank
Roy H. Rechkemmer, Jr. 34 Vice President of Finance and Treasurer of the
Company and the Bank
Mary-Jo Rawson 43 Vice President and Chief Accounting Officer of
the Company and the Bank
Earl C. McPherson. Mr. McPherson presently serves as a director as well as
President and Chief Executive Officer of Essex First and as Executive Vice
President of Loan Production and Secondary Marketing of the Bank. Mr. McPherson
served as President of Essex Industrial Loan Association/Virginia Beach from
January 1992 through May 1992. From January 1990 through December 1991, Mr.
McPherson served as President of Mortgage Centers, Inc. ("MCI"). Prior to his
employment with MCI, Mr. McPherson served as Divisional, Regional, and Training
Director for Security Pacific Financial Services, Inc. Mr. McPherson has a
Bachelor of Arts from the University of Richmond. Mr. McPherson also attended
the American Financial Services Association Management program at the University
of North Carolina at Chapel Hill.
Roy H. Rechkemmer, Jr. Mr. Rechkemmer presently serves as Vice President
of Finance and Treasurer of the Company and the Bank. Mr. Rechkemmer also serves
as chairman of the Bank's Asset and Liability Management Committee, manager of
the Bank's investment portfolio and administrator of the Bank's branches. Mr.
Rechkemmer received a Bachelor of Science Degree in Finance from the University
of Wisconsin-La Crosse in 1985. He has been employed by the Bank and
subsidiaries since 1987.
Mary-Jo Rawson. Ms. Rawson presently serves as Vice President and Chief
Accounting Officer of the Company and the Bank. Prior to her employment with the
Company, Ms. Rawson served in various accounting officer positions at
NationsBank Corporation and its predecessor institution C&S/Sovran. Ms. Rawson's
primary responsibilities emphasized regulatory reporting and accounting policies
and procedures. At the time of her departure from NationsBank in 1992, Ms.
Rawson was a Senior Vice President and the controller of the Bankcard Division.
Ms. Rawson received a Bachelor of Science Degree in Business Administration from
Old Dominion University in 1976.
Information regarding compliance with Section 16(a) of the Securities
Exchange Act is included in the Company's Proxy Statement for the Annual Meeting
to be held on May 29, 1997 under the heading "Compliance with Section 16(a) of
the Exchange Act" on page 13, and the information included therein is
incorporated herein by reference.
Item 11. Executive Compensation
Information regarding compensation of executive officers and directors is
incorporated herein by reference to the Company's Proxy Statement for the Annual
Meeting to be held on May 29, 1997 under the headings "Directors Fees" on page 6
and "Executive Compensation" on pages 6 through 9.
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<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and
management is included in the Company's Proxy Statement for the Annual Meeting
to be held on May 29, 1997 under the headings "Securities Ownership of Certain
Beneficial Owners" on pages 2 through 3, and "Information with Respect to
Nominee and Continuing Directors" on pages 4 through 5, and the information
included therein is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is
included in the Company's Proxy Statement for the Annual Meeting to be held on
May 29, 1997 under the heading "Transactions with Certain Related Persons" on
page 13, and the information included therein is incorporated herein by
reference.
48
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Financial Statements:
Page in
Annual
Report*
-------
The following documents are filed as part of this report:
Report of Independent Accountants ............................ 34
Consolidated Balance Sheets at December 31, 1996 and 1995..... 35
Consolidated Statements of Operations for the three
years ended December 31, 1996.............................. 37
Consolidated Statements of Shareholders' Equity for
the two years ended December 31, 1996...................... 39
Consolidated Statement of Partners' Capital (Deficit)
for the year ended December 31, 1994....................... 40
Consolidated Statements of Cash Flows for the three
years ended December 31, 1996.............................. 41
Notes to Consolidated Financial Statements.................... 44
*Incorporated by reference from the indicated pages of the 1996
Annual Report to Stockholders.
The financial statements, together with the report thereon of
Price Waterhouse LLP dated February 25, 1997, appearing on pages
34 through 69 of the accompanying 1996 Annual Report to
Stockholders are incorporated by reference in this Form 10-K
Annual Report. With the exception of the aforementioned
information and the information incorporated in Items 1, 6, 7 and
8, the 1996 Annual Report to Stockholders is not to be deemed
filed as part of this Form 10-K Annual Report.
2. Financial Statement Schedules:
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the
consolidated financial statements or notes thereto.
49
<PAGE>
3. Exhibits:
The following exhibits are either filed as part of this Part IV or
are incorporated herein by reference:
Exhibit No. Description
3.1* Certificate of Incorporation of Essex Bancorp,
Inc., dated June 21, 1994. Filed as Exhibit 3.1 to
the Registrant's Form S-4 Registration Statement
under the Securities Act of 1933 as filed on August
15, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc.,
dated August 10, 1994. Filed as Exhibit 3.2 to the
Registrant's Form S-4 Registration Statement under
the Securities Act of 1933 as filed on August 15,
1994.
3.3* Bylaws of Essex Bancorp, Inc., effective July 25,
1994. Filed as Exhibit 3.3 to the Registrant's Form
S-4 Registration Statement under the Securities Act
of 1933 as filed on August 15, 1994.
4.1* Certificate of Designation of the Series A
Preferred Stock of Essex Bancorp, Inc. Filed as
Exhibit 4.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
4.2* Certificate of Designations of Cumulative Perpetual
Preferred Stock, Series B of Essex Bancorp, Inc.
Filed as Exhibit 4.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1995.
4.3* Certificate of Designations of Cumulative Perpetual
Preferred Stock, Series C of Essex Bancorp, Inc.
Filed as Exhibit 4.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1995.
4.4* Form of Common Stock Purchase Warrant Certificate.
Filed as Exhibit 4.3 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1995.
4.5* Specimen Common Stock Certificate of Essex Bancorp,
Inc. Filed as Exhibit 4.1 to the Registrant's
Pre-Effective Amendment No. 1 to Form S-4
Registration Statement under the Securities Act of
1933, as filed on October 12, 1994.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
50
<PAGE>
4.6* Specimen Series B 9.5% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc. Filed as Exhibit
4.6 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
4.7* Specimen Series C 8% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc. Filed as Exhibit
4.7 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
10.1* FNMA/FHLMC/Private Investor Mortgage Servicing
Purchase and Sale Agreement by and between Essex
Mortgage Corporation and Chase Home Mortgage
Corporation dated June 8, 1993. Filed as Exhibit
10.19 to Essex Financial Partners, L.P.'s Annual
Report on the Second Amended and Restated Form 10-K
for the year ended December 31, 1992.
10.2* Essex Bancorp, Inc. Non-Employee Directors Stock
Option Plan. Filed as Exhibit 10.18 to the
Registrant's Form 10-K for the year ended December
31, 1994.
10.3* First Amendment to the Essex Bancorp, Inc.
Non-Employee Directors Stock Option Plan dated July
29, 1995. Filed as Exhibit 10.6 to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1995.
10.4* Essex Bancorp, Inc. Stock Option Plan. Filed as
Exhibit 10.19 to the Registrant's Form 10-K for the
year ended December 31, 1994.
10.5* First Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated June 29, 1995. Filed as Exhibit
10.8 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
10.6 Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996. Filed as an exhibit
to this report.
10.7* Essex Bancorp, Inc. Employee Stock Purchase Plan.
Filed as Exhibit 10.20 to the Registrant's Form
10-K for the year ended December 31, 1994.
10.8* First Amendment to the Essex Bancorp, Inc. Employee
Stock Purchase Plan dated June 29, 1995. Filed as
Exhibit 10.10 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
51
<PAGE>
10.9* Agreement and Plan of Reorganization dated as of
June 30, 1995 by and among Essex Bancorp, Inc.,
Essex Savings Bank, F.S.B., Home Bancorp, Inc., and
Home Savings Bank, F.S.B. Filed as Exhibit 10.1 to
the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995.
10.10* Employment Agreement dated January 4, 1996 by and
among Essex Bancorp, Inc., Essex Acquisition Corp.,
Essex Savings Bank, F.S.B., Essex Mortgage
Corporation, and Gene D. Ross. Filed as Exhibit
10.12 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1995.
10.11* Executive Services Agreement dated October 28, 1993
by and between Essex Savings Bank, F.S.B. and its
subsidiaries, and Earl C. McPherson. Filed as
Exhibit 10.11 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1993.
10.12* First Amendment to Executive Services Agreement by
and between Essex Savings Bank, F.S.B., Essex First
Mortgage Corporation, and Earl McPherson dated as
of April 1, 1995. Filed as Exhibit 10.14 to the
Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995.
10.13* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Bank of
Mecklenburg dated as of December 8, 1995. Filed as
Exhibit 10.15 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
10.14* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Centura Bank
dated as of April 11, 1996. Filed as Exhibit 10.1
to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1996.
10.15* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and CENIT Bank,
FSB dated as of July 2, 1996. Filed as Exhibit 10.1
to the Registrant's Current Report on Form 8-K
dated July 3, 1996.
11 Statement re computation of per share earnings.
13 The 1996 Annual Report is attached as Exhibit 13.
Portions of the 1996 Annual Report are incorporated
by reference into this Form 10-K.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
52
<PAGE>
21* Subsidiaries of the Registrant. Filed as Exhibit 21
to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1995.
27 Financial Data Schedule.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
53
<PAGE>
(b) Reports on Form 8-K Filed in the Fourth Quarter of 1996
On October 9, 1996, the Registrant filed a Form 8-K in which it disclosed
under Item 2-Acquisition or Disposition of Assets-the Bank's sale of the
deposits and related assets of its Norfolk, Portsmouth, Hampton and
Newport News, Virginia branches to CENIT Bank, FSB pursuant to the Branch
Purchase and Deposit Assumption Agreement dated July 2, 1996. In addition,
under Item 7-Financial Statements and Exhibits-unaudited pro forma
financial information was provided which included the historical financial
statements of the Registrant, pro forma adjustments directly attributable
to the sale of the branches and pro forma results as of June 30, 1996 with
regard to the pro forma consolidated balance sheet and for the year ended
December 31, 1995 and for the six months ended June 30, 1996 with regard
to the unaudited pro forma consolidated statements of operations.
(c) Exhibits
See Exhibit Index contained herein.
(d) Financial Statements Excluded from Annual Report to Shareholders Pursuant
to Rule 14a3(b)
Not applicable.
54
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Essex Bancorp, Inc.
By: /s/ Gene D. Ross
----------------------------------
Gene D. Ross
Chairman, President,
and Chief Executive
Officer
March 21, 1997
----------------------
(Date)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Gene D. Ross March 21, 1997
------------------------------ ----------------------
Gene D. Ross (Date)
Chairman, President, Chief
Executive Officer and
Principal Financial Officer
By: /s/ Mary-Jo Rawson March 21, 1997
------------------------------ ----------------------
Mary-Jo Rawson (Date)
Chief Accounting Officer
By: /s/ Roscoe D. Lacy, Jr. March 21, 1997
------------------------------ ----------------------
Roscoe D. Lacy, Jr. (Date)
Director
By: /s/ Harry F. Radcliffe March 21, 1997
------------------------------ ----------------------
Harry F. Radcliffe (Date)
Director
By: /s/ Robert G. Hecht March 21, 1997
------------------------------ ----------------------
Robert G. Hecht (Date)
Director
55
<PAGE>
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
Exhibit Index
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation of Essex Bancorp, Inc.,
dated June 21, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc., dated
August 10, 1994.
3.3* Bylaws of Essex Bancorp, Inc., effective July 25, 1994.
4.1* Certificate of Designation of the Series A Preferred
Stock of Essex Bancorp, Inc.
4.2* Certificate of Designations of Cumulative Perpetual
Preferred Stock, Series B of Essex Bancorp, Inc.
4.3* Certificate of Designations of Cumulative Perpetual
Preferred Stock, Series C of Essex Bancorp, Inc.
4.4* Form of Common Stock Purchase Warrant Certificate
4.5* Specimen Common Stock Certificate of Essex Bancorp,
Inc.
4.6* Specimen Series B 9.5% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc.
4.7* Specimen Series C 8% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc.
10.1* FNMA/FHLMC/Private Investor Mortgage Servicing Purchase
and Sale Agreement by and between Essex Mortgage
Corporation and Chase Home Mortgage Corporation dated
June 8, 1993.
10.2* Essex Bancorp, Inc. Non-Employee Directors Stock Option
Plan.
10.3* First Amendment to the Essex Bancorp, Inc. Non-Employee
Directors Stock Option Plan dated July 29, 1995.
10.4* Essex Bancorp, Inc. Stock Option Plan.
- ----------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated be reference.
E-1
<PAGE>
10.5* First Amendment to the Essex Bancorp, Inc. Stock Option
Plan dated June 29, 1995.
10.6 Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996.
10.7* Essex Bancorp, Inc. Employee Stock Purchase Plan.
10.8* First Amendment to the Essex Bancorp, Inc. Employee
Stock Purchase Plan dated June 29, 1995.
10.9* Agreement and Plan of Reorganization dated as of June
30, 1995 by and among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Home Bancorp, Inc., and Home
Savings Bank, F.S.B.
10.10* Employment Agreement dated January 4, 1996 by and among
Essex Bancorp, Inc., Essex Acquisition Corp., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation, and
Gene D. Ross.
10.11* Executive Services Agreement dated October 28, 1993 by
and between Essex Savings Bank, F.S.B. and its
subsidiaries, and Earl C. McPherson.
10.12* First Amendment to Executive Services Agreement by and
between Essex Savings Bank, F.S.B., Essex First
Mortgage Corporation, and Earl McPherson dated as of
April 1, 1995.
10.13* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Bank of
Mecklenburg dated as of December 8, 1995.
10.14* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Centura Bank
dated as of April 11, 1996.
10.15* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and CENIT Bank, FSB
dated as of July 2, 1996.
11 Statement re computation of per share earnings.
- ----------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated be reference.
E-2
<PAGE>
13 The 1996 Annual Report is attached as Exhibit 13.
Portions of the 1996 Annual Report are incorporated by
reference into this Form 10-K.
21* Subsidiaries of the Registrant, as updated.
27 Financial Data Schedule
- ----------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated be reference.
E-3
<PAGE>
EXHIBIT 10.6
SECOND AMENDMENT
TO THE ESSEX BANCORP, INC.
STOCK OPTION PLAN
WHEREAS, Essex Bancorp, Inc. (the "Corporation") has established the Essex
Bancorp, Inc. Stock Option Plan (the "Plan") for the benefit of its executive
employees and the executive employees of its subsidiaries; and
WHEREAS, the Corporation's Board of Directors has reserved the right to
amend the Plan at any time and from time to time, provided that any amendment
which materially increases benefits under the Plan to participants is also
approved by the shareholders of the Corporation.
WHEREAS, on February 9, 1996 the Corporations' Board approved the Second
Amendment to the Plan, changing the Plan's definition of a "Change in Control,"
contingent upon shareholder approval; and
WHEREAS, shareholder approval of the Second Amendment to the Plan has now
been obtained;
NOW, THEREFORE, the Plan is hereby amended effective February 9, 1996 as
follows:
1. Section 1.13 of the Plan is amended to insert the following sentence at
the end thereof:
Additionally, a "Change in Control" shall mean any transfer after
February 1, 1996, or series of transfers within a twelve month
period commencing after February 1, 1996, to one or more entities
other than the Corporation or a Subsidiary of fifty percent 50% or
more of the assets (measured by book value) comprising the retail
banking, mortgage lending or mortgage servicing business of the
Corporation and its Subsidiaries.
2. Except as provided above, the Plan shall continue in full force and
effect.
IN TESTIMONY WHEREOF, Essex Bancorp, Inc. has caused this Second Amendment
to the Plan to be executed in its name by its President this 23rd day of May,
1996.
ESSEX BANCORP, INC.
By: /s/ Gene D. Ross
---------------------------------
Its: President & CEO
<PAGE>
EXHIBIT 11
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
Year Ended December 31, 1996
(Dollars in thousands, except per share amounts)
Loss before cumulative effect of change in accounting
accounting principle, extraordinary item, and
income taxes $ (7,377)
Effect of dividends in arrears on preferred stock (1,447)
-----------
$ (8,824)
-----------
Average shares outstanding 1,051,180
Net effect of the assumed exercise of stock options and
warrants - based on the modified treasury stock method 4,073,684
-----------
5,124,864
-----------
Loss per share before cumulative effect of change in
accounting principle, extraordinary item, and income
taxes $ (1.72)
-----------
<PAGE>
EXHIBIT 13
ESSEX
BANCORP, INC.
1996 ANNUAL REPORT
<PAGE>
ESSEX
BANCORP, INC.
Table of Contents
Page
----
Report to Our Stockholders 1
Five Year Financial Summary 12
Management's Discussion and Analysis 13
Report of Independent Accountants 34
Consolidated Financial Statements 35
Notes to Consolidated Financial Statements 44
Investor Information 70
Directors and Officers 71
Corporate Information 72
<PAGE>
[LOGO]
ESSEX
BANCORP, INC.
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
As you may recall, we advised you in the 1995 Annual Report and our Message to
Stockholders, as well as other public filings, that in January 1996 the Board of
Directors of Essex Bancorp, Inc. (the "Company") formed a special committee of
the board, the Strategic Evaluation Committee (the "Committee"). The purpose of
the Committee, among other objectives, was to review strategic alternatives to
enhance shareholder value. During the first quarter of 1996, the Committee
evaluated the benefits of (i) investing precious capital in expanding the retail
bank branch network and retrofitting the existing branches to more closely
conform with traditional bank franchises or (ii) selling branches and,
therefore, materially downsizing the Company. The decision was made to downsize
and a review by an independent consultant corroborated the Committee's decision.
Accordingly, over an approximate nine month period in 1996, Essex Savings Bank,
F.S.B. (the "Bank"), the Company's primary asset, sold nine non-strategic
branches (the "Branches") in three separate transactions and the size of its
asset base declined by approximately 50%.
Today the Bank's four remaining branches provide a community branch network with
the greatest potential for growth in market share. Moreover, as a result of the
branch sales, intangible assets associated with the original acquisition of
certain of the Branches have been removed from the balance sheet of the Bank and
will not encumber the future earnings performance of the Company.
<PAGE>
Clearly the sale of Branches was the most significant accomplishment in 1996;
however, the following sections describe other achievements and set forth the
outlook for the Company's near term future.
SUMMARY OF 1996 ACCOMPLISHMENTS
Retail Banking
The following map illustrates the Bank's branch network following the sale
of the Branches.
[MAP OF NORTH CAROLINA]
2
<PAGE>
As a result of the Committee's decision to downsize, the following branches were
identified for sale: Greensboro, Raleigh, and Wilmington, North Carolina, and
Portsmouth, Newport News, Grafton, Hampton, and Norfolk, Virginia. In December
1995, the Bank had accepted an unsolicited offer from a state-chartered
financial institution in North Carolina to purchase the Bank's Charlotte, North
Carolina branch. The sale of the Charlotte branch was completed in March 1996.
The marketing process for the other branches commenced and parties of interest
were identified. The remaining non-strategic North Carolina branches were sold
in July 1996 and the Virginia branches were sold in September 1996, except for
the Grafton branch, which closed in November 1996. The aggregate deposits and
related accrued interest sold were $167.5 million. In order to complete the sale
of deposits, the Bank sold securities and loans and utilized a portion of its
excess liquidity. Accordingly, assets declined to approximately $174 million as
of December 31, 1996.
Contemporaneously with the process of selling the Branches, the Bank was
continuing its efforts to position the remaining strategic branches to more
nearly conform to the activities of a traditional savings institution. To that
end, the Bank and its mortgage banking subsidiary introduced a wider range of
consumer and mortgage loan products to attract new business and maximize the
potential of its existing customer base.
In September 1996, the Bank executed a purchase agreement on a parcel in
Suffolk, Virginia with the intent to relocate its Suffolk branch from a leased
facility to a location with much anticipated potential for significant growth.
Subject to the outcome of the Bank's due diligence and weather interruptions
during construction, the new branch is expected to open for business in the
fourth quarter of 1997. Regulatory approval to relocate the existing branch has
already been received.
Mortgage Loan Production
The Bank's wholly-owned mortgage banking subsidiary, Essex First Mortgage
Corporation ("Essex First"), continued its efforts to diversify and increase its
lending production in 1996.
3
<PAGE>
The following graph illustrates the historical production of Essex First.
Essex First Loan Production
As of December 31
[BAR CHART OMITTED]
Essex First intends to increase its origination of investment grade
single-family residential loans by selectively expanding into new market areas
as well as by focusing on existing locations. Because Essex First's loan
origination activities are primarily supported by its development of well
established relationships within the real estate and builder communities and
because the Bank has retained its more strategic locations, the downsizing of
the Bank should have minimal impact. Although the Bank branch network provides
Essex First with referrals for mortgage loan products, Essex First's main source
of referrals for first mortgages is through real estate agents and local
builders, and Essex First plans to continue to promote and further develop
these valuable contacts.
During 1996, Essex First established a wholesale construction / permanent ("CP")
lending program. Currently, a network of approximately 40 approved brokers are
responsible for originating and processing CP loans and submitting them to the
Bank for underwriting approval.
4
<PAGE>
Single-family lending is a natural extension of the wholesale CP lending
program. Accordingly, Essex First recently began soliciting its network of
approved brokers for their single-family mortgage loans. Essex First has already
begun closing both investment grade and sub-prime single-family residential
loans from its approved list of brokers.
With the success of the builder/construction lending program in the Richmond,
Virginia market as well as in the Tidewater, Virginia area, Essex First is
expanding this program to include counties in northeastern North Carolina, a
market where substantial new-home development is predicted over the next few
years.
Mortgage Loan Servicing
A significant line of business for the Company is conducted through Essex Home
Mortgage Servicing Corporation ("Essex Home"), which is an operating subsidiary
of the Bank. Essex Home is committed to generating fee income by providing
competitively-priced and profitable residential mortgage loan servicing and
subservicing and is approved by the Federal National Mortgage Association, the
Federal Home Loan Mortgage Corporation and the Government National Mortgage
Association. In addition, Essex Home services and subservices loans for
approximately 28 private investors.
During 1996, Essex Home continued its marketing efforts to acquire subservicing
contracts as a means of generating loan servicing fees and ancillary income. The
following graph illustrates the progress that Essex Home has made in attracting
new business since 1993 following a major restructuring by the Company which
largely depleted Essex Home's servicing portfolio:
5
<PAGE>
ESSEX HOME LOAN SERVICING VOLUME
As of December 31
[BAR CHART OMITTED]
In February 1997, Essex Home received notice from its largest subservicing
client of its intention not to renew its contract beyond June 1, 1997. As of
December 31, 1996, Essex Home was servicing approximately 7,000 loans with
principal balances of approximately $860 million for this client and servicing
fee income for 1996 included approximately $409,000 attributable to servicing
activities performed for this client. While the Company's servicing subsidiary
has intensified its marketing efforts in order to minimize the impact of this
loss on the earnings performance of the Company, no assurances can be made that
this significant servicing volume can be replaced in its entirety in the near
term. Management believes, however, that its marketing efforts will be buoyed by
the much-improved capital position of the Bank, which is deemed a
"well-capitalized" institution under the Prompt Corrective Action provisions of
the Federal Deposit Insurance Act. In the meantime, the Company is examining
expenses associated with the servicing of this client in contemplation of
reductions to minimize the loss in servicing fee income.
6
<PAGE>
Asset Quality
As illustrated in the following graph, the Company's asset quality has improved
considerably and, most dramatically from 1992 when new management was
introduced. For the first time, nonperforming assets as of December 31, 1996
have fallen below 3% of total assets. Our expectation is that the trend will
continue to be positive. The Bank has only nominal restructured loans and very
few commercial loans of any size that could result in long-term problems for the
institution.
ESSEX BANCORP, INC.
AND SUBSIDIARIES
Non-Performing Assets & Delinquent Loans
As of December 31
[BAR CHART OMITTED]
The majority of the remaining nonperforming assets consist of consumer and first
mortgage loans originated in earlier years when underwriting standards were less
conservative. In the years since 1992, management's focus has been diverted to
the resolution of nonperforming loans. While our plans are to increase our
portfolio of consumer and sub-prime loans, which by their nature have a greater
risk, we intend to emphasize the importance of asset quality and the need for
continuation of the positive trends evidenced in the above graph.
7
<PAGE>
Operating Expense Reductions
Reduction in the Company's operating expenses remains a high priority. During
1996, as the size of the Bank was decreasing approximately 50% due to the sale
of the Branches, efforts were undertaken to restructure the overhead to mirror
an institution half its size. Two significant improvements are noteworthy. The
sale of the Branches resulted in the write off of substantially all intangible
assets, primarily goodwill, associated with certain of the Branches acquired in
1995, as well as the elimination of associated operating costs such as personnel
and occupancy expenses. In addition, the relocation of the corporate
headquarter's office enabled the Company to considerably downsize its space
requirements and leasing costs. Our more modest facilities will result in a
savings in excess of $100,000 per year. Notwithstanding these efforts, the
relationship of noninterest expenses to total assets is high when compared to
financial institutions whose operations are similar. See pages 24 and 25 of the
Annual Report for further discussion. Management continues to evaluate the
Bank's operating requirements in order to identify areas where efficiencies can
be achieved.
While the one-time write-off of intangible assets resulted in an increase in
noninterest expenses during 1996, the following graph demonstrates the
significant reductions that have been made in operating expenses since May 1992,
when a change in management occurred and operating expenses were at their
highest levels.
8
<PAGE>
ESSEX BANCORP, INC.
AND SUBSIDIARIES
NON-INTEREST EXPENSES
[BAR CHART OMITTED]
NEAR-TERM OUTLOOK
The Board of Directors and the Committee continue to evaluate profitability
enhancements and other possibilities for corporate restructurings. This
undertaking is critical in order to restore the Company to profitability. The
absence of profitability for the Company is troublesome given that the dividend
return requirements on the Series B and C Preferred Stock approximates 9.75% on
a compounded basis.
For the first time since I joined the Company in 1992, we have significant
regulatory capital. As of December 31, 1996, the Bank's core and risk-based
regulatory capital ratios were 8.66% and 14.73%, respectively, resulting in
excesses in core capital of $8.1 million and risk-based capital of $7.5 million
over the regulatory requirements. With these regulatory capital ratios, the Bank
is considered a "well
9
<PAGE>
capitalized" institution under the Prompt Corrective Action provisions of the
Federal Deposit Insurance Act. Our capital position coupled with continuing
improvement in nonperforming assets and the write-off of significant intangible
assets have considerably improved the outlook for the Company. Going forward, we
believe our challenges to be the reduction of operating expenses in tandem with
the prudent utilization of our capital through growth and improvement in our net
interest margin. The margin has been impacted by our conservative policies in
the past, which were necessitated due to the high level of nonperforming assets.
However, we plan to increase consumer and sub-prime loans, as well as our
investment grade loan products in order to increase the overall yield on our
loan portfolio and improve the net interest margin, resulting in better earnings
performance.
The four remaining community bank branches are well positioned for growth. By
emphasizing transaction accounts, we believe the Bank's core deposit
relationship with customers will be enhanced and lead to a more stabilized cost
of funds. Thus far, we are meeting our internal growth targets.
In the 1995 Annual Report, we indicated that we were focusing our energies on
not only preserving but enhancing the value of your investment. We believe we
have made considerable progress. However, 1997 is another threshold year for the
Company and returning to profitability is essential. We believe if we
effectively manage the three areas of operating expenses, capital utilization
and net interest margin, the Company can return to profitability and provide
value to our shareholders. Management and the Board are singularly focused on
that objective.
In June 1996, John J. Brennan retired as a director of the Company. Mr. Brennan
became a director of the predecessor companies of Essex Bancorp, Inc. at the
time of its organization in 1984. He served as a director of many of the
Company's subsidiaries, including the Bank. With over 40 years of experience in
banking, mortgage banking and consumer finance, Mr. Brennan's advice, counsel
and insight will be missed by the members of the Board. John's help to me over
the past years in the dramatic restructuring of the Company and under trying
circumstances was indispensable. I hope you will join me in thanking him for his
contribution and wishing him well in his years of retirement.
10
<PAGE>
We look forward to reporting the results of our ongoing efforts and, as always,
we appreciate your support.
/s/ Gene D. Ross
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 31, 1997
11
<PAGE>
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets......................... $174,267 $338,724 $296,231 $390,958 $419,384
Net loans ........................... 145,551 266,632 237,392 206,781 256,794
Deposits ........................... 131,033 283,497 222,462 328,781 345,343
Federal Home Loan Bank advances...... 25,690 29,833 58,952 41,661 35,500
Notes payable........................ 96 120 2,691 21,891 25,563
Shareholders' equity and total
partners' capital (deficit)........ 15,106 22,630 8,140 (4,950) 3,531
Nonperforming assets................. 5,215 11,257 13,652 18,090 24,817
Allowance for loan losses............ 2,556 5,251 3,429 3,039 4,489
OPERATIONS DATA:
Interest income...................... $ 19,872 $ 22,547 $ 22,966 $ 27,727 $ 33,368
Interest expense..................... 13,764 16,627 15,956 19,027 24,217
Net interest income.................. 6,108 5,920 7,010 8,700 9,151
Provision for loan losses............ 1,411 2,477 1,604 1,085 4,569
Noninterest income................... 4,282 3,172 4,068 7,372 14,475
Noninterest expense:
Amortization....................... 7,011 956 1,360 6,420 17,989
Other.............................. 9,345 9,814 15,619 17,048 19,012
Income (loss) before cumulative
effect of accounting policy
change, extraordinary items,
and income taxes................... (7,377) (4,155) (7,505) (8,481) (17,944)
Cumulative effect of accounting
policy change...................... -- -- 179 -- --
Extraordinary items, net of tax...... -- 2,945 (1) 20,416 (2) -- --
Net income (loss).................... (7,377) (1,210) 13,090 (8,481) (17,944)
Net income (loss) per share (3)...... (1.72) (1.13) -- -- --
Pro forma net income (loss) per
share (3).......................... -- -- 12.47 (8.08) --
OTHER DATA:
Return on average assets............. (2.73)% (.39)% (1) 3.88% (2) (2.12)% (4.02)%
Return on average capital............ (39.51)% (10.59)% (4) (4) (4)
Average capital to average assets.... 6.92% 3.67% (5) (5) 3.21%
Net interest spread.................. 2.20% 2.00% 2.46% 2.73% 2.49%
Net interest margin.................. 2.41% 2.01% 2.20% 2.34% 2.13%
Nonperforming assets as a percent
of total assets at end of year..... 2.99% 3.32% 4.61% 4.63% 5.92%
Allowance for loan losses as a
percent of total loans at end
of year ........................... 1.73% 1.93% 1.42% 1.45% 1.72%
Net charge-offs as a percent of
average total loans................ 1.89% .46% .55% .95% 1.85%
Retail banking offices............... 4 12 8 11 12
</TABLE>
(1) Refer to Notes 1 and 3 of the Notes to Consolidated Financial
Statements for a description of the $2.9 million forgiveness of debt
during 1995. The return on average assets excluding the impact of
this extraordinary item was (1.33)% for the year ended December 31,
1995.
(2) Refer to Note 3 of the Notes to Consolidated Financial Statements
for a description of the litigation settlement during 1994 that
resulted in a $20.4 million forgiveness of debt, net of income
taxes. The return on average assets excluding the impact of this
extraordinary item was (2.17)% for the year ended December 31, 1994.
(3) Refer to Note 2 of the Notes to Consolidated Financial Statements
for a description of the earnings per share calculation for 1996 and
1995 and the pro forma earnings per share calculation for 1994 and
1993. Pro forma earnings per share for 1992 is not presented because
the data is not meaningful.
(4) Ratio exceeds (100.00)%.
(5) Ratio is less than 0.00%.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Essex Bancorp, Inc. (the "Company") is a Delaware corporation that was
formed in 1994 to be the single thrift holding company for Essex Savings Bank,
F.S.B. (the "Bank"), a federally-chartered savings bank which operates four
branches in North Carolina and Virginia. The Company is the successor by merger
to Essex Financial Partners, L.P. (the "Partnership"), a Delaware limited
partnership which was formed in 1988 in order to acquire the former holding
company of the Bank. The Partnership and the Bank's former holding company were
merged into the Company in January 1995. The Company is engaged primarily in the
operation of the Bank as a wholly-owned subsidiary. In addition, the Company's
other principal operating subsidiaries are Essex First Mortgage Corporation
("Essex First"), a wholly-owned subsidiary of the Bank that is engaged primarily
in the origination and sale of residential mortgage loans, and Essex Home
Mortgage Servicing Corporation ("Essex Home"), an indirect subsidiary of the
Company and the Bank that is engaged primarily in the servicing of mortgage
loans owned by the Bank, various governmental agencies, and various third party
investors. Essex Mortgage Corporation ("EMC") is also a direct subsidiary of the
Company that was formerly engaged in various mortgage banking activities and, at
December 31, 1996, held loans and other assets as a result of its past
activities.
In January 1996, the Company's Board of Directors formed a special
committee of the Board, the Strategic Evaluation Committee (the "Committee").
Although the Bank exceeded all regulatory capital requirements after the Bank's
acquisition of Home Bancorp, Inc. ("Home Bancorp") and its wholly-owned
subsidiary Home Savings Bank, F.S.B. ("Home Savings") on September 15, 1995 (the
"Home Acquisition"), the core operations of the Company since the Home
Acquisition had not been profitable and the retail banking branches acquired
from Home Savings required additional capital in order to be successful
full-service facilities. In early 1996, the Committee began exploring the
possible benefits of further expansion or contraction by branch sales. In May
1996, an independent consultant retained by the Company issued a report that
validated the Committee's conclusions that selling non-strategic bank branches
and effectively shrinking the size of the asset base by approximately 50% was a
strategy that ultimately would be in the best interests of the common and the
preferred shareholders of the Company. Accordingly, in addition to completing
the already-negotiated sales of the Bank's Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina branches, the Company proceeded to negotiate the sale
of the Bank's Norfolk, Portsmouth, Hampton, Newport News and Grafton, Virginia
branches, which were completed during the last two quarters of 1996.
Collectively, the nine branches sold during 1996 are referred to as the
"Branches." The outcome of the strategy to downsize is that the Company has
retained the most strategic branches with the greatest potential for significant
market share growth, has approximately 8.7% tangible capital as of December 31,
1996 and has removed goodwill associated with the Home Acquisition from its
balance sheet. Prospectively, the Company's operating expenses will be reduced
due to the elimination of the amortization of goodwill and the operation
expenses associated with the Branches.
As part of the Home Acquisition, the stockholders of Home Bancorp received
2,250,000 shares of nonvoting perpetual preferred stock of the Company with an
aggregate redemption and liquidation value of $15 million, and bearing
cumulative annual dividend rates of either 8% or 9.5%. Cumulative but undeclared
dividends and accrued interest thereon for the Series B and Series C preferred
stock approximated $1.8 million at December 31, 1996. The Bank's core and
risk-based regulatory capital ratios were 8.66% and 14.73%, respectively, at
December 31, 1996 resulting in excess core capital of $8.1 million and excess
risk-based capital of $7.5 million over the minimum regulatory requirements.
While management is of the opinion that capital compliance will be maintained
throughout 1997, until the Company's core profitability is restored,
13
<PAGE>
management cannot provide assurances that compliance with all regulatory capital
requirements can be sustained beyond that horizon. Moreover, the Company's
losses and continuing inability to generate income sufficient to cover the
cumulative dividends on the Series B and C preferred stock will continue to
affect the equity of the holders of the Company's common and preferred stock.
The Committee will continue to evaluate strategic alternatives to enhance
shareholder value.
The following discussion and analysis of financial condition and results
of operations should also be read in conjunction with the "Five Year Financial
Summary" and the Consolidated Financial Statements and related Notes included
herein.
Financial Condition
General. The Company's total assets decreased by $164.5 million or 48.6%
during the year ended December 31, 1996. The decrease in total assets was
attributable to the sale of the Branches and related transactions as described
in Note 5 of the Notes to Consolidated Financial Statements, which resulted in
(i) the sale of first mortgage loans and related accrued interest totaling
$118.3 million, mortgage-backed securities available for sale totaling $9.9
million and premises and equipment totaling $1.2 million, (ii) the utilization
of a portion of the Bank's excess liquidity, and (iii) a $7.8 million write down
of goodwill associated with the Branches. Unrelated to the sale of the Branches,
Federal Home Loan Bank ("FHLB") stock decreased $1.1 million as redemption
proceeds were used to partially fund the scheduled maturities of FHLB advances
during 1996, and securities held for investment decreased $2.0 million.
Cash and Cash Equivalents. Cash and cash equivalents (consisting of cash,
interest-bearing deposits in other banks, federal funds sold and securities
purchased under agreements to resell) decreased by $9.8 million or 61.3% during
1996 due to the utilization of a portion of the Bank's excess liquidity to
complete the sale of the Branches during 1996.
Investment Securities. As a matter of policy, the Company generally
emphasizes lending activities (as opposed to investing activities) in order to
enhance the weighted average yield on its interest-earning assets and, thus, its
results of operations. Investment securities (including securities classified as
available for sale) consist of U.S. Government and agency obligations, FHLB
stock, and mutual fund investments. During the year ended December 31, 1996,
investment securities declined by $4.5 million or 34.7%. The decrease during
1996 was attributable to the redemption of $1.1 million of FHLB stock, a $2.0
million redemption of U.S. Government securities pursuant to the securities'
call provisions, and a $1.5 million decrease in mutual fund investments.
Mortgage-Backed Securities. Mortgage-backed securities (including
mortgage-backed securities classified as available for sale), which consist
primarily of securities insured or guaranteed by the Federal Home Loan Mortgage
Corporation ("FHLMC"), the Federal National Mortgage Association ("FNMA") or the
Government National Mortgage Association ("GNMA"), decreased by $13.7 million or
87.8% during the year ended December 31, 1996. The decrease during 1996 resulted
from (i) the sale of $9.9 million of mortgage-backed securities classified as
available for sale at December 31, 1995 in order to provide funds for the sale
of the Branches, (ii) the receipt of $990,000 in principal repayments, and (iii)
the termination of the Bank's $2.7 million interest in a real estate mortgage
investment conduit ("REMIC"). Mortgage-backed securities increase the credit
quality of the Company's assets by virtue of the insurance or guarantees of
federal agencies that back them, generally require less capital under risk-based
regulatory capital requirements than non-insured or non-guaranteed mortgage
loans, are more liquid than individual mortgage loans, and may be used to
collateralize borrowings or other obligations of the Company.
14
<PAGE>
Loans. Net loans (including loans classified as held for sale) decreased
by $121.9 million or 45.2% during 1996. As previously mentioned, $118.3 million
of loans were sold in order to provide funds for the sale of the Branches. In
addition to scheduled contractual amortization and prepayments, reductions in
net loans included provisions for loan losses of $1.4 million during the year
ended December 31, 1996, as well as reclassifications from loans to foreclosed
properties. While in the past, the Company has placed less emphasis on the
origination of consumer and sub-prime loans, which by their nature have greater
risk, it is management's intent to emphasize the origination and purchase of
various types of consumer and sub-prime loans and, consequently, management
expects the balance of such loans to increase.
Nonperforming Assets. The Company's nonperforming assets, net of specific
reserves for collateral-dependent real estate loans ("CDRELs") and foreclosed
properties, decreased from $11.3 million at December 31, 1995 to $5.2 million at
December 31, 1996, and are summarized as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
---- ----
(in thousands)
<S> <C> <C>
Nonaccrual loans:
Collateral-dependent real estate loans, net $ 609 $ 2,737
Other 2,299 3,344
Accruing loans 90 days or more past due 30 177
Troubled debt restructured loans 223 143
------- --------
Total nonperforming loans 3,161 6,401
Foreclosed properties, net 2,054 4,856
------- --------
Total nonperforming assets $ 5,215 $ 11,257
======= ========
Delinquent loans 30-89 days past due $ 1,491 $ 3,164
======= ========
</TABLE>
The decrease in nonperforming assets consisted of a $3.2 million decline
in nonperforming loans and a $2.8 million decline in foreclosed properties.
During 1996, the Bank increased the specific loss allowance on its CDREL secured
by a low-income apartment complex in Richmond, Virginia. This credit (the
"Richmond Apartments loan") originated in February 1990 and has been modified
several times since then in efforts to facilitate a renovation and sale of the
apartment complex. Because management has now concluded that the sale of the
apartment complex will not occur in the foreseeable future, the Richmond
Apartments loan totaling $2.8 million was charged off in its entirety in 1996.
Other nonaccrual loans decreased primarily as a result of collections on the
Bank's nonaccruing commercial real estate loans to a single borrower that were
secured by nursing home facilities.
The decline in delinquent loans was attributable to the improvement in the
mortgage loan portfolio acquired from Home Savings on September 15, 1995 as a
result of the transfer of servicing to Essex Home and the more diligent
collection efforts. At December 31, 1995, loans 30-59 days past due in the Home
Savings portfolio totaled $977,000 and loans 60-89 days past due totaled
$381,000 as compared to $185,000 and $70,000, respectively, at December 31,
1996.
The decrease in foreclosed properties resulted primarily from the 1996
sale of the Bank's largest foreclosed property consisting of 2,554 acres of
farmland in Currituck, North Carolina, which resulted in a $2.2 million
reduction in foreclosed properties. Also, during 1996 the Company sold the
remaining lots and townhouse pads associated with a townhouse development in
Richmond, Virginia resulting in a further reduction in foreclosed properties of
$321,000.
15
<PAGE>
A more detailed summary of nonperforming assets at December 31 follows
(dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Nonaccrual loans, net:
First and second mortgages............... $2,513 1.70% $ 2,959 1.09% $ 3,158 1.31%
Construction and development............. 220 .15 378 .14 1,253 .52
Commercial............................... 22 .01 2,636 .97 2,306 .96
Consumer................................. 153 .10 108 .04 57 .02
Accruing loans 90 days or more past due..... 30 .02 177 .06 539 .22
Troubled debt restructurings................ 223 .15 143 .05 1,049 .44
------ ---- ------- ---- -------- ----
Total nonperforming loans.............. 3,161 2.13 6,401 2.35 8,362 3.47
Foreclosed properties, net.................. 2,054 1.39 4,856 1.78 5,290 2.19
------ ---- ------- ---- -------- ----
Total nonperforming assets............. $5,215 3.52% $11,257 4.13% $ 13,652 5.66%
====== ==== ======= ==== ======== ====
Nonperforming assets to total assets........ 2.99% 3.32% 4.61%
Nonperforming loans to total loans.......... 2.13 2.35 3.47
Allowance for loan losses to total loans.... 1.73 1.93 1.42
Allowance for loan losses to nonaccrual
loans.................................... 87.90 86.35 50.62
Allowance for loan losses to nonperforming
loans.................................... 80.86 82.03 41.01
<CAPTION>
1993 1992
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
<S> <C> <C> <C> <C>
Nonaccrual loans, net:
First and second mortgages............... $ 4,801 2.28% $10,101 3.85%
Construction and development............. 17 .01 7 -
Commercial............................... 513 .25 3,703 1.41
Consumer................................. 93 .04 196 .08
Accruing loans 90 days or more past due..... 1,136 .54 139 .05
Troubled debt restructurings................ 2,948 1.40 2,300 .88
------- ---- ------- ----
Total nonperforming loans.............. 9,508 4.52 16,446 6.27
Foreclosed properties, net.................. 8,582 4.08 8,371 3.20
------- ---- ------- ----
Total nonperforming assets............. $18,090 8.60% $24,817 9.47%
======= ==== ======= ====
Nonperforming assets to total assets........ 4.63% 5.92%
Nonperforming loans to total loans.......... 4.52 6.27
Allowance for loan losses to total loans.... 1.45 1.72
Allowance for loan losses to nonaccrual
loans.................................... 56.03 32.05
Allowance for loan losses to nonperforming
loans.................................... 31.96 27.30
</TABLE>
Gross interest income that would have been recognized for the years ended
December 31, 1996, 1995, and 1994 if nonaccrual loans at the respective dates
had been performing in accordance with their original terms approximated
$291,000, $678,000, and $406,000, respectively. The Company's future results of
operations will be favorably affected if it is able to achieve a further
reduction in nonperforming assets without incurring additional material losses.
The $2.1 million of foreclosed properties included in nonperforming assets
at December 31, 1996 is reported net of related reserves totaling $179,000. In
addition, approximately $676,000 of losses and write-downs have been previously
recognized on foreclosed properties held at December 31, 1996.
16
<PAGE>
The following table sets forth the types of properties which represent the
Company's foreclosed properties (net of related reserves) at December 31 (in
thousands):
1996 1995
---- ----
Residential real estate development
projects $ 390 $ 321
Single-family residential real estate 1,300 1,431
Land and subdivisions 364 3,104
------ ------
$2,054 $4,856
====== ======
In addition to the $5.2 million of nonperforming assets at December 31,
1996, as of such date the Company had classified for regulatory purposes an
additional approximately $2.3 million of assets (including accrued interest and
advances and net of specific loss reserves) based on a rating system adopted by
the Company, as compared to $11.3 million of nonperforming assets and $1.9
million of classified assets at December 31, 1995. These loans evidence one or
more weaknesses or potential weaknesses and, depending on the regional economy
and other factors, may become nonperforming assets in future periods. There can
be no assurance that the regulatory examiners would agree with the Company's
classification of its assets.
PMSRs, OMSRs and Loan Premiums. As of December 31, 1996 and 1995, the
Company reported $207,000 and $79,000, respectively, of purchased mortgage
servicing rights ("PMSRs"), $1.1 million and $1.6 million, respectively, of
originated mortgage servicing rights ("OMSRs"), and $565,000 and $1.2 million,
respectively, of capitalized loan premiums. The carrying value of the Company's
PMSRs, OMSRs and loan premiums are dependent upon the cash flows from the
underlying mortgage loans and their carrying value may be impaired if prepayment
activity exceeds expectations. While the Company acquired the servicing rights
for several mortgage loan portfolios during 1996, the Company's investment in
PMSRs is not substantial. Therefore, there should not be any significant
amortization or impairment adjustments with respect to PMSRs in the foreseeable
future. However, at December 31, 1996, no assurance can be made that further
significant amortization or impairment adjustments will not be necessary with
respect to the Company's OMSRs or capitalized loan premiums if a lowering of
interest rates in the future results in the acceleration of prepayment activity
in excess of expectations.
Deposits. Deposits, the primary source of the Company's funds, decreased
by $152.5 million or 53.8% during the year ended December 31, 1996. This
decrease was attributable to the sale of the Branches with deposits totaling
$167.1 million on their respective sale dates. However, at the Bank's four
remaining branches at December 31, 1996, deposits increased $20.8 million during
1996, which reinforces the Committee's conclusions regarding the growth
potential provided by the remaining community branch network.
Borrowings. The Company's borrowings consist of advances from the FHLB,
notes payable and subordinated capital notes. FHLB advances decreased by $4.1
million or 13.9% during the year ended December 31, 1996 as a result of
scheduled maturities. At December 31, 1996, the unused lendable collateral value
for additional FHLB advances was $11.2 million. The Company's notes payable
totaled $96,000 and $120,000 at December 31, 1996 and 1995, respectively, and
consisted solely of a note payable to the former president of Home Bancorp and
Home Savings. For additional information about this obligation, see Note 16 of
the Notes to Consolidated Financial Statements. The Bank's subordinated capital
notes issued in 1988 and 1989 at interest rates of 11.5% to 12% were redeemed at
par in their entirety in August 1996.
Shareholders' Equity. Total shareholders' equity at December 31, 1996 was
$15.1 million, a decrease of $7.5 million from shareholders' equity of $22.6
million at December 31, 1995. This change reflects the Company's net loss of
$7.4 million for the year ended December
17
<PAGE>
31, 1996, which is further described below. As previously mentioned, the Series
B and Series C preferred stock issued by the Company in connection with the Home
Acquisition has a stated value and liquidation preference of $15.0 million,
exclusive of cumulative but undeclared dividends and accrued interest thereon of
$1.8 million at December 31, 1996.
Results of Operations
Overview of Business Activity. The Company's results of operations depend
substantially on its net interest income, which is the difference between
interest income on interest-earning assets, which consist primarily of loans,
mortgage-backed securities and investment securities, and interest expense on
interest-bearing liabilities, which consist primarily of deposits and
borrowings. Net interest income is also impacted by normal amortization and
impairment adjustments with respect to loan premiums. The Company's results of
operations are also significantly affected by provisions for loan losses,
resulting from the Company's assessment of the adequacy of the allowance for
loan losses; the level of its noninterest income, including loan servicing and
other fees, mortgage banking income and gains from the sale of loans; the level
of its noninterest expenses, such as salaries and employee benefits, net
occupancy and equipment costs, normal amortization and impairment adjustments
with respect to PMSRs and OMSRs, deposit insurance premiums and, in recent
periods, expenses associated with the administration of nonperforming and other
classified assets.
The Company's major business segments consist of (i) attracting deposits
from the general public and using such deposits, together with borrowings in the
form of advances from the FHLB and other sources of funds, for reinvestment in
real estate mortgages, other loans, investments and mortgage-backed securities
(the "Retail Banking Segment"), and (ii) the origination by Essex First of real
estate mortgage loans for sale to third parties with Essex Home providing
servicing in certain instances (the "Mortgage Banking Segment"). The Retail
Banking Segment depends on the difference between interest earned on loans and
investments over interest paid on deposits to fund operating activities and
generate a profit. Historically, the Company's branch activities resulted in
less reliance on deposit service charges and other ancillary income. However,
this strategy is in transition as the Company moves to more traditional banking,
albeit through a smaller community branch network.
The Mortgage Banking Segment depends on gains from the sale of loans in
the secondary market and loan servicing income to fund operating expenses.
During the years ended December 31, 1996, 1995, and 1994, the predominant
percentage of loans originated by the Company were sold on a servicing released
basis in order to recognize gains to supplement the core capital of the Bank. In
April 1993, the Company began a marketing effort to acquire subservicing
contracts resulting in a servicing portfolio that has grown to approximately
13,300 loans with an aggregate principal balance of $1.1 billion at December 31,
1996, which were serviced or subserviced by Essex Home. However, on February 28,
1997, the Company was notified by its largest subservicing client of its
intention not to renew its contract beyond June 1, 1997. As of December 31,
1996, the Company serviced approximately 7,000 loans totaling $858.9 million for
this client and servicing fee income for 1996 included approximately $409,000
attributable to servicing activities performed for this client. While the
Company's management has intensified its marketing efforts in order to minimize
the impact of this loss on the earnings performance of the Company, no
assurances can be made that this significant servicing volume can be replaced in
its entirety in the near term. Management believes, however, that its marketing
efforts will be buoyed by the much-improved capital position of the Bank, which
is deemed a "well capitalized" institution under the Prompt Corrective Action
provisions of the Federal Deposit Insurance Act. In the meantime, the Company is
examining expenses associated with the servicing of this client in contemplation
of reductions to minimize the loss in servicing fee income.
18
<PAGE>
See Note 23 of the Notes to Consolidated Financial Statements for the mix
of the major business segments based on the allocation of total revenue, loss
before income taxes, depreciation and amortization of premises and equipment,
and identifiable assets between the Retail Banking Segment and the Mortgage
Banking Segment.
General. The Company's net loss for the year ended December 31, 1996
totaled $7.4 million, compared to a net loss of $1.2 million for the year ended
December 31, 1995 and net income of $13.1 million for the year ended December
31, 1994. The Home Acquisition was accounted for using the purchase method of
accounting. Therefore, results of operations for the year ended December 31,
1995 have not been restated to reflect the Home Acquisition, which occurred on
September 15, 1995.
During 1996, the Company's operating results benefited from a $3.9 million
total premium on deposits sold and a $216,000 gain on sale of premises and
equipment in connection with the sale of the Branches described in Note 5 of the
Notes to Consolidated Financial Statements. In addition, operating results were
favorably impacted by a $153,000 gain on sale of mortgage-backed securities
available for sale related to the sale of the Branches. However, the Company's
operating results were adversely impacted by a $1.0 million loss on the sale of
loans in connection with funding the sale of the Branches and a $7.8 million
write down in goodwill associated with the Branches. Excluding the impact of
these nonrecurring transactions, the Company incurred a net loss of $2.8 million
during 1996, which was a $1.4 million improvement over the $4.2 million loss
from continuing operations for the year ended December 31, 1995. This
improvement in 1996 was the result of a $1.1 million reduction in loan loss
provisions, a $188,000 increase in net interest income and a $294,000 reduction
in noninterest expense as a result of gains realized on the sale of foreclosed
properties.
During 1995, the Company's operating results benefited from the
recognition of income from extraordinary items attributable to $2.9 million of
debt forgiveness. Contemporaneously with the Home Acquisition, PaineWebber
Capital Inc. ("PWC") forgave $1.7 million of short-term debt payable by the
Company, plus accrued interest thereon, and PaineWebber Inc. ("PWI") and PWC
agreed to loan the funds necessary to enable the Company to redeem the
Redeemable Preferred Stock for $1 million (the "Redemption Loan") plus accrued
dividends. The date of this redemption was September 18, 1995, and the
Redemption Loan was forgiven effective that date. In addition, during the first
quarter of 1995, EMC sold substantially all of the collateral underlying its
credit facility with PWI. The proceeds of the sale were used to pay
substantially all of the balance of the credit facility, except for $262,000 of
debt that was forgiven by PWI.
Exclusive of the nonrecurring income from extraordinary items during 1995,
the Company incurred a loss from continuing operations of $4.2 million for the
year ended December 31, 1995. Operating results benefited from a $500,000
settlement with the Resolution Trust Corporation ("RTC") to satisfy the RTC's
recourse obligations as servicer of record for a balloon second mortgage loan
portfolio for which the Bank had previously established reserves in 1995.
However, the Company's operating results were adversely impacted by loan loss
provisions of $2.5 million and lower levels of net interest income and mortgage
banking income.
During the year ended December 31, 1994, the Company benefited from the
recognition of $20.4 million of extraordinary gain from forgiveness of debt and
$179,000 of income from a change in accounting principle. On October 24, 1994,
the Company consummated the closing of the principal aspects of the settlement
of class action litigation (the "Litigation Settlement") against the Company and
other defendants, as described in Note 3 of the Notes to Consolidated Financial
Statements. Under the terms of the Litigation Settlement, PWC and its affiliates
forgave approximately $20.7 million of debt owed by the Company and its
subsidiaries. The benefit of the debt forgiveness was offset by resulting income
taxes of approximately $330,000, and accordingly, the Company recognized a net
extraordinary gain of $20.4 million during 1994.
19
<PAGE>
Also, the Company benefited during 1994 from $179,000 of income that was
reported as a cumulative effect of a change in accounting principle related to
securities classified as available for sale, which resulted from the adoption of
Statement of Financial Accounting Standards No. 115 - Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115").
The Company incurred a loss from continuing operations of $7.5 million
during the year ended December 31, 1994. The Company's operating results were
adversely impacted by Litigation Settlement expenses of $2.4 million, which
primarily consisted of the obligation to issue $1.0 million in Series A
Preferred Stock to certain members of the settlement class, a $1.3 million
contribution that was made by the Company towards a settlement fund, and the
incurrence of certain litigation expenses. Furthermore, operating results were
negatively effected by interest expense of $815,000 related to the debt that was
forgiven on October 24, 1994, expenses associated with foreclosed properties of
$2.3 million and loan loss provisions of $1.6 million. In addition, EMC recorded
a $409,000 unrealized loss during 1994 in order to reflect a change in the
estimated value of the collateral underlying its credit facility with PWI, which
was paid in full on March 15, 1995. However, the Company benefited from a net
gain of $772,000 related to the sale during 1994 of its Florida branches.
Net Interest Income. Net interest income totaled $6.1 million, $5.9
million, and $7.0 million for the years ended December 31, 1996, 1995, and 1994,
respectively. In addition, the annualized yield on interest-earning assets was
2.41%, 2.01%, and 2.20% for the years ended December 31, 1996, 1995, and 1994,
respectively. The increase from 1995 to 1996 in net interest income and the net
yield on interest-earning assets reflects the impact of improvement in the ratio
of interest-earning assets to interest-bearing liabilities, which increased from
100.24% during 1995 to 103.98% during 1996. The most significant factors
impacting the improvement in net interest income were (i) the improved yield on
loans resulting from repricing of adjustable-rate mortgages while interest rates
paid on deposits remained constant and (ii) the reduction in higher-costing FHLB
advances and notes payable. Offsetting such improvements were the impact of
selling higher-yielding first mortgage loans and mortgage-backed securities and
maintaining excess liquidity in lower-yielding interest earning assets in
anticipation of funding the sales of the Branches. While there was little change
in the interest rates paid on deposits from 1995 to 1996, deposits are more
sensitive to changes in the interest rate environment. Therefore, a trend of
declining interest rates may favorably impact the Company's earnings due to the
repricing of significant deposits with shorter maturities as compared to the
large amount of interest-earning assets, predominantly loans, which have either
fixed interest rates or interest rates that adjust over longer periods.
The Company's net interest margin decreased from 2.20% during 1994 to
2.01% during 1995 because, notwithstanding the increase in loan yields, the
Company's net interest margin for 1995 was more adversely affected by the higher
interest rates on deposits that had matured and repriced before the downward
trend in interest rates.
The following table presents for the periods indicated the total dollar
amount of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. All average
balances are based on month-end balances adjusted for branch sales occurring at
or near the end of a month.
20
<PAGE>
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------ ------------------------------- ------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)...................... $221,215 $ 17,882 8.08% $254,548 $ 19,779 7.77% $256,538 $ 19,557 7.62%
Investment securities.......... 11,012 615 5.59 14,694 836 5.69 25,120 1,168 4.65
Mortgage-backed securities (2). 6,320 498 7.95 16,991 1,286 7.57 22,255 1,520 6.83
Federal funds sold and
securities purchased under
agreements to resell......... 6,094 319 5.24 4,011 280 6.98 9,506 383 4.02
Other.......................... 10,094 558 (3) 5.38 5,210 366 (3) 6.69 5,417 338 (3) 5.80
-------- -------- -------- -------- -------- --------
Total interest-earning
assets ................... 254,735 19,872 (3) 7.80 295,454 22,547 (3) 7.63 318,836 22,966 (3) 7.19
Cash............................. 3,083 2,739 2,785
PMSRs ........................... 86 108 2,157
Other, less allowance for loan
losses ........................ 11,858 13,134 13,605
-------- -------- --------
Total assets................... $269,762 $311,435 $337,383
======== ======== ========
Interest-bearing liabilities:
Time deposits.................. $183,710 10,620 5.78% $213,605 12,284 5.75% $216,723 10,249 4.73%
Other deposits................. 33,218 1,325 3.99 32,084 1,221 3.81 50,519 1,686 3.34
-------- -------- -------- -------- -------- --------
Total deposits.............. 216,928 11,945 5.51 245,689 13,505 5.50 267,242 11,935 4.47
Notes payable.................. 113 11 9.50 1,360 131 9.61 17,735 1,037 5.85
FHLB advances.................. 27,137 1,626 5.99 46,617 2,798 6.00 50,034 2,771 5.54
Subordinated capital notes..... 399 52 13.15 621 73 11.78 618 72 11.63
Other.......................... 405 130 (4) 18.32 459 120 (4) 17.94 623 141 (4) 16.72
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities.............. 244,982 13,764 (4) 5.60 294,746 16,627 (4) 5.63 336,252 15,956 (4) 4.73
-------- -------- --------
Demand deposits.................. 1,433 1,285 927
Other............................ 4,675 3,365 2,957
-------- -------- --------
Total liabilities.............. 251,090 299,396 340,136
Redeemable preferred stock....... - 615 -
Shareholders' equity............. 18,672 11,424 -
Partners' capital................ - - (2,753)
-------- -------- --------
Total liabilities, shareholders'
equity, and partners' capital $269,762 $311,435 $337,383
======== ======== ========
Net interest earnings............ $ 6,108 $ 5,920 $ 7,010
======== ======== ========
Net interest spread (2)(3)(4).... 2.20% 2.00% 2.46%
==== ===== ====
Net interest margin (2)(3)(4)(5). 2.41% 2.01% 2.20%
==== ===== ====
Average interest-earning assets
to average interest-bearing
liabilities.................... 103.98% 100.24% 94.82%
====== ====== =====
</TABLE>
(1) Nonaccrual loans and loans classified as held for sale are included in the
average balance of loans.
(2) Calculation is based on historical cost balances of mortgage-backed
securities available for sale and does not give effect to changes in fair
value that are reflected as a component of shareholders' equity.
(3) Yield calculation in 1996, 1995, and 1994 includes the accretion of net
deferred loan fees and excludes $15,140, $17,378, and $23,704,
respectively, which consists primarily of interest earned on custodial
accounts maintained for servicing investors.
(4) Rate calculation in 1996, 1995, and 1994 excludes $56,004, $37,995, and
$37,609, respectively, which consists primarily of interest paid on escrow
accounts.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
21
<PAGE>
The following table presents the extent to which changes in interest rates
and changes in volume of interest-related assets and liabilities have affected
the Company's interest income and expense during the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in volume multiplied by prior year rate), (ii) changes in rate (change in rate
multiplied by prior year volume), and (iii) total change in rate and volume. The
combined effect of changes in both rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
<TABLE>
<CAPTION>
Increase (Decrease) From Increase (Decrease) From
1995 to 1996 Due to 1994 to 1995 Due to
--------------------------- ------------------------------
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans (1) $773 $(2,670) $(1,897) $ 374 $ (152) $ 222
Investment securities (15) (206) (221) 224 (556) (332)
Mortgage-backed securities 62 (850) (788) 152 (386) (234)
Federal funds sold and securities
purchased under agreements
to resell (82) 121 39 190 (293) (103)
Other interest-earning assets (82) 274 192 40 (12) 28
---- ------- ------- ------- ------- -------
Total interest income (2) 656 (3,331) (2,675) 980 (1,399) (419)
---- ------- ------- ------- ------- -------
Interest expense on:
Time deposits 64 (1,728) (1,664) 2,184 (149) 2,035
Other deposits 60 44 104 406 (871) (465)
Notes payable (2) (118) (120) 414 (1,320) (906)
FHLB advances and
other borrowings (5) (1,167) (1,172) 223 (196) 27
Subordinated capital notes 8 (29) (21) 1 - 1
Other interest-bearing
liabilities 20 (10) 10 8 (29) (21)
---- ------- ------- ------- ------- -------
Total interest expense 145 (3,008) (2,863) 3,236 (2,565) 671
---- ------- ------- ------- ------- -------
Net interest income $511 $ (323) $ 188 $(2,256) $ 1,166 $(1,090)
==== ======= ======= ======= ======= =======
</TABLE>
(1) Includes loans classified as held for sale.
(2) Includes the amortization of premiums.
Provision for Loan Losses. The provision for loan losses represents the
charge against earnings that is required to fund the allowance for loan losses.
The level of the allowance for loan losses is determined by management of the
Company based upon its evaluation of the inherent risks within the Company's
loan portfolio. This evaluation consists of an ongoing analysis of individual
loans and the overall risk characteristics, size and composition of the loan
portfolio. The Company also considers, among other things, present and
prospective industry trends and regional and national economic conditions, past
estimates of loan losses as compared to actual losses, potential problems with
sizable loans, large loan concentrations and historical losses on loans. As
adjustments become identified through this ongoing managerial assessment, they
are reported in the earnings of the period in which they become known.
For the years ended December 31, 1996, 1995, and 1994, provisions for loan
losses amounted to $1.4 million, $2.5 million, and $1.6 million, respectively,
which had a significant impact on the Company's results of operations in each of
such periods. The level of the provision for loan losses during the periods
presented was necessary in order to maintain the allowance for loan losses at an
adequate level after it was reduced by net charge-offs of $4.1 million, $1.2
million, and $1.2 million during these respective periods. Net charge-offs for
the year ended December 31, 1996 includes the $2.8 million charge-off of the
Richmond Apartments loan. The
22
<PAGE>
ratio of the allowance for loan losses to total nonperforming loans was 81% at
December 31, 1996, 82% at December 31, 1995, and 41% at December 31, 1994. In
addition, the ratio of the allowance for loan losses to total loans held for
investment was 1.7% at December 31, 1996, 1.9% at December 31, 1995, and 1.4% at
December 31, 1994.
Although management utilizes its best judgment in providing for possible
losses, there can be no assurance that the Company will not have to increase its
provision for loan losses in the future as a result of unforeseen changes in the
portfolio. Any such increase could adversely affect the Company's results of
operations. In addition, the Office of Thrift Supervision ("OTS"), as an
integral part of its regulatory examination process, periodically reviews the
Company's allowance for loan losses and the carrying value of its other
nonperforming assets. The OTS may require the Company to recognize additions to
its allowance for losses on loans and allowance for losses on foreclosed
properties based on the OTS' judgment about information available to it at the
time of its examination.
Noninterest Income. The following table sets forth information regarding
noninterest income for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Loan servicing fees......................... $1,665,768 $1,765,617 $1,858,503
Mortgage banking income..................... 577,130 504,715 628,895
Other service charges and fees. 497,316 428,811 386,636
Net gain (loss) on sales of:
Securities................................ 153,188 -- (114,430)
Loans..................................... (1,018,185) 115,538 460,018
Deposits.................................. 1,940,010 -- 484,689
Other....................................... 466,519 357,309 363,397
---------- ---------- ----------
$4,281,746 $3,171,990 $4,067,708
========= ========= =========
</TABLE>
Total noninterest income amounted to $4.3 million during the year ended
December 31, 1996, a $1.1 million or 35.0% increase from the $3.2 million
recognized during the year ended December 31, 1995. The increase resulted from
the gains on sales of securities, deposits and premises and equipment, which
totaled $2.3 million, associated with the sale of the Branches described in Note
5 of the Notes to Consolidated Financial Statements, which were partially offset
by a $1.0 million loss on loans sold to partially fund the sale of the Branches.
Exclusive of these transactions related to the sale of the Branches, noninterest
income decreased $181,000 during the year ended December 31, 1996, which
resulted from a $107,000 decrease in other noninterest income during 1996 and
the nonrecurrence of the $115,000 gain on sale of loans recognized during 1995
as a result of a loan sale required to ensure compliance with regulatory growth
restrictions in effect prior to the Home Acquisition.
Loan servicing fees and other service charges and fees (primarily
consisting of ancillary fees associated with Essex Home's loan servicing)
decreased in the aggregate $31,000 or 1.4% during the year ended December 31,
1996. The decrease was primarily attributable to the loss of a third-party
servicing contract in 1995 caused by the Bank's capital deficiency at the time.
Mortgage banking income increased $72,000 or 14.3% during 1996 as a result
of an increase in mortgage banking activity at Essex First, which was
attributable to the lower interest rate environment. Essex First was adversely
impacted during 1995 by a lower volume of loan refinancings, which was
attributable to higher mortgage rates and a general slowdown in refinancings.
23
<PAGE>
Total noninterest income amounted to $3.2 million during the year ended
December 31, 1995, an $896,000 or 22.0% decrease from the $4.1 million
recognized during the year ended December 31, 1994. The primary reason for the
decline in total noninterest income was the nonrecurrence of the net gain of
$772,000 recognized in the second quarter of 1994 related to the sale of the
Florida branches, which consisted of a $485,000 net gain on sale of deposits, a
$338,000 gain on sale of loans, a $79,000 gain on sale of fixed assets, and a
$130,000 loss on sale of securities.
Mortgage banking income decreased $124,000 or 19.7% during the year ended
December 31, 1995 as a result of a decrease in loan origination volume. The
level of mortgage banking activity at Essex First was adversely impacted by a
lower volume of loan refinancings, which was attributable to higher mortgage
rates during the first half of 1995 and sustained adverse publicity related to
the Bank's capital deficiency.
Loan servicing fees and other service charges and fees decreased in the
aggregate $51,000 or 2.3% during the year ended December 31, 1995. In April
1993, the Company began a marketing effort to acquire subservicing contracts as
a means of generating loan servicing fees and ancillary income. By the end of
1993, the Company had entered into a subservicing contract for a loan portfolio
that approximated $430 million at December 31, 1994. The Company began
subservicing this loan portfolio during the first quarter of 1994, and this
portfolio increased to $682 million by the end of 1995. Also by the end of 1994,
the Company had entered into several additional subservicing contracts, which
when combined with the other subservicing provided significant flow basis
servicing. Nevertheless, the additional income from subservicing contracts was
partially offset by the loss of a third-party servicing contract in 1995 caused
by the Bank's capital deficiency.
Noninterest Expense. The following table sets forth certain information
regarding noninterest expense for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Salaries and employee benefits.............. $ 4,554,540 $ 4,387,760 $ 4,926,398
Net occupancy and equipment................. 1,470,284 1,671,352 1,713,908
Deposit insurance premiums.................. 674,730 722,106 911,716
Amortization of intangible assets........... 7,011,288 956,257 1,359,738
Service bureau fees......................... 599,207 523,526 468,598
Professional fees........................... 507,031 476,224 718,892
Foreclosed properties, net.................. (175,055) 187,715 2,315,222
Litigation settlement expenses.............. - - 2,390,105
Other....................................... 1,713,958 1,845,102 2,173,970
----------- ----------- -----------
$16,355,983 $10,770,042 $16,978,547
=========== =========== ===========
</TABLE>
Total noninterest expense amounted to $16.4 million during the year ended
December 31, 1996, an increase of $5.6 million or 51.9% from the $10.8 million
recognized during the year ended December 31, 1995. The largest portion of the
increase in noninterest expense was attributable to the $6.1 million increase in
the amortization of intangible assets. The Company recorded goodwill of
approximately $8.6 million in connection with the Home Acquisition, which was
being amortized on an accelerated basis over 15 years. For the year ended
December 31, 1996, normal amortization of this goodwill totaled $541,000. As a
result of the Bank's decision to sell certain of the branches acquired in the
Home Acquisition, the Bank recognized additional amortization of $5.9 million
during the second quarter of 1996. Exclusive of the write down of goodwill,
noninterest expense as a percent of average assets was 3.9% for the year ended
December 31, 1996, as compared to 3.5% for the year ended December 31, 1995.
24
<PAGE>
Salaries and employee benefits increased $167,000 or 3.8% during 1996.
This increase resulted primarily from a $378,000 increase in compensation
expense associated with certain of the Company's stock options, which are
described in Note 19 of the Notes to Consolidated Financial Statements. This
increase was partially offset by the impact of the sale of the Branches on the
number of personnel at the Bank, which declined from 79 as of December 31, 1995
to 50 as of December 31, 1996. Overall, the number of the Company's full-time
and part-time employees declined from 152 as of December 31, 1995 to 114 as of
December 31, 1996. The impact of these staff reductions on reducing personnel
expenses will be more pronounced in future periods.
Net occupancy and equipment expense decreased $201,000 or 12.0% during
1996. While the Bank incurred additional occupancy expense during most of 1996
attributable to the branches acquired in connection with the Home Acquisition,
it was more than offset by reductions resulting from the downsizing of the
Company's leased corporate facilities and the closure of Essex First's loan
production offices in Chesapeake and Manassas, Virginia.
Deposit insurance premiums decreased $47,000 or 6.6% during 1996. This
decrease reflects the reduction in the deposit assessment base resulting from
the Branch sales, as well as the improvement in the Bank's risk classification
for assessment purposes. Refer to "Regulatory Matters" below for a discussion of
matters impacting the Company's deposit assessment in the future.
Service bureau expense increased $76,000 or 14.5% during 1996. This
increase reflects the impact of the higher deposit levels throughout most of
1996 attributable to the branches acquired in connection with the Home
Acquisition and deposit growth during 1996. In addition, service bureau expense
increased at Essex Home as a result of an increase in the servicing portfolio
during 1996.
Foreclosed properties expense decreased $363,000 during 1996 as a result
of (i) a gain of $295,000 on the sale of the Bank's largest foreclosed property
consisting originally of 2,554 acres of farmland located in Currituck, North
Carolina and (ii) a gain of $69,000 on the sale of the remaining lots and
townhouse pads associated with a townhouse development in Richmond, Virginia.
The significant components of other miscellaneous noninterest expense for
the years ended December 31, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
Change
1996 1995 Amount Percent
---- ---- ------ -------
<S> <C> <C> <C> <C>
Loan expense....................... $ 280,041 $ 208,747 $ 71,294 34.2%
Telephone.......................... 225,599 279,228 (53,629) (19.2)
Postage and courier................ 200,300 198,993 1,307 .7
Stationery and supplies............ 131,572 198,086 (66,514) (33.6)
Advertising and marketing.......... 185,191 237,628 (52,437) (22.1)
Corporate insurance................ 182,009 157,364 24,645 15.7
Travel............................. 76,301 80,682 (4,381) (5.4)
Provision for servicing losses..... 26,000 9,000 17,000 100.0+
Other.............................. 406,945 475,374 (68,429) (14.4)
---------- ---------- ---------
$1,713,958 $1,845,102 $(131,144) (7.1)
========== ========== =========
</TABLE>
Total noninterest expense amounted to $10.8 million during the year ended
December 31, 1995, a decrease of $6.2 million or 36.6% from the $17.0 million
recognized during the year ended December 31, 1994. Total noninterest expense as
a percentage of average total assets amounted to 3.5% for the year ended
December 31, 1995, as compared to 5.0% for the year ended December 31, 1994.
25
<PAGE>
The largest portion of the decrease in noninterest expense is the result
of nonrecurring litigation settlement expenses of $2.4 million which were
recorded in 1994. In addition, expenses associated with foreclosed properties
decreased $2.1 million or 91.9% during the year ended December 31, 1995. The
provision for losses on foreclosed properties amounted to $79,000 during the
year ended December 31, 1995, as compared to $1.9 million during the year ended
December 31, 1994. A $1.1 million provision for losses relating to farmland in
North Carolina was recognized in 1994; whereas, no provision for losses on this
property was required in 1995. The remaining decrease in the provision for
losses on foreclosed properties reflects the decreased level of foreclosed
properties, which declined from $8.6 million at December 31, 1993 to $4.9
million at December 31, 1995.
Another portion of the decrease in noninterest expense is accounted for by
a $403,000 decrease in amortization of intangible assets. Normal amortization of
PMSRs and excess servicing for the year ended December 31, 1995 was $580,000
compared to $815,000 for the year ended December 31, 1994. Also, as a result of
the prepayment of the loans underlying the PMSRs and excess servicing in excess
of expectations, additional amortization to record impairment adjustments
totaling $90,000 was required during 1994, whereas no impairment adjustments
were required during 1995. The decrease in amortization of intangible assets was
also attributable to a nonrecurring write-off of miscellaneous intangible assets
during 1994.
Also included in amortization of intangible assets for the year ended
December 31, 1995 was $314,000 associated with the amortization of the $8.6
million excess of cost over net assets acquired in connection with the Home
Acquisition, which was being amortized using an accelerated method over 15
years.
Salaries and employee benefits decreased $539,000 or 10.9% during the year
ended December 31, 1995. The decrease is attributable to the lower level of
mortgage origination activities and a streamlining of operations, which resulted
in a 17.4% reduction in the number of full-time and part-time employees from 184
at January 1, 1994 to 152 at December 31, 1995, despite an increase of 19
employees due to the Home Acquisition.
Net occupancy and equipment expense declined $43,000 or 2.5% during the
year ended December 31, 1995. This reduction was attributable to the sale of the
Bank's three Florida branches on June 30, 1994, and the renewal of the corporate
headquarters lease at a lower cost. These reductions were partially offset by
additional costs incurred during 1995 in connection with the opening of three
loan production offices by Essex First, and costs associated with relocating the
Bank's branches in Richmond, Virginia and Charlotte, North Carolina. These
branch relocations were completed in May 1995. In addition, net occupancy and
equipment expense included expenses for branches acquired in connection with the
Home Acquisition, including the costs of relocating the Norfolk, Virginia branch
and consolidating the Newport News, Virginia branch with an existing branch.
Deposit insurance premiums decreased by $190,000 or 20.8% during the year
ended December 31, 1995, which was primarily attributable to lower assessed
deposit levels. Professional fees decreased $243,000 or 33.8% due primarily to
nonrecurring legal fees incurred during 1994 in connection with the merger of
the Partnership and the Bank's former holding company into the Company during
January 1995. Service bureau expense increased $55,000 or 11.7% primarily
because of nonrecurring charges for the conversion of mortgage loans acquired in
connection with the Home Acquisition and an increase in loan servicing volume at
Essex Home.
26
<PAGE>
The significant components of other miscellaneous noninterest expense for
the years ended December 31, 1995 and 1994 are presented below:
<TABLE>
<CAPTION>
Change
1995 1994 Amount Percent
---- ---- ------ -------
<S> <C> <C> <C> <C>
Loan expense....................... $ 208,747 $ 339,138 $(130,391) (38.4)%
Telephone.......................... 279,228 305,293 (26,065) (8.5)
Postage and courier................ 198,993 183,181 15,812 8.6
Stationery and supplies............ 198,086 173,761 24,325 14.0
Advertising and marketing.......... 237,628 351,122 (113,494) (32.3)
Corporate insurance................ 157,364 172,885 (15,521) (9.0)
Travel............................. 80,682 85,772 (5,090) (5.9)
Provision for servicing losses..... 9,000 89,873 (80,873) (90.0)
Other.............................. 475,374 472,945 2,429 .5
---------- ---------- --------- -----
$1,845,102 $2,173,970 $(328,868) (15.1)
========== ========== ========= =====
</TABLE>
Provision For Income Taxes. There was no income tax provision recognized
for financial reporting purposes during the years ended December 31, 1996, 1995,
or 1994 because the Company had significant net operating loss carryforwards,
which approximated $21.1 million at December 31, 1996. Also, until consistent
profitability is demonstrated, deferred income tax assets related to the
Company's net operating loss carryforwards and temporary differences will not be
recognized. In connection with the Litigation Settlement described herein,
approximately $20.7 million of notes payable were forgiven, which reduced the
net operating loss carryforwards of the Company by approximately $20.0 million
and resulted in alternative minimum taxes of approximately $330,000. For
additional information, see Notes 3 and 14 of the Notes to Consolidated
Financial Statements.
Asset and Liability Management
The Bank, like other thrift institutions, is vulnerable to an increase in
interest rates to the extent that interest-bearing liabilities mature or reprice
more rapidly than interest-earning assets. The lending activities of thrift
institutions, including the Bank, have historically emphasized the origination
of long-term loans secured by single-family residences, and the primary source
of funds for such institutions has been deposits. The deposit accounts of thrift
institutions largely mature or are subject to repricing within a short period of
time. This factor, in combination with substantial investments in long-term
loans, has historically caused the income earned by thrift institutions,
including the Bank, on their loan portfolios to adjust more slowly to changes in
interest rates than their cost of funds. While having liabilities that reprice
more frequently than assets is generally beneficial to net interest income in
times of declining interest rates, such an asset/liability mismatch is generally
unfavorable during periods of rising interest rates. To reduce the effect of
adverse changes in interest rates on its operations, the Bank has implemented
the asset and liability management policies described below.
The Bank has established an Asset and Liability Management Committee that
meets quarterly in order to structure and price the Bank's assets and
liabilities so as to maintain an acceptable interest rate spread while reducing
the effects of changes in interest rates.
The Bank's Asset and Liability Management Committee, following its
formation in 1992, implemented asset and liability management policies designed
to better match the maturities and repricing terms of the Bank's
interest-earning assets and interest-bearing liabilities in order to minimize
the adverse effects of material and prolonged increases in interest rates on the
Bank's results of operations. The Bank has undertaken a variety of strategies to
reduce its exposure to interest rate fluctuations, including (i) emphasizing
investment in adjustable-rate single-family residential loans ("ARMs") or
shorter-term (seven years or less), fixed-rate single-family residential loans;
(ii) selling longer-term (over seven years), fixed-rate single-family
27
<PAGE>
residential loans in the secondary market; (iii) purchasing adjustable-rate
mortgage-backed securities; (iv) maintaining higher liquidity by holding
short-term investments and cash equivalents; and (v) increasing the average
maturity of the Bank's interest-bearing liabilities by utilizing long-term
advances and attempting to attract longer-term retail deposits.
The effect of interest rate changes on a financial institution's assets
and liabilities may be analyzed by examining the extent to which such assets and
liabilities are "interest rate sensitive" and by monitoring an institution's
interest rate sensitivity "gap." An asset or liability is said to be interest
rate sensitive within a specific time period if it will mature or reprice within
that time period. The interest rate sensitivity "gap" is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities. A gap is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a positive gap would tend to
adversely affect net interest income, while a negative gap would tend to result
in an increase in net interest income. During a period of rising interest rates,
a positive gap would tend to result in an increase in net interest income while
a negative gap would tend to affect net interest income adversely.
As a result of the acquisition of Home Savings, whose loans were
predominantly fixed-rate mortgage loans with maturities in excess of seven
years, and whose deposits were predominantly fixed-rate certificates with
maturities of one year or less, the Bank's one-year interest rate sensitivity
gap amounted to a negative 7.7% of total assets at December 31, 1995. However,
through the balance sheet restructuring that resulted from the sale of the
Branches during 1996, the Bank was able to significantly improve its one-year
interest rate sensitivity gap to approximately zero as of December 31, 1996.
Furthermore, the total cumulative ratio of interest earning assets to
interest-bearing liabilities increased from 97.2% as of December 31, 1995 to
101.4% as of December 31, 1996.
The following table presents the difference between the Bank's
interest-earning assets and interest-bearing liabilities within specified
maturities at December 31, 1996. This table does not necessarily indicate the
impact of general interest rate movements on the Bank's net interest income
because the repricing of certain assets and liabilities is subject to
competition and other limitations. As a result, certain assets and liabilities
indicated as maturing or otherwise repricing within a stated period may in fact
mature or reprice at different times and at different volumes. In addition, the
following table presents information as of December 31, 1996 and is not
necessarily indicative of the Bank's interest rate sensitivity at any other
time.
28
<PAGE>
<TABLE>
<CAPTION>
0 to 7 months 1-3 3-5 Over 5 Total % of
6 months to 1 year years years years Balance Total
-------- --------- ----- ----- ----- ------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable and
mortgage-backed securities:
First mortgage:
Adjustable-rate $ 42,616 $17,980 $ 2,416 $ 4,856 $ -- $ 67,868 42.5%
Fixed-rate 4,733 4,283 15,290 17,981 16,696 58,983 37.0
Second mortgage 5,265 816 2,642 1,854 1,148 11,725 7.4
All other 2,619 1,024 4,602 182 -- 8,427 5.3
Investments 10,368 2,000 -- -- -- 12,368 7.8
-------- ------- --------- -------- --------- --------- ----
Total 65,601 26,103 24,950 24,873 17,844 $ 159,371 100.0%
========= =====
Interest-bearing liabilities:
Deposits 48,784 27,636 40,019 10,949 3,657 $ 131,045 83.4%
Fixed-rate borrowings 6,100 7,105 9,090 792 -- 23,087 14.7
Variable-rate borrowings 3,000 -- -- -- -- 3,000 1.9
-------- ------- --------- -------- --------- --------- ----
Total 57,884 34,741 49,109 11,741 3,657 $ 157,132 100.0%
========= =====
Effect of off-balance sheet
items (1) 721 186 (197) (159) (572)
-------- -------- -------- -------- ---------
Maturity gap $ 8,438 $(8,452) $ (24,356) $ 12,973 $ 13,615
======== ======= ========= ======== =========
Cumulative gap $ 8,438 $ (14) $ (24,370) $(11,397) $ 2,218
======== ======= ========= ======== =========
Cumulative gap as a percent
of total assets 4.8% 0.0% (14.0)% (6.5)% 1.3%
======== ======= ========= ======== =========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 113.3% 99.0% 82.3% 92.2% 101.4%
======== ======= ========= ======== =========
</TABLE>
(1) Reflects the effect of entering into commitments with third parties to
sell loans.
Data for the table above was obtained from the FHLB Interest Rate Risk
Service Sensitivity Report, adjusted in some cases where management was able to
use more detailed information than was available to the FHLB. Using the Bank's
Thrift Financial Report, which details scheduled maturity and interest rates,
the FHLB applies asset prepayment rates and deposit retention rates which
management believes to be reasonable in determining the interest rate
sensitivity gaps.
The Bank utilizes interest rate sensitivity analyses, as developed by the
OTS, to measure the changes in net portfolio value ("NPV"), expressed as a
percentage of the Bank's market value of assets, assuming certain percentage
changes in interest rates. NPV is the difference between incoming and outgoing
discounted cash flows from assets, liabilities, and off-balance sheet contracts.
In August 1993, the OTS adopted a final rule incorporating an interest-rate risk
component into the risk-based capital regulation. Under the rule, an institution
with a greater than "normal" level of interest rate risk will be subject to a
deduction of its interest rate risk component from total capital for purposes of
calculating its risk-based capital requirement. The final rule was effective
January 1, 1994. However, the date that institutions are first required to
deduct the interest rate risk component has been postponed indefinitely until a
final rule is published by the OTS. The table below presents the Bank's NPV as
of December 31, 1996, as calculated by the OTS, based on information provided to
the OTS by the Bank. Based upon the
29
<PAGE>
OTS calculations there would not have been an interest rate risk component for
the Bank as of December 31, 1996.
<TABLE>
<CAPTION>
Net Portfolio Value
--------------------------------------------------------
Change
----------------------------------
Change in Interest Rates % of Estimated
in Basis Points Market Value of
(Rate Shock) Amount $ Total Assets
------------ ------ ------- ------------
(Dollars in Thousands)
<S> <C> <C> <C>
400 $14,283 $(6,968) (3.26)%
300 16,461 (4,790) (2.17)
200 18,535 (2,715) (1.18)
100 20,244 (1,007) (.40)
Static 21,251 -- --
(100) 21,537 286 .05
(200) 21,098 (152) (.25)
(300) 20,596 (655) (.58)
(400) 20,493 (757) (.72)
</TABLE>
Liquidity and Commitments
Liquidity refers to the Company's ability to generate sufficient cash to
meet the funding needs of current loan demand, savings deposit withdrawals, and
to pay operating expenses. The Company generally has no significant source of
income other than dividends from its subsidiaries. As a result of prior
regulatory examinations, the Company and the Bank had entered into Supervisory
Agreements with the OTS which precluded the Bank from making dividend payments
to the Company. While these Supervisory Agreements are no longer in effect as a
result of the Home Acquisition, the Company is still obligated to comply with
the spirit of the agreements. Consequently, the Company's source of funds is
currently limited to assessments to its subsidiaries for certain operating
expenses, tax payments, if any, by such subsidiaries to the Company, and asset
sales.
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of United States
Treasury, federal agency and other investments having maturities of five years
or less. Regulations currently in effect require the Bank to maintain liquid
assets of not less than 5% of its net withdrawable accounts plus short-term
borrowings, of which short-term liquid assets must consist of not less than 1%.
These levels are changed from time to time by the OTS to reflect economic
conditions.
It is management's policy to maintain greater liquidity than required in
order to be in a position to fund loan purchases and originations, to meet
withdrawals from deposit accounts, and to make investments that take advantage
of interest rate spreads. The Bank's regulatory liquidity ratio at December 31,
1996 and 1995 amounted to approximately 7.26% and 7.32%, respectively.
The Bank monitors its liquidity in accordance with internal guidelines and
applicable regulatory requirements. The Bank's need for liquidity is affected by
loan demand and net changes in deposit levels. The Bank can minimize the cash
required during the times of heavy loan demand by modifying its credit policies
or reducing its marketing efforts. Liquidity demand caused by net reductions in
deposits are usually caused by factors over which the Bank has limited control.
The Bank derives its liquidity from both its assets and liabilities. Liquidity
is derived from assets by receipt of interest and principal payments and
prepayments, by the ability to sell assets at market prices and by utilizing
unpledged assets as collateral for borrowings. Liquidity is derived from
liabilities by maintaining a variety of funding sources, including deposits,
advances from the FHLB and other borrowings.
30
<PAGE>
The Bank's liquidity management is both a daily and long-term function of
funds management. Liquidity is generally invested in short-term investments such
as federal funds sold, certificates of deposit, and in U.S. Treasury and U.S.
Government agency securities of maturities of five years or less. If the Bank
requires funds which cannot be generated internally (i.e., funds generated
through contractual maturities of loans), borrowings from the FHLB may provide
an additional source of funds. At December 31, 1996, the Bank had $25.7 million
in outstanding borrowings from the FHLB. The Bank has not relied upon brokered
deposits as a source of new liquidity, and does not anticipate a change in this
practice in the foreseeable future.
The Bank anticipates that it will have sufficient funds available to meet
its current loan commitments. At December 31, 1996, the Bank had outstanding
commitments (including unused lines of credit) to originate and/or purchase
mortgage and non-mortgage loans of $3.6 million. Certificates of deposit which
are scheduled to mature within one year totaled $61.3 million at December 31,
1996, and borrowings from the FHLB that are scheduled to mature within the same
period amounted to $16.1 million. Essex First's commitments to originate
residential construction builder loans and construction/permanent loans totaled
$28.6 million and $7.8 million, respectively, as of December 31, 1996.
Regulatory Capital
The Bank is required pursuant to the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and OTS regulations promulgated
thereunder to have (i) tangible capital equal to 1.5% of adjusted total assets,
(ii) core capital equal to 3.0% of adjusted total assets, and (iii) total
capital equal to 8.0% of risk-weighted assets. As of December 31, 1996, the
Bank's tangible and core capital amounted to 8.66% of adjusted total assets and
the Bank's total capital amounted to 14.73% of risk-weighted assets and,
consequently, the Bank was in compliance with its core and risk-based capital
requirements as of such date.
Furthermore, the federal regulations under the Federal Deposit Insurance
Corporation ("FDIC") Improvement Act of 1991 classify savings institutions based
on four separate requirements of specified capital as a percent of the
appropriate asset base: tangible equity, Tier I core capital, Tier I risk-based
capital, and total risk-based capital. At December 31, 1996, the Bank's Tier I
core, Tier I risk-based, and total risk-based capital ratios were 8.66%, 13.48%,
and 14.73%, respectively, compared to the minimum capital standards to be "well
capitalized" under the FDIC Improvement Act of 1991 ("FDICIA") of =>5%, =>6%,
and =>10%, respectively. As a result, the dollar amount of the excess in the
Bank's Tier I core, Tier I risk-based, and risk-based regulatory capital under
FDICIA totaled $6.4 million, $8.4 million, and $5.3 million, respectively, at
December 31, 1996.
The OTS has proposed to modify the core capital requirement. Under the OTS
proposal, only savings institutions rated a composite 1 under the OTS CAMEL
rating system will be permitted to operate at or near the regulatory minimum
leverage ratio of 3%. For all other savings institutions, the minimum core
capital leverage ratio will be 3% plus at least an additional 100 to 200 basis
points. Furthermore, as discussed above, the OTS has also issued a rule adding
an interest rate risk component to its risk-based capital requirement. See
"Asset and Liability Management" for a description of this rule.
Deposits of the Bank are currently insured by the Savings Association
Insurance Fund ("SAIF"). Both the SAIF and the Bank Insurance Fund ("BIF"), the
deposit insurance fund that covers most commercial bank deposits, are
statutorily required to be recapitalized to a ratio of 1.25% of insured reserve
deposits. The BIF has achieved the required reserve ratio, and as a result, the
FDIC reduced the average deposit insurance premium paid by BIF-insured banks to
a
31
<PAGE>
level substantially below the average premium paid by savings institutions.
Banking legislation was enacted on September 30, 1996 to eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions. The
legislation provided that all insured depository institutions with
SAIF-assessable deposits as of March 31, 1995 pay a special one-time assessment
to recapitalize the SAIF. Pursuant to this legislation, the FDIC promulgated a
rule that established the special assessment necessary to recapitalize the SAIF
at 65.7 basis points of SAIF-assessable deposits held by affected institutions
as of March 31, 1995. However, as a result of the Bank's financial condition, on
November 8, 1996, the Bank was notified by the FDIC that its application for
exemption had been approved. As a result, the Bank was exempt from paying the
special one-time assessment (which would have amounted to $1.8 million).
Instead, the Bank will continue to pay future assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995. Therefore, as of
December 31, 1996, the Bank's annual assessment for deposit insurance was 30
basis points of insured deposits as opposed to 6.4 basis points of insured
deposits (the assessment rate for "well capitalized" savings institutions).
Another component of the SAIF recapitalization plan provides for the
merger of the SAIF and the BIF on January 1, 1999, provided no insured
depository institution is a savings association on that date. If legislation is
enacted which required the Bank to convert to a bank charter, the Company would
become a bank holding company subject to the more restrictive activity limits
imposed on bank holding companies unless special grandfather provisions are
included in the legislation. The Company does not believe that its activities
would be materially affected in the event that it was required to become a bank
holding company. In addition, although a merger of the insurance funds will not
become effective until 1999, insured depository institutions must begin paying
in 1997 a portion of the interest due annually on the Financing Corporation
("FICO") bonds issued in the 1980s to provide funding for the SAIF. The FICO
annualized assessment rate for the first semi-annual period of 1997 will
approximate 6.5 basis points on SAIF-assessable deposits.
Quarterly Results of Operations
Fourth Quarter Operations. Included in 1996 fourth quarter operations is a
$351,000 net gain on the sale of foreclosed properties, which was primarily
attributable to the completion of the sale of the Bank's largest foreclosed
property consisting of 2,554 acres of farmland located in Currituck, North
Carolina.
32
<PAGE>
Quarterly unaudited financial data for the years ended December 31, 1996
and 1995 is presented below (dollars in thousands, except per unit data).
<TABLE>
<CAPTION>
Year Ended December 31, 1996
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net interest income $ 1,767 $ 1,651 $ 1,477 $ 1,213
Provision for loan losses -- 803 575 33
------- ------- ------- -------
Net interest income after
provision for loan losses 1,767 848 902 1,180
Noninterest income 2,007 682 833 760
Noninterest expenses 3,178 9,047 2,488 1,643
------- ------- ------- -------
Net income (loss) $ 596 $(7,517) $ (753) $ 297
======== ======= ======== =======
Net income (loss) per common and
common equivalent share $ .04 $ (7.15) $ (.72) $ .01
======== ======= ======== =======
<CAPTION>
Year Ended December 31, 1995
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net interest income $ 1,661 $ 1,313 $ 1,259 $ 1,687
Provision for loan losses 1,595 597 154 131
------- ------- ------- -------
Net interest income after
provision for loan losses 66 716 1,105 1,556
Noninterest income 793 711 708 960
Noninterest expenses 2,755 2,620 2,538 2,857
------- ------- ------- -------
Income (loss) before extraordinary
items (1,896) (1,193) (725) (341)
Extraordinary items 262 -- 2,683 -
------- ------- ------- -------
Net income (loss) $(1,634) $(1,193) $ 1,958 $ (341)
======== ======= ======== =======
Earnings (loss) per common and
common equivalent share:
Net loss before extraordinary
items $ (1.81) $ (1.14) $ (.31) $ (.66)
Extraordinary items .25 -- 1.16 -
------- ------- ------- -------
Net income (loss) $ (1.56) $ (1.14) $ .85 $ (.66)
======== ======= ======== =======
</TABLE>
33
<PAGE>
Report of Independent Accountants
February 25, 1997
To the Board of Directors and Shareholders of
Essex Bancorp, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity, of partners'
capital and of cash flows present fairly, in all material respects, the
financial position of Essex Bancorp, Inc. and its subsidiaries at December 31,
1996 and 1995, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As further discussed in Note 21 to the financial statements, the Company's bank
subsidiary meets applicable regulatory capital requirements as of December 31,
1996, and management expects the Bank will maintain capital compliance through
1997. The Board of Directors and management of the Company and the Bank continue
to evaluate strategies to achieve profitable operations and possibilities for
corporate restructuring.
As discussed in Note 2, in 1994 the Company adopted FAS 115 which changed the
method of accounting for investments.
PRICE WATERHOUSE LLP
34
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
ASSETS
Cash ................................................................. $ 1,824,160 $ 3,262,080
Interest-bearing deposits ............................................ 1,727,091 7,833,638
Federal funds sold and securities purchased under agreements to resell 2,644,000 4,913,000
------------ ------------
Cash and cash equivalents ................................... 6,195,251 16,008,718
Federal Home Loan Bank stock ......................................... 2,540,000 3,602,800
Securities available for sale - cost approximates market ............. 9,162 1,493,646
Securities held for investment - market value of $5,890,000 in 1996
and $7,840,000 in 1995 ............................................. 6,003,219 7,998,631
Mortgage-backed securities available for sale - cost of
$13,590,000 in 1995 ................................................ -- 13,744,471
Mortgage-backed securities held for investment - market value of
$1,869,000 in 1996 and $1,806,000 in 1995 .......................... 1,905,327 1,905,554
Loans, net of allowance for loan losses of $2,556,000 in 1996 and
$5,251,000 in 1995 ................................................. 145,550,845 266,631,520
Loans held for sale .................................................. 2,462,525 3,263,060
Purchased and originated mortgage servicing rights ................... 1,349,160 1,634,307
Foreclosed properties, net ........................................... 2,054,213 4,855,887
Accrued interest receivable .......................................... 1,147,933 2,148,779
Excess of cost over net assets acquired, less accumulated
amortization of $2,016,000 in 1996 and $2,562,000 in 1995 .......... 221,815 8,577,073
Advances for taxes, insurance, and other ............................. 790,928 669,557
Premises and equipment, net .......................................... 2,485,122 4,121,922
Other assets ......................................................... 1,551,352 2,068,489
------------ ------------
Total Assets ................................................ $174,266,852 $338,724,414
============ ============
</TABLE>
Continued
35
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing ........................................... $ 1,070,037 $ 1,495,976
Interest-bearing .............................................. 129,963,341 282,001,130
------------- -------------
Total deposits ......................................... 131,033,378 283,497,106
Federal Home Loan Bank advances ................................. 25,690,000 29,833,333
Notes payable ................................................... 96,142 120,203
Capital lease obligations ....................................... 385,251 424,956
Subordinated capital notes ...................................... -- 627,858
Mortgages payable on foreclosed properties ...................... 10,391 25,258
Other liabilities ............................................... 1,945,988 1,566,048
------------- -------------
Total Liabilities ...................................... 159,161,150 316,094,762
Commitments and contingencies
SHAREHOLDERS' EQUITY
Series B preferred stock, $.01 par value (Note 18):
Authorized shares - 2,250,000
Issued and outstanding shares - 2,125,000 in 1996 and 1995 .... 21,250 21,250
Series C preferred stock, $.01 par value (Note 18):
Authorized shares - 125,000
Issued and outstanding shares - 125,000 in 1996 and 1995 ...... 1,250 1,250
Common stock, $.01 par value:
Authorized shares - 10,000,000
Issued and outstanding shares - 1,053,379 in 1996 and 1,049,684
in 1995 .................................................... 10,534 10,497
Capital in excess of par ........................................ 23,659,333 23,652,135
Holding gain on securities available for sale ................... -- 154,174
Accumulated deficit ............................................. (8,586,665) (1,209,654)
------------- -------------
Total Shareholders' Equity ............................. 15,105,702 22,629,652
------------- -------------
Total Liabilities and Shareholders' Equity ............. $ 174,266,852 $ 338,724,414
============= =============
</TABLE>
See notes to consolidated financial statements.
36
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees ........................... $ 17,881,529 $19,778,781 $ 19,556,759
Federal funds sold and securities purchased
under agreements to resell .................... 319,298 279,909 382,320
Investment securities, including dividend income 615,429 836,637 1,168,086
Mortgage-backed securities ...................... 497,879 1,285,889 1,520,243
Other ........................................... 558,139 365,821 338,122
------------ ----------- ------------
Total Interest Income .................. 19,872,274 22,547,037 22,965,530
------------ ----------- ------------
INTEREST EXPENSE
Deposits ........................................ 11,945,273 13,504,940 11,934,954
Federal Home Loan Bank advances ................. 1,625,574 2,797,688 2,770,704
Notes payable ................................... 10,750 130,705 1,036,737
Subordinated capital notes ...................... 52,444 73,183 71,834
Other ........................................... 130,297 120,284 141,777
------------ ----------- ------------
Total Interest Expense ................. 13,764,338 16,626,800 15,956,006
------------ ----------- ------------
Net Interest Income .................... 6,107,936 5,920,237 7,009,524
PROVISION FOR LOAN LOSSES ........................... 1,410,710 2,476,903 1,603,895
------------ ----------- ------------
Net Interest Income After
Provision for Loan Losses .............. 4,697,226 3,443,334 5,405,629
NONINTEREST INCOME
Loan servicing fees ............................. 1,665,768 1,765,617 1,858,503
Mortgage banking income, including
gain on sale of loans ......................... 577,130 504,715 628,895
Other service charges and fees .................. 497,316 428,811 386,636
Net gain (loss) on sale of:
Securities .................................... 153,188 -- (114,430)
Loans ......................................... (1,018,185) 115,538 460,018
Deposits ...................................... 1,940,010 -- 484,689
Other ........................................... 466,519 357,309 363,397
------------ ----------- ------------
Total Noninterest Income ............... 4,281,746 3,171,990 4,067,708
------------ ----------- ------------
</TABLE>
(Continued)
37
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NONINTEREST EXPENSE
Salaries and employee benefits ............... 4,554,540 4,387,760 4,926,398
Net occupancy and equipment .................. 1,470,284 1,671,352 1,713,908
Deposit insurance premiums ................... 674,730 722,106 911,716
Amortization of intangible assets ............ 7,011,288 956,257 1,359,738
Service bureau fees .......................... 599,207 523,526 468,598
Professional fees ............................ 507,031 476,224 718,892
Foreclosed properties, net ................... (175,055) 187,715 2,315,222
Litigation settlement expenses ............... -- -- 2,390,105
Other ........................................ 1,713,958 1,845,102 2,173,970
------------ ------------ ------------
Total Noninterest Expense ........... 16,355,983 10,770,042 16,978,547
------------ ------------ ------------
Loss Before Cumulative Effect of
Change in Accounting Principle,
Extraordinary Item, and Income Taxes (7,377,011) (4,154,718) (7,505,210)
PROVISION FOR INCOME TAXES ....................... -- -- --
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (Note 6) ................ -- -- 179,117
EXTRAORDINARY ITEM - FORGIVENESS
OF DEBT, NET OF $330,000 OF
INCOME TAXES IN 1994 (Note 14) ............... -- 2,945,064 20,415,785
------------ ------------ ------------
Net Income (Loss) ................... $ (7,377,011) $ (1,209,654) $ 13,089,692
============ ============ ============
Earnings (loss) per common and common
equivalent share (Note 2):
Loss before cumulative effect of change in
accounting principle and extraordinary item $ (1.72) $ (3.29) $ --
Extraordinary item ......................... -- 2.16 --
------------ ------------ ------------
Net loss ................................... $ (1.72) $ (1.13) $ --
============ ============ ============
Pro forma earnings (loss) per common share
(unaudited) (Note 2):
Loss before cumulative effect of change in
accounting principle and extraordinary item $ -- $ -- $ (7.15)
Cumulative effect of change in accounting
principle and extraordinary item .......... -- -- 19.62
------------ ------------ ------------
Net income (loss) .......................... $ -- $ -- $ 12.47
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
38
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Series B Series C Holding Gain
Common Preferred Preferred Capital in on Securities
Stock, $.01 Stock, $.01 Stock, $.01 Excess Accumulated Available
Par Value Par Value Par Value of Par Deficit for Sale Total
--------- --------- --------- ------ ------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Transfer of partners' capital in
connection with the merger of
Essex Financial Partners, L.P.
into Essex Bancorp, Inc.......... $ 10,497 $ -- $ -- $ 8,129,135 -- $ -- $ 8,139,632
Issuance of preferred stock in
connection with the merger of
Home Bancorp, Inc. into Essex
Bancorp, Inc..................... -- 21,250 1,250 15,523,000 -- -- 15,545,500
Net increase in holding gain on
securities available for sale.... -- -- -- -- -- 154,174 154,174
Net loss........................... -- -- -- -- (1,209,654) -- (1,209,654)
-------- ------- -------- ----------- ----------- -------- -----------
Balance, December 31, 1995......... 10,497 21,250 1,250 23,652,135 (1,209,654) 154,174 22,629,652
Common stock issued under the
Employee Stock Purchase Plan..... 37 -- -- 7,198 -- -- 7,235
Net decrease in holding gain on
securities available for sale.... -- -- -- -- -- (154,174) (154,174)
Net loss........................... -- -- -- -- (7,377,011) -- (7,377,011)
-------- ------- -------- ----------- ----------- -------- -----------
Balance, December 31, 1996......... $ 10,534 $21,250 $ 1,250 $23,659,333 $(8,586,665) $ -- $15,105,702
======== ======= ======== =========== =========== ======== ===========
</TABLE>
See notes to consolidated financial statements.
39
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (DEFICIT)
For the year ended December 31, 1994
<TABLE>
<CAPTION>
GENERAL PARTNER'S CAPITAL (DEFICIT) LIMITED PARTNERS' CAPITAL
--------------------------------------- ---------------------------------------
Total Total
General General Limited TOTAL
Partner's Common Partner's Class A Common Partners' CAPITAL
Interest Units Deficit Units Units Capital (DEFICIT)
-------- ----- ------- ----- ----- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994.... $ (4,970,844) $ -- $(4,970,844) $ -- $20,784 $ 20,784 $ (4,950,060)
Net income............... 5,052,032 -- 5,052,032 8,037,660 -- 8,037,660 13,089,692
------------ --------- ----------- ----------- ------- ----------- ------------
Balance, December 31, 1994.. $ 81,188 $ -- $ 81,188 $ 8,037,660 $20,784 $ 8,058,444 $ 8,139,632
============ ========= =========== =========== ======= =========== ============
</TABLE>
See notes to consolidated financial statements.
40
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ..................................... $ (7,377,011) $ (1,209,654) $ 13,089,692
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Forgiveness of debt before income taxes ............. -- (2,945,064) $(20,745,785)
Cumulative effect of change in accounting
principle ......................................... -- -- (179,117)
Provision for:
Losses on loans, foreclosed properties, and
servicing .................................. 1,415,365 2,565,297 3,616,801
Depreciation and amortization of premises
and equipment .............................. 538,561 490,249 551,990
Unrealized loss on loans held for sale ......... -- -- 408,938
Amortization (accretion) of:
Premiums and discounts on loans, investments
and mortgage-backed securities ........... 211,642 376,334 595,469
Purchased and originated mortgage servicing
rights ................................... 528,444 580,295 904,625
Excess of costs over net assets acquired ... 6,482,843 375,962 228,421
Other ...................................... (94,399) (27,576) 198,466
Mortgage banking activities:
Proceeds from loan sales ....................... 56,311,191 50,828,101 81,130,740
Loan originations and purchases ................ (54,961,912) (52,881,403) (60,049,443)
Realized gains from sale of loans .............. (548,744) (492,493) (637,850)
Realized (gains) and losses from sales of:
Securities available for sale .................. -- -- (15,400)
Mortgage-backed securities available for sale .. (153,188) -- 129,830
Loans .......................................... 1,018,185 (115,538) (460,018)
Deposits ....................................... (1,940,011) -- (484,689)
Other .......................................... (599,062) (64,021) (73,864)
Federal Home Loan Bank stock dividend ............. -- -- (60,800)
Changes in operating assets and liabilities
exclusive of business acquisitions:
Accrued interest receivable ................ 1,000,846 200,354 491,146
Other assets ............................... 325,152 372,536 (184,210)
Other liabilities .......................... 483,325 (771,319) 1,020,500
------------ ------------ ------------
Net cash provided by (used in) operating activities ... 2,641,227 (2,717,940) 19,475,442
------------ ------------ ------------
</TABLE>
(Continued)
41
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions ............................ (17,000,000) -- (9,000,000)
Proceeds from maturities of certificates of deposit
in other financial institutions ................... 17,000,000 -- 9,000,000
Redemption of Federal Home Loan Bank stock ............ 1,062,800 1,823,100 --
Purchase of securities held to maturity ............... (1,020,625) -- (10,033,984)
Proceeds from maturities of securities held to maturity 3,000,000 3,000,000 18,986,244
Purchase of securities available for sale ............. (5,165,516) (9,240,201) (30,237,494)
Proceeds from sale of securities available for sale ... 6,650,000 8,575,000 32,424,561
Principal remittances on mortgage-backed securities ... -- 2,723,925 3,414,156
Purchase of mortgage-backed securities ................ -- -- (4,812,413)
Principal remittances on mortgage-backed securities
available for sale ................................ 990,065 -- 613,924
Proceeds from sales of mortgage-backed securities
available for sale ................................ 10,068,189 -- 9,709,792
Proceeds from sales of loans .......................... 117,509,060 8,215,597 72,436,620
Net (increase) decrease in net loans .................. 1,834,572 8,095,445 (40,562,262)
Proceeds from sales of foreclosed properties .......... 5,270,509 3,797,022 5,939,240
Additions to foreclosed properties .................... (174,753) (318,471) (1,494,368)
Increase in purchased and originated mortgage
servicing rights .................................. (243,297) -- --
Purchase of premises and equipment .................... (197,281) (1,489,856) (92,830)
Proceeds from sales of premises and equipment ......... 1,414,705 1,984 173,650
Cash and cash equivalents of Home Bancorp
at date of acquisition ............................. -- 7,459,288 --
------------- ----------- ------------
Net cash provided by investing activities ............. 140,998,428 32,642,833 56,464,836
------------- ----------- ------------
FINANCING ACTIVITIES
Decrease in deposits attributable to branch sales:
NOW and savings deposits ........................... (18,937,078) -- (10,560,317)
Certificates of deposit ............................ (144,669,198) -- (81,423,609)
Net increase (decrease) in NOW and savings deposits ... 4,898,050 (9,592,820) (16,910,234)
Net increase in certificates of deposit ............... 10,211,469 18,831,588 3,528,596
Proceeds from Federal Home Loan Bank advances ......... 4,000,000 14,500,000 105,000,000
Repayment of Federal Home Loan Bank advances .......... (8,143,333) (43,618,334) (87,709,047)
Proceeds from notes payable ........................... -- 1,003,893 1,535,052
Payments on Essex 11's notes .......................... -- -- (90,332)
Payments on credit facility ........................... -- (894,377) (524,343)
Payments on other notes payable ....................... (24,061) -- (25,000)
Redemptions of subordinated notes ..................... (627,858) -- --
Payments on capital lease obligation .................. (39,705) (56,030) (158,124)
Repayments of mortgages payable on foreclosed
properties ......................................... (25,258) (164,743) (435,356)
Increase in liability for Settlement Preferred Stock .. -- -- 1,000,000
Redemption of Settlement Preferred Stock .............. (103,385) (831,511) --
Common stock issued under the Employee Stock
Purchase Plan ...................................... 7,235 -- --
------------- ----------- ------------
Net cash used in financing activities ................. (153,453,122) (20,822,334) (86,772,714)
------------- ----------- ------------
Increase (decrease) in cash and cash equivalents ... (9,813,467) 9,102,559 (10,832,436)
Cash and cash equivalents at beginning of period ... 16,008,718 6,906,159 17,738,595
------------- ----------- ------------
Cash and cash equivalents at end of period ......... $ 6,195,251 $ 16,008,718 $ 6,906,159
============= ============ ============
</TABLE>
(Continued)
42
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer from loans to foreclosed properties ............. $ 1,865,227 $ 2,929,567 $ 2,905,028
Termination of Essex Mortgage Trust I REMIC .............. 2,678,222 -- --
Transfer of investment securities and mortgage-backed
securities held for investment to available for sale . -- 13,590,296 --
Increase (decrease) in mortgages payable on
foreclosed properties ................................ 10,391 (7,630) 179,155
Acquisition of Home Bancorp:
Increase in assets:
Net loans ......................................... -- 50,498,727 --
Excess of cost over net assets acquired ........... -- 8,607,098 --
Other ............................................. -- 2,100,783 --
Increase in liabilities:
Deposits .......................................... -- 51,826,331 --
Other ............................................. -- 814,909 --
Capitalization of accrued interest on notes payable ...... -- -- 1,116,395
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest ............................................. $ 13,814,733 $16,628,737 $ 15,076,200
Income taxes, net of refunds ......................... (109,244) (6,252) 329,915
</TABLE>
See notes to consolidated financial statements.
43
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1996, 1995 and 1994
NOTE 1 - ORGANIZATION
Essex Bancorp, Inc. ("EBI") is a Delaware corporation that was formed in 1994 to
be the single thrift holding company for Essex Savings Bank, F.S.B. (the
"Bank"), a federally-chartered savings bank which operates four branches in
North Carolina and Virginia at December 31, 1996. EBI is the successor by merger
to Essex Financial Partners, L.P. (the "Partnership"), a Delaware limited
partnership which was formed in 1988 in order to acquire the former holding
company of the Bank. The Partnership and the Bank's former holding company were
merged into EBI in January 1995. In addition to the Bank, EBI's other principal
operating subsidiaries are Essex First Mortgage Corporation ("Essex First"), a
wholly-owned subsidiary of the Bank that is engaged primarily in the origination
and sale of residential mortgage loans, and Essex Home Mortgage Servicing
Corporation ("Essex Home"), an indirect subsidiary of the Company and the Bank
that is engaged primarily in the servicing of mortgage loans owned by the Bank,
various governmental agencies, and various third party investors. Essex Mortgage
Corporation ("EMC") is also a direct subsidiary of EBI that was formerly engaged
in various mortgage banking activities and, at December 31, 1996, held loans and
other assets as a result of its past activities.
On August 25, 1994, EBI obtained approval from the Office of Thrift Supervision
("OTS") to become the Bank's unitary thrift holding company. On August 29, 1994,
the Partnership transferred to EBI all of the capital stock of Essex Bancorp.
("Bancorp"), the Bank's former holding company, previously held by the
Partnership in exchange for EBI's assumption of all of the Partnership's
liabilities. Also, on November 14, 1994, EBI began a proxy solicitation process
to obtain the approval of the Partnership's unitholders to merge the Partnership
and Bancorp into EBI (the "Merger"). The Partnership's unitholders approved the
Merger at a special meeting on January 17, 1995, and the Partnership and Bancorp
were merged into EBI on January 18, 1995 and January 31, 1995, respectively. The
Merger was accounted for in a manner similar to a pooling of interests. As a
result of the Merger, the Partnership's unitholders and the general partner
became stockholders of EBI, whose common stock is listed on the American Stock
Exchange. Partnership unitholders received one share of EBI common stock in
exchange for each two limited partnership units. In addition, the general
partner received shares of EBI common stock equivalent to one percent of total
shares outstanding after the exchange.
Because neither the Partnership nor EBI had sufficient liquidity to fund
expenses associated with the Merger, PaineWebber Capital Inc. ("PWC") made a
$200,000 loan (the "Merger Note") to EBI. Contemporaneously with the acquisition
described in Note 4, PWC forgave the Merger Note and the accrued interest
thereon. EBI recognized an extraordinary gain of $217,000 during the third
quarter of 1995 in connection with the forgiveness of this debt.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of EBI, the Partnership, and their subsidiaries (together the
"Company"). Significant intercompany accounts and transactions have been
eliminated in consolidation.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts
44
<PAGE>
of assets and liabilities and the disclosures of contingent assets and
liabilities at the date of the financial statements and that affect the reported
amounts of income and expenses during the reporting period. Actual results could
differ from those estimated.
Cash and Cash Equivalents: Cash equivalents include interest-bearing deposits,
federal funds sold and securities purchased under agreements to resell.
Generally, federal funds sold and securities purchased under agreements to
resell are purchased for one-day periods. Securities purchased under agreements
to resell are purchased from a commercial bank and collateralized by
mortgage-backed securities issued by the Government National Mortgage
Association ("GNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC"), or
the Federal National Mortgage Association ("FNMA").
Investments and Mortgage-Backed Securities: On January 1, 1994, the Company
adopted Statement of Financial Accounting Standards No. 115 - Accounting for
Certain Investments in Debt and Equity Securities ("SFAS 115"). At acquisition,
investment securities and mortgage-backed securities ("MBS") purchased are
classified as held for investment or available for sale. Those securities and
MBS designated as held for investment are carried at cost adjusted for
amortization of premiums and accretion of discounts. Residual interests in
mortgage pass-through certificates are recorded at cost and amortized to income
over the period of expected cash flows. Interest income, including amortization
of premiums and accretion of discounts, is recognized by the interest method,
adjusted for effects of changes in prepayments and other assumptions.
Those securities and MBS designated as available for sale are carried at fair
value, and unrealized gains and losses are reported as a component of
shareholders' equity. If securities are sold, the adjusted cost of the specific
security sold is used to compute the gain or loss on the sale. The market value
of securities available for sale is based upon valuations obtained from brokers
and their market analyses and management estimates.
Loans and Foreclosed Properties: Loans held for investment are stated at the
principal amount outstanding with adjustments for related premiums or discounts,
net deferred loan fees, participations sold, and an allowance for loan losses.
The allowance for loan losses is maintained to absorb potential losses in the
loan portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loan loss experience, current
economic conditions, volume, growth and composition of the loan portfolio, and
other relevant factors. The allowance is increased by provisions for loan losses
charged against income. Actual future losses may differ from estimates as a
result of unforeseen events.
Statement of Financial Accounting Standard No. 114 - Accounting by Creditors for
Impairment of a Loan ("SFAS 114"), requires certain loans to be adjusted for
impairment. A loan is impaired when, based on current information and events, it
is probable that the Company will be unable to collect all contractual interest
and principal payments as scheduled in the loan agreement.
The impaired value of collateral-dependent loans is generally determined based
on the fair value of the collateral when it is determined that foreclosure is
probable. Generally, it is management's policy to charge-off the impaired
portion of any collateral-dependent loan where supported by appraisals or other
evidence of value. Otherwise, the impairment is determined based on the present
value of the expected cash flows and deficiencies are provided for through the
allowance for loan losses. Any change in the carrying value of the impaired loan
is reported as an addition or a reduction in the related allowance.
Properties acquired in settlement of loans are initially recorded at fair value
less estimated cost to sell. Valuations are periodically performed by
management, and an allowance for losses is established by a charge to operations
if the carrying value of a property exceeds its fair market
45
<PAGE>
value less the estimated cost to sell. Costs incurred in connection with
ownership of the property, including interest on senior indebtedness, are
expensed to the extent not previously allowed for in calculating fair value less
estimated cost to sell. Costs relating to the development or improvement of the
property are capitalized to the extent these costs increase fair value less
estimated cost to sell.
Management believes that the allowances for losses on loans and foreclosed
properties are adequate. While management uses available information to
recognize losses on loans and foreclosed properties, future additions to the
allowances may be necessary based on changes in economic conditions. In
addition, the OTS, as an integral part of its examination process, periodically
reviews the Bank's allowances for losses on loans and foreclosed properties, and
may require the Bank to recognize additions to the allowances.
Loan Income: Income on loans is derived from interest, the sale of loans and
various fees. Interest on loans, including amortization of premiums and
accretion of discounts, is computed using methods that result in level rates of
return on principal amounts outstanding. Loan origination fees and direct loan
origination costs are deferred and amortized over the contractual lives of the
related loans using methods that result in a constant effective yield on
principal amounts outstanding.
The accrual of interest on loans is discontinued based on delinquency status, an
evaluation of the related collateral, and on the borrower's ability to repay the
loan. Generally, loans past due more than 90 days are placed on nonaccrual
status; however, in instances where the borrower has demonstrated an ability to
make timely payments, loans past due more than 90 days may be returned to an
accruing status provided two criteria are met: (1) all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within a reasonable period, and (2) there is a sustained period of
repayment performance (generally a minimum of six months) by the borrower. The
receipt of interest payments from an impaired loan is generally recognized as
interest income when received, except in cases where impairment adjustments have
been material, in which case the interest payments are treated as principal
reductions.
Mortgage Banking Activities: Loans held for sale are valued at the lower of
aggregate cost or market. The market value of loans held for sale is estimated
by management based on comparable loan sales in the secondary market. Gains or
losses on loan sales are recognized for financial reporting purposes at the time
of sale and are determined by the difference between the sales proceeds and the
carrying value of the loans, with an adjustment for recourse provisions or an
allocation of the basis to the estimated fair value of servicing rights if
servicing is retained.
In May 1995, the Financial Accounting Standards Board issued Statement No. 122 -
Accounting for Mortgage Servicing Rights ("SFAS 122"). This standard, which
became effective January 1, 1996, amends Statement No. 65 - Accounting for
Certain Mortgage Banking Activities. SFAS 122 applies to transactions in which a
mortgage banking enterprise sells or securitizes mortgage loans with servicing
rights retained and to impairment evaluations of all amounts capitalized as
mortgage servicing rights, including those purchased before the adoption of SFAS
122. The Company adopted SFAS 122 during 1996, but it did not have a significant
effect on the Company because predominantly all loans currently originated for
resale by the Company are sold on a servicing released basis.
Purchased mortgage servicing rights ("PMSRs") represent the unamortized costs of
purchased mortgage servicing contracts. PMSRs are carried at cost, which is
amortized in proportion to the estimated net servicing income from the related
mortgage loans over the estimated period of net servicing income. Originated
mortgage servicing rights ("OMSRs") represent the present value of future
servicing revenue on loans sold on a servicing-retained basis, which is
amortized over the estimated period of net servicing income. SFAS 122 requires
that mortgage servicing rights be
46
<PAGE>
assessed for impairment based on the fair value of those rights using a
stratified method based on one or more predominant characteristics of the
underlying loans. The Company evaluates it PMSRs and OMSRs each quarter on a
pooled basis by year of acquisition in the case of PMSRs and by year the
underlying loans were sold in the case of OMSRs. The Company recognizes an
impairment when actual prepayments exceed those previously anticipated. Future
normal amortization is prospectively adjusted after the recognition of the
impairment, if any.
Fees for servicing loans are credited to mortgage servicing income when the
related mortgage payments are collected. Depending on the terms of the servicing
contracts, such fees are normally based upon either the outstanding principal
balance of such loans or the number of loans processed. Servicing expenses are
charged to operations when incurred.
In June 1996, the Financial Accounting Standards Board issued Statement No. 125
- - Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities ("SFAS 125"). This standard became effective January 1, 1997 for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. For servicing contracts in existence before
January 1, 1997, SFAS 125 requires that previously recognized servicing rights
and excess servicing receivables that do not exceed contractually specified
servicing fees be combined as a servicing asset. Thereafter, the servicing asset
must be evaluated and measured for impairment by stratifying it based on one or
more of the predominant risk characteristics of the underlying financial assets.
The amount of impairment recognized will be the amount by which the carrying
amount of servicing assets for a stratum exceeds their fair value. Management
does not expect that adoption of this standard will have a material impact on
its financial statements.
Premises and Equipment: Premises and equipment are stated at cost, less
accumulated depreciation and are being depreciated over their estimated useful
lives, using the straight-line method of depreciation.
Long-Lived Assets: The Company periodically evaluates the carrying value of
long-lived assets in accordance with the provisions of Statement of Financial
Accounting Standards No. 121 - "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121"), which was
adopted by the Company on January 1, 1996.
Income Taxes: The Partnership was not subject to income taxes because it was
classified as a partnership. Consolidated corporate income tax returns are filed
for EBI and its subsidiaries. In February 1992, the Financial Accounting
Standards Board issued Statement No. 109 - Accounting for Income Taxes ("SFAS
109"), which requires an asset and liability approach for determining income
taxes. The new standard was adopted during 1993, but will not have a significant
effect on the Company's operating results unless the Company demonstrates
consistent profitability.
Earnings Per Share: Earnings per share is computed based upon income adjusted
for preferred stock dividends, divided by the average number of common shares
outstanding. If dilutive for any period, warrants and options are treated as
outstanding using the modified treasury stock method. The weighted average
number of common and common equivalent shares outstanding used in the earnings
per share calculation for 1996 was 5,124,864 and for 1995 was 1,365,135.
Pro forma earnings per share for the year ended December 31, 1994 was determined
by giving retroactive effect to the conversion of the Partnership's Class A
units and general partner's interest to 1,049,684 shares of EBI common stock in
January 1995.
47
<PAGE>
NOTE 3 - LITIGATION SETTLEMENT AND EXTRAORDINARY ITEMS
Restructuring: On April 8, 1993, the Partnership and certain of its subsidiaries
entered into definitive agreements with PWC and certain of its affiliates
regarding a substantial restructuring of certain of the Essex companies (the
"Restructuring"). The Restructuring included (i) the consummation by PWC of a
cash offer to purchase for an amount equal to their principal balance all of the
outstanding $23.4 million of debt securities ("Essex 11's") issued by EMC in
January and February of 1991, and guaranteed by the Partnership, (ii) the
substantial restructuring of the Essex 11's, which reduced interest expense and
the Partnership's overall debt burden by replacing the Essex 11's with a
ten-year $14.2 million note (the "10-Year Note") payable by the Partnership to
PWC, and (iii) a $3 million loan to the Partnership by PWC, the proceeds of
which were used to further capitalize the Bank in exchange for a seven-year note
(the "7-Year Note") payable to PWC. The Restructuring was completed on May 6,
1993. In connection with the Restructuring, EMC completed in July 1993 the sale
to a third-party purchaser of its entire portfolio of PMSRs, which served as the
principal collateral for the Essex 11's.
Litigation: On December 30, 1993, a lawsuit was filed in the District Court of
Jefferson County, Texas against the Partnership, PaineWebber Inc. ("PWI") and
certain of its affiliates, Essex Financial Group, Inc. (the former general
partner of the Partnership) ("EFG"), and Lawrence N. Smith (the principal
executive officer of EFG and the Partnership's operating subsidiaries until
EFG's 1992 removal as the general partner of the Partnership). The lawsuit was
initiated by individual investors who purchased the Partnership's units in its
November 1989 public offering, and by an investor who purchased units after the
public offering. The lawsuit alleged the mismanagement of the Partnership by EFG
and Mr. Smith through April 1992, immediately prior to EFG's removal as general
partner of the Partnership. The lawsuit also alleged improper sales practices in
connection with the sale of the Partnership's units to the investors.
On January 31, 1994, a second lawsuit was filed in a Texas federal court by the
same and additional plaintiffs against the Partnership and the aforementioned
defendants. The lawsuit was amended to include Ernst & Young, the Partnership's
former independent accountants, as a defendant. The complaint in the lawsuit, as
amended, which alleged numerous wrongful actions by the defendants, including
the same claims brought in the state court action as well as claims based on
Federal law, sought substantial monetary damages and class action status on
behalf of an estimated 3,500 limited partners across the nation. Counsel for the
plaintiffs pursued this federal court action rather than the Texas state court
litigation. The removed state action and the federal action, as consolidated,
are referred to herein as the "Litigation."
On July 27, 1994, the defendants in the Litigation entered into a stipulation of
settlement (the "Settlement"), which was approved by the court on September 8,
1994, and resulted in the following transactions:
o More than $20 million in outstanding indebtedness to PWC, including all of
the Partnership's indebtedness with respect to the 7-Year and 10-Year
Notes delivered by the Partnership to PWC in May 1993, and all of the
remaining indebtedness of the Partnership and its subsidiaries with
respect to the Essex 11's, was forgiven effective October 24, 1994. The
Company recognized an extraordinary after-tax gain of $20.4 million during
the fourth quarter of 1994 in connection with this forgiveness of debt.
o The Partnership agreed to make arrangements for PWI or its affiliates to
receive document and credit holdbacks held by the purchaser of PMSRs sold
by EMC in 1993.
o EBI issued $1.0 million in nonvoting, noncumulative preferred stock (the
"Settlement Preferred Stock") in January 1995. The $1.0 million obligation
to issue the Settlement Preferred Stock was recorded as a liability at
December 31, 1994 and was included in
48
<PAGE>
litigation settlement expenses for the year then ended. The Settlement
Preferred Stock was distributed on January 9, 1995 to qualifying members
of the settlement class who suffered trading losses in the Partnership's
limited partnership units ("LPUs") prior to July 27, 1994, the date on
which the Settlement was announced. Contemporaneously with the acquisition
described in Note 4, PWC and PWI agreed to loan the funds necessary to
enable EBI to redeem the Redeemable Preferred Stock for $1.0 million (the
"Redemption Loan") plus accrued dividends. The effective date of this
redemption was September 18, 1995, and the Redemption Loan was forgiven
effective that date. The Company recognized an extraordinary gain of $1.0
million during the third quarter of 1995 in connection with the
forgiveness of this debt.
o EBI contributed $1.3 million to a settlement fund established by the
defendants, which was recorded as a litigation settlement expense during
the third quarter of 1994. The court provided for a portion of this
settlement fund to be distributed in cash to the same class members who
were to receive the Settlement Preferred Stock, and the remaining portion
of the fund was to be used to pay fees and expenses of plaintiffs' counsel
and to make certain payments to named plaintiffs. Neither the Partnership
nor EBI had sufficient liquidity to fund this contribution to the
Settlement. Accordingly, PWC, which was a settling defendant, made a $1.3
million loan (the "Settlement Note") to EBI in order to facilitate the
completion of the Settlement. In addition, PWC made a $39,000 loan (the
"Litigation Note") to EBI in order for EBI to pay legal expenses
associated with the Settlement. Contemporaneously with the acquisition
described in Note 4, PWC forgave the Settlement Note and the Litigation
Note, plus accrued interest thereon. The Company recognized an
extraordinary gain of $1.5 million during the third quarter of 1995 in
connection with the forgiveness of this debt.
NOTE 4 - ACQUISITION
On September 15, 1995, EBI and the Bank merged with Home Bancorp, Inc. ("Home
Bancorp"), and its wholly-owned subsidiary Home Savings Bank, F.S.B. ("Home
Savings"), a Norfolk, Virginia-based savings institution (the "Home
Acquisition"). The transaction was accounted for using the purchase method of
accounting and the purchase price was allocated among the assets and liabilities
of Home Bancorp and Home Savings at their fair value, which was $60.1 million
and $52.6 million, respectively, as of September 15, 1995. The excess of cost
over net assets acquired ("goodwill") of approximately $8.6 million was being
amortized using an accelerated method over a period of 15 years. However, as a
result of the 1996 sale of four of the five Home Savings branches acquired,
goodwill associated with the Home Acquisition was written off in 1996.
In exchange for all of the outstanding stock of Home Bancorp, the stockholders
of Home Bancorp received 2,250,000 shares of nonvoting perpetual preferred stock
of EBI with an aggregate redemption and liquidation value of $15 million and
warrants to purchase 7,949,000 shares of EBI common stock at a price of $0.9375
per share, which was the price of EBI common stock as of June 30, 1995. The
warrants are exercisable beginning in September 1998. The fair market value of
the preferred stock and the warrants was estimated in a third party valuation to
approximate $15.5 million at the time of issuance. Following the completion of
the transaction, two representatives designated by Home Bancorp joined the Board
of Directors of EBI, and two joined the Board of Directors of the Bank, filling
existing vacancies on those Boards.
49
<PAGE>
The following unaudited pro forma financial information for the year ended
December 31, 1994 assumes the acquisition was consummated on September 30, 1994,
the date on which Home Bancorp and Home Savings began operations. The pro forma
financial information for the year ended December 31, 1995 assumes the
acquisition was consummated on January 1, 1995.
<TABLE>
<CAPTION>
Year Ended December 31,
1995 1994
---- ----
(in thousands, except per share data)
<S> <C> <C>
Total interest income $25,859 $23,798
Net interest income 7,568 7,322
Provision for loan losses 2,477 1,604
Noninterest income 3,195 4,077
Noninterest expense 13,218 17,712
Loss before change in accounting principle
and extraordinary items (4,932) (7,917)
Net income (loss) (2,096) 15,361
Income (loss) before change in accounting
principle and extraordinary items per share (2.09) (7.88)(1)
Net income (loss) per share (1.14) 14.30 (1)
</TABLE>
(1) Per share data for 1994 is presented on a pro forma basis giving
retroactive effect to the conversion of Partnership units and
general partner's interest to shares of EBI common stock.
NOTE 5 - SALES OF BRANCHES
In January 1996, the Company formed a Strategic Evaluation Committee (the
"Committee") to explore the possible benefits of further expansion or
contraction by branch sales. It was concluded with assistance from an
independent consultant, that selling non-strategic bank branches and effectively
shrinking the size of the asset base by approximately 50% was a strategy that
ultimately would be in the best interests of the common and the preferred
shareholders of the Company. Accordingly, in addition to completing the
already-negotiated sales of the Bank's Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina branches, the Company proceeded to negotiate the sale
of the Bank's Norfolk, Portsmouth, Hampton, Newport News and Grafton, Virginia
branches, which were completed during the last two quarters of 1996.
Collectively, the nine branches sold during 1996 are referred to as the
"Branches" and each sale is detailed below.
Effective March 15, 1996, the Bank sold the deposits and related accrued
interest of its Charlotte, North Carolina retail bank branch, which totaled
$28.1 million, along with loans and related accrued interest totaling $64,000,
premises and equipment totaling $586,000, and other assets totaling $69,000. In
connection with the sale of the Charlotte branch, the Bank recognized a $1.1
million net gain on the sale of deposits and a $64,000 gain on the sale of
premises and equipment. The sale of the Charlotte branch required cash of $26.3
million, which was funded by the sale of fixed-rate first mortgage loans
totaling $7.3 million and mortgage-backed securities available for sale totaling
$9.9 million, as well as the utilization of a portion of the Bank's excess
liquidity. The Bank recognized a gain of $558 and $153,000 from the sale of
loans and mortgage-backed securities, respectively. In the aggregate, the Bank
recognized a net gain of $1.3 million on the sale of the Charlotte branch.
Effective July 25, 1996, the Bank sold the deposits and related accrued interest
of its Raleigh, Wilmington and Greensboro, North Carolina retail bank branches,
which totaled $71.2 million, along with deposit loans and related accrued
interest totaling $72,000. In connection with the sale of the Branches, the Bank
recognized a $701,000 net gain on the sale of deposits. The sale of these
branches required cash of $70.3 million, which was funded by the sale of
fixed-rate and
50
<PAGE>
adjustable-rate first mortgage loans totaling $60.9 million, as well as the
utilization of a portion of the Bank's excess liquidity. The Bank recognized a
loss of $186,000 on the sale of loans. In the aggregate, the Bank recognized a
net gain of $516,000 on the sale of the Raleigh, Wilmington and Greensboro
branches.
Effective September 26, 1996, the Bank sold the deposits and related accrued
interest of its Norfolk, Portsmouth, Hampton and Newport News, Virginia retail
bank branches, which totaled $62.9 million, along with deposit loans and related
accrued interest totaling $68,000 and premises and equipment totaling $600,000.
The Bank concluded its branch sales on November 7, 1996 with the sale of its
Grafton, Virginia retail bank branch with deposits and related accrued interest
totaling $5.3 million. In connection with these sales, the Bank recognized a
$174,000 net gain on the sale of deposits and a $152,000 gain on the sale of
premises and equipment. In addition to transaction costs, the gain on the sale
of deposits was reduced by a $1.9 million write-off of the remaining goodwill
associated with the branches. The sale of these branches required cash of $65.4
million, which was funded by the sale of fixed-rate and adjustable-rate first
mortgage loans totaling $50.1 million, as well as the utilization of a portion
of the Bank's excess liquidity. The Bank recognized a loss of $833,000 on the
sale of loans. In the aggregate, the Bank recognized a net loss of $507,000 on
the sale of the Norfolk, Portsmouth, Hampton, Newport News, and Grafton
branches.
Effective June 30, 1994, in order to reposition the Bank's operations in the
more geographically concentrated and defined market areas of eastern North
Carolina and Virginia, the Bank sold deposits and related accrued interest of
the Bank's branches in Florida, which at June 30, 1994 totaled $93 million,
along with loans, investment securities, mortgage-backed securities, accrued
interest, fixed assets, and other assets. In connection with the sale of the
Florida branches, the Bank recognized a net gain of $772,000, which consisted of
a $485,000 net gain on sale of deposits, a $338,000 gain on sale of loans, a
$79,000 gain on sale of fixed assets, and a $130,000 loss on sale of securities.
NOTE 6 - INVESTMENT SECURITIES
The amortized cost and fair value of securities held for investment at December
31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
--------------------------------------- ---------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities $ 1,003 $ -- $ -- $1,003 $ 1,000 $ -- $ 1 $ 999
Securities of other U.S.
government agencies 5,000 -- 113 4,887 6,998 -- 157 6,841
$ 6,003 $ -- $ 113 $5,890 $ 7,998 $ -- $ 158 $ 7,840
</TABLE>
No securities held for investment were sold prior to maturity in 1996, 1995, and
1994. A U.S. Treasury Note with a book value of $1,003,153 is pledged as
collateral for public depository accounts over $100,000 at December 31, 1996.
Securities available for sale at December 31, 1996 and 1995 consisted of a
mutual fund investment that is designed for use as an overnight liquid
investment. The mutual fund portfolio is invested in federal funds and
repurchase agreements, which are fully collateralized by U.S. Government and/or
agency obligations. The fund is managed to have an average maturity of one to
seven days, and to maintain a stable net asset value of $1.00 per share.
51
<PAGE>
Proceeds from the sale of securities available for sale totaled $6,650,000,
$8,575,000, and $32,424,561 in 1996, 1995, and 1994, respectively. No gains or
losses were realized in 1996 and 1995. However, gross gains of $28,000 and gross
losses of $12,600 were realized in 1994.
The amortized cost and fair value of securities held for investment and
securities available for sale at December 31, 1996, by expected maturity are
summarized below (in thousands). Actual maturities may differ from expected
maturities.
<TABLE>
<CAPTION>
Securities Held for Investment Securities Available for Sale
------------------------------ -----------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in one year or less $4,003 $3,981 $ 9 $ 9
Due after one year but
less than five years 2,000 1,909 -- --
Due after five years but
less than ten years -- -- -- --
------ ------ ------- -------
$6,003 $5,890 $ 9 $ 9
====== ====== ======= =======
</TABLE>
As a result of adopting SFAS 115, the Company reported $179,000 of income in
1994 as a cumulative effect of a change in accounting principle, which is
attributable to the reclassification of the lower of cost or market valuation
allowance for securities held for sale at December 31, 1993 to a component of
shareholders' equity.
NOTE 7 - MORTGAGE-BACKED SECURITIES
The amortized cost and fair value of MBS held for investment, which consisted
solely of the Company's interests in a real estate mortgage investment conduit
("REMIC"), at December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
--------------------------------------- ----------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government agencies:
Floating-rate REMIC $1,905 $ -- $ 36 $1,869 $1,906 $ -- $ 100 $1,806
===== ====== ====== ====== ====== ======= ======= ======
</TABLE>
There were no sales of MBS held for investment in 1996, 1995 and 1994.
Effective November 15, 1995, the Financial Accounting Standards Board ("FASB")
provided a one-time opportunity for institutions to reassess the appropriateness
of the designations of all securities held upon initial application of the FASB
Special Report, "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities" (the "Special Report"). Any
resulting redesignations were required to occur no later than December 31, 1995
and such redesignations were required to be accounted for at fair value in
accordance with SFAS 115. Accordingly, on December 31, 1995, the Bank
transferred MBS with a total amortized cost of $13.6 million and a total fair
value of $13.7 million from the "held to maturity" designation to the "available
for sale" designation. In accordance with SFAS 115, the transfer was accounted
for at fair value and the Company recorded a holding gain of $154,000 as a
separate component of its shareholders' equity.
52
<PAGE>
No MBS were classified as available for sale at December 31, 1996. The amortized
cost and fair value of MBS available for sale at December 31, 1995 were as
follows (in thousands):
Amortized Gross Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U.S. government agencies:
Adjustable-rate MBS $ 3,331 $ 16 $ 5 $ 3,342
Fixed-rate MBS 5,429 127 14 5,542
Fixed-rate REMIC 1,558 - 25 1,533
Essex Mortgage Trust I
REMIC 3,272 55 - 3,327
------- ------- ------- -------
$13,590 $ 198 $ 44 $13,744
======= ======= ======= =======
During 1996, the Essex Mortgage Trust I REMIC, a Company-issued second mortgage
REMIC, was terminated, at which time $2.7 million of mortgage-backed securities
were reclassified to loans. Proceeds from the sale of MBS available for sale
totaled $10,068,189 in 1996 and $9,709,792 in 1994. Gross gains of $196,525 were
realized in 1996 and gross losses of $43,337 and $129,830 were realized in 1996
and 1994, respectively. There were no sales of MBS in 1995.
NOTE 8 - LOANS
Net loans at December 31 include (in thousands):
1996 1995
---- ----
Real estate:
First mortgages $103,643 $223,531
Second mortgages 12,384 13,398
Construction and development 17,190 15,078
Commercial 6,313 10,611
Consumer 5,828 6,488
Commercial - other 1,915 2,171
Secured by deposits 842 994
-------- --------
Total Loans 148,115 272,271
Less:
Unearned loan fees and discounts 8 388
Allowance for loan losses 2,556 5,251
-------- --------
Net Loans $145,551 $266,632
======== ========
Included in total loans at December 31, 1996 and 1995 are unamortized premiums
of $565,000 and $1.2 million, respectively.
53
<PAGE>
At December 31, net loans included the following collateral-dependent real
estate loans (in thousands):
1996 1995
------ ------
First mortgages $ 539 $ 614
Second mortgages 122 409
Construction and development 17 17
Commercial -- 2,768
------ ------
Total collateral-dependent real estate loans 678 3,808
Less:
Allowance for loan losses 69 1,071
------ ------
Net collateral-dependent real estate loans $ 609 $2,737
====== ======
As of December 31, 1996, the Bank had outstanding commitments to fund
approximately $34.6 million in adjustable rate mortgage loans, $2.2 million in
fixed rate mortgage loans and $242,000 in nonmortgage loans. Commitments to
extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Because it is possible that the commitments can expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the counterparty. Collateral held generally consists of real estate.
The Bank originates first and second mortgage and consumer loans primarily in
North Carolina and Virginia. In the past, the Bank also acquired a substantial
portion of its real estate mortgage loans from third parties. Loans previously
acquired comprised approximately 43% and 56% of total loans at December 31, 1996
and 1995, respectively. The Bank requires collateral on all residential mortgage
loans and, at origination, generally requires that loan-to-value ratios be no
greater than 80%, unless private mortgage insurance has been obtained, in which
case higher loan-to-value ratios may be maintained.
At December 31, 1996 and 1995, the Company had $2.9 million and $6.1 million,
respectively, in nonaccrual loans held for investment. Interest income which
would have been recorded in accordance with the original terms of the nonaccrual
loans amounted to approximately $291,000, $678,000, and $406,000 for the years
ended December 31, 1996, 1995, and 1994, respectively.
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
1996 1995 1994
---- ---- ----
Balance at beginning of period $ 5,251,295 $ 3,429,365 $ 3,038,775
Allowance transferred in connection
with the Home Acquisition -- 500,000 --
Provision for loan losses 1,410,710 2,476,904 1,603,895
----------- ----------- -----------
6,662,005 6,406,269 4,642,670
Loans charged-off, net of recoveries (4,106,317) (1,154,974) (1,213,305)
----------- ----------- -----------
Balance at end of period $ 2,555,688 $ 5,251,295 $ 3,429,365
=========== =========== ===========
Loans held for sale at December 31, 1996 and 1995 consisted of first mortgage
loans originated by Essex First. As of December 31, 1996, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $2.9
million, which were committed for sale to unaffiliated third parties.
54
<PAGE>
NOTE 9 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
1996 1995
---- ----
Properties acquired through foreclosure $2,233,150 $5,055,032
Less allowance for losses 178,937 199,145
---------- ----------
$2,054,213 $4,855,887
========== ==========
Changes in the allowance for losses on foreclosed properties for the year ended
December 31 are as follows:
1996 1995 1994
--------- ----------- -----------
Balance at beginning of year $ 199,145 $ 417,805 $ 724,293
Provision for losses on
foreclosed properties (21,345) 79,393 1,923,033
--------- ----------- -----------
177,800 497,198 2,647,326
Charge-offs on foreclosed
properties 1,137 (298,053) (2,229,521)
--------- ----------- -----------
Balance at end of year $ 178,937 $ 199,145 $ 417,805
========= =========== ===========
NOTE 10 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
1996 1995
---- ----
Land $ 591,766 $ 754,406
Buildings 1,230,819 2,164,062
Furniture and equipment 2,675,397 2,972,464
Leasehold improvements 183,497 217,242
Property under capitalized lease 537,737 537,737
---------- ----------
5,219,216 6,645,911
Less accumulated depreciation
and amortization 2,734,094 2,523,989
---------- ----------
$2,485,122 $4,121,922
========== ==========
Certain premises are occupied under noncancelable operating lease agreements.
Leases having contractual attributes of purchased premises or equipment are
capitalized and shown in the table above along with related amortization.
55
<PAGE>
Future minimum lease commitments with terms in excess of one year at December
31, 1996, including cost escalation provisions, are as follows:
Capital Noncancelable
Lease Operating Leases
----- ----------------
1997 $ 119,201 $ 284,086
1998 119,201 277,585
1999 119,201 246,924
2000 119,201 228,030
2001 119,201 214,776
Later years -- --
--------- ----------
Total minimum lease payments 596,005 $1,251,401
==========
Amount representing interest 210,754
---------
Present value of net minimum capitalized
payments $ 385,251
=========
Rent expense for the years ended December 31, 1996, 1995, and 1994 amounted to
$602,190, $903,922, and $953,867, respectively.
NOTE 11 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
1996 1995
-------------------- -------------------
Balances by Interest Rate Amount Percent Amount Percent
------ ------- ------ -------
NOW accounts -
noninterest-bearing $ 1,070 .82% $ 1,496 .53%
Passbook and Christmas
Club - 3.25% to 3.50% in
1996 and 2.50% to 3.70%
in 1995 3,765 2.87 7,973 2.81
NOW accounts - 2.75% to
3.0% in 1996 and 2.25%
to 4.50% in 1995 4,175 3.19 6,061 2.14
Money market -3.25% to
5.02% in 1996 and 3.50%
to 4.11% in 1995 16,350 12.48 24,349 8.59
Certificate accounts -
2.01% to 4.00% -- -- 283 .10
4.01% to 6.00% 80,203 61.20 132,438 46.71
6.01% to 8.00% 25,433 19.41 108,574 38.30
8.01% to 10.00% 37 .03 2,192 .77
10.01% to 12.00% -- -- 131 .05
-------- ------ -------- ------
$131,033 100.00% $283,497 100.00%
======== ====== ======== ======
56
<PAGE>
A summary of certificates by scheduled maturity at December 31, 1996 is as
follows (in thousands):
1997 $ 61,262
1998 25,100
1999 10,383
2000 6,193
2001 and thereafter 2,735
--------
$105,673
Certificate accounts of $100,000 or more at December 31, 1996 and 1995 amounted
to $14.8 million and $41.2 million, respectively.
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------------- ------------------- ------------------
Interest Rate Interest Rate Interest Rate
<S> <C> <C> <C> <C> <C> <C>
Passbook and
Christmas Club $ 225,525 3.33% $ 181,926 3.33% $ 173,273 3.32%
NOW accounts 149,324 2.80 138,251 2.85 132,725 2.73
Money Market
accounts 949,835 4.50 900,719 4.14 1,379,483 3.41
Certificate accounts 10,620,589 5.78 12,284,044 5.75 10,249,473 4.73
----------- ---- ----------- ---- ----------- ----
$11,945,273 5.51 $13,504,940 5.50 $11,934,954 4.47
=========== ==== =========== ==== =========== ====
</TABLE>
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the Federal Home Loan Bank ("FHLB") at December 31 consist of
the following (in thousands):
Maturity Interest Rate 1996 1995
- -------- ------------- ----------- -------
1996 4.01% to 7.00% $ -- $ 7,143
1997 4.01% to 8.00% 16,144 13,144
1998 4.01% to 6.00% 7,138 7,138
1999 5.01% to 6.00% 1,808 1,808
2000 5.01% to 6.00% 600 600
-------- --------
$ 25,690 $ 29,833
======== ========
Weighted average rate at end of period 6.14% 6.00%
==== ====
With the exception of $3.0 million of FHLB advances outstanding at December 31,
1996, all FHLB advances outstanding at December 31, 1996 and 1995 carried fixed
rates of interest. The $3.0 million adjustable rate FHLB advances outstanding at
December 31, 1996 will mature in 1997 and the applicable rate is indexed to the
FHLB overnight deposit rate.
Advances from the FHLB at December 31, 1996 are collateralized by mortgage loans
with a total principal balance of approximately $43.4 million. The unused
lendable collateral value was $11.2 million at December 31, 1996.
57
<PAGE>
NOTE 13 - SUBORDINATED CAPITAL NOTES
During 1989 and January 1990, the Bank sold $3.3 million of subordinated capital
notes with a ten-year maturity. The notes were issued in minimum denominations
of $2,500 at interest rates of 11.5% to 12%, the rates prevailing at the time of
issuance. In July 1993, the Bank redeemed $2.8 million of the subordinated
capital notes. In August 1996, the Bank redeemed the remaining subordinated
capital notes at par in their entirety.
NOTE 14 - INCOME TAXES
The Company is subject to federal income taxes, and files a consolidated federal
income tax return with its subsidiaries. The Partnership, however, was
classified as a partnership for federal income tax purposes and was not subject
to federal income taxes. Partnership income, gain, loss, deduction, credit, and
items of tax preference (if any), determined in accordance with the partnership
agreement, were taxable to the partners.
The Company's provision for (benefit from) income taxes for financial reporting
purposes differs from the amount computed by applying the statutory federal tax
rate to loss before cumulative effect of change in accounting principle,
extraordinary item, and income taxes for the years ended December 31 as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------------------- ------------------- ---------------------
Amount % Amount % Amount %
------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C>
Provision for income taxes at
statutory federal tax rate $(2,508,184) (34.0)% $(1,412,604) (34.0)% $(2,551,771) (34.0)%
Increase (decrease) resulting from:
Unrecognized tax benefits 991,196 13.4 1,407,828 33.9 2,175,931 28.9
Partnership loss excluded from
corporate taxation -- -- -- -- 349,336 4.7
Amortization of excess of cost
over net assets acquired 1,507,950 20.5 76,717 1.8 (68,550) (0.9)
Other 9,038 0.1 (71,941) (1.7) 95,054 1.3
----------- ----- ----------- ----- ----------- -----
$ -- --%$ -- --% $ -- --%
=========== ===== =========== ===== =========== =====
</TABLE>
58
<PAGE>
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Deferred tax liabilities
FHLB stock $ 231,880 $ 375,982
Basis in acquired loans 2,430,234 2,920,534
Premises and equipment 67,610 95,219
------------ -----------
Total deferred liabilities 2,729,724 3,391,735
Deferred tax assets
Federal net operating loss ("NOL") carryforwards 8,007,145 7,545,516
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
PMSRs 97,849 117,419
Allowance for losses on loans and
foreclosed properties 659,128 1,277,919
Core deposit intangible 1,130,022 17,080
Other 137,941 57,753
------------ -----------
Total deferred assets 10,362,085 9,345,687
Valuation allowance for deferred tax assets (7,632,361) (5,953,952)
------------ -----------
Net deferred tax assets $ -- $ --
============ ===========
</TABLE>
The Company applies an asset and liability approach for determining income taxes
as required by SFAS 109. A valuation allowance has been established for the
Company's deferred tax assets and liabilities because, based on management's
assessment, their ultimate realizability cannot be assured.
The Bank and its subsidiaries qualify under provisions of the Internal Revenue
Code that permit federal income taxes to be computed after deductions for
additions to bad debt reserves. These deductions may be computed using either
actual charge-offs or additions to its reserves based on the Bank's historical
experience. If the amounts which have qualified as bad debt deductions
(approximately $525,000 at December 31, 1996) are used for purposes other than
to absorb bad debt losses, they will be subject to federal income tax at the
then applicable rates.
The extraordinary item related to the forgiveness of debt in 1994 of $20.4
million (see Note 3) is net of $330,000 of income taxes. Although NOL
carryforwards were utilized to eliminate the regular income tax liability, the
Company recognized $330,000 of AMT related to the extraordinary item due to
limitations on the utilization of NOL carryforwards for AMT purposes. As a
result, the Company had an AMT credit carryover of $330,000 at December 31,
1996, which can be carried forward indefinitely.
At December 31, 1996, the Company had NOL carryforwards for income tax purposes
of approximately $21.1 million expiring in the years 2007 through 2011. The
utilization of such NOL carryforwards may be limited by the Internal Revenue
Code in certain circumstances, including a change in ownership of the Company's
stock.
59
<PAGE>
NOTE 15 - MORTGAGE LOAN SERVICING
At December 31, 1996, 1995, and 1994, EBI through its subsidiaries serviced or
subserviced approximately 13,300, 12,400, and 10,000 loans, respectively, with
the following approximate principal balances (in thousands) at December 31 and
related servicing fee income during the respective years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------- ---------------------- ----------------------
Loan Loan Loan Loan Loan Loan
Principal Servicing Principal Servicing Principal Servicing
Balances Fee Income Balances Fee Income Balances Fee Income
-------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Loans owned by the
Company $ 126,373 $ -- $194,736 $ -- $132,369 $ --
Servicing and sub-
servicing rights owned/
participated in by the
Company 997,279 1,665,768 796,103 1,765,617 693,394 1,858,503
---------- ---------- -------- ---------- -------- ----------
$1,123,652 $1,665,768 $990,839 $1,765,617 $825,763 $1,858,503
========== ========== ======== ========== ======== ==========
</TABLE>
Servicing fee income is net of $1,878,725 in 1996, $1,459,570 in 1995, and
$1,488,001 in 1994 paid to unaffiliated subservicing clients.
On February 28, 1997, the Company was notified by its largest subservicing
client of its intention not to renew its contract beyond June 1, 1997. As of
December 31, 1996, the Company serviced approximately 7,000 loans totaling
$858.9 million for this client and servicing fee income for 1996 included
approximately $409,000 attributable to servicing activities performed for this
client. While the Company's management has intensified its marketing efforts in
order to minimize the impact of this loss on the earnings performance of the
Company, no assurances can be made that this significant servicing volume can be
replaced in its entirety in the near term. In the meantime, the Company is
examining expenses associated with the servicing of this client in contemplation
of reductions to minimize the loss in servicing fee income.
As agent for investors for whom loans are serviced, the Company maintains escrow
and custodial accounts in which borrower payments for principal, interest, taxes
and insurance are deposited. At December 31, 1996, approximately $9.8 million of
such accounts were on deposit at unaffiliated banks and $261,000 of such
accounts were on deposit at the Bank.
Following is an analysis of the balances of PMSRs, excess servicing fees
receivable and OMSRs for the years ended December 31:
<TABLE>
<CAPTION>
Excess
PMSRs Servicing OMSRs
----- --------- -----
<S> <C> <C> <C>
Balance at January 1, 1994 $ 250,208 $2,167,945 $ --
Additions -- 802,107 --
Sales -- (101,033) --
Amortization (107,041) (707,742) --
Valuation adjustments due to changes in
prepayment and other assumptions -- (89,842) --
--------- ---------- --------
Balance at December 31, 1994 143,167 2,071,435 --
Amortization (63,990) (516,305) --
--------- ---------- --------
Balance at December 31, 1995 79,177 1,555,130 --
Additions 170,067 -- 73,230
Amortization (42,678) (474,610) (11,156)
--------- ---------- --------
Balance at December 31, 1996 $ 206,566 $1,080,520 $ 62,074
========= ========== ========
</TABLE>
60
<PAGE>
NOTE 16 - NOTES PAYABLE
The balance of notes payable at December 31, 1996 consisted of a note payable to
the former president of Home Bancorp and Home Savings. The note accrues interest
at 9.50% per annum. The note is due in five equal annual installments, plus
accrued interest thereon.
NOTE 17 - EMPLOYEE BENEFIT PLANS
Employees of EBI's subsidiaries participate in a 401(k) retirement plan
administered by EBI. Annual contributions to the plan are discretionary, as
authorized by the boards of directors of EBI and its subsidiaries. Expenses of
the plan were $40,177 and $30,097 for 1995 and 1994, respectively. The Company
did not make a contribution to the plan for 1996.
Effective in 1993, certain employees of EBI's subsidiaries began participating
in a Supplemental Executive Retirement Plan ("SERP"). An expense of $38,836,
$28,738, and $23,397 was recognized in 1996, 1995 and 1994, respectively, in
connection with employee vesting in the SERP. The SERP provides deferred
compensation of 5% to 10% of a covered employee's salary and vests at a rate of
20% per year. Deferred compensation in excess of 5% is discretionary and subject
to the approval of EBI's Executive Compensation Committee.
NOTE 18 - PREFERRED STOCK
As described in Note 5, on September 15, 1995, EBI merged with Home Bancorp. In
exchange for all of the outstanding stock of Home Bancorp, the stockholders of
Home Bancorp received 2,250,000 shares of nonvoting perpetual preferred stock of
EBI with an aggregate redemption and liquidation value of $15 million. The
2,125,000 shares of Series B preferred stock bear a cumulative annual dividend
rate of 9.5% (based on the redemption value) and the 125,000 shares of Series C
preferred stock bear a cumulative annual dividend rate of 8.0% (based on the
redemption value). The Series C preferred stock is senior to Series B preferred
stock with respect to the payment of dividends, and the holders of the Series C
preferred stock may, in their discretion, from time to time in whole or in part,
elect to convert such shares of Series C preferred stock into a like amount of
Series B Preferred Stock. Cumulative but undeclared dividends and accrued
interest thereon for the Series B and Series C preferred stock were $1,729,472
and $85,418, respectively, as of December 31, 1996.
NOTE 19 - COMMON STOCK
Warrants: In connection with the Home Acquisition, the stockholders of Home
Bancorp received warrants to purchase 7,949,000 shares of EBI common stock at a
price of $0.9375 per share, which was the price of EBI common stock as of June
30, 1995. The warrants are exercisable beginning in September 1998 and expire in
September 2005.
Stock Options: In 1995, the Company adopted the Essex Bancorp, Inc. Stock Option
Plan (the "Option Plan"), which was submitted to and approved by the
shareholders of EBI in May 1995. In June 1995, EBI's board of directors approved
the First Amendment to the Option Plan which reduced the number of options and
rights which can be granted with respect to EBI's common stock under the Option
Plan to 930,000 shares. Stock appreciation rights ("SARs") may be issued in
tandem with options granted under the Plan. These SARs entitle the holder to
receive, without any payment to EBI, either cash or shares of EBI common stock,
or a combination thereof, in an amount or having a fair market value determined
as of the date of exercise equal to the excess of the fair market value per
share on the date of exercise of the SAR over the price of
61
<PAGE>
the related option. Options granted under the Option Plan become exercisable
over a three-year period (one-third per year), or earlier upon a change in
control as defined in the Second Amendment to the Option Plan. SARs become
exercisable only in the event of a change of control. Such a change in control
occurred during 1996 as a result of the sale of the Branches, thus accelerating
the vesting of all of the Company's employee stock options and their related
SARs.
In 1995, the Company also adopted the Essex Bancorp, Inc. Non-Employee Directors
Stock Option Plan (the "Directors Option Plan"), which was submitted to and
approved by the shareholders of EBI in May 1995. In June 1995, EBI's board of
directors approved the First Amendment to the Directors Option Plan. The First
Amendment reduced the maximum number of options and rights which can be granted
with respect to EBI common stock under the Directors Option Plan to 20,000
shares. Similar to the Option Plan, SARs may be issued in tandem with options
granted under the Directors Option Plan.
The following table summarizes activity under the option plans for years ended
December 31, 1996 and 1995 and the status at December 31, 1996.
<TABLE>
<CAPTION>
Option Plan Directors Option Plan
---------------------- ------------------------
Number of Option Number of Option
Options Price Options Price
------- ----- ------- -----
<S> <C> <C> <C> <C>
Options granted, June 30, 1995 498,233 $0.9375 2,000 $0.9375
Granted - - 900 3.8750
Canceled (56,692) 0.9375 - -
-------- ------
Options outstanding, December 31, 1995 441,541 0.9375 2,900 0.9375-3.8750
Granted 40,398 3.2500 1,350 2.0625
Exercised (210,955) 0.9375 (1,000) 0.9375
Canceled (10,000) 3.2500 - -
Canceled (46,294) 0.9375 - -
-------- ------
Options outstanding, December 31, 1996 214,690 0.9375-3.2500 3,250 0.9375-3.8750
======== ======
Options exercisable as of December 31, 1996 214,690 0.9375-3.2500 1,900 0.9375-3.8750
======== ======
Options available for future grant
as of December 31, 1996 504,355 15,750
======== ======
</TABLE>
In October 1995, the FASB issued Statement No. 123 - Accounting for Stock-Based
Compensation ("SFAS 123"), which became effective January 1, 1996. SFAS 123
prescribes accounting and reporting for all stock-based compensation plans,
including employee stock options. SFAS 123 does not require companies to change
their existing accounting for employee stock options under Accounting Principles
Board Opinion No. 25 - Accounting for Stock Issued to Employees ("APB 25").
Instead the new rules encourage companies to recognize expense for stock-based
awards based on their estimated fair value on the grant date. Companies electing
to continue following present accounting rules under APB 25 are required to
provide pro forma disclosures of what net income and earnings per share would
have been had the fair value method been used. During 1996, the Company followed
the accounting rules of APB 25. Accordingly, because of the accelerated vesting
of substantially all of the Company's stock options and their related SARs in
accordance with the change in control provisions of the Option Plan, the
Company's method of accounting for its stock option liability resulted in
compensation expense based on changes in the Company's common stock price. This
method of accounting conforms with the provisions of SFAS 123 for awards that
call for settlement in cash rather than by issuing equity instruments.
Therefore, the provisions of SFAS 123 requiring pro forma disclosures based on
the fair value method of accounting for stock-based compensation are not
applicable to the Company.
62
<PAGE>
Stock Purchase Plan. In 1995, the Company adopted the Essex Bancorp, Inc.
Employee Stock Purchase Plan (the "Stock Purchase Plan"), which was submitted
and approved by the shareholders of EBI in May 1995. The Stock Purchase Plan
permits all eligible employees of the Company to purchase through after-tax
payroll deductions, at a 15% discount, shares of the Company's common stock.
During the year ended December 31, 1996, employees acquired approximately 3,694
newly-issued shares of the Company's common stock under the Stock Purchase Plan.
Per Unit Allocations: The historical allocations of net income (loss) based on
the Partnership's former allocation formula for the year ended December 31, 1994
was as follows:
Allocation of net income (loss):
Class A Units $ 8,037,660
General Partner's interest 5,052,032
------------
$ 13,089,692
============
Net income (loss) per:
Class A Unit $ 3.87
Average number of units outstanding:
Class A Units 2,078,382
------------
Common Units 2,078,382
============
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 - Disclosure About Fair
Value of Financial Instruments ("SFAS 107"), requires the disclosure of
estimated fair values for financial instruments. Quoted market prices, if
available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company's financial instruments, the fair value of such instruments has been
based on assumptions, which management believes to be reasonable, with respect
to future economic conditions, the amount and timing of future cash flows and
estimated discount rates. Different assumptions could significantly affect these
estimates. Because these estimates do not necessarily represent actual purchases
or sales of financial instruments, the market value could be materially
different from the estimates presented below. In addition, the estimates are
only indicative of individual financial instruments' value and should not be
considered an indication of the fair value of the Company taken as a whole.
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments. Much of the
information used to determine fair value is highly subjective and judgmental in
nature, and therefore, the results may not be precise. The subjective factors
utilized include, among other things, estimates of cash flows, risk
characteristics, credit quality, and interest rates, all of which are subject to
change. In addition, the calculation of estimated fair values is based on market
conditions at December 31, 1996 and 1995 and may not be reflective of current or
future fair values.
Financial Assets. The carrying amounts reported for cash and cash equivalents,
FHLB stock, loans held for sale, and securities available for sale approximate
those assets' fair values. Fair values for securities and mortgage-backed
securities held for investment are based on quoted market prices or dealer
quotes. The fair value of residential and consumer loans held for investment is
based on the Sensitivity Report produced for the Bank by the FHLB. The fair
value of excess servicing fees receivable is based on the present value of
future servicing revenue in excess of normal servicing revenue on loans sold.
The fair values in this Sensitivity Report are
63
<PAGE>
determined by discounted cash flows based upon yield, maturity, repricing, and
current rate data reported by the Bank to the OTS. Commercial real estate and
construction and development loans are valued based upon discounted cash flows
with discount rates approximating rates that would be offered those individual
borrowers to extend their credits as of December 31, 1996 and 1995. For
nonperforming loans, the estimated fair value is not greater than the estimated
fair value of the underlying collateral.
Financial Liabilities. The fair value of demand deposits, savings accounts, and
money market deposits is the amount payable on demand at the reporting date. The
fair values of fixed maturity certificates of deposit, FHLB advances, and
subordinated capital notes are based on the Sensitivity Report produced for the
Bank by the FHLB. The fair values in this Sensitivity Report are determined by
discounted cash flows based upon maturity, cost, and current rate data as
reported by the Bank to the OTS. The carrying amount of notes payable
approximates the fair value for those liabilities.
The Company has off-balance sheet financial instruments in the form of
commitments to extend credit, recourse on PMSRs acquired from third parties, and
recourse on loans sold to third parties. Because commitments to extend credit
approximate current market commitment terms, their fair value is not considered
significant. The fair value of recourse on PMSRs acquired from third parties and
loans sold to third parties is the estimated loss allocated to off-balance sheet
recourse.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------ -----------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(in thousands)
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents..................... $ 6,195 $ 6,195 $ 16,009 $ 16,009
FHLB stock.................................... 2,540 2,540 3,603 3,603
Securities available for sale................. 9 9 1,494 1,494
Securities held for investment................ 6,003 5,890 7,999 7,840
Mortgage-backed securities available for sale. - - 13,744 13,744
Mortgage-backed securities held for
investment................................. 1,905 1,869 1,906 1,806
Loans held for sale........................... 2,463 2,463 3,263 3,263
Loans held for investment, net................ 145,551 147,123 266,632 271,778
Originated mortgage servicing rights.......... 1,143 1,143 1,555 1,555
Financial Liabilities
Deposits with no stated maturity.............. $ 25,360 $ 25,361 $ 39,879 $ 39,879
Time deposits................................. 105,673 105,977 243,618 246,266
FHLB advances................................. 25,690 25,767 29,833 30,210
Notes payable................................. 96 96 120 120
Capital lease obligations..................... 385 386 425 431
Subordinated capital notes.................... - - 628 636
Off-balance sheet commitments
and recourse obligations................... - 89 - 113
</TABLE>
64
<PAGE>
NOTE 21 - REGULATORY MATTERS
Regulatory Capital. The Bank is required pursuant to the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and OTS regulations
promulgated thereunder to satisfy three separate requirements of specified
capital as a percent of the appropriate asset base: a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
At December 31, 1996, the Bank was in compliance with the capital requirements
established by FIRREA.
Section 38 of the Federal Deposit Insurance Act, as added by the FDIC
Improvement Act ("FDICIA"), requires each appropriate agency and the FDIC to,
among other things, take prompt corrective action ("PCA") to resolve the
problems of insured depository institutions that fall below certain capital
ratios. Federal regulations under FDICIA classify savings institutions based on
four separate requirements of specified capital as a percent of the appropriate
asset base: tangible equity, Tier I core capital, Tier I risk-based capital, and
total risk-based capital. As of December 31, 1996, the Bank was "well
capitalized" for PCA purposes as compared to "adequately capitalized" for PCA
purposes as of December 31, 1995.
The Bank's capital amounts and ratios as of December 31, 1996 and 1995 are
presented in the following tables (dollars in thousands):
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996
Total capital (to
risk-weighted assets) $16,495 14.73% $8,959 8.0% $11,198 =>10.0%
Tier I capital (to
risk-weighted assets) 15,090 13.48% 4,480 4.0% 6,719 =>6.0%
Tier I capital (to
total assets) 15,090 8.66% 6,969 4.0% 8,711 =>5.0%
Tangible capital (to
total assets) 15,090 8.66% 2,613 1.5% - -
</TABLE>
<TABLE>
<CAPTION>
To Be Adequately
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
----------------- ----------------- --------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1995
Total capital (to
risk-weighted assets) $16,927 8.89% $15,250 8.0% $15,250 =>8.0%
Tier I capital (to
risk-weighted assets) 14,181 7.44% 7,625 4.0% 7,625 =>4.0%
Tier I capital (to
total assets) 14,181 4.28% 13,267 4.0% 13,267 =>4.0%
Tangible capital (to
total assets) 14,181 4.28% 4,975 1.5% - -
</TABLE>
Regulatory Compliance. On June 30, 1995, EBI and the Bank entered into a
definitive agreement to acquire Home Bancorp and its wholly-owned subsidiary,
Home Savings. The Home Acquisition was consummated on September 15, 1995, and as
a result of the transaction, the OTS terminated supervisory agreements EBI and
the Bank had entered into with the OTS. However,
65
<PAGE>
the boards of directors of EBI and the Bank have undertaken, as required by the
OTS, to continue to implement and adhere to the spirit of the provisions of the
agreements. Such provisions include restrictions on dividend payments and
expense reimbursements, and among other areas of compliance, restrictions on
transactions with affiliates, continued oversight of asset quality, and the
submission of an updated business plan for 1997, which was submitted to the OTS
on January 3, 1997.
The much-improved capital ratios of the Bank as of December 31, 1996 resulted
from the impact of the sale of the Branches on the Bank's total asset size.
While management is of the opinion that capital compliance will be maintained
throughout 1997, maintaining compliance with all regulatory capital requirements
beyond the near term and enhancing shareholder value will depend to a
significant degree on the Bank's ability to generate recurring profitability. To
that end, the boards of directors of EBI and the Bank and the Committee continue
to evaluate profitability enhancements and possibilities for corporate
restructurings.
Management plans to focus on (i) the reduction in the level of noninterest
expenses in relation to the Company's asset size through cost reduction and
containment strategies, (ii) the prudent utilization of capital and improvement
in net interest margin through loan growth with an emphasis on community
consumer lending and construction loan production and (iii) an emphasis on core
deposit relationships with the Bank's customers to provide a stabilized source
of funds for growth.
NOTE 22 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial information of EBI is presented below. As a result of the
Merger described in Note 1, the parent company information presented within this
note includes the operating results of the Partnership for the year ended
December 31, 1994. While the supervisory agreements with the OTS are no longer
in effect as a result of the Home Acquisition, the Company is still obligated to
comply with the spirit of the agreements. Therefore, the Bank is currently
precluded from making dividend payments to EBI.
Balance Sheets
December 31, 1996 and 1995
(in thousands)
1996 1995
---- ----
ASSETS
Cash $ 117 $ 195
Investment in subsidiaries 15,458 22,884
Other 1 156
------- -------
$15,576 $23,235
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Notes payable $ 96 $ 120
Redeemable Preferred Stock redemption proceeds payable 90 194
Other 284 291
------- -------
Total Liabilities 470 605
SHAREHOLDERS' EQUITY 15,106 22,630
------- -------
$15,576 $23,235
======= =======
66
<PAGE>
Statements of Operations
For the years ended December 31, 1996, 1995 and 1994
(in thousands)
1996 1995 1994
------- ------- --------
Interest expense on notes payable $ (11) $ (113) $ (723)
Net operating income (expenses) 60 686 (197)
------- ------- --------
Net income (loss) before undistributed loss
of subsidiaries and extraordinary items 49 573 (920)
Undistributed income (loss) of subsidiaries (7,426) (4,466) 14,010
------- ------- --------
Net income (loss) before extraordinary items (7,377) (3,893) 13,090
Extraordinary items -- 2,683 --
------- ------- --------
Net income (loss) $(7,377) $(1,210) $ 13,090
======= ======= ========
Statements of Cash Flows
For the years ended December 31, 1996, 1995 and 1994
(in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $(7,377) $ (1,210) $ 13,090
Adjustments to reconcile net income (loss) to
cash provided by (used in) operating activities:
Extraordinary item - forgiveness of debt -- (2,683) --
Equity in (income) loss of subsidiaries 7,426 4,466 (14,010)
Amortization of organization costs -- -- 20
Accretion of premium on notes payable -- -- (24)
Decrease (increase) in other assets 1 (432) 143
Increase (decrease) in other liabilities (7) (118) 777
------- -------- --------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 43 23 (4)
------- -------- --------
FINANCING ACTIVITIES
Proceeds from notes payable -- 1,004 4
Payments on notes payable (24) -- --
Redemption of Settlement Preferred Stock (104) (832) --
Common stock issued under the Employee Stock
Purchase Plan 7 -- --
------- -------- --------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (121) 172 4
------- -------- --------
NET INCREASE (DECREASE) IN CASH (78) 195 --
CASH AT BEGINNING OF PERIOD 195 -- --
------- -------- --------
CASH AT END OF PERIOD $ 117 $ 195 $ --
======= ======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES
Valuation of preferred stock and warrants issued
in connection with the Home Acquisition $ -- $ 15,545 $ --
Transfer by the Partnership of assets and
liabilities to EBI -- -- 5,859
Capitalization of accrued interest on the
10-Year and 7-Year Notes -- -- 550
</TABLE>
67
<PAGE>
NOTE 23 - SEGMENT DATA
The Company's major business segments consist of (i) attracting deposits from
the general public and using such deposits, together with borrowings in the form
of advances from the FHLB and other sources of funds, for reinvestment in real
estate mortgages, other loans, investments, and mortgage-backed securities (the
"Retail Banking Segment"), and (ii) the origination of real estate mortgage
loans for sale to third parties with servicing retained in certain instances
(the "Mortgage Banking Segment"). The Retail Banking Segment depends on the
difference between interest earned on loans and investments over interest paid
on deposits to fund operating activities and generate a profit. Historically,
the nature of the Company's branch activities resulted in less reliance on
deposit service charges and other ancillary income. However, this strategy is in
transition as the Company moves to more traditional banking.
The Mortgage Banking Segment depends on gains from the sale of loans in the
secondary market and loan servicing income to fund operating expenses. During
the years ended December 31, 1996, 1995, and 1994, predominantly all loans
originated by the Company were sold on a servicing released basis in order to
supplement the regulatory capital of the Bank.
The following table summarizes the mix of the major business segments (in
thousands):
<TABLE>
<CAPTION>
Retail Mortgage
Banking Banking
Segment Segment Consolidated
------- ------- ------------
<S> <C> <C> <C>
1996
Total revenue $ 7,652 $ 2,738 $ 10,390
Loss before extraordinary items
and income taxes (6,187) (1,190) (7,377)
Depreciation and amortization of
premises and equipment 313 226 539
Identifiable assets 169,457 4,810 174,267
1995
Total revenue $ 6,402 $ 2,690 $ 9,092
Loss before extraordinary items
and income taxes (2,452) (1,703) (4,155)
Depreciation and amortization of
premises and equipment 262 228 490
Identifiable assets 332,454 6,270 338,724
1994
Total revenue $ 8,318 $ 2,759 $ 11,077
Loss before cumulative effect
of change in accounting principle,
extraordinary item, and income taxes (4,921) (2,584) (7,505)
Depreciation and amortization of
premises and equipment 317 235 552
Identifiable assets 287,943 8,288 296,231
</TABLE>
Revenue is defined as net interest income before loan loss provisions plus
noninterest income. Revenue by major business segment represents revenue from
unaffiliated customers.
68
<PAGE>
The Mortgage Banking Segment consists of the operations of Essex First Mortgage
Corporation, a wholly-owned subsidiary of the Bank engaged primarily in the
origination and sale of residential mortgage loans; Essex Home Mortgage
Servicing Corporation and its subsidiary, indirect subsidiaries of EBI and the
Bank that are engaged primarily in the servicing of mortgage loans owned by the
Bank, various governmental agencies, and various third party investors; and EMC,
a direct subsidiary of EBI that has been engaged in various mortgage banking
activities. Furthermore, the Mortgage Banking Segment includes the OMSRs and
PMSRs held by the Bank, in addition to income and expenses associated with these
servicing assets, such as the Bank's loan servicing fees and related
amortization of the OMSRs and PMSRs.
The Retail Banking Segment consists of all interest-earning assets,
interest-bearing liabilities, and related net interest income after provision
for loan losses of EBI and its subsidiaries, in addition to the operations of
EBI, the Partnership, the Bank (excluding the impact of servicing assets and
related income and expenses), and Essex Capital Corporation.
69
<PAGE>
INVESTOR INFORMATION
Annual Meeting of Stockholders
The Annual Meeting of Stockholders of Essex Bancorp, Inc. will be held at
The Koger Center, Building 9, Second Floor Conference Room, Norfolk, Virginia on
May 29, 1997 at 1:00 p.m.
Stock Price Information
Essex Bancorp, Inc.'s common stock is listed on the American Stock
Exchange (AMEX) under the symbol "ESX." The table below sets forth the high and
low sales prices of the common stock, as reported by the AMEX during 1996 and
1995.
1996 1995
------------------ -----------------
Quarter High Low High Low
- ------- ---- --- ---- ---
First $5.0000 $2.0000 $6.2500 $1.7500
Second 3.2500 2.0000 2.1250 0.6250
Third 2.8125 1.5000 5.6250 1.0000
Fourth 2.3750 1.7500 5.0000 1.6250
Stock Transfer Agent
Stockholders who have questions about their accounts or who wish to change
ownership or address of stock; to report lost, stolen or destroyed certificates;
or to consolidate accounts, should contact:
Service Data Corporation
2424 South 130th Circle
Omaha, Nebraska 68144
Telephone (800) 223-3464
Annual Report on Form 10-K and Additional Information
A copy of Form 10-K as filed with the Securities and Exchange Commission is
available without charge to stockholders upon written request. Requests for this
or other financial information about Essex Bancorp, Inc. should be directed to:
Jennifer L. DeAngelo, Corporate Secretary
Essex Bancorp, Inc.
The Koger Center, Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1326
Independent Accountants
Price Waterhouse LLP
700 World Trade Center
Norfolk, Virginia 23510-9916
Telephone (757) 622-5005
70
<PAGE>
DIRECTORS AND OFFICERS
EXECUTIVE OFFICERS
Gene D. Ross
Chairman, President and Chief Executive
Officer
Essex Bancorp, Inc.,
Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing
Corporation
Roy H. Rechkemmer, Jr.
Vice President-Finance/Treasurer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Mary-Jo Rawson
Chief Accounting Officer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Earl C. McPherson
President and Chief Executive Officer
Essex First Mortgage Corporation
DIRECTORS
Gene D. Ross
Chairman, President and Chief Executive
Officer
Essex Bancorp, Inc.
Roscoe D. Lacy, Jr.
Vice President and General Manager
Miles Jennings, Inc.
Elizabeth City, North Carolina
(industrial supply company)
Robert G. Hecht
Chief Executive Officer
Trumbull Corporation
Pittsburgh, Pennsylvania
(highway construction company)
Harry F. Radcliffe
President and Chief Executive Officer
First Home Savings Bank, F.S.B.
Pittsburgh, Pennsylvania
71
<PAGE>
CORPORATE INFORMATION
Executive Offices
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Subsidiaries of Essex Bancorp, Inc.
Essex Savings Bank, F.S.B.
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Essex Home Mortgage Servicing
Corporation
2420 Virginia Beach Boulevard, Suite 109
Virginia Beach, Virginia 23454
Telephone (757) 631-4240
Subsidiary of Essex Savings Bank, F.S.B.
Essex First Mortgage Corporation
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Essex Savings Bank, F.S.B.
Retail Banking Offices
Virginia
520 South Main Street
Emporia, Virginia 23847
1401 Gaskins Road
Richmond, Virginia 23233
1455 N. Main Street
Suffolk, Virginia 23434
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
Telephone (919) 338-0871
Essex First Mortgage Corporation
Mortgage Loan Production Offices
Virginia
1401 Gaskins Road
Richmond, Virginia 23233
2430 Southland Drive, 3rd Floor
Chester, Virginia 23831
The Koger Center, Building 9, Suite 100
Norfolk, Virginia 23502
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
Registrant's 1996 Annual Report to Stockholders.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,824
<INT-BEARING-DEPOSITS> 1,727
<FED-FUNDS-SOLD> 2,644
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 9
<INVESTMENTS-CARRYING> 7,908
<INVESTMENTS-MARKET> 7,759
<LOANS> 148,115
<ALLOWANCE> 2,556
<TOTAL-ASSETS> 174,267
<DEPOSITS> 131,033
<SHORT-TERM> 16,221
<LIABILITIES-OTHER> 1,947
<LONG-TERM> 9,960
0
15,000
<COMMON> 11
<OTHER-SE> 95
<TOTAL-LIABILITIES-AND-EQUITY> 174,267
<INTEREST-LOAN> 17,882
<INTEREST-INVEST> 1,113
<INTEREST-OTHER> 877
<INTEREST-TOTAL> 19,872
<INTEREST-DEPOSIT> 11,945
<INTEREST-EXPENSE> 13,764
<INTEREST-INCOME-NET> 6,108
<LOAN-LOSSES> 1,411
<SECURITIES-GAINS> 153
<EXPENSE-OTHER> 16,356
<INCOME-PRETAX> (7,377)
<INCOME-PRE-EXTRAORDINARY> (7,377)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,377)
<EPS-PRIMARY> (1.72)
<EPS-DILUTED> (1.72)
<YIELD-ACTUAL> 2.41
<LOANS-NON> 2,908
<LOANS-PAST> 30
<LOANS-TROUBLED> 223
<LOANS-PROBLEM> 2304
<ALLOWANCE-OPEN> 5,251
<CHARGE-OFFS> 4,132
<RECOVERIES> 26
<ALLOWANCE-CLOSE> 2,556
<ALLOWANCE-DOMESTIC> 2,440
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 116
</TABLE>
