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
For the fiscal year ended December 31, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10506
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Essex Bancorp, Inc.
(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
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(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 25, 1998 held by nonaffiliates of the
Registrant was $5,536,582.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1997 are incorporated by reference into Parts I and II hereof.
Portions of the Proxy Statement for the Annual Meeting to be held on May 28,
1998 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, 1997
Table of Contents
Page
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Part I
Item 1 Business................................................ 3
Item 2 Properties.............................................. 41
Item 3 Legal Proceedings....................................... 41
Item 4 Submission of Matters to a Vote
of Security Holders................................. 42
Part II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters..................... 42
Item 6 Selected Financial Data................................. 43
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations........................... 43
Item 8 Financial Statements and
Supplementary Data.................................. 43
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure................................ 43
Part III
Item 10 Directors and Executive Officers
of the Registrant................................... 44
Item 11 Executive Compensation.................................. 45
Item 12 Security Ownership of Certain
Beneficial Owners and Management.................... 45
Item 13 Certain Relationships and
Related Transactions................................ 45
Part IV
Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K............................. 46
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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, 1997. 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
<TABLE>
<S> <C>
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| The Company |
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| The Bank | | EMC | | EAC |
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| 69% | 31%
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| Essex First | | ECC |
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| Essex Home |
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| EHADC |
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</TABLE>
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. At December 31, 1997, the Company had total
assets of $195.1 million, total liabilities of $180.3 million, including total
deposits of $153.9 million, and total shareholders' equity of $14.8 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 raised $41.6 million in partnership equity in order to fund
the acquisition of smaller, predominantly undercapitalized thrift institutions
located in the southeastern United States. The Partnership's goal was to
operationally link these thrift institutions through common control by Bancorp,
a multi-state thrift holding company. The bank branch network was 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, however, made only three acquisitions.
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 mortgage servicing rights 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 purchased and originated servicing rights portfolios
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.
By mid-1992, the Partnership was (i) operating under a broadly
restrictive supervisory agreement imposed by its regulators after the 1990
examination of the Partnership and its subsidiaries, (ii) failing its regulatory
capital requirements, an event which required the submission of a capital
restoration plan, (iii) in default on certain terms of the indenture under which
the Essex 11's were issued and (iv) indefinitely delaying payment of dividends
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 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 Essex Savings Bank, F.S.B. (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
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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 mortgage servicing
rights, 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 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.
6
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Capital Raising Efforts. On June 29, 1995, the Office of Thrift
Supervision ("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
Resolution Trust Company ("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 $15.0 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
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 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 markets 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 asset 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 7.9% tangible capital as of
December 31, 1997 and has largely removed goodwill from its balance sheet. See
Note 5 on pages 37 and 38 of the Notes to Consolidated Financial Statements of
the 1997 Annual Report to Stockholders, which is attached hereto as Exhibit 13
and incorporated herein by reference.
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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. This parcel was acquired in 1997 and construction has begun
on the new retail bank branch, which will be completed in April 1998.
Expansion of Residential Construction and Consumer Lending. Since 1992,
the Company has increased its emphasis on 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
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
purchased and originated mortgage servicing rights 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. During
1997, the Company implemented additional cost reductions so that the on-going
expense structure is compatible with institutions the Company's size and nature
of business. 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 $3.3 million or 1.69% of total assets at December
31, 1997. Such results for 1997 are over a significantly smaller asset base than
the results for 1992. 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 $940,000 or 0.6% of total loans held for investment at December 31,
1997. Reduced provisions for loan losses contributed to improved operating
results during the year ended December 31, 1997.
Expansion of Subservicing Activities. In its efforts to generate fee
income, the Bank continues to pursue profitable residential mortgage loan
servicing and subservicing. Essex Home is a service corporation subsidiary
licensed by the Federal National Mortgage Association ("Fannie Mae"), the
Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Government
National Mortgage Association ("Ginnie Mae"). Essex Home also services and
subservices loans for approximately 50 other private investors.
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Through various networking and referral opportunities and advertising
efforts, Essex Home has 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. 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. Because no
assurances could be made that this significant servicing volume could be
replaced in its entirety in the near term, Essex Home implemented a plan for
operating expense reductions. Notwithstanding the impact of the cancellation of
this subservicing contract, Essex Home offset some of the reduction in its
servicing portfolio in 1997 by acquiring servicing rights and by entering into
18 new subservicing contracts consisting of approximately 2,100 loans with an
aggregate principal balance of $201.4 million as of December 31, 1997.
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. During 1997, underwriting policies were further expanded to include
an assessment of the Year 2000 readiness of potential commercial borrowers.
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. The Bank's one-year interest rate sensitivity gap
amounted to a negative 14.9% at December 31, 1997, which reflects the impact of
shortening deposit maturities as the Bank's deposit customers are reluctant to
enter into extended maturities in the current low interest rate environment. The
negative gap also reflects near-term maturities of higher-rate Federal Home Loan
Bank advances. The Company will benefit from the lower cost of funds as these
borrowings mature and may consider extended maturities in order to mitigate the
impact of an increase in interest rates in the future. While the Company
continues to emphasize investment in adjustable-rate loan portfolios, customer
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demand for such loans is lessening as borrowers demand for lower fixed-rate
loans is increasing. Within the spectrum of loan products offered by the Bank,
the percentage of balloon payment and adjustable-rate loans with longer initial
adjustment terms has increased. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Market Risk Management" on pages
16 through 19 of the 1997 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 Federal Deposit Insurance Corporation
("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 comprising 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.
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, 1997, the Company's net loan portfolio
(excluding loans classified as held for sale) totaled $167.4 million,
representing approximately 85.8% of its $195.1 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 Federal Housing Administration ("FHA") nor partially guaranteed
by the Veterans Administration ("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. The Company 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
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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 borrower if
the loans are fully secured by readily marketable securities. See "Regulation -
Regulation of the Bank - General." At December 31, 1997, 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, 1997, the Bank's five largest commercial loans-to-one
borrower and their related entities amounted to $1.4 million, $1.2 million,
$565,000, $515,000 and $448,000. In addition, as of December 31, 1997, the
Bank's largest lines of credit with unaffiliated home builders consisted of one
in the amount of $2.0 million (of which $716,000 had been drawn upon as of such
date), another in the amount of $1.5 million (of which $959,000 had been drawn
upon as of such date), another in the amount of $1.5 million (of which $214,000
had been drawn upon as of such date), another in the amount of $1.5 million (of
which $185,000 had been drawn upon as of such date) and another in the amount of
$1.3 million (of which $29,000 had been drawn upon as of such date). At December
31, 1997, the $1.4 million loan was 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 $1.4 million group of loans consists of (i) a commercial real
estate loan of $955,000 as of December 31, 1997, 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
with an outstanding balance of $440,000 as of December 31, 1997. 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, 1997, the Bank and
its subsidiaries leased ten of the mini-storage units. The property was most
recently appraised in November 1992 for $915,000. As of December 31, 1997, the
Bank had established a $300,000 specific reserve with respect to the loans and
the remaining $1.1 million was classified as substandard.
11
<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>
<S> <C>
December 31,
------------------------------------------------------------------
1997 1996 1995
---- ---- ----
$ % $ % $ %
- - - - - -
(dollars in thousands)
Real estate:
Single-family residential:
First mortgages................ $130,486 76.8% $103,643 70.0% $223,531 82.1%
Second mortgages............... 8,699 5.1 12,384 8.3 13,398 4.9
Construction and development..... 16,583 9.8 17,190 11.6 15,078 5.5
Commercial real estate........... 5,970 3.5 6,313 4.3 10,611 3.9
-------- ---- -------- ---- -------- ----
Total real estate loans........ 161,738 95.2 139,530 94.2 262,618 96.4
Commercial business loans........... 1,883 1.1 1,915 1.3 2,171 .8
Consumer loans:
Other............................ 5,426 3.2 5,828 3.9 6,488 2.4
Secured by deposits.............. 805 .5 842 .6 994 .
-------- ---- -------- ---- -------- ----
Total consumer loans........... 6,231 3.7 6,670 4.5 7,482 2.8
-------- ---- -------- ---- -------- ----
Total Loans.............. 169,852 100.0% 148,115 100.0% 272,271 100.0%
===== ===== =====
Less:
Unearned loan fees and discounts. 29 8 388
Allowance for loan losses........ 2,382 2,556 5,251
--------- --------- ---------
2,411 2,564 5,639
--------- --------- ---------
Net Loans................ $167,441 $145,551 $266,632
======= ======= =======
<CAPTION>
1994 1993
---- ----
$ % $ %
- - - -
Real estate:
Single-family residential:
First mortgages................ $187,607 77.7% $159,398 75.8%
Second mortgages............... 18,717 7.8 24,851 11.8
Construction and development..... 15,501 6.4 9,137 4.4
Commercial real estate........... 11,499 4.8 10,781 5.1
-------- ---- -------- ----
Total real estate loans........ 233,324 96.7 204,167 97.1
Commercial business loans........... 1,824 .8 1,946 .9
Consumer loans:
Other............................ 5,320 2.2 2,884 1.4
Secured by deposits.............. 835 .3 1,263 .6
-------- ---- -------- ----
Total consumer loans........... 6,155 2.5 4,147 2.0
-------- ---- -------- ----
Total Loans.............. 241,303 100.0% 210,260 100.0%
===== =====
Less:
Unearned loan fees and discounts. 482 440
Allowance for loan losses........ 3,429 3,039
--------- ---------
3,911 3,479
--------- ---------
Net Loans................ $237,392 $206,781
======= =======
</TABLE>
12
<PAGE>
Total loans decreased by an aggregate of $40.5 million or 19.3% from
December 31, 1993 to December 31, 1997 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. The acquisition of $22.2 million of adjustable rate first
mortgage loans in 1997 partially offsets the decline and reflects the Company's
strategy of investing proceeds from the maturities of investment securities and
funds provided by the growth in deposits into higher yielding loans. Since 1992,
the Company has placed increased emphasis on single-family first mortgage loans,
which, together with construction loans secured by single-family residences,
increased from 80.2% of total loans held for investment at December 31, 1993 to
86.6% of total loans held for investment at December 31, 1997. Single-family
second mortgage loans declined substantially from 11.8% of total loans held for
investment at December 31, 1993 to 5.1% of total loans held for investment at
December 31, 1997. 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. Commercial real
estate loans decreased from 5.1% of total loans held for investment at December
31, 1993 to 3.5% of total loans held for investment at December 31, 1997, while
commercial business loans increased slightly from .9% of total loans held for
investment at December 31, 1993 to 1.1% of total loans held for investment at
December 31, 1997. Consumer loans increased from 2.0% of total loans held for
investment at December 31, 1993 to 3.7% of total loans held for investment at
December 31, 1997. The Company increased its emphasis during 1997 and 1996 on
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, 1997. 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>
<S> <C>
Commercial Commercial
Construction Real Estate Business Total
------------ ----------- -------- -----
(dollars in thousands)
Amounts due:
One year or less $15,876 $ 268 $1,102 $17,246
After one year through
five years 157 3,773 781 4,711
Beyond five years 550 1,929 - 2,479
-------- ----- -------- -------
Total $16,583 $5,970 $1,883 $24,436
Interest rate terms on
amounts due after one
year:
Fixed $ 339 $1,418 $ 678 $ 2,435
======= ===== ===== =======
Adjustable $ 368 $4,284 $ 103 $ 4,755
======= ===== ===== =======
</TABLE>
Origination, Purchase and Sale of 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 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 has
13
<PAGE>
enabled 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, 1997, Essex First conducted its operations out of four offices,
which are located in Norfolk, 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, 1997, 1996, and 1995, Essex First originated $65.6 million, $104.2 million
and $101.8 million of loans (consisting primarily of both permanent and
construction loans secured by single-family residential real estate). During
such periods, $25.9 million, $29.3 million and $26.3 million of such loans,
respectively, were sold by Essex First to the Bank, with the remainder 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 Freddie Mac, Fannie Mae and Ginnie Mae. 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
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 conventional loans in the secondary market with recourse,
and may continue to sell certain conventional loans in the secondary market with
recourse. However, as of December 31, 1997 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. 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. Alternatively, when loans are sold with servicing
retained, the Company recognizes additional gains based on the estimated 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 officers
are compensated in accordance with pricing guidelines which are based on the
purchase price received from the third party investors purchasing the loans.
Therefore, in most cases, the loan officer 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
14
<PAGE>
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 reflected in the loan officer'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 markets. During
the years ended December 31, 1997 and 1995, the Bank purchased $22.2 million and
$50.7 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 accommodate the sale of the Branches.
At December 31, 1997, 1996, and 1995, loans classified by the Company
as held for sale amounted to $2.2 million, $2.5 million and $3.3 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 37 and 38 of the Notes to Consolidated Financial Statements of the 1997
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 officers who solicit and refer mortgage loan applications
to Essex First. These loan officers 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 lending program, which
consists primarily of construction/permanent ("C/P") lending. 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 underwriting guidelines and
procedures (which generally follow Freddie Mac and Fannie Mae 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, they are 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 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
15
<PAGE>
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. 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 the Bank or at nonaffiliated banks if so
required by the mortgage investors.
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 ("Lending Guidelines"). The
Lending 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 Lending Guidelines, including supervisory loan-to-value ("LTV") limits, loan
portfolio management, loan administration procedures and underwriting standards.
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 calculating this ratio. The Lending 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 Lending 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, 1997, $130.4 million
or 76.8% of the Company's total loans held for investment consisted of such
loans.
16
<PAGE>
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. These loans have up to 30-year terms
and interest rates which adjust 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 certain loans
(i.e., ARMs with 95% LTV) on a basis that is no less stringent than the
underwriting guidelines of the Fannie Mae. 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
56.4% of the permanent single-family residential loans in the Company's loan
portfolio held for investment at December 31, 1997 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
and the loan rates adjust upward, 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, depending on the LTV and the
initial repricing frequency of the ARMs, the Company underwrites certain of
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, 1997, approximately 43.6% 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 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 an owner-occupied 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.
17
<PAGE>
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. Substantially all of 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, 1997, home
equity lines of credit totaled $417,000 ($248,000 of which had been utilized by
borrowers 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, the Tidewater, Virginia area and counties in northeastern North
Carolina. At December 31, 1997, construction loans amounted to $16.6 million or
9.8% 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 loan originations are made by Essex First loan officers or through the
wholesale C/P lending program, which is a network of 68 approved brokers. 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, 1997, the Company's C/P portfolio included 60 C/P loans
with an aggregate principal balance of $7.1 million (and an additional $10.9
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 for the construction of 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 100 basis points to 200 basis
points 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. 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
18
<PAGE>
and total exposure to other lenders. Although at December 31, 1997, 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, 1997, the
Company's construction loan portfolio included 101 loans to 39 different
builders with an aggregate principal balance of $8.5 million (and an additional
$26.3 million was subject to legally binding commitments but had not been
advanced as of such date). Of this $8.5 million of builder loans, approximately
$6.8 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 LTV (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, 1997, $6.0 million or 3.5% 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, 1997, $1.3 million or 21.7% 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 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. LTV 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,
19
<PAGE>
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. At December
31, 1997, $1.9 million or 1.1% 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,
1997, $6.2 million or 3.7% 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, loans
secured by deposit accounts and unsecured personal loans.
The Company currently offers loans secured by deposit accounts, which
amounted to $805,000 at December 31, 1997. 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, 1997, the Company's loan
portfolio also included $1.5 million of automobile loans, $384,000 of mobile
home loans and $41,000 of boat and recreational vehicle loans.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans and 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 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 miscellaneous services related to its loans. Income from these
activities varies from period to period with the volume and types 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
20
<PAGE>
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 locked-in with the
buyer. Sales prices for loans originated for resale are generally locked-in 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, which are capitalized and amortized in proportion to, and over
the period of, the estimated future net servicing income stream of the
underlying mortgage loans. OMSRs amounted to $782,000, $1.1 million and $1.6
million at December 31, 1997, 1996 and 1995, respectively. For additional
information regarding the Company's servicing assets, see Note 2 of the Notes to
Consolidated Financial Statements on pages 32 through 35 of the 1997 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, 1997, approximately 8,400 loans with
principal balances of $482.7 million were serviced or subserviced by Essex Home
as compared to approximately 13,300 loans with principal balances of $1.1
billion as of December 31, 1996. On February 28, 1997, the Company was notified
by its largest subservicing client (with approximately 7,000 loans totaling
$858.9 million as of December 31, 1996) of its intention not to renew its
contract beyond June 1, 1997. As a result, during 1997 the Company's management
intensified its marketing efforts and initiated cost reductions in order to
minimize the impact of this loss on the earnings performance of Essex Home and
the Company. Essex Home has replaced a portion of the lost servicing volume by
entering into 18 new subservicing contracts consisting of approximately 2,100
loans with an aggregate principal balance of $201.4 million as of December 31,
1997 and, to a lesser extent, by acquiring mortgage servicing rights. However,
no assurances can be made that the lost servicing volume can be replaced in its
entirety in the near term.
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.
21
<PAGE>
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>
<S> <C>
December 31,
-----------------------------------------------------------------
1997 1996 1995
------------------- ------------------- --------------------
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
30-59 days (1)................. $ 645 .38% $1,156 .78% $2,222 .82%
60-89 days (1)................. 295 .17 335 .23 942 .34
90 or more days (1), (2)....... 1,577 .93 2,938 1.98 6,258 2.30
----- ----- ----- ----- ----- ----
$2,517 1.48% $4,429 2.99% $9,422 3.46%
===== ===== ===== ===== ====== ====
</TABLE>
(1) Includes at December 31, 1997, $217,000, $16,000 and $305,000 of
loans delinquent 30-59 days, 60-89 days and 90 days or more,
respectively, which were acquired in connection with the Home
Acquisition. 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 with 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 $21,000, $30,000 and $177,000 of loans that were accruing
interest at December 31, 1997, 1996, and 1995, respectively.
Nonperforming Assets. All loans are reviewed on a regular basis and are
placed in 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 in 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 in
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 loans
are initially recorded at fair value less estimated costs 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 costs to sell. Costs incurred
in connection with ownership of the property, including interest on senior
22
<PAGE>
indebtedness, are expensed to the extent not previously allowed for in
calculating fair value less estimated costs to sell. Costs relating to the
development or improvement of the property are capitalized to the extent these
costs increase fair value less estimated costs 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.
The following table sets forth information regarding nonperforming
assets held by the Company at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
December 31,
-----------------------------------------------------------------
1997 1996 1995
---- ---- ----
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
Nonaccrual loans, net:
Single-family residential................ $1,203 .71% $2,513 1.70% $ 2,959 1.09%
Construction............................. 133 .08 220 .15 378 .14
Commercial............................... 132 .08 22 .01 2,636 .97
Consumer................................. 88 .05 153 .10 108 .04
----- ----- ----- ---- ------- ----
Total nonaccrual loans................. 1,556 .92 2,908 1.96 6,081 2.24
Accruing loans 90 days or more past due..... 21 .01 30 .02 177 .06
Troubled debt restructurings................ 209 .12 223 .15 143 .05
----- ----- ----- ---- ------- ----
Total nonperforming loans.............. 1,786 1.05 3,161 2.13 6,401 2.35
Foreclosed properties, net.................. 1,512 .89 2,054 1.39 4,856 1.78
----- ----- ----- ---- ------- ----
Total nonperforming assets............. $3,298 1.94% $5,215 3.52% $11,257 4.13%
===== ==== ===== ==== ====== ====
Nonperforming loans to total loans.......... 1.05% 2.13% 2.35%
Nonperforming assets to total assets........ 1.69 2.99 3.32
Allowance for loan losses to total loans.... 1.40 1.73 1.93
Allowance for loan losses to nonaccrual
loans.................................... 153.09 87.90 86.35
Allowance for loan losses to nonperforming
loans.................................... 133.37 80.86 82.03
<CAPTION>
1994 1993
---- ----
% of % of
Total Total
Amount Loans Amount Loans
Nonaccrual loans, net: ------ ----- ------ -----
Single-family residential................ $ 3,158 1.31% $ 4,801 2.28%
Construction............................. 1,253 .52 17 .01
Commercial............................... 2,306 .96 513 .25
Consumer................................. 57 .02 93 .04
------- ---- ------- ----
Total nonaccrual loans................. 6,774 2.81 5,424 2.58
Accruing loans 90 days or more past due..... 539 .22 1,136 .54
Troubled debt restructurings................ 1,049 .44 2,948 1.40
------- ---- ------- ----
Total nonperforming loans.............. 8,362 3.47 9,508 4.52
Foreclosed properties, net.................. 5,290 2.19 8,582 4.08
------- ---- ------- ----
Total nonperforming assets............. $13,652 5.66% $18,090 8.60%
====== ==== ====== ====
Nonperforming loans to total loans.......... 3.47% 4.52%
Nonperforming assets to total assets........ 4.61 4.63
Allowance for loan losses to total loans.... 1.42 1.45
Allowance for loan losses to nonaccrual
loans.................................... 50.62 56.03
Allowance for loan losses to nonperforming
loans.................................... 41.01 31.96
</TABLE>
23
<PAGE>
Gross interest income that would have been recorded during the years
ended December 31, 1997, 1996, and 1995 if the Company's nonaccrual loans at the
end of such periods had been performing in accordance with their terms during
such periods was $171,000, $291,000 and $678,000, respectively.
The $1.6 million of nonaccrual loans at December 31, 1997 consisted of
$1.2 million of loans secured by single-family residential property, $133,000 of
construction loans (which were secured by residential property), $132,000 of
loans secured by commercial property and $88,000 of consumer loans. The $21,000
of accruing loans 90 days or more past due at December 31, 1997 consisted of one
loan secured by single-family residential property. The $209,000 of troubled
debt restructurings at December 31, 1997 consisted of three loans secured by
single-family residential property, one secured commercial loan and one
unsecured loan.
The Company's decrease in nonaccrual loans during 1997 occurred
primarily in loans secured by single-family residential property. This $1.4
million decrease was attributable to the improvement in asset quality as
evidenced by the decline in delinquencies.
The $1.5 million of foreclosed properties at December 31, 1997
consisted of $1.3 of single-family residential properties and $257,000 of land.
The Company's decrease in foreclosed properties reflected the impact of the
decline in nonperforming and delinquent loans during 1997 and prior years. In
addition, during 1997 the Company completed the sale of residential lots located
in the Outer Banks of North Carolina, which had a carrying value of $164,000 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 6 and 7 and
Notes 8 and 9 of the Notes to Consolidated Financial Statements on pages 39
through 41 of the 1997 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.
24
<PAGE>
In addition to the nonperforming assets discussed above, at December
31, 1997, the Company had classified for regulatory and internal purposes an
additional $2.1 million of assets, $1.6 million of which were classified
substandard, $149,000 of which were classified doubtful and $350,000 of which
were classified loss.
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 39 through 41 of the 1997 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>
<S> <C>
Year Ended December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(dollars in thousands)
Loans, net of unearned fees and discounts:
Year-end.................................. $169,823 $148,107 $271,883 $240,821 $209,820
Average outstanding during period......... 156,217 216,803 251,108 218,806 267,143
Allowance for loan losses:
Balance, beginning of year................ $2,556 $5,251 $ 3,429 $ 3,039 $ 4,489
Allowance transferred in connection
with the Home Acquisition............. - - 500 - -
Provision for loan losses................. 113 1,411 2,477 1,604 1,085
------ ----- --------- --------- ---------
2,669 6,662 6,406 4,643 5,574
Charge-offs, net of recoveries (1):
Commercial (2)........................ (366) 2,892 644 - 82
Real estate - mortgage................ 535 894 494 1,255 2,248
Consumer ....................... 118 320 17 (41) 205
------ ----- --------- --------- ---------
Total (2)........................ 287 4,106 1,155 1,214 2,535
------ ----- --------- --------- ---------
Balance, end of year...................... $2,382 $2,556 $ 5,251 $ 3,429 $ 3,039
===== ===== ========= ========= =========
Ratio of net charge-offs to average
outstanding loans (2)........................ .18% 1.89% .46% .55% .95%
Allowance for loan losses to year-end
total nonperforming loans.................... 133.37% 80.86% 82.03% 41.01% 31.96%
Allowance for loan losses to year-end
loans, net of unearned fees and discounts.... 1.40% 1.73% 1.93% 1.42% 1.45%
</TABLE>
(1) Except as noted in (2) below, recoveries of prior loan charge-offs
were not significant for the periods presented.
(2) Charge-offs during 1997 include a $329,000 recovery on a loan
guarantee associated with the Richmond Apartments loan and a $39,000
recovery associated with claims against the estate of a deceased
borrower. Excluding the impact of these recoveries, the ratio of net
charge-offs to average outstanding loans for 1997 was .42%.
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%.
25
<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>
<S> <C>
December 31,
----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------ ------- ------ ------- ------ -------
(dollars in thousands)
Residential mortgage $1,139 91.7% $1,636 89.9% $2,607 92.5% 2,068 91.9% $2,080 92.0%
Commercial (1) 545 4.6 505 5.6 1,530 4.7 861 5.6 387 6.0
Consumer 254 3.7 299 4.5 323 2.8 467 2.5 424 2.0
Unallocated 444 - 116 - 791 - 33 - 148 -
------ ---- ------ ---- ------ ---- ----- ---- ------ ----
$2,382 100.0% $2,556 100.0% $5,251 100.0% $3,429 100.0% $3,039 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
(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:
<CAPTION>
Year Ended December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at beginning of year..................... $ 179 $199 $ 418
Provision for losses on
foreclosed properties.......................... 159 (21) 79
---- ---- -----
338 178 497
Charge-offs, net of recoveries................... (183) 1 (298)
---- ----- ----
Balance at end of year........................... $ 155 $179 $ 199
==== === ====
</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 Freddie Mac,
Fannie Mae and Ginnie Mae.
Freddie Mac is a public corporation chartered by the U.S. Government
and owned by the 12 Federal Home Loan Banks and federally-insured member
institutions of the Federal Home Loan Bank system. Freddie Mac issues
participation certificates backed principally by conventional mortgage loans.
Freddie Mac guarantees the timely payment of interest and the ultimate return of
principal. Fannie Mae is a private corporation chartered by the U.S. Congress
with a mandate to establish a secondary market for conventional mortgage loans.
Fannie Mae guarantees the timely payment of principal and interest on Fannie Mae
securities. Freddie Mac and Fannie Mae securities are not backed by the full
faith and credit of the United States, but because Freddie Mac and Fannie Mae
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. Ginnie Mae is a government agency within the Department of
Housing and Urban Development which is intended to help finance
government-assisted housing programs. Ginnie Mae securities are backed by
26
<PAGE>
FHA-insured and VA-guaranteed loans, and the timely payment of principal and
interest on Ginnie Mae securities are guaranteed by Ginnie Mae and backed by the
full faith and credit of the U.S. Government. Because Freddie Mac, Fannie Mae
and Ginnie Mae were established to provide support for low- and middle-income
housing, there are limits to the maximum size of loans that qualify for these
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 Fannie Mae, Freddie Mac or Ginnie Mae. 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>
<S> <C>
At or For the Year Ended December 31,
---------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at beginning of year............ $1,905 $15,650 $18,223
Sales................................... - (9,915) (1) -
Repayments.............................. - (3,668) (2) (2,724)
Amortization............................ - (8) (3)
Valuation adjustments................... - (154) 154
-------- ------- --------
Balance at end of year.................. $1,905 $ 1,905 $15,650 (3)
====== ======= =======
Weighted average coupon at end
of year.............................. 6.65% 6.40% 7.25%
====== ======= =======
</TABLE>
(1) Represents sale of mortgage-backed securities in connection with
the sale of branches during 1996.
(2) Includes the termination and reclassification of a Company-issued
second mortgage REMIC totaling $2.7 million from mortgage-backed
securities to loans.
(3) Includes $13.7 million of mortgage-backed securities classified as
available for sale at December 31, 1995.
The Company's investment in mortgage-backed securities at December 31,
1997 consists solely of a $1.9 million Fannie Mae guaranteed adjustable rate
REMIC. The Company does not currently own and does not anticipate investing in
27
<PAGE>
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 page 39 of the 1997 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 page 38 of the 1997 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>
<S> <C>
December 31,
1997 1996 1995
----------------------- ----------------------- -----------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(dollars in thousands)
U.S. Government securities...... $ - $ - $1,003 $1,003 $ 1,000 $ 999
U.S. Government agency
securities (1)............... 2,299 2,217 5,000 4,887 6,998 6,841
FHLB stock...................... 1,431 1,431 2,540 2,540 3,603 3,603
----- ----- ----- ----- ------- -------
Total (2)................... $3,730 $3,648 $8,543 $8,430 $11,601 $11,443
===== ===== ===== ===== ====== ======
</TABLE>
(1) Of the $2.3 million of U.S. Government agency securities held for
investment at December 31, 1997, $2.0 million consisted of a note
issued by the FHLB and $299,000 consisted of a note issued by Fannie
Mae. The $2.0 million FHLB note adjusts semi-annually based on the
yield of three-year constant maturity treasury notes. The $299,000
Fannie Mae note earns interest at a fixed rate.
(2) Does not include investment securities classified as available for sale
which consisted of a $17,000, $9,000 and $1.5 million investment in a
money market mutual fund at December 31, 1997, 1996 and 1995,
respectively.
28
<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, 1997 is presented below. FHLB
stock is neither a debt nor an equity security because its ownership is
restricted and it lacks a market. FHLB stock can be sold at its par of $100 per
share only to the FHLBs or to another member institution.
<TABLE>
<CAPTION>
<S> <C>
One Year After One to After Five to Over 10
or Less Five Years 10 Years Years Total
(dollars in thousands)
U.S. Government agency securities...... $ - $2,299 $ - $ - $2,299
======= ====== ======= ======== ======
Weighted average yield................. -% 4.98% -% -% 4.98%
======= ====== ======= ======== ======
</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 market risk 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 - $99,999) and jumbo (generally equal
to or greater than $100,000) certificates of deposit and individual retirement
accounts.
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, 1997, deposit accounts totaling
$4.1 million or 2.7% 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
$1.9 million at December 31, 1997, and represented a decline from the $2.8
million of such certificates at December 31, 1996. 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.
29
<PAGE>
The following table sets forth the average balances and rates of the
Company's deposits for the periods indicated:
<TABLE>
<CAPTION>
<S> <C>
Year Ended December 31,
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ ------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
------- ---- ------- ---- ------- ----
(dollars in thousands)
Noninterest-bearing deposits... $3,143 -% $ 1,433 -% $ 1,285 -%
Passbook savings............... 3,839 3.48 6,782 3.33 5,465 3.33
NOW accounts................... 4,344 2.83 5,332 2.80 4,859 2.85
Money market accounts.......... 21,401 4.87 21,104 4.50 21,760 4.14
Certificates of deposit:
Consumer................... 53,256 5.78 92,771 5.83 95,363 5.99
Mini-jumbo................. 44,932 5.65 71,269 5.69 90,216 5.60
Jumbo...................... 13,206 5.78 19,670 5.86 28,026 5.46
-------- -------- --------
$144,121 $218,361 $246,974
======= ======= =======
The following table shows the interest rate and maturity information
for the Company's time deposits at December 31, 1997:
<CAPTION>
Maturity Date
--------------------------------------------------------------------------
One Year Over
or Less 1-2 Years 2-3 Years 3 Years Total
------- --------- --------- ------- -----
(dollars in thousands)
4.01% to 5.00%............. $ 1,125 $ 2 $ - $ - $ 1,127
5.01% to 6.00%............. 67,575 12,574 3,179 2,923 86,251
6.01% to 7.00%............. 7,388 5,477 6,035 5,187 24,087
7.01% to 8.00%............. 600 251 2,906 - 3,757
8.01% to 9.00%............. 32 - 6 - 38
--------- ----------- ---------- --------- ----------
$76,720 $18,304 $12,126 $8,110 $115,260
====== ====== ====== ===== =======
The following table shows the Company's certificates of deposit of
$100,000 or more outstanding at the dates indicated:
<CAPTION>
December 31,
--------------------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
3 months or less........................ $ 4,624 $ 2,709 $ 6,638
Over 3 through 6 months................. 4,785 3,505 11,270
Over 6 through 12 months................ 3,747 2,625 12,834
Over 12 months ......................... 5,365 5,919 10,489
-------- -------- --------
Total.......................... $ 18,521 $ 14,758 $ 41,231
======== ======== ========
</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.
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
30
<PAGE>
calendar year, or 5% of its advances (borrowings) from the FHLB, whichever is
greater. The Bank had a $1.4 million investment in stock of the FHLB at December
31, 1997, which was in compliance with this requirement. At December 31, 1997,
the Bank had $23.5 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>
<S> <C>
At or For the Year Ended December 31,
-------------------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at end of period.................. $23,547 $25,690 $29,833
Weighted average interest rate
at end of period..................... 5.75% 6.14% 6.00%
Maximum amount outstanding
at any month's end................... $28,118 $29,833 $59,952
Average amount outstanding
during the period.................... $24,885 $27,137 $46,617
Weighted average interest rate
during the period.................... 5.92% 5.99% 6.00%
</TABLE>
The outstanding FHLB advances at December 31, 1997 mature as follows
(in thousands):
1998.................................... $21,139
1999.................................... 1,808
2000.................................... 600
--------
$23,547
The Company's notes payable amounted to $72,000, $96,000 and $120,000
at December 31, 1997, 1996, and 1995, respectively. Notes payable on these dates
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. However, in
conjunction with a severance settlement with the former employee, the Company
repaid this note in its entirety in February 1998. See "Item 3. - Legal
Proceedings."
During 1989 and 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 ranging between 11.5% and 12.0%. In
July 1993, the Bank redeemed $2.8 million of the subordinated capital notes. The
Company's subordinated capital notes amounted to $628,000 at December 31, 1995.
In August 1996, the Bank redeemed the remaining subordinated capital notes at
par in their entirety
Other Liabilities. As of December 31, 1997, other liabilities of the
Company included a $703,000 obligation to the Company's Chief Executive Officer
resulting from the exercise of his stock appreciation rights in November 1997. A
determination has not yet been made as to the date and method of payment to
satisfy this obligation. See Note 19 of the Notes to Consolidated Financial
Statements on pages 47 and 48 of the 1997 Annual Report to Stockholders, which
is attached hereto as Exhibit 13 and incorporated herein by reference.
Year 2000 Costs
For information about the Company's Year 2000 readiness and associated
costs, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Year 2000 Costs" on page 21 of the 1997 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference.
31
<PAGE>
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, 1997, the Company employed 99 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."
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
32
<PAGE>
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, 1997, 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.
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.
33
<PAGE>
The OTS's 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.
Under FDIC regulations, institutions are assigned to one of three
capital groups for insurance premium purposes - "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 Federal Deposit Insurance Act ("FDIA"), 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,
1998, 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 6.4 basis points is 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 previously achieved the required reserve ratio, and as a result, the
FDIC reduced the average deposit insurance premium paid by BIF-insured banks to
a 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
34
<PAGE>
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 is continuing to pay future assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995. Therefore, as of
December 31, 1997, the Bank's annual assessment for deposit insurance was 26
basis points of insured deposits as opposed to three basis points of insured
deposits (the assessment rate otherwise charged to "well capitalized" savings
institutions such as the Bank).
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. 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 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-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.
35
<PAGE>
An association which is not in capital compliance or which is otherwise
deemed to require more than normal supervision 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's 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 to the interest rate risk component as of
December 31, 1997.
At December 31, 1997, the Bank's actual capital ratios and the minimum
requirements under FIRREA were as follows (dollars in thousands):
Minimum
Actual Requirement Excess
------ ----------- ------
Tangible capital $15,298 7.86% $2,921 1.5% $12,377
Core capital 15,298 7.86 7,790 4.0 7,508
Risk-based capital 16,762 14.33 9,354 8.0 7,408
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 50 and 51 of the 1997 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference. At December 31, 1997, 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
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
36
<PAGE>
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, 1997, 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 (including cash, certain time
deposits and savings accounts, bankers' acceptances, certain government
obligations and certain other investments) 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 4%. The Bank has consistently exceeded such regulatory
liquidity requirement and, at December 31, 1997, had a liquidity ratio of 8.72%.
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).
Under 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 1997, 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"
37
<PAGE>
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 (such as the Bank), 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.
The OTS has proposed to amend its capital distribution regulation to
bring such regulations into greater conformity with the other bank regulatory
agencies. Under the proposed regulation, certain savings associations would not
be required to file with the OTS. Specifically, savings associations that remain
at least adequately capitalized following a capital distribution, under the
proposed regulation, would not be subject to any requirement for notice or
application unless the total amount of all capital distributions, including any
proposed capital distribution, for the applicable calendar year would exceed an
amount equal to the savings association's net income for that year to date plus
the savings association's retained net income for the preceding two years.
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, 1997, the Bank had $1.4 million in FHLB stock,
which was in compliance with this requirement.
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, 1997, the
Bank was in compliance with applicable requirements. However, because required
38
<PAGE>
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 internal
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. At December 31, 1997, the Bank was in
compliance with the Guidelines.
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 effect of
eliminating or deferring the tax consequences of intercompany 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 44 and 45 of the 1997 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.
39
<PAGE>
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.
[intentionally blank]
40
<PAGE>
Item 2. Properties
The following table sets forth information with respect to offices of
the Company and its subsidiaries as of December 31, 1997.
<TABLE>
<CAPTION>
<S> <C>
Lease Date Total Net Book
Owned/ Expiration Date Acquired/ Office Value at
Location Leased Including Options Leased Square Ft. (1) 12/31/97 (2)
- -------- ------ ----------------- ------ -------------- ------------
The Company
Executive Office:
The Koger Center Leased 01/31/02 10/96 7,328 $ 26,121
Building 9, Suite 200
Norfolk, VA 23502
The Bank
Main Office:
400 W. Ehringhaus Street Owned - 11/78 3,805 201,750
Elizabeth City, NC 27906
Branch Offices:
520 South Main Street Owned - 05/86 6,517 685,326
Emporia, VA 23847
1401 Gaskins Road Leased 09/07/98 05/95 5,876 11,184
Richmond, VA 23233
1455 N. Main Street Leased (3) 12/31/99 09/95 1,200 -
Suffolk, VA 23434
Essex First
The Koger Center Leased 01/31/02 10/96 5,554 -
Building 9, Suite 200
Norfolk, VA 23502
1401 Gaskins Road Leased (4) 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 (4) - 07/94 750 -
Elizabeth City, NC 27906
Essex Home
2420 Virginia Beach Blvd. Leased 12/31/01 12/91 11,950 8,780
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) The Company has begun construction of a retail bank branch at a new
Suffolk, Virginia location. As of December 31, 1997, the land had a
carrying value of $215,000 and building construction-in-process had a
carrying value of $83,000. The Company has recognized an estimated lease
termination penalty of $28,000 during the year ended December 31, 1997.
The Company anticipates completion of construction in April 1998.
(4) Leased or subleased from the Bank.
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.
41
<PAGE>
As of December 31, 1997, the Company and the Bank were parties to
litigation pending in the Circuit Court of the City of Norfolk, Virginia under
the style of Roger E. Early v. Essex Bancorp, Inc., Essex Savings Bank, F.S.B.,
Home Bancorp, Inc. and Home Savings, F.S.B. (the "Early Litigation"). The
plaintiff in this action, Roger E. Early, was the former President and Chief
Executive Officer of Home Bancorp and Home Savings prior to the Home
Acquisition. Immediately prior to the Home Acquisition, Home Bancorp and Home
Savings terminated Mr. Early's Employment Agreement. Mr. Early claimed that the
Company and the Bank became liable for severance payments by operation of law
upon consummation of the Home Acquisition.
On February 13, 1998, all parties to the Early Litigation entered into
a Settlement and Agreement and Mutual Release whereby the Company agreed to pay
$136,500 to Mr. Early. This amount was recognized as an expense during the year
ended December 31, 1997. In addition, the Company agreed to pay its note
obligation to Mr. Early totaling $72,102 as of December 31, 1997, plus accrued
interest thereon, in its entirety in February 1998.
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, 1997.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Common Stock is currently traded on the American Stock Exchange
("AMEX") under the symbol "ESX." The information contained on page 56 of the
1997 Annual Report to Stockholders, which is attached hereto as Exhibit 13,
under the caption "Stock Price Information," is incorporated herein by
reference. As a company listed on the AMEX, the Company is subject to the AMEX
rules regarding continued listing, and does not fully satisfy those continued
listing guidelines. Accordingly, there can be no assurance that the listing of
the Common Stock on the AMEX will be continued. In this regard, however, the
Company believes that its recently improved operating results will favorably
impact the AMEX's evaluation.
As of March 25, 1998, there were 1,058,136 shares of Common Stock
outstanding, which were held by approximately 2,100 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. 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 Company and the
Bank are no longer operating under any supervisory agreements, the Bank must
seek a letter of nonobjection from the OTS prior to making dividend payments to
the Company.
42
<PAGE>
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 $15.0 million in exchange for all of the outstanding stock
of Home Bancorp. The preferred stock is redeemable at the option of the Company.
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, 1997, dividends and accrued
interest thereon in arrears on the Series B and Series C preferred stock were
$3,289,386 and $160,992, 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.
Item 6. Selected Financial Data
The selected financial data for the five years ended December 31, 1997,
which appears on page 3 of the 1997 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 4 through 22 of the 1997 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, 1997
and 1996 and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997, 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 23 through 55 of the Company's 1997
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.
43
<PAGE>
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 28, 1998
under the heading "Information with Respect to Continuing Directors," and the
information included therein is incorporated herein by reference.
Set forth below is information with respect to the executive officers
of the Company and its subsidiaries who do not serve as directors of the
Company.
<TABLE>
<CAPTION>
<S> <C>
Name Age Title
---- --- -----
Earl C. McPherson 44 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. 35 Senior Vice President of Finance and Treasurer
of the Company and the Bank
Mary-Jo Rawson 44 Vice President and Chief Accounting
Officer of the Company and the Bank
</TABLE>
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 Senior 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
44
<PAGE>
to be held on May 28, 1998 under the heading "Compliance with Section 16(a) of
the Exchange Act," 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 28, 1998 under the headings "Directors Fees"
and "Executive Compensation."
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 28, 1998 under the headings "Securities Ownership of
Certain Beneficial Owners" and "Information with Respect to Continuing
Directors," 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 28, 1998 under the heading "Transactions with Certain Related Persons," and
the information included therein is incorporated herein by reference.
45
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
<TABLE>
<CAPTION>
<S> <C>
(a) 1. Financial Statements:
Page in
Annual
Report*
-------
The following documents are filed as part of this report:
Report of Independent Accountants ................................. 23
Consolidated Balance Sheets at December 31, 1997
and 1996......................................................... 24
Consolidated Statements of Operations for the three
years ended December 31, 1997.................................... 26
Consolidated Statements of Shareholders' Equity for
the three years ended December 31, 1997.......................... 28
Consolidated Statements of Cash Flows for the three
years ended December 31, 1997.................................... 29
Notes to Consolidated Financial Statements.......................... 32
</TABLE>
*Incorporated by reference from the indicated pages of the 1997
Annual Report to Stockholders.
The financial statements, together with the report thereon of
Price Waterhouse LLP dated February 18, 1998, appearing on
pages 23 through 55 of the accompanying 1997 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 1997 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.
46
<PAGE>
3. Exhibits:
The following exhibits are either filed as part of
this Part IV or are incorporated herein by reference:
<TABLE>
<CAPTION>
<S> <C>
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.
47
<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 Essex Savings Bank, F.S.B. Supplemental Executive
Retirement Plan dated August 26, 1993. Filed as an
exhibit to this report.
10.2 First Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated June
5, 1997. Filed as an exhibit to this report.
10.3 Second Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated
November 1, 1997. Filed as an exhibit to this
report.
10.4* Fannie Mae/Freddie Mac/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.
10.5* 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.
10.6* 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.
10.7* 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.
10.8* 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.
* 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.
48
<PAGE>
10.9* Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996. Filed as Exhibit
10.6 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1996.
10.10* 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.
10.11* 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.
10.12 Restated Employment Agreement dated January 1,
1998 by and among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation
and Gene D. Ross. Filed as an exhibit to this
report.
10.13 Restated Executive Services Agreement dated
January 1, 1998 by and among Essex Savings Bank,
F.S.B., Essex First Mortgage Corporation and Earl
C. McPherson. Filed as an exhibit to this report.
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.
13 The 1997 Annual Report is attached as Exhibit 13.
Portions of the 1997 Annual Report are
incorporated by reference into this Form 10-K.
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.
</TABLE>
49
<PAGE>
(b) Reports on Form 8-K Filed in the Fourth Quarter of 1997
Not applicable.
(c) Exhibits
See Exhibit Index contained herein.
(d) Financial Statements Excluded from Annual Report to
Shareholders Pursuant to Rule 14a3(b)
Not applicable.
[intentionally blank]
50
<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 31, 1998
--------------
(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 31, 1998
- -------------------- --------------
Gene D. Ross (Date)
Chairman, President, Chief
Executive Officer and
Principal Financial Officer
By: /s/ Mary-Jo Rawson March 31, 1998
- ---------------------- --------------
Mary-Jo Rawson (Date)
Chief Accounting Officer
By: /s/ Roscoe D. Lacy, Jr. March 31, 1998
- --------------------------- --------------
Roscoe D. Lacy, Jr. (Date)
Director
By: /s/ Harry F. Radcliffe March 31, 1998
- -------------------------- --------------
Harry F. Radcliffe (Date)
Director
51
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
<S> <C>
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 Essex Savings Bank, F.S.B Supplemental Executive
Retirement Plan.
10.2 First Amendment to the Savings Bank, F.S.B
Supplemental Executive Retirement Plan.
10.3 Second Amendment to the Savings Bank, F.S.B
Supplemental Executive Retirement Plan.
10.4* Fannie Mae/Freddie Mac/Private Investor Mortgage
Servicing Purchase and Sale Agreement by and
between Essex Mortgage Corporation and Chase Home
Mortgage Corporation dated June 8, 1993.
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
E-1
<PAGE>
10.5* Essex Bancorp, Inc. Non-Employee Directors Stock
Option Plan.
10.6* First Amendment to the Essex Bancorp, Inc.
Non-Employee Directors Stock Option Plan dated
July 29, 1995.
10.7* Essex Bancorp, Inc. Stock Option Plan.
10.8* First Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated June 29, 1995.
10.9* Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996.
10.10* Essex Bancorp, Inc. Employee Stock Purchase Plan.
10.11* First Amendment to the Essex Bancorp, Inc.
Employee Stock Purchase Plan dated June 29, 1995.
10.12 Restated Employment Agreement dated January 1,
1998 by an among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation
and Gene D. Ross.
10.13 Restated Executive Services Agreement dated
January 1, 1998 by and among Essex Savings Bank,
F.S.B., Essex First Mortgage Corporation and Earl
C. McPherson.
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.
13 The 1997 Annual Report is attached as Exhibit 13.
Portions of the 1997 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 by reference.
</TABLE>
E-2
EXHIBIT 10.1
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
ARTICLE I
PURPOSE
The Essex Savings Bank, FSB Supplemental Executive Retirement Plan
("Plan") is intended to advance the interest of Essex Savings Bank, FSB (the
"Bank") and its subsidiaries (collectively the "Employers") by aiding the
Employers in attracting and retaining key officers and management personnel and
by motivating senior management to enhance the value of the Employers through
achievement of corporate profit objectives. The Board of Directors of Essex
Savings Bank, FSB believes that the Plan is necessary to provide competitive
retirement benefits for key officers and will afford flexibility in delivering
retirement benefits in light of changing economic, competitive and regulatory
conditions.
ARTICLE II
DEFINITIONS
The following terms shall have the meanings set forth in this Article
unless the context requires a different meaning:
<PAGE>
Administrator. The Bank.
Bank. Essex Savings Bank, FSB.
Change in Control. Except as provided below, a "Change in Control"
shall occur if any "person" or "group" (as such terms are used in Sections 13(d)
and 14(d) of the Securities Exchange Act of 1934), other than Essex Financial
Partners, L.P. or a wholly owned subsidiary thereof, directly or indirectly,
becomes the "beneficial owner" (as that term is defined in Rule 13d-3 under the
Securities Exchange Act of 1934) of securities of Employer, Essex Bancorp or
Essex Financial Partners, L.P., representing 20% or more of the combined voting
power of the then outstanding securities of such entity; or if a change in the
composition of a majority of the Board occurs within twelve months after such
"person" or "group" (other than Essex Financial Partners, L.P. or a wholly owned
subsidiary thereof) becomes the "beneficial owner", directly or indirectly, of
securities of Employer, Essex Bancorp or Essex Financial Partners, L.P.,
representing 5% or more of the combined voting power of the then outstanding
securities of such entity.
Code. The Internal Revenue Code of 1986, as amended.
Committee. The Executive Compensation Committee of the Bank, comprised
of outside directors and the Chief Executive Officer of the Bank as a non-voting
member.
Compensation. The total compensation paid to or for a Member during a
Plan Year, including "wages" under Code Section
<PAGE>
3401. A Member's compensation shall be calculated prior to reduction for the
amount of the Member's pre-tax contributions to the Bank's Code Section 401(k)
plan and any cafeteria plan maintained by the Bank under Section 125 of the
Code, but reduced by the amount of any moving expenses or taxable
reimbursements. Amounts paid under the Bank's Key Employee Incentive
Compensation Plan shall be taken into account in the Plan Year in which actually
paid.
Effective Date. January 1, 1993.
Employee. An employee of an Employer, as determined under the common
law of Virginia, who is a key executive officer of the Employer.
Employer. The Bank and its subsidiaries.
Hardship. A sudden and unexpected illness or accident or other
unforeseeable emergency beyond the control of a Member suffered by the Member of
a member of this immediate family and causing a severe financial hardship to the
Member, as determined by the Administrator in its sole discretion.
Investment Adjustments. The adjustments to a Member's Retirement
Account made pursuant to Article IV to reflect the income and other items deemed
to be applicable thereto.
Member. Each Employee participating in the plan under Article III
below.
Plan Year. January 1, 1993 through December 31, 1993 and each fiscal
year of the Bank thereafter.
Pension Credits. The fixed percentage Employer contribution amounts
credited to a Member's Retirement Account under Article IV A below.
Profit-Sharing Credits. The discretionary Employer contribution
amounts, if any, credited to a Member's Retirement Account under Article IV B.
Retirement Account. The bookkeeping account maintained for each Member
under Article IV D below, consisting of his Pension Credits, Profit-Sharing
Credits and net Investment Adjustments thereto.
Vested Benefit. The vested portion of a Member's Retirement Account as
determined under Article V below.
Year of Service. A Plan Year during which a Member is continuously
employed by an Employer for the entire Plan Year.
ARTICLE III
PARTICIPATION
A. Membership. Each Employee who is eligible to participate as a Member
in the Plan is listed on Exhibit A attached hereto. The Board of Directors of
the Bank my designate other Employees as Members from time to time and shall
update Exhibit A to reflect such additional designations. Only those Employees
who are listed on Exhibit A shall participate in the Plan.
<PAGE>
B. Termination. A Member's participation in the Plan shall terminate
than the Member has no Vested Benefit remaining under the Plan.
C. Termination of Employment. For all purposes under this Plan, a
transfer of employment from one Employer to another shall not be deemed a
termination of employment.
ARTICLE IV
CREDITS AND RETIREMENT ACCOUNT
A. Pension Credits. For each Plan Year in which a Member completes a
Year of Service, his Employer shall credit on behalf of the Member a Pension
Credit of five percent (5%) of the Member's Compensation for the Plan Year. No
Pension Credit will be provided to a Member for any Plan Year in which he fails
to complete a Year of Service. The Pension Credit will be credited to the
Member's Retirement Account and deemed invested under IV C below as of the last
day of the Plan Year to which it is attributable.
B. Profit-Sharing Credits. For each Plan Year during which the Bank has
a net profit before taxes and the granting of Profit-Sharing Credits hereunder,
as determined for financial accounting purposes, each Employer, at the
discretion of the Committee, may, but need not, also credit on behalf of each
Member employed by it who has completed a Year of Service for the Plan Year, a
discretionary Profit-Sharing Credit not in excess of
<PAGE>
five percent (5%) of each such Member's Compensation for the Plan Year. No
Profit-Sharing Credit will be provided on behalf of any Member who fails to
complete a Year of Service for the Plan Year in question. Moreover, in no event
will the aggregate Profit-Sharing Credits for any Plan Year exceed ten percent
(10%) of the Employer's net profit before taxes and Profit-Sharing Credits
hereunder for the Plan Year. The Profit-Sharing Credits will be credited to each
applicable Member's Retirement Account and deemed invested under Article IV C
below as of the last day of the Plan Year to which it is attributable.
C. Deemed Investment and Investment Adjustments. As of the end of each
Plan Year, the Pension Credits and Profit-Sharing Credits in each Member's
Retirement Account (plus any accumulated Investment Adjustments from prior
years) shall be deemed to be invested (or reinvested, as the case may be) in one
year certificates of deposit of the Bank, at the interest rate in effect on the
last day of the Plan Year. The Employer shall cause annual Investment
Adjustments to be made to each Member's Retirement Account so as to reflect the
interest income and any other adjustments that would be applicable thereto if
the Retirement Accounts were actually invested in the certificates of deposit.
D. Bookkeeping Account. For bookkeeping purposes only, each Employer
shall maintain a Retirement Account reflecting a
<PAGE>
Member's Pension Credits, Profit-Sharing Credits and all the Investment
Adjustments applicable thereto.
ARTICLE V
VESTING
A Member's Retirement Account shall fully vest and become
nonforfeitable upon the first to occur of the Member's death, permanent
disability within the meaning of Code Section 72(m)(7), retirement at or after
attainment of age 65, or any "Change in Control." In the event of the
termination of a Member's employment with the Employers prior to death,
permanent disability, attainment of age 65 or a Change in Control, the Member's
vested nonforfeitable interest in his Retirement Account shall be determined in
accordance with the following percentage vesting schedule based upon the
Member's number of complete Plan Years of Service with the Employers, excluding
years prior to the Effective Date.
Complete Plan Years Vested Percentage Forfeited Percentage
of Service With of Retirement of Retirement
Employer After 1992 Account Account
- ------------------- ------- -------
1 20% 80%
2 40% 60%
3 60% 40%
4 80% 20%
5 100% 0%
<PAGE>
The non-vested portion of a Member's Retirement Account shall be forfeited upon
his termination of employment with the Employers
ARTICLE VI
DISTRIBUTIONS
A. Time of Payment. The vested portion of a Member's Retirement Account
shall be payable to the Member (or if applicable, to his Beneficiary) by the
Member's Employer within one hundred eighty days (180) after: (i) the close of
the Plan Year in which occurs his termination of employment with the Employers;
or (ii) any Change in Control, whichever occurs first.
B. Method of Payment. A Member's Retirement Account shall be paid to
the Member (or his Beneficiary, if applicable) by the Member's Employer in a
lump sum, net of all applicable withholding taxes.
C. Beneficiary Designation. A Member shall be entitled to designate a
beneficiary under the Plan by filing a designation in writing with the
Administrator on the form provided for that purpose. Any beneficiary designation
under the Plan shall remain effective until changed or revoked hereunder. Any
beneficiary designation may include multiple, contingent or successive
beneficiaries and may specify the proportionate distribution to each
beneficiary. A beneficiary designation may be changed by a Member at any time or
from time to time by filing a new designation in writing with the Administrator.
If a Member dies without having designated a beneficiary, or if the beneficiary
so designated has predeceased the Member, then the Member's surviving spouse, or
if none, his estate, shall be deemed to be his beneficiary. If a beneficiary of
a Member shall survive the Member but die before the Member's Retirement Account
has been distributed, than absent any other provision by the Member, the unpaid
amount thereof shall be distributed to the estate of the deceased beneficiary.
If multiple beneficiaries are designated, absent any other provision by the
Member, those named or the survivors of them shall share equally in any amounts
payable under the Plan.
D. Hardship Distributions. Notwithstanding the preceding paragraphs,
the Administrator may, in its sole discretion, at any time direct the payment of
all or a portion of a Member's vested Retirement Account to or on behalf of a
Member if the Administrator determines that the payment is necessary to
alleviate a Hardship; provided, however, that the amount so distributed shall
not exceed the amount reasonably needed to alleviate the Hardship after taking
into account the other financial resources available to the Member.
E. Regulatory Approval. Any provision herein to the contrary
notwithstanding, adoption of this Plan is contingent upon approval by the Office
of Thrift Supervision ("OTS"). In the event OTS approval is not obtained, the
Plan shall be terminated effective as if never adopted and all Retirement
Accounts shall be void ab initio. All payments hereunder are also subject to and
conditioned upon their compliance with Section 1828(k) of Title 12 of the United
States Code and any regulations promulgated thereunder.
ARTICLE VII
FUNDING
Nothing contained herein shall be deemed to create a trust of any kind
or create any fiduciary relationship, and the undertaking to pay Pension Credits
and Profit-Sharing Credits and to make Investment Adjustments hereunder shall be
an unfunded obligation payable solely from the general assets of the Employers
subject to the claims of the Employers' creditors. The Employers may, but shall
not be obligated to, invest an amount equal to a Member's Retirement Account
balance in the investment vehicles in which the Member's Retirement Account is
deemed to be invested under Article IV C. Any investment of a Member's
Retirement Account shall be a general asset of the applicable Employer, and no
Member or beneficiary shall have any property or security interest in any
specific asset of the Employer. To the extent that any person acquires a right
to receive payments under this Plan, that right shall be no greater than the
right of any unsecured general creditor of the Employers.
<PAGE>
ARTICLE VIII
ADMINISTRATION
The Bank, by action of its Chief Executive Officer, shall serve as the
Administrator of the Plan. The Administrator shall have the authority and
responsibility to construe and interpret the Plan, to make determinations under
the Plan with respect to eligibility for, amount of and distribution of
benefits, and otherwise to manage the Plan's operation in accordance with its
provisions.
ARTICLE IX
TERMINATION OR AMENDMENT
The Plan may be terminated at any time by the Bank. The Plan may be
amended in whole or in part from time to time by the Bank effective as of any
date specified, but no amendment shall operate to decrease the vested Retirement
Account balance accrued on behalf of any Member as of the earlier of the date on
which the amendment or termination is approved by the Board of Directors of the
Bank or the date on which an instrument of amendment or termination is signed.
Nor shall any amendment lengthen the vesting schedules set forth in Article V
below. Any provision in Article V to the contrary notwithstanding, upon
termination of the Plan all Members shall be fully vested in their Retirement
Accounts.
<PAGE>
The Chief Executive Officer of the Bank shall be authorized to adopt on
behalf of the Bank and to execute any technical amendment or amendments to the
Plan which in the opinion of counsel for the Bank is required by law and is
deemed advisable by him, and to so adopt and execute any other discretionary
amendment or amendments to the Plan which do not, in his view, materially affect
costs or the eligibility or benefit provisions of the Plan and which in his
opinion are deemed advisable.
ARTICLE X
EMPLOYMENT RELATIONSHIP
The action of the Employers in establishing or adopting this Plan, and
any action taken by any Employer shall not be construed as giving any Member or
other employee of the Employer the right to be retained in the Employer's
employ. The Plan shall not be construed as creating or modifying any contract of
employment relationship between an Employer and any person.
ARTICLE XI
SPENDTHRIFT
The interests of each Member under the Plan are not subject to the
claims of the Member's creditors and may not, in any way, be assigned, pledged,
alienated or encumbered.
<PAGE>
ARTICLE XII
GOVERNING LAW
This Plan shall be established, construed and enforced according to the
laws of the Commonwealth of Virginia.
IN TESTIMONY WHEREOF, the Employers have caused this Plan to be signed
by their officers thereunto duly authorized this 26th day of August, 1993.
ESSEX SAVINGS BANK, FSB
By
Its
ESSEX FIRST MORTGAGE CORPORATION
By
Its
ESSEX HOME MORTGAGE
SERVICING CORPORATION
By
Its
<PAGE>
EXHIBIT "A"
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(List of Members - 1993)
Gene D. Ross
G. Wilson Thomas, II
Earl C. McPherson
Harvard R. Birdsong, II
Michael H. Harris
Donald R. Fisher, Jr.
Roy H. Rechkemmer, Jr.
Diane G. Scott
EXHIBIT 10.2
FIRST AMENDMENT
TO THE
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
THIS FIRST AMENDMENT to the Essex Savings Bank, FSB Supplemental
Executive Retirement Plan ("Plan") is made as of the first day of May, 1997.
WHEREAS, Essex Savings Bank, FSB (the "Bank") maintains the Essex
Savings Bank, FSB Supplemental Executive Retirement Plan (the "Plan") for the
benefit of certain of its executive employees; and
WHEREAS, it is necessary and desirable to amend the Plan in certain
respects; and
WHEREAS, the Bank has reserved the right to amend the Plan from time to
time.
NOW, THEREFORE, the Plan is hereby amended effective May 1, 1997 as
follows:
1. Article II, the definition of "Compensation," is amended to add the
following sentence at the end thereof:
Notwithstanding the foregoing, in determining a Member's
Compensation for any plan year ending on or after December
31, 1996, any reduction in the Member's base salary below the
rate of base salary in effect on May 1, 1997 shall be
disregarded such that the Member's Compensation shall take
into account the amount of base salary that the Member
otherwise would have received but for the post-May 1, 1997
reduction in base salary.
2. Except as provided above, the Plan shall continue in accordance with
its original terms.
IN TESTIMONY WHEREOF, the Bank has caused this amendment to be executed
by its duly authorized officer this 5th day of June, 1997.
ESSEX SAVINGS BANK, FSB
By: /s/ Gene D. Ross
Its: Chairman/President/CEO
EXHIBIT 10.3
SECOND AMENDMENT
TO THE
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
THIS SECOND AMENDMENT to the Essex Savings Bank, FSB Supplemental
Executive Retirement Plan ("Plan") is made as of the first day of November,
1997.
WHEREAS, Essex Savings Bank, FSB (the "Bank") maintains the Essex
Savings Bank, FSB Supplemental Executive Retirement Plan (the "Plan") for the
benefit of certain of its executive employees and certain executive employees of
its subsidiaries; and
WHEREAS, it is necessary and desirable to amend the Plan in certain
respects; and
WHEREAS, the Bank has reserved the right to amend the Plan from time to
time.
NOW, THEREFORE, the Plan is hereby amended effective November 1, 1997
as follows:
1. Article III A is amended to add the following sentence at the end
thereof:
Any provision herein to the contrary notwithstanding, no
Employee shall earn or otherwise accrue any Pension or
Profit-Sharing credits for any Plan Year prior to the year he
or she first becomes a Member, but he or she shall receive
vesting credit under Article V below for all Years of Service
after 1992.
2. The first sentence of Article IV A of the Plan document is amended
to read as follows:
For each Plan Year in which a Member completes a Year of
Service as a Member of the Plan, his Employer shall credit on
behalf of the Member a Pension Credit of five percent (5%) of
the Members Compensation for the Plan Year.
3. Exhibit "A" to the Plan document is amended to read as provided in
Amended Exhibit "A" attached hereto.
4. Except as provided above, the Plan shall continue in accordance with
its original terms.
IN TESTIMONY WHEREOF, the Bank has caused this amendment to be executed
by its duly authorized officer this 1st day of November, 1997.
ESSEX SAVINGS BANK, FSB
By: /s/ Gene D. Ross
Its: Chairman/President/CEO
<PAGE>
AMENDED EXHIBIT "A"
TO THE ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(as of November 1, 1997)
Members Plan Year of Initial Membership
- ------- -------------------------------
Gene D. Ross 1993
Earl C. McPherson 1993
Roy H. Rechkemmer, Jr. 1993
Mary Jo Rawson 1997
O.V. Gillikin 1997
Steven Sager 1997
EXHIBIT 10.12
RESTATED
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT, dated as of January 1, 1998 (Agreement) is
made by and among ESSEX BANCORP, INC. ("BANCORP"), ESSEX SAVINGS BANK, F.S.B.
("ESB") AND ESSEX MORTGAGE CORPORATION ("EMC") (Bancorp, ESB and EMC are
referred to collectively herein as the Essex Employers), and GENE D. ROSS (the
"Employee").
WHEREAS, the Essex Employers and Employee entered into a comprehensive
employment agreement in 1995, which agreement was subsequently amended (the
"1995 Agreement"); and
WHEREAS, the Essex Employers and Employee desire to restate the 1995
Agreement and continue the employment of Employee on the terms provided herein;
NOW, THEREFORE, in consideration of the mutual covenants contained
herein, the parties agree as follows:
ARTICLE I
EMPLOYMENT OF THE EMPLOYEE BY THE ESSEX EMPLOYERS
Section 1.1. Employment. Each of the Essex Employers hereby confirms
the continued employment of Employee in the respective capacities described
below:
Bancorp President and Chief Executive Officer
ESB President and Chief Executive Officer
EMC President and Chief Executive Officer
Employee accepts such continued employment and agrees to abide by the respective
Certificates or Articles of Incorporation, Bylaws and the decisions of the
Boards of Directors of each of the Essex Employers. Employer and Employee
acknowledge that Employee also serves as an officer of certain other direct and
indirect subsidiaries of the Essex Employers.
Section 1.2. Term. This Agreement and Employee s employment hereunder
shall continue for a period of one year (the "Initial Term"), subject, however,
to earlier termination as provided in Article III below. Prior to the end of the
Initial Term (or any renewal period thereafter), the Employee and the Boards of
Directors of the Essex Employers may agree in writing to renew the term of this
Agreement for a successive one (1) year period. Prior to such renewal, the
Boards of Directors of the Essex Employers, or committees thereof, shall prepare
an annual performance evaluation of Employee. The Boards of Directors of the
Essex Employers will review the Agreement and Employee s performance evaluation
annually for the purpose of determining whether to renew the Agreement. The
results of the Boards review shall be included in minutes of the applicable
Board meetings. The Initial Term, together with any renewals thereof is referred
to herein as the "Term."
Section 1.3. Director of Essex Employers. The Employee shall, if
elected or appointed, serve as a Director of each of the Essex Employers.
However, nothing in this Agreement shall be construed as requiring the Essex
Employers, its shareholders or agents to cause the election or appointment of
the Employee as a Director of the Essex Employers.
Section 1.4. Duties and Responsibilities. The Employee is employed
pursuant to the terms of this Agreement and agrees to devote his entire work
time, attention and energies to the business of the Essex Employers. The
Employee shall have such rights and responsibilities, and shall perform such
duties, as are customary for the offices of President and Chief Executive
Officer (and any other applicable officer), as the case may be with respect to
each of the Essex Employers, of a corporation, as the same may be modified or
otherwise determined and assigned to him by the respective Boards of Directors
of the Essex Employers. The Employee understands that he shall be required to
maintain his present residence in the general vicinity of Virginia Beach,
Virginia for the purpose of performing his duties under this Agreement.
Section 1.5. Indemnification.
(a) Indemnification by Bancorp. Bancorp hereby agrees to
indemnify and hold harmless the Employee from and against any loss, liability,
claim or expense arising from the Employee s performance of his duties under
this Agreement to any of the Essex Employers, or to any other direct or indirect
subsidiary of Bancorp to the fullest extent permitted by Section 145 of the
Delaware General Corporation Law.
(b) Indemnification by ESB. ESB hereby agrees to indemnify and
hold harmless the Employee from and against any loss, liability, claim or
expense arising from the Employee's performance of his duties under this
Agreement to ESB, to the fullest extent permitted by applicable federal statutes
and regulations, including, without limitation, 12 C.F.R. ss. 545.121.
(c) Indemnification by EMC. EMC hereby agrees to indemnify and
hold harmless the Employee from and against any loss, liability, claim or
expense arising from Employee's performance of his duties to EMC, or to any
direct or indirect subsidiary of EMC under this Agreement to the fullest extent
permitted by the Virginia Stock Corporation Act.
ARTICLE II
COMPENSATION
Section 2.1. Basic Salary. The Essex Employers shall pay to the
Employee an aggregate basic salary at a rate of $189,000 per year (the "Salary")
during the Term of this Agreement, payable in arrears in semi-monthly
installments (after deduction of federal, state and local withholding and
similar taxes and charges) in accordance with the usual employment practices of
the Essex Employers.
Section 2.2. Bonus. The Employee may, but is not entitled to, receive
from the Essex Employers increases in Salary or Bonuses (collectively, the
"Bonus") based on standards of financial performance for Bancorp to be
established by the Board of Directors of Bancorp and, if required, approved by
the Office of Thrift Supervision ("OTS"), which Bonuses may be awarded not more
frequently than one time during each calendar year.
Section 2.3. Regulatory Approval. Any compensation payable to the
Employee pursuant to this Agreement, including any severance pay or benefits
otherwise due under Section 3.7, shall be subject to review and disallowance by
the OTS or other competent regulatory body, provided that any modification in
the Employee s compensation required by the OTS or other competent regulatory
body shall not alter in any way the duties or obligations of the Employee under
this Agreement. All filing fees and charges incident to any application of the
Employee for approval of this Agreement or amounts payable hereunder will be
paid by the Essex Employers.
Section 2.4. Vacation. Employee shall be entitled to paid annual
vacation in accordance with the policies established from time to time by the
Board of Directors of Bancorp. In the event Employee fails to use his full
annual paid vacation during any year, he shall be paid for each day of such
unused vacation (with the amount of such payment based on his Annual Salary
prorated on a daily basis).
ARTICLE III
TERMINATION
Section 3.1. Termination by Bancorp Without Cause. The Board of
Directors of Bancorp may terminate this Agreement and Employee s employment
hereunder without Cause (as defined in Section 3.3 below) at any time upon
forty-five (45) days written notice to the Employee. In such event, the
Employee, if requested by the Board of Directors of Bancorp, shall continue to
render the services to the Essex Employers required under this Agreement, and in
any event shall be paid the amount of Salary and vacation pay otherwise payable
if the Employee had remained an Employee hereunder, to the date of termination.
No termination hereunder shall be effective to avoid the payment of any Bonus,
Salary and vacation pay previously earned by the Employee. If Employee is
terminated by Bancorp without Cause, Employee shall be entitled to the severance
benefit described in Section 3.7(a) below (assuming termination prior to a
Change in Control as defined in Section 3.7(b) below). In the event the Essex
Employers decline to renew this Agreement upon expiration of its Initial Term or
any annual renewal term thereafter, Bancorp shall be deemed to have terminated
Employee without Cause.
Section 3.2. Termination by the Employee Without Just Cause. The
Employee, without Just Cause (as defined in Section 3.4 below), may terminate
this Agreement and his employment hereunder as to any of the Essex Employers
upon 45 days written notice to each of the directors of Bancorp. In such event,
the Employee shall continue to render the services to such Essex Employers
required under this Agreement and shall be paid solely the Salary and vacation
accrued and prorated to the date of the termination.
Section 3.3. Termination by Bancorp With Cause. The Board of Directors
of Bancorp may terminate this Agreement and Employee s employment as to all
Essex Employers at any time immediately with notice for "Cause." For purposes of
this Agreement, termination for "Cause" shall mean termination because of the
Employee s personal dishonesty, gross incompetence, willful misconduct, breach
of fiduciary duty involving personal profit, intentional failure to perform
stated duties, willful violation of any law, rule or regulation (other than
traffic violations or other violations that have no material detrimental effect
on the Essex Employers) or final cease and desist order, or material breach of
any provision of this Agreement. In such event, the Employee shall be paid
solely his Salary and vacation pay accrued and prorated to the date of
termination.
Section 3.4. Termination by Employee With Just Cause. The Employee may
terminate this Agreement and his employment hereunder as to all Essex Employers
at any time, immediately with notice, for "Just Cause." For purposes of this
Section 3.4, the term "Just Cause" shall mean: (a) a reduction in Employee's
Salary without his consent; (b) an Essex Employer-imposed requirement that
Employee relocate his office to a location which is more than ninety (90) miles
from Norfolk, Virginia without Employee's consent; (c) a material change by the
Essex Employers in Employee's titles and/or reporting responsibilities without
Employee's consent, which change is not reversed within ten (10) business days
after written notice by Employee objecting to the change; or (d) failure by the
Essex Employers to comply with any material provision of this Agreement, which
failure has not been cured within ten (10) business days after written notice of
such noncompliance has been given by the Employee to each of the directors of
Bancorp. In the event the Employee terminates this Agreement for Just Cause, the
Employee shall be entitled to the severance benefits described in Section 3.7
below (assuming termination prior to a Change in Control as defined in Section
3.7(b) below), plus his Salary and vacation pay accrued and prorated through the
effective date of termination.
Section 3.5. Termination Upon Death or Permanent Disability of
Employee.
In addition to any other provision relating to termination, this
Agreement shall be automatically terminated in the event of the Employee's death
or permanent disability as defined in Bancorp's group long term disability
insurance plan for employees. In such event, the Employee shall be paid the
amount of the Salary otherwise payable if the Employee had remained an Employee
for an additional six (6) months subsequent to his death (or disability, as
applicable), as well as the Salary and vacation pay accrued and prorated to the
date of death (or disability, as applicable). No termination hereunder shall be
effective to avoid the payment of any Bonus previously earned by the Employee.
Section 3.6. Suspension or Termination as Required by Government
Regulations.
(a) If the Employee is suspended and/or temporarily prohibited
from participating in the conduct of affairs of ESB by a notice served under
Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act (12 U.S.C.
Section 1818(e)(3) and (g)(1)), ESB's obligations under this Agreement shall be
suspended as of the date of service unless stayed by appropriate proceedings. If
the charges in the notice are dismissed, ESB may in its discretion (i) pay the
Employee all or part of the compensation withheld while its obligations under
this Agreement were suspended, and (ii) reinstate (in whole or in part) any of
its obligations which were suspended.
(b) If the Employee is removed and/or permanently prohibited
from participating in the conduct of ESB's affairs by an order issued under
Section 8(e)(4) or (g)(1) of the Federal Deposit Insurance Act (12 U.S.C.
Section 1818(e)(4) or (g)(1)), all obligations of ESB under this Agreement shall
terminate as of the effective date of the order, but vested rights of the
parties hereto shall not be affected.
(c) If ESB is in default (as defined in Section 3(x)(1) of the
Federal Deposit Insurance Act), all obligations of ESB under this Agreement
shall terminate as of the date of default, but this paragraph shall not affect
any vested rights of the parties hereto.
(d) All obligations of ESB under this Agreement shall
terminate, except to the extent determined that continuation of the contract is
necessary of the continued operation of ESB (i) by the director of Office of
Thrift Supervision (the "Director") or his or her designee, at the time the
Federal Deposit Insurance Corporation enters into an agreement to provide
assistance to or on behalf of ESB under the authority contained in Section 13(c)
of the Federal Deposit Insurance Act; or (ii) by the Director or his or her
designee, at the time the Director or his or her designee approves a supervisory
merger to resolve problems related to operation of ESB or when ESB is determined
by the Director to be in an unsafe or unsound condition; but any rights of the
parties hereto that have already vested shall not be affected by such action.
Section 3.7. Severance Benefit and Change in Control Payment.
(a) In the event of termination of this Agreement and Employee
s employment hereunder prior to a Change in Control (as defined in Section
3.7(b) below) by Bancorp without "Cause" under Section 3.1 above or by the
Employee with "Just Cause" under Section 3.4 above, the Essex Employers, jointly
and severally, shall: (1) pay to the Employee in a lump sum within thirty (30)
days of termination an amount equal to one hundred and fifty percent (150%) of
his highest rate of annual Salary in effect during the period commencing on May
1, 1997 and ending on the date of his termination; and (2) provide continuing
health and medical insurance, disability insurance and life insurance coverage
on behalf of the Employee (and Employee's other family members, if applicable)
for a period of eighteen (18) months following termination on the same basis as
was in effect immediately prior to the effective date of termination.
(b) In the event a Change in Control occurs prior to or on the
date of termination of this Agreement, the Essex Employers, jointly and
severally, shall: (1) pay to the Employee in a lump sum within thirty (30) days
of the Change of Control an amount equal to two hundred percent (200%) of his
highest rate of annual Salary in effect during the period commencing on May 1,
1997 and ending on the date of the Change in Control; and (2) provide continuing
health and medical insurance, disability insurance and life insurance coverage
on behalf of the Employee (and his other family members, if applicable) for a
period of two (2) years following the Change in Control on the same basis as was
in effect immediately prior to the Change in Control. For purposes of this
Agreement, a "Change in Control" shall occur if and only if after December 31,
1997 a "person" or "group" (as such term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934), directly or indirectly, first becomes the
beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of
1934) of securities of Bancorp representing twenty percent (20%) or more of the
combined voting power of the then outstanding securities of Bancorp. Any
provision herein to the contrary notwithstanding, no Change in Control shall be
deemed to occur as a result of: (1) any transaction prior to January 1, 1998;
(2) any purchase, transfer, or other disposition of the Series B and Series C
preferred shares of Bancorp; or (3) any exercise or conversion of warrants or
options of Bancorp which were issued prior to 1996 (and any exercise, or
conversion of such warrants or options shall be disregarded in determining
whether a Change of Control has occurred).
(c) Any provision herein to the contrary notwithstanding: (i)
no severance payment under Section 3.7(a) or Change in Control payment under
Section 3.7(b) shall be due to Employee if Employer terminates Employee for
Cause under Section 3.3 prior to a Change in Control or Employee resigns without
Just Cause under Section 3.2 prior to a Change in Control; and (ii) under no
circumstances shall Employee be entitled to payment under both Section 3.7(a)
and Section 3.7(b) above.
(d) If the payments and benefits pursuant to this Section 3.7,
either alone or together with other payments and benefits which Employee has the
right to receive from the Essex Employers, would constitute a "parachute
payment" as defined in Section 280G of the Code, the payments and benefits
provided herein shall be reduced, in the manner determined by the Employee, by
the amount, if any, which is the minimum necessary to result in no portion of
the payments and benefits under this Section 3.7 being non-deductible to the
Essex Employers pursuant to Section 280G of the Code and subject to the excise
tax imposed under Section 4999 of the Code. The determination of any reduction
in the payments and benefits to be made pursuant to this Section 3.7 shall be
based upon the opinion of independent tax counsel selected by the Essex
Employers' independent public accountants, which opinion shall be final and
binding upon the parties. Nothing contained herein shall result in a reduction
of any payments or benefits to which the Employee may be entitled upon
termination of employment under any circumstances other than as specified in
Section 3.7(b), or a reduction in payments and benefits specified in Section
3.7(b) below zero.
(e) All payments under this Section 3.7 shall be subject to
the approval of the OTS to the extent required by federal law and are
conditioned upon compliance with Section 1828(b) of Title 12 of the United
States Code and the regulations promulgated thereunder. The amounts due under
this Section 3.7, if any, shall not be subject to offset for any other income
earned by Employee from a subsequent Employer or discontinuance should Employee
obtain such other employment.
Section 3.8. Adverse Statements and/or Action. The Essex Employers and
Employee agree that during the Term of this Agreement and thereafter they will
refrain from making any adverse public statements about each other, or the Essex
Employers' employees. An adverse statement is one which is derogatory or
otherwise of such a nature that it tends to be embarrassing, humiliating or
injurious to the name, reputation or business of the party about whom the
statement is made,whether or not the party making such statement believes it to
be true. Upon termination of this Agreement, the Essex Employers and Employee
will use their best efforts to reach agreement on the text of any public
statement, if necessary, regarding the employment relationship which is
satisfactory to both. Notwithstanding the foregoing, neither party shall be
prohibited from making any public statement compelled by law or which is
otherwise legally privileged, or from correcting or commenting upon a public
statement or public reports originating from any other source. This provision
shall be in addition to any other rights and duties which may arise under the
laws of defamation, unfair competition and similar laws.
ARTICLE IV
EMPLOYEE REPRESENTATIONS AND COVENANTS
Section 4.1. Capacity. The Employee hereby represents and warrants that
he has full legal capacity to enter into and perform this Agreement and is under
no contractual, legal or other disability to enter into and perform this
Agreement.
Section 4.2. Regulatory Clearance. The Employee has received regulatory
clearance to act as a chief executive officer of a savings and loan institution
pursuant to regulatory review of Form 1393 or equivalent regulatory application
and, to the best of his knowledge, maintains good standing with the OTS and
other competent regulatory authorities.
Section 4.3. Loyalty; Non-piracy; Confidentiality.
(a) The Employee shall devote his full time and best efforts
to the performance of his employment under this Agreement. The Employee shall
abide by the Essex Employers' "Corporate Code of Conduct." During his employment
under this Agreement, the Employee shall not engage in any business or activity
contrary to the business affairs or interests of the Essex Employers. Nothing
contained in this Section 4.3, however, shall be deemed to prevent or limit the
right of Employee to invest in the capital stock or other securities of any
business dissimilar from that of the Essex Employers, or, solely as a passive
and minority investor, in any business. In no event shall Employee use or
disclose to others confidential inside information regarding the Essex Employers
or their affiliates or engage, directly or indirectly, in any transaction
involving the securities of Bancorp based upon such "inside information."
(b) During Employee's term of employment with the Essex
Employers and for nine (9) months thereafter (irrespective of the time, manner
or cause of termination or resignation), Employee shall not, directly or
indirectly, on behalf of Employee or any entity or person other than the Essex
Employers hire or solicit for employment in, employ in, or cause to be employed
in any Competing Business any personnel of the Essex Employers who are or were
employed by any of the Essex Employers at any time during the period beginning
one year prior to Employee s termination or resignation, unless any such person
has not been employed by the Essex Employers for a period in excess of one
continuous year. For purposes of this Section 4.3(b), a Competing Business means
any person or entity which is engaged directly or indirectly in any business
engaged in by the Essex Employers and whose market area for such businesses
overlaps that of the Essex Employers. Notwithstanding the foregoing, this
Section 4.3(b) shall not apply if Employee is terminated without Cause under
Section 3.1 above and the Essex Employers fail to pay to Employee the amounts
required to be paid under Sections 3.1 and 3.7(a) above.
(c) At no time during or following the term of Employee's
employment with the Essex Employers (irrespective of the time, manner, or cause
of the termination or resignation), shall Employee disclose to any other person
or entity, nor shall Employee use for Employee's own benefit or for the benefit
of any other entity or person, any confidential information or trade secrets of
the Essex Employers, including, without limitation, any confidential information
relating to the identities, background, historical information, or terms of
dealings with any of the Essex Employers' customers, prospects, potential
customers, suppliers, or sales or purchasing agents, or confidential information
respecting financial arrangements, marketing strategies, pricing methods and
determinations,methods of operation, procedures or any other material of a
similar nature or relating to the Essex Employers' conduct of their businesses.
Upon cessation of Employee's employment hereunder, Employee will surrender and
deliver to the Essex Employers all lists, books, records, and data of every
kind, including machine readable data, relating to or in connection with the
Essex Employers' customers and businesses.
(d) The provisions of this Section 4.3 shall apply to any
resignation or termination of Employee's employment, with or without Cause, and
shall survive termination of this Agreement.
(e) Employee acknowledges that the failure to adhere strictly
to the requirements of this Section 4.3 will cause substantial and irreparable
harm to the Essex Employers. Accordingly, in the event Employee, at any time,
violates any provision hereof, the Essex Employers shall be entitled to enforce
all of the following cumulative remedies from time to time: (1) to obtain
injunctive relief or other equitable remedies to cause cessation of activities
in violation of the terms of this Section 4.3; and (2) to seek all damages
proximately caused by such activities. In any such action brought by the Essex
Employers, the prevailing party shall be entitled to recover all expenses
incurred and reasonable attorney's fees.
ARTICLE V
GENERAL MATTERS
Section 5.1. Governing Law. This Agreement shall be governed by the
substantive laws of the State of Delaware and shall be construed in accordance
therewith.
Section 5.2. No Waiver and Notification. No provision of this Agreement
may be waived except by an agreement in writing signed by the waiving party. A
waiver of any term or provision shall be construed as a waiver of any other term
or provision.
Section 5.3. Amendment. This Agreement may be amended, altered or
revoked at any time, in whole or in part, only by a written instrument setting
forth such changes, signed by all of the parties.
Section 5.4. Benefit. This Agreement shall be binding upon the
Employee, and the Essex Employers, shall not be assignable in any event by the
Employee and may be assigned by an Essex Employer only to any of the other Essex
Employers. An assignment by the Essex Employers to any other entity shall be
effected only with the consent of the Employee.
Section 5.5. Construction. Throughout this Agreement and singular shall
include the plural, and the plural shall include the singular, wherever the
context so requires. To the extent that any provision of this Agreement directly
and expressly conflicts with the provisions of 12 C.F.R. Section 563.39(b), or
any successor regulation, the provisions of such regulation shall control.
Section 5.6. Text to Control. The headings of articles and sections are
included solely for convenience of reference. If any conflict between any
heading and the text of this Agreement exists, the text shall control.
Section 5.7. Severability. If any provision of this Agreement is
declared by any court of competent jurisdiction to be invalid for any reason,
such invalidity shall not affect the remaining provisions. On the contrary, such
remaining provisions shall be construed and enforced as if such invalid
provisions never had been inserted in the Agreement.
ESSEX BANCORP, INC.
By /s/ Roscoe D. Lacy, Jr.
Its: Director
ESSEX SAVINGS BANK, F.S.B.
By /s/ Roscoe D. Lacy, Jr.
Its: Director
ESSEX MORTGAGE CORPORATION
By /s/ Gene D. Ross
Its: President
EMPLOYEE
/s/ Gene D. Ross
EXHIBIT 10.13
RESTATED
EXECUTIVE SERVICES AGREEMENT
This Restated Executive Services Agreement, made as of the 1st day of
January, 1998 by and among ESSEX SAVINGS BANK, FSB (the "Bank"), ESSEX FIRST
MORTGAGE CORPORATION, a subsidiary of the Bank (collectively, the "Employers"),
and EARL MCPHERSON ("Employee").
WITNESSETH:
WHEREAS, the Employee has heretofore been employed as Executive Vice
President of the Bank and President and Chief Executive Officer of Essex First
Mortgage Corporation pursuant to that certain Executive Services Agreement
between the Employers and Employee, dated as of July 1, 1993 and subsequently
amended, (the "Original Agreement"); and
WHEREAS, the Employers and Employee desire to amend and restate the
Original Agreement.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth herein, and other good and valuable consideration, the adequacy of
which is hereby acknowledged, the Employers and the Employee amend and restate
the Original Agreement to read as follows:
1. Employment. The Employers hereby continue the employment of the
Employee as Executive Vice President of Essex Savings Bank, FSB and President
and Chief Executive Officer of Essex First Mortgage Corporation. The Employee
accepts such continued employment, and agrees to abide by the respective
Certificates or Articles of Incorporation, Bylaws and the decisions of the
Boards of Directors of the Employers.
2. Duties and Responsibilities. The Employee agrees to devote his full
time attention and energies to the business affairs of the Employers. The
Employee shall render such administrative and management services for the
Employers as are customarily performed by persons situated in a similar
capacity. The Employee's duties shall be such as the Boards of Directors of the
Employers or the Chief Executive Officer of the Bank may from time to time
direct.
3. Term of Agreement. This Restated Executive Services Agreement (the
"Agreement") and Employee s employment hereunder shall continue until terminated
as provided in Section 9 below.
4. Salary and Incentive Bonus.
(a) During 1998, the Employers shall pay to Employee an
aggregate basic salary at the rate of One Hundred Nine Thousand Six Hundred
Twenty Dollars ($109,620) per year ("Salary") payable in arrears no less
frequently than semi-monthly (after deduction of federal, state and local
withholding and similar taxes, amounts required to be withheld pursuant to any
employee benefits programs, and other authorized payroll deductions) in
accordance with the usual employee payroll practices of the Employers. The rate
of Employee's Salary shall be reviewed by the Employers not less often than
annually and may be increased from time to time in such amounts as the Bank's
Board of Directors in its discretion may determine based upon Employee's
performance.
(b) In addition to his Salary, Employee may, but shall not be
entitled to, receive from the Employers such cash bonuses, if any, as the Board
of Directors of the Employers in their sole discretion elect to award to
Employee.
5. Other Benefits. Throughout the term of this Agreement, the Employers
shall provide Employee with group life, health and disability insurance
coverage, in amounts and on terms and conditions as favorable as the coverage
provided other executive employees of the Employers from time to time. Employee
shall also be a participant in the Essex Savings Bank, FSB Supplemental
Executive Retirement Plan and any other pension or retirement plan maintained
from time to time by Employers. Moreover, Employee shall be eligible to
participate in any fringe benefit program which may be or become applicable to
executives of the Employers of comparable rank having comparable
responsibilities.
6. Regulatory Approval. So long as employment agreements between the
Bank and any executive officer are subject to prior approval by the Office of
Thrift Supervision ("OTS") or other federal agency (including the prior approval
requirement of OTS Regulatory Bulletin 27a), any compensation payable to
Employee pursuant to this Agreement (including severance benefits and Change in
Control benefits payable to Employee under Section 11) shall be subject to and
conditioned upon approval by the OTS or other regulatory agency. All payments
hereunder are also subject to and conditioned upon their compliance with Section
1828(k) of Title 12 of the United States Code and any regulations promulgated
thereunder. Any modification in the Employee's compensation required by the OTS
or other competent regulatory agency shall not alter in any way the duties or
obligations of Employee under this Agreement.
7. Vacation and Sick Leave. Employee shall be entitled to paid vacation
each year in the amount he is currently authorized to take by the Employers.
Employee shall not be entitled to receive any additional compensation from the
Employers on account of his failure to take a vacation except that accrued
vacation pay will be paid upon termination of employment; nor shall he be
entitled to accumulate unused vacation from one calendar year to the next except
to the extent authorized by the Boards of Directors of the Employers. In
addition, the Employee shall be entitled to annual sick leave as established by
the Employers for management officials of the Employers. In the event any sick
leave time shall not have been used during any year, such leave shall accrue to
subsequent years to the extent authorized under generally applicable Employer
policies. Upon termination of his employment, the Employee shall not be entitled
to receive any additional compensation from the Employers for unused sick leave,
except as is permitted under generally applicable Employer policies.
8. Loyalty; Non-piracy; Confidentiality.
(a) The Employee shall devote his full time and best efforts
to the performance of his employment under this Agreement. The Employee shall
abide by the Employers' "Corporate Code of Conduct." During his employment under
this Agreement, the Employee shall not engage in any business or activity
contrary to the business affairs or interests of the Employers. Nothing
contained in this Section 8, however, shall be deemed to prevent or limit the
right of Employee to invest in the capital stock or other securities of any
business dissimilar from that of Employers, or, solely as a passive and minority
investor, in any business. In no event shall Employee use or disclose to others
confidential "inside information" regarding the Employers or their affiliates or
engage, directly or indirectly, in any transaction involving the securities of
the parent of the Employers based upon such "inside information."
(b) During Employee's term of employment with Employers and
for nine (9) months thereafter (irrespective of the time, manner or cause of
termination or resignation), Employee shall not, directly or indirectly, on
behalf of Employee or any entity or person other than Employers hire or solicit
for employment in, employ in, or cause to be employed in any Competing Business
any personnel of the Employers who are or were employed by Employers at any time
during the period beginning one year prior to Employee s termination or
resignation, unless any such person has not been employed by the Employers for a
period in excess of one continuous year. For purposes of this Section 8(b), a
Competing Business means any person or entity which is engaged directly or
indirectly in any business engaged in by the Employers and whose market area for
such businesses overlaps that of the Employers. Notwithstanding the foregoing,
this Section 8(b) shall not apply if Employee is terminated without Cause under
Section 9(b) below and Employers fail to pay to Employee the amounts required to
be paid under Sections 9(b) and 11(a) below.
(c) At no time during or following the term of Employee s
employment with Employer (irrespective of the time, manner, or cause of the
termination or resignation), shall Employee disclose to any other person or
entity, nor shall Employee use for Employee's own benefit or for the benefit of
any other entity or person, any confidential information or trade secrets of
Employers, including, without limitation, any confidential information relating
to the identities, background, historical information, or terms of dealings with
any of Employers' customers, prospects, potential customers, suppliers, or sales
or purchasing agents, or confidential information respecting financial
arrangements, marketing strategies, pricing methods and determinations, methods
of operation, procedures or any other material of a similar nature or relating
to Employers' conduct of their business(es). Upon cessation of Employee's
employment hereunder, Employee will surrender and deliver to Employers all
lists, books, records, and data of every kind, including machine readable data,
relating to or in connection with Employers customers and business.
(d) The provisions of this Section 8 shall apply to any
resignation or termination of Employee s employment, with or without Cause, and
shall survive termination of this Agreement.
(e) Employee acknowledges that the failure to adhere strictly
to the requirements of this Section 8 will cause substantial and irreparable
harm to Employers. Accordingly, in the event Employee, at any time, violates any
provision hereof, Employers shall be entitled to enforce all of the following
cumulative remedies from time to time: (1) to obtain injunctive relief or other
equitable remedies to cause cessation of activities in violation of the terms of
this Section 8; and (2) to seek all damages proximately caused by such
activities. In any such action brought by Employers, the prevailing party shall
be entitled to recover all expenses incurred and reasonable attorney's fees.
9. Termination.
(a) Termination by an Employer with Cause. The Board of
Directors of any Employer may terminate this Agreement (and the Employee's
employment hereunder) at any time, immediately with notice, for "Cause." For
purposes of this Agreement, termination of Employee for "Cause" shall include
termination as a result of Employee's personal dishonesty, incompetence, willful
misconduct, breach of fiduciary duty involving personal profit, conviction of a
felony, willful violation of any law, rule or regulation (other than traffic
violations or similar offenses) or final cease and desist order, intentional
breach or neglect by Employee of his duties hereunder, persistent negligence or
misconduct in the performance of such duties, or material breach of any
provision of this Agreement. In the event of termination of Employee by any
Employer for "Cause," the Employee shall be paid solely the Salary and vacation
pay accrued and prorated to the date of his termination. For purposes of this
Section 9(a), any act or omission to act by the Employee in reliance upon any
opinion of counsel to an Employer or counsel to the Employee shall not be deemed
to be willful.
(b) Termination by an Employer Without Cause. The Board of
Directors of any Employer may terminate this Agreement (and Employee's
employment hereunder) without "Cause" (as defined above), at any time upon
thirty (30) days advance written notice to the Employee. In such event, the
Employee, if requested by the Board of Directors of the Employer, shall continue
to render his services to the Employers according to this Agreement through the
effective date of his termination. In the event the Board of Directors of any
Employer terminates this Agreement (and Employee's employment) without "Cause,"
the Employee shall be entitled to the severance benefits described in Section
11(a) below (assuming termination prior to a Change in Control), plus his Salary
and vacation pay accrued and prorated through the date of his termination.
(c) Termination by Employee with Just Cause. The Employee may
terminate this Agreement (and his employment hereunder) at any time, immediately
with notice, for "Just Cause." For purposes of this Section 9(c), the term "Just
Cause" shall mean: (i) a reduction in Employee's Salary without his consent;
(ii) an Employer-imposed requirement that Employee relocate his office to a
location which is more than ninety (90) miles from Norfolk, Virginia without
Employee's consent; (iii) a material change by Employers in Employee's titles
and/or reporting responsibilities without Employee's consent, which change is
not reversed within ten (10) business days after written notice by Employee
objecting to the change; or (iv) failure by the Employers to comply with any
material provision of this Agreement, which failure has not been cured within
ten (10) business days after written notice of such noncompliance has been given
by the Employee to the Employers. In the event the Employee terminates this
Agreement for Just Cause, the Employee shall be entitled to the severance
benefits described in Section 11(a) below (assuming termination prior to a
Change in Control), plus his Salary and vacation pay accrued and prorated
through the effective date of termination.
(d) Termination by Employee Without Just Cause. The Employee,
without Just Cause, may terminate this Agreement (and his employment hereunder)
upon thirty (30) days' written notice to the Employers. In such event, the
Employee shall continue to render the services required under this Agreement
(unless directed not to do so by any Employer's Board of Directors) and shall be
paid solely the Salary and vacation accrued and prorated through the effective
date of his termination.
(e) Termination Upon Death or Disability of Employee. In
addition to any other provision relating to termination, this Agreement shall be
automatically terminated in the event of Employee's death or permanent
disability. In such event the Employee shall be paid the amount of Salary and
vacation accrued and prorated through the date of death or permanent disability,
as well as other benefits provided to deceased or disabled employees generally
under Employers' policies and benefit plans.
10. Suspension or Termination as Required by Government Regulations.
(a) If the Employee is suspended and/or temporarily prohibited
from participating in the conduct of affairs of the Bank by notice served under
Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act (12 U.S.C.
ss.1818(e)(3) and (g)(1)), the Employers' obligations under this Agreement shall
be suspended as of the date of service unless stayed by appropriate proceedings.
If the charges in the notice are dismissed, the Employers may in their
discretion pay the Employee all or part of the compensation withheld while their
obligations under this Agreement were suspended, and reinstate (in whole or in
part) any of their obligations which were suspended.
(b) If the Employee is removed and/or permanently prohibited
from participating in the conduct of the Bank's affairs by an order issued under
Section 8(e)(4) or (g)(1) of the Federal Deposit Insurance Act (12 U.S.C.
ss.1818(e)(4) or (g)(1)), all obligations of the Employers under this Agreement
shall terminate as of the effective date of the order, but rights of the parties
which vested prior to that effective date shall not be affected.
(c) If the Bank is in default (as defined in Section 3(x)(1)
of the Federal Deposit Insurance Act) all obligations of the Employers under
this Agreement shall terminate as of the date of default, but this paragraph
shall not affect any rights of the parties hereto which vested prior to the date
of that default.
(d) All obligations of the Employers under this Agreement
shall terminate, except to the extent that continuation of the contract is
determined to be necessary for the continued operation of the Employers by (i)
the director of the OTS (the "Director") or his designee, at the time the
Federal Deposit Insurance Corporation enters into an agreement to provide
assistance to or on behalf of the Bank under the authority contained in Section
13(c) of the Federal Deposit Insurance Act; or (ii) the Director or his
designee, at the time the Director or his designee approves a supervisory merger
to resolve problems related to the operation of the Bank or when the Bank is
determined by the Director to be an unsafe or unsound condition; but any rights
of the parties hereto that have already vested prior to such determination or
action shall not be affected by such determination or action.
11. Severance Benefit and Change of Control Payment.
(a) In the event of termination of this Agreement and Employee
s employment hereunder prior to a Change in Control (as defined in Section 11(b)
below) by the Employers without "Cause" under Section 9(b) or by the Employee
with "Just Cause" under Section 9(c) the Employers shall: (1) pay to the
Employee in a lump sum within thirty (30) days of termination an amount equal to
one hundred and fifty percent (150%) of his highest rate of annual Salary in
effect during the period commencing on May 1, 1997 and ending on the date of his
termination; and (2) provide continuing health and medical insurance, disability
insurance and life insurance coverage on behalf of the Employee (and Employee's
other family members, if applicable) for a period of twelve months following
termination on the same basis as was in effect as of the effective date of
termination.
(b) In the event of a Change in Control occurs prior to or on
the date of termination of this Agreement, the Employers shall: (1) pay to the
Employee in a lump sum within thirty (30) days of the Change of Control an
amount equal to one hundred and fifty percent (150%) of his highest rate of
annual Salary in effect during the period commencing on May 1, 1997 and ending
on the date of the Change in Control; and (2) provide continuing health and
medical insurance, disability insurance and life insurance coverage on behalf of
the Employee (and his other family members, if applicable) for a period of
twelve (12) months following the Change in Control on the same basis as was in
effect as of the effective date of termination. For purposes of this Agreement,
a Change in Control shall occur if and only if after December 31, 1997 a person
or group (as such term is used in Sections 13(d) and 14(d) of the Securities
Exchange Act of 1934), directly or indirectly, first becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) of
securities of Essex Bancorp, Inc. representing 20% or more of the combined
voting power of the then outstanding securities of Essex Bancorp, Inc. Any
provision herein to the contrary notwithstanding, no Change in Control shall be
deemed to occur as a result of: (1) any transaction prior to January 1, 1998;
(2) any purchase, transfer, or other disposition of the Series B and Series C
preferred shares of Essex Bancorp, Inc.; or (3) any exercise or conversion of
warrants or options of Essex Bancorp, Inc. which were issued prior to 1996 (and
any exercise, or conversion of such warrants or options shall be disregarded in
determining whether a Change of Control has occurred.)
(c) Any provision herein to the contrary notwithstanding: (i)
no severance payment under Section 11(a) or Change in Control payment under
Section 11(b) shall be due to Employee if Employer terminates Employee for Cause
under Section 9(a) or Employee resigns without Just Cause under Section 9(d)
prior to a Change in Control; and (ii) under no circumstances shall Employee be
entitled to a payment under both Section 11(a) and Section 11(b) above.
12. Adverse Statements and/or Action. The Employers and Employee agree
that during the term of this Agreement and thereafter they will refrain from
making any adverse public statements about each other, or the Employers'
employees. An adverse statement is one which is derogatory or otherwise of such
a nature that it tends to be embarrassing, humiliating or injurious to the name,
reputation or business of the party about whom the statement is made, whether or
not the party making such statement believes it to be true. Upon termination of
this Agreement, the Employers and Employee will use their best efforts to reach
agreement on the text of any public statement, if necessary, regarding the
employment relationship which is satisfactory to both. Notwithstanding the
foregoing, neither party shall be prohibited from making any public statement
compelled by law or which is otherwise legally privileged, or from correcting or
commenting upon a public statement or public reports originating from any other
source. This provision shall be in addition to any other rights and duties which
may arise under the laws of defamation, unfair competition and similar laws.
13. General Matters.
(a) This Agreement shall be governed by the substantive laws
of the State of Virginia and shall be construed in accordance therewith. This
Agreement constitutes the entire agreement between the parties as to the matters
described herein and supersedes all prior employment and executive services
agreements and understandings between the parties.
(b) No provision of this Agreement may be waived except by
agreement in writing signed by the waiving party. A waiver of any term or
provision shall not be construed as a waiver of any other term or provision.
(c) This Agreement may be amended, altered or revoked at any
time, in whole or in part, only by a written instrument setting forth such
changes, signed by all the parties.
(d) This Agreement shall be binding upon the Employee and the
Employers, and shall not be assignable in any event by the Employee.
(e) Throughout this Agreement the singular shall include the
plural and the plural shall include the singular whenever the context so
requires.
(f) To the extent that any provision of this Agreement
directly and expressly conflicts with the provisions of 12 C.F.R. Section
563.39(b), or any successor regulation, the provisions of such regulation shall
control.
(g) If any provision of this Agreement is declared by any
court of common jurisdiction to be invalid for any reason such invalidity shall
not affect the remaining provisions.
On the contrary, such remaining provisions shall be construed in force as if
such invalid provisions had never been inserted in this Agreement.
IN TESTIMONY WHEREOF, the parties have caused this Agreement to be
executed as of the 1st day of January, 1998.
ESSEX SAVINGS BANK, FSB
By /s/ Gene D. Ross
Its: President
ESSEX FIRST MORTGAGE CORPORATION
By /s/ Gene D. Ross
Its: Chairman
/s/ Earl C. McPherson (SEAL)
Employee
EXHIBIT 13
ESSEX BANCORP, INC.
1997 ANNUAL REPORT
<PAGE>
ESSEX BANCORP, INC.
Table of Contents
Page
----
Report to Our Stockholders 1
Five Year Financial Summary 3
Management's Discussion and Analysis 4
Report of Independent Accountants 23
Consolidated Financial Statements 24
Notes to Consolidated Financial Statements 32
Investor Information 56
Directors and Officers 57
Corporate Information 58
<PAGE>
[LOGO]
BANCORP, INC.
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
In our past reports to our stockholders we have extensively chronicled the
problems of Essex Bancorp, Inc. (the "Company") and the many restructuring
activities that we have undergone. All of these efforts were undertaken to
better position the Company for growth and profitability. During 1997 our
investor base changed dramatically as a result of the volatility in the
Company's common stock. We surmise that such investors are more interested in
the potential of their investment rather than the history of the Company, which
is reflected in our current and previous public filings. It is important for you
to know that we are singularly focused on achieving profitability and looking
forward.
Following a material downsizing of the Company during 1996 through the sale of
nine non-strategic branches in three separate transactions, 1997 was a year of
improving our financial fundamentals, leveraging our capital with 17.5% deposit
growth in our retail branch banking franchise, reducing nonperforming assets by
36.8%, and increasing total assets by 11.9%, thereby better positioning
ourselves to be profitable in 1998.
In 1997 we began to execute many of the strategies that were developed out of
prior year strategic planning sessions and the work of the Strategic Evaluation
Committee. The fundamentals of the Company have changed dramatically since 1992
when combined losses from operations at Essex
1
<PAGE>
Bancorp, Inc. for the five years through 1996 following the change in management
in 1992 amounted to $45.5 million. Our 1997 loss of $297,000 represents a major
improvement; however, we recognize that nothing short of profitability above and
beyond the amounts we must earn to cover the accruing dividends on our preferred
stock will be satisfactory. I encourage you to read the Management's Discussion
and Analysis of Financial Condition and Results of Operations in order to
enhance your perspective of the Company's performance during 1997.
1998 is a critical year in which we must achieve profitability and demonstrate
that we do have the ability to leverage our capital through growth, and achieve
sufficient returns for common and preferred shareholders. The outlook appears to
present many favorable market opportunities for us. We believe our mortgage
company can succeed in a lower rate environment in which mortgage production,
both residential and construction, should be active. Our servicing company has
the capacity to expand by attracting new subservicing contracts, and we believe
our costs are low and our pricing very competitive. Finally, with the April 1998
relocation of our Suffolk, Virginia branch into its newly constructed
full-service branch, we will have four excellent retail bank branch locations
that have growing market share in expanding markets. In view of the significant
consolidation of financial institutions in Virginia through merger, we are
reviewing opportunities to expand our banking franchise.
In summary, we believe Essex has accomplished a great deal and we have employees
who are capable and motivated to achieve much greater successes in 1998. The
management of the Company and the Board of Directors are committed to expanding
the business and achieving profitability. We appreciate your support and welcome
hearing from you.
/s/ Gene D. Ross
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 31, 1998
2
<PAGE>
<TABLE>
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
<CAPTION>
At or For the Year Ended December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C>
BALANCE SHEET DATA:
Total assets......................... $195,088 $174,267 $338,724 $296,231 $390,958
Net loans ........................... 167,441 145,551 266,632 237,392 206,781
Deposits ........................... 153,927 131,033 283,497 222,462 328,781
Federal Home Loan Bank advances...... 23,547 25,690 29,833 58,952 41,661
Notes payable........................ 72 96 120 2,691 21,891
Shareholders' equity and total
partners' capital (deficit)........ 14,817 15,106 22,630 8,140 (4,950)
Nonperforming assets................. 3,298 5,215 11,257 13,652 18,090
Allowance for loan losses............ 2,382 2,556 5,251 3,429 3,039
OPERATIONS DATA:
Interest income...................... $ 14,547 $ 19,872 $ 22,547 $ 22,966 $ 27,727
Interest expense..................... 9,230 13,764 16,627 15,956 19,027
Net interest income.................. 5,317 6,108 5,920 7,010 8,700
Provision for loan losses............ 113 1,411 2,477 1,604 1,085
Noninterest income................... 2,463 4,282 3,172 4,068 7,372
Noninterest expense:
Amortization....................... 531 7,011 956 1,360 6,420
Other.............................. 7,433 9,345 9,814 15,619 17,048
Income (loss) before cumulative
effect of change in accounting
principle, extraordinary items,
and income taxes................... (297) (7,377) (4,155) (7,505) (8,481)
Cumulative effect of change in
accounting principle............... - - - 179 -
Extraordinary items, net of tax...... - - 2,945 (1) 20,416 (2) -
Net income (loss).................... (297) (7,377) (1,210) 13,090 (8,481)
Net income (loss) available to common
stockholders....................... (1,932) (8,824) (1,578) 13,090 (8,481)
Basic and diluted net loss per
common share (3)................... (1.83) (8.39) (1.50) - -
Pro forma basic and diluted net
income (loss) per common
share (3).......................... - - - 12.47 (8.08)
OTHER DATA:
Return on average assets............. (.16)% (2.73)% (.39)% (1) 3.88% (2) (2.12)%
Return on average capital............ (1.96)% (39.51)% (10.59)% (4) (4)
Average capital to average assets.... 8.13% 6.92% 3.67% (5) (5)
Net interest spread.................. 2.69% 2.20% 2.00% 2.46% 2.73%
Net interest margin.................. 3.01% 2.41% 2.01% 2.20% 2.34%
Nonperforming assets as a percent
of total assets at end of year..... 1.69% 2.99% 3.32% 4.61% 4.63%
Allowance for loan losses as a
percent of total loans at end
of year ........................... 1.40% 1.73% 1.93% 1.42% 1.45%
Net charge-offs as a percent of
average total loans................ .18% 1.89% .46% .55% .95%
Retail banking offices............... 4 4 12 8 11
</TABLE>
(1) The Company recognized a $2.9 million extraordinary credit to earnings
related to the 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) The Company recognized a $20.4 million extraordinary credit (net of
income taxes) to earnings related to a litigation settlement during
1994. The return on average assets excluding the impact of this
extraordinary item was (2.17)% for the year ended December 31, 1994.
(3) The Company adopted Statement of Financial Accounting Standards No. 128
- Earnings Per Share during 1997 and has restated per share data
accordingly for all periods presented.
(4) Ratio exceeds (100.00)%.
(5) Ratio is less than 0.00%.
3
<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, 1997, 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 achieved a "well capitalized" status for regulatory
capital purposes and has removed goodwill associated with the Home Acquisition
from its balance sheet. In addition, the Company's operating expenses in 1997
were reduced due to the elimination of the amortization of goodwill and the
operating 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 $15.0 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 $3.5 million at December 31, 1997. The Bank's core and
risk-based regulatory capital ratios were 7.86% and 14.33%, respectively, at
December 31, 1997 resulting in excess core capital of $7.5 million and excess
risk-based capital of $7.4 million over the minimum regulatory requirements.
While management is of the opinion that capital compliance will be maintained
4
<PAGE>
throughout 1998, until the Company's core profitability is restored, 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. Total assets of the Company at December 31, 1997 were $195.1
million as compared to $174.3 million at December 31, 1996, an increase of
approximately $20.8 million or 11.9%. The increase in assets was primarily
attributable to a $21.9 million increase in loans held for investment, which
reflected the Company's strategy of investing proceeds from the maturities of
investment securities and funds provided by the growth in deposits into higher
yielding loans.
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) increased by $4.8 million or
78.1% during 1997 due to the excess liquidity maintained at December 31, 1997 in
order to fund upcoming deposit maturities. In addition, the level of cash and
cash equivalents was lower at December 31, 1996 because a portion of the Bank's
excess liquidity had been used 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, Federal
Home Loan Bank ("FHLB") stock, and mutual fund investments. During the year
ended December 31, 1997, investment securities declined by $4.8 million or
56.2%. The decrease during 1997 was attributable to (i) the redemption of $1.2
million of FHLB stock resulting from the FHLB's policy regarding stock holdings
in excess of membership requirements, which limits any FHLB member's excess
stock to no more than $500,000 and (ii) the maturity of $4.0 million in U.S.
Treasury and U.S. government agency securities. Funds obtained from the decline
in investment securities were used to fund the acquisition of higher yielding
loans.
Mortgage-Backed Securities. 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. Because the
Company is emphasizing lending and the investment of the proceeds from the
maturities of securities into higher yielding loans, there were no new
investments in mortgage-backed securities in 1997.
Loans. Net loans (including loans classified as held for sale)
increased by $21.6 million or 14.6% during 1997 resulting from purchases of
adjustable-rate first mortgage loan portfolios totaling $22.2 million and
mortgage loan originations by Essex First. The Company relied on acquisitions of
adjustable-rate portfolios during 1997 because customer demand during the period
of low interest rates has emphasized fixed rate loans, which the Company sells
in the secondary market.
5
<PAGE>
Nonperforming Assets. The Company's nonperforming assets, net of
specific reserves for collateral-dependent real estate loans ("CDRELs") and
foreclosed properties, decreased from $5.2 million at December 31, 1996 to $3.3
million at December 31, 1997, and consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
<S> <C>
1997 1996
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
Nonaccrual loans, net:
First and second mortgages................ $1,203 .71% $2,513 1.70%
Construction and development.............. 133 .08 220 .15
Commercial................................ 132 .08 22 .01
Consumer.................................. 88 .05 153 .10
Accruing loans 90 days or more past due..... 21 .01 30 .02
Troubled debt restructurings................ 209 .12 223 .15
------ --- ------ ---
Total nonperforming loans............... 1,786 1.05 3,161 2.13
Foreclosed properties, net.................. 1,512 .89 2,054 1.39
----- ----- ----- ----
Total nonperforming assets.............. $3,298 1.94% $5,215 3.52%
===== ==== ===== ====
Nonperforming assets to total assets........ 1.69% 2.99%
Nonperforming loans to total loans.......... 1.05 2.13
Allowance for loan losses to
total loans............................... 1.40 1.73
Allowance for loan losses to
nonaccrual loans.......................... 153.09 87.90
Allowance for loan losses to
nonperforming loans....................... 133.37 80.86
</TABLE>
The decrease in nonperforming assets consisted of a $1.4 million
decline in nonperforming loans and a $542,000 decline in foreclosed properties.
The decrease in nonaccrual loans was attributable to the improvement in asset
quality evidenced by the decline in delinquencies from $1.5 million at December
31, 1996 to $940,000 at December 31, 1997. The decline in delinquent loans was
attributable to a decline in the number of delinquent residential mortgage loans
and the restructuring of a $288,000 loan secured by an apartment complex in
Suffolk, Virginia, which had been delinquent at December 31, 1996.
Gross interest income that would have been recognized for the years
ended December 31, 1997, 1996 and 1995 if nonaccrual loans at the respective
dates had been performing in accordance with their original terms approximated
$171,000, $291,000 and $678,000, 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 Company's decrease in foreclosed properties reflected the impact of
the decline in nonperforming and delinquent loans during 1997 and prior years.
In addition, during 1997 the Company completed the sale of residential lots
located in the Outer Banks of North Carolina, which had a carrying value of
$164,000 at December 31, 1996. The $1.5 million of foreclosed properties
included in nonperforming assets at December 31, 1997 is reported net of related
reserves totaling $155,000. In addition, approximately $334,000 of losses and
write-downs have been previously recognized on foreclosed properties held at
December 31, 1997.
6
<PAGE>
The following table sets forth the types of properties which comprise
the Company's foreclosed properties (net of related reserves) at December 31 (in
thousands):
1997 1996
---- ----
Residential real estate development
projects $ 485 $ 390
Single-family residential real estate 770 1,300
Land and subdivisions 257 364
------ ------
$1,512 $2,054
===== =====
In addition to the $3.3 million of nonperforming assets at December 31,
1997, as of such date the Company had classified for regulatory purposes an
additional $1.8 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 $5.2 million of nonperforming assets and $2.3 million of
classified assets at December 31, 1996. These classified 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.
Mortgage Servicing Rights and Loan Premiums. As of December 31, 1997
and 1996, the Company reported $1.2 million and $1.3 million, respectively, of
purchased and originated mortgage servicing rights (collectively, "MSRs") and
$668,000 and $565,000, respectively, of capitalized loan premiums. The increases
in MSRs and loan premiums were attributable to purchases of servicing rights and
adjustable-rate loan portfolios during 1997. The carrying value of the Company's
MSRs 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. At December 31, 1997, no assurance can be made that
further significant amortization or impairment adjustments will not be necessary
with respect to the Company's MSRs or capitalized loan premiums if the lower
interest rate environment results in the acceleration of prepayment activity in
excess of expectations.
Deposits. Deposits, the primary source of the Company's funds,
increased by $22.9 million or 17.5% during the year ended December 31, 1997. The
increase in deposits was attributable to increases in money market accounts and
certificates of deposit. While deposits grew at each of the Bank's branches, the
most significant growth occurred at the Suffolk and Richmond, Virginia branches,
which experienced deposit growth of 49.4% and 35.8%, respectively. In addition,
because of the improvement in the Bank's overall financial condition, Essex Home
transferred a portion of its servicing escrow accounts from a nonaffiliated
financial institution to the Bank. This transfer was reflected in the increase
in noninterest-bearing deposits.
Borrowings. The Company's borrowings consist of advances from the FHLB
and notes payable. FHLB advances decreased by $2.1 million or 8.3% during the
year ended December 31, 1997 as a result of scheduled maturities. At December
31, 1997, the unused lendable collateral value for additional FHLB advances was
$20.9 million. The Company's notes payable totaled $72,000 and $96,000 at
December 31, 1997 and 1996, respectively, and consisted solely of a note payable
to the former president of Home Bancorp and Home Savings. In conjunction with a
severance settlement with the former employee, the Company repaid this note in
its entirety in February 1998.
Other Liabilities. As of December 31, 1997, other liabilities included
a $703,000 obligation to the Company's Chief Executive Officer resulting from
the exercise of his stock appreciation rights in November 1997. A determination
has not yet been made as to the date and method of payment to satisfy this
obligation. For additional information about the Company's stock option plans,
see Note 19 of the Notes to Consolidated Financial Statements.
7
<PAGE>
Shareholders' Equity. Total shareholders' equity at December 31, 1997
was $14.8 million, a decrease of $289,000 from shareholders' equity of $15.1
million at December 31, 1996. This change reflects the Company's net loss of
$297,000 for the year ended December 31, 1997, 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 $3.5 million at December 31, 1997. To
the extent that the Company's income is not sufficient to cover the cumulative
dividends and accrued interest on the Series B and C preferred stock, the equity
of the Company's common shareholders will continue to decline. Accordingly, the
Company's Board of Directors and the Committee continue to evaluate
profitability enhancements and possibilities for corporate restructurings.
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, primarily loans and investment
securities, and interest expense on interest-bearing liabilities, primarily
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 and mortgage banking income; 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
MSRs, deposit insurance premiums and 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 and
borrowings 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, 1997, 1996, and 1995, the predominant
percentage of loans originated for resale by the Company were sold on a
servicing released basis in order to recognize gains to supplement the core
capital of the Bank. The Mortgage Banking Segment also depends on the fees
generated by Essex Home in connection with its mortgage loan servicing
activities. As of December 31, 1997, the Company serviced approximately 5,500
loans totaling $354.2 million for nonaffiliated servicing clients.
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. The segment information in Note 23 indicates a loss
before income taxes for the Mortgage Banking Segment for the year ended December
8
<PAGE>
31, 1997. However, intersegment income received from the Retail Banking Segment
for loan servicing and loan originations has been eliminated from the Mortgage
Banking Segment's loss before income taxes and total revenue. If the Mortgage
Banking Segment did not perform these servicing and loan origination functions
for the Retail Banking Segment, the Company would incur costs associated with
third party processors and capitalized loan premiums.
General. The Company's net loss for the year ended December 31, 1997
totaled $297,000, compared to a net loss of $7.4 million for the year ended
December 31, 1996 and a net loss of $1.2 million for the year ended December 31,
1995. The Home Acquisition, which occurred on September 15, 1995, 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.
As detailed below, the Company's operating results for the year ended
December 31, 1996 included nonrecurring transactions associated with the sale of
the Branches. Excluding the impact of these transactions, the Company incurred a
net loss of $2.8 million during 1996 resulting in an effective $2.5 million
increase in operating results during the year ended December 31, 1997. This
improvement in operating results during 1997 reflected the impact of (i) an
increase in the net interest margin on interest earning assets, (ii) a $1.3
million decrease in the provision for loan losses resulting from a decline in
nonperforming assets and (iii) a decrease in noninterest expenses resulting from
the elimination of $1.7 million of operating expenses associated with the
Branches sold during 1996. These favorable impacts were partially offset by the
loss of net interest income on interest-earning assets sold in connection with
the sale of the Branches.
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. Refer to Note 3 of the Notes to Consolidated Financial
Statements for a description of the components of these extraordinary items.
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.
Net Interest Income. Net interest income totaled $5.3 million, $6.1
million and $5.9 million for the years ended December 31, 1997, 1996, and 1995,
respectively. In addition, the net interest margin was 3.01%, 2.41% and 2.01%
for the years ended December 31, 1997, 1996, and 1995, respectively. The
decrease from 1996 to 1997 in net interest income reflects the loss of net
interest income associated with assets and deposits sold in connection with the
sale of the Branches during 1996. However, the net interest margin on
9
<PAGE>
interest-earning assets increased 60 basis points from 2.41% during 1996 to
3.01% during 1997 as a result of an increase in the ratio of interest-earning
assets to interest-bearing liabilities from 103.98% during 1996 to 106.13%
during 1997, along with an increase in the yield on loans from 8.08% during 1996
to 8.53% during 1997, which reflected the Bank's emphasis on investment in
adjustable-rate single-family residential loans. The net interest margin during
1997 also benefited from a decline in the Company's cost of funds resulting from
the generally lower interest rate environment during 1997 as compared to 1996.
Typically, declining interest rates favorably impact the Company's earnings due
to the repricing of deposits with shorter maturities as compared to
interest-earning assets, predominantly loans, which have either fixed interest
rates or interest rates that adjust over longer periods. However, in an extended
period of lower interest rates, the Company can also expect pressure on the net
interest margin resulting from an increase in the volume of refinancings to
lower fixed rate loans.
The increase from 1995 to 1996 in net interest income and the net
interest margin 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.
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.
[intentionally blank]
10
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
1997 1996
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $159,370 $13,588 8.53% $221,215 $17,882 8.08%
Investment securities.......... 6,457 354 5.48 11,012 615 5.59
Mortgage-backed securities (2). 1,905 124 6.54 6,320 498 7.95
Federal funds sold and securities
purchased under agreements
to resell.................... 2,757 151 5.48 6,094 319 5.24
Other.......................... 6,024 330(3)
5.48 10,094 558(3) 5.38
-------- -------- -------- --------
Total interest-earning assets 176,513 14,547(3) 8.24 254,735 19,872(3) 7.80
Cash.............................. 2,065 3,083
Other, less allowance for loan losses 7,831 11,944
-------- --------
Total assets................... $186,409 $269,762
======= =======
Interest-bearing liabilities:
Time deposits.................. $111,394 6,381 5.73% $183,710 10,620 5.78%
Other deposits................. 29,584 1,298 4.39 33,218 1,325 3.99
-------- ------- -------- -------
Total deposits.............. 140,978 7,679 5.45 216,928 11,945 5.51
Notes payable.................. 96 9 9.50 113 11 9.50
FHLB advances.................. 24,885 1,474 5.92 27,137 1,626 5.99
Subordinated capital notes..... - - - 399 52 13.15
Other.......................... 360 68(4)18.29 405 130(4)18.32
--------- -------- ---------- -------- -
Total interest-bearing
liabilities.............. 166,319 9,230(4) 5.55 244,982 13,764(4) 5.60
------- ------
Demand deposits................... 3,143 1,433
Other............................. 1,795 4,675
--------- ---------
Total liabilities.............. 171,257 251,090
Redeemable preferred stock........ - -
Shareholders' equity.............. 15,152 18,672
-------- --------
Total liabilities and
shareholders' equity........ $186,409 $269,762
======= =======
Net interest earnings............. $ 5,317 $ 6,108
======= =======
Net interest spread (2)(3)(4)..... 2.69% 2.20%
==== ====
Net interest margin (2)(3)(4)(5).. 3.01% 2.41%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities.................... 106.13% 103.98%
====== ======
1995
---------------------------------
Average Yield/
Balance Interest Rate
------- -------- ----
Interest-earning assets:
Loans (1)...................... $254,548 $19,779 7.77%
Investment securities.......... 14,694 836 5.69
Mortgage-backed securities (2). 16,991 1,286 7.57
Federal funds sold and securities
purchased under agreements
to resell.................... 4,011 280 6.98
Other.......................... 5,210 366(3) 6.69
--------- --------
Total interest-earning assets 295,454 22,547(3) 7.63
Cash.............................. 2,739
Other, less allowance for loan losses 13,242
--------
Total assets................... $311,435
=======
Interest-bearing liabilities:
Time deposits.................. $213,605 12,284 5.75%
Other deposits................. 32,084 1,221 3.81
-------- -------
Total deposits.............. 245,689 13,505 5.50
Notes payable.................. 1,360 131 9.61
FHLB advances.................. 46,617 2,798 6.00
Subordinated capital notes..... 621 73 11.78
Other.......................... 459 120(4)17.94
---------- --------
Total interest-bearing
liabilities.............. 294,746 16,627(4) 5.63
------
Demand deposits................... 1,285
Other............................. 3,365
----------
Total liabilities.............. 299,396
Redeemable preferred stock........ 615
Shareholders' equity.............. 11,424
--------
Total liabilities and
shareholders' equity........ $311,435
=======
Net interest earnings............. $ 5,920
=======
Net interest spread (2)(3)(4)..... 2.00%
====
Net interest margin (2)(3)(4)(5).. 2.01%
====
Average interest-earning assets
to average interest-bearing
liabilities.................... 100.24%
======
</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 1997, 1996, and 1995 includes the accretion of net
deferred loan fees and excludes $15,140 and $17,378 in 1996 and 1995,
respectively, which consists primarily of interest earned on custodial
accounts maintained for servicing investors.
(4) Rate calculation in 1997, 1996, and 1995 excludes $1,873, $56,004 and
$37,995, respectively, which consists primarily of interest paid on escrow
accounts.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
11
<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>
<S> <C>
Increase (Decrease) From Increase (Decrease) From
1996 to 1997 Due to 1995 to 1996 Due to
------------------------------- -------------------------------
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
(dollars in thousands)
Interest income on:
Loans (1) $934 $(5,228) $(4,294) $773 $(2,670) $(1,897)
Investment securities (11) (250) (261) (15) (206) (221)
Mortgage-backed securities (77) (297) (374) 62 (850) (788)
Federal funds sold and securities
purchased under agreements
to resell 14 (182) (168) (82) 121 39
Other interest-earning assets 9 (237) (228) (82) 274 192
---- ------- -------- ---- -------- ---------
Total interest income (2) 869 (6,194) (5,325) 656 (3,331) (2,675)
---- ------- -------- ---- -------- ---------
Interest expense on:
Time deposits (96) (4,143) (4,239) 64 (1,728) (1,664)
Other deposits 126 (153) (27) 60 44 104
Notes payable - (2) (2) (2) (118) (120)
FHLB advances (18) (134) (152) (5) (1,167) (1,172)
Subordinated capital notes (26) (26) (52) 8 (29) (21)
Other interest-bearing
liabilities - (62) (62) 20 (10) 10
---- ------- -------- ---- -------- ---------
Total interest expense (14) (4,520) (4,534) 145 (3,008) (2,863)
---- ------- -------- ---- -------- ---------
Net interest income $883 $(1,674) $ (791) $511 $ (323) $ 188
==== ======= ======== ==== ======== =========
</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, 1997, 1996, and 1995, provisions for
loan losses amounted to $113,000, $1.4 million and $2.5 million, respectively.
The lower provision for loan losses during 1997 reflected the impact of the
improvement in asset quality. In addition, a $329,000 recovery on a loan
guarantee during 1997 was used to increase the loan loss allowance. The level of
the provision for loan losses during 1996 and 1995 was necessary to maintain the
allowance for loan losses at an adequate level after it was reduced by net
charge-offs of $4.1 million and $1.2 million, respectively. Net charge-offs
during 1997 totaled $288,000. The ratio of the allowance for loan losses to
12
<PAGE>
total nonperforming loans was 133% at December 31, 1997, 81% at December 31,
1996 and 82% at December 31, 1995. In addition, the ratio of the allowance for
loan losses to total loans held for investment was 1.4% at December 31, 1997,
1.7% at December 31, 1996 and 1.9% at December 31, 1995.
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's 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>
<S> <C>
1997 1996 1995
---- ---- ----
Loan servicing fees......................... $1,312,476 $1,665,768 $1,765,617
Mortgage banking income..................... 458,520 577,130 504,715
Other service charges and fees.............. 368,671 497,316 428,811
Net gain (loss) on sales of:
Securities............................. - 153,188 -
Loans.................................. (1,458) (1,018,185) 115,538
Deposits............................... - 1,940,010 -
Other....................................... 324,596 466,519 357,309
---------- ---------- ----------
$2,462,805 $4,281,746 $3,171,990
========= ========= =========
</TABLE>
Total noninterest income amounted to $2.5 million during the year ended
December 31, 1997, a $1.8 million or 42.5% decrease from the $4.3 million
recognized during the year ended December 31, 1996. Noninterest income during
1997 included (i) an aggregate gain of $97,000 on the sale of the Bank's former
Newport News and Portsmouth, Virginia branch facilities, which had been vacant
since the sale of related deposits in September 1996 and (ii) termination fees
approximating $113,000 received in connection with the cancellation of Essex
Home's largest subservicing client's contract effective May 31, 1997.
Noninterest income in 1996 included the gains on sales of securities, deposits,
and premises and equipment, which totaled $2.3 million, associated with the sale
of the Branches, which were partially offset by a $1.0 million loss on loans
sold to partially fund the sale of the Branches. Exclusive of the impacts of
these transactions during 1997 and 1996, the effective decline in noninterest
income during the year ended December 31, 1997 was $738,000. This decline was
primarily attributable to (i) lower loan servicing fees resulting from
fluctuations in loan servicing volume including the impact of the subservicing
contract cancellation effective May 31, 1997, (ii) lower mortgage banking income
resulting from fewer loans originated for sale in the secondary market as Essex
First focused on expanding its construction lending programs and (iii) lower
service charges and fees resulting primarily from the Bank's sale of the
Branches during 1996.
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
13
<PAGE>
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.
Noninterest Expense. The following table sets forth information
regarding noninterest expense for the years ended December 31:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
---- ---- ----
Salaries and employee benefits.............. $3,788,695 $4,554,540 $ 4,387,760
Net occupancy and equipment................. 1,084,593 1,470,284 1,671,352
Deposit insurance premiums.................. 478,684 674,730 722,106
Amortization of intangible assets........... 530,707 7,011,288 956,257
Service bureau fees......................... 461,217 599,207 523,526
Professional fees........................... 349,218 507,031 476,224
Foreclosed properties, net.................. 182,880 (175,055) 187,715
Other....................................... 1,087,362 1,713,958 1,845,102
--------- ----------- -----------
$7,963,356 $16,355,983 $10,770,042
========= ========== ==========
</TABLE>
Total noninterest expense amounted to $8.0 million during the year
ended December 31, 1997, a decrease of $8.4 million or 51.3% from the $16.4
million recognized during the year ended December 31, 1996. The sale of the
Branches during 1996 had a pervasive impact on noninterest expense. In addition
to the $5.9 million write down in the net asset value of certain of the sold
Branches, total noninterest expense associated with the sold Branches, including
normal amortization of goodwill, approximated $1.7 million during the year ended
December 31, 1996. Noninterest expense as a percent of average assets was 4.3%
for the year ended December 31, 1997, as compared to 3.9% (excluding the $5.9
million write down of goodwill) for the year ended December 31, 1996.
Salaries and employee benefits declined $766,000 or 16.8% during 1997.
This decrease resulted primarily from nonrecurring personnel expenses during
1996 totaling $367,000 associated with the sold Branches and the impact of the
Company's downsizing efforts, which resulted in a decline in the number of the
Company's full-time and part-time employees from 114 as of December 31, 1996 to
99 as of December 31, 1997. These decreases were partially offset by an $82,000
increase in compensation expense associated with certain of the Company's stock
options and a $136,500 severance settlement with the former president of Home
Bancorp and Home Savings.
Net occupancy and equipment expense declined $386,000 or 26.2% during
1997. This decrease resulted primarily from nonrecurring occupancy and equipment
expenses during 1996 totaling $227,000 associated with the sold Branches and the
relocation of the Company's corporate headquarters to a smaller more economical
facility. These decreases were partially offset by a $28,000 estimated lease
termination penalty in connection with the relocation of the Bank's Suffolk,
Virginia retail bank branch.
Deposit insurance premiums declined $196,000 or 29.1% during 1997. This
decrease reflects the reduction in the deposit assessment base resulting from
the sale of the Branches, 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. Likewise, service bureau fees declined $138,000 or 23.0% during 1997.
This decrease was primarily attributable to the reduction in deposits which
occurred in connection with the sale of the Branches.
Amortization of intangible assets declined $6.5 million or 92.4% during
1997. This decrease was attributable to nonrecurring expense during 1996 arising
from the $541,000 amortization of goodwill and the $5.9 million write down of
goodwill associated with certain of the sold Branches.
14
<PAGE>
Professional fees declined $158,000 or 31.1% during 1997. This decrease
was attributable to the cancellation of a consulting contract that had been
entered into in connection with the Home Acquisition.
Foreclosed properties expense increased $358,000 during 1997, which was
attributable to nonrecurring gains recognized in 1996 in connection with the
sale of the Bank's largest foreclosed property consisting originally of 2,554
acres of farmland located in Currituck, North Carolina and the sale of lots and
townhouse pads associated with a townhouse development in Richmond.
The significant components of other miscellaneous noninterest expense
for the years ended December 31, 1997 and 1996 are presented below:
<TABLE>
<CAPTION>
<S> <C>
Change
1997 1996 Amount Percent
---- ---- ------ -------
Loan expense....................... $ 150,457 $ 280,041 $(129,584) (46.3)%
Telephone.......................... 175,474 225,599 (50,125) (22.2)
Postage and courier................ 153,349 200,300 (46,951) (23.4)
Stationery and supplies............ 99,545 131,572 (32,027) (24.3)
Advertising and marketing.......... 155,654 185,191 (29,537) (15.9)
Corporate insurance................ 116,882 182,009 (65,127) (35.8)
Travel............................. 47,453 76,301 (28,848) (37.8)
Provision for servicing losses..... 24,000 26,000 (2,000) (7.7)
Other.............................. 164,548 406,945 (242,397) (59.6)
---------- ---------- --------
$1,087,362 $1,713,958 $(626,596) (36.6)
========= ========= ========
</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 declined $294,000 during the year ended December 31, 1996.
The decline was primarily attributable to (i) a $201,000 decrease in net
occupancy and equipment expense 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 and (ii) a $363,000 decrease in
foreclosed properties expense resulting from gains on the sale of foreclosed
properties. These declines were partially offset by a $167,000 increase in
salaries and employee benefits resulting from an increase in compensation
expense associated with certain of the Company's stock options.
15
<PAGE>
The significant components of other miscellaneous noninterest expense
for the years ended December 31, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
<S> <C>
Change
1996 1995 Amount Percent
---- ---- ------ -------
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 17,000 188.9
Other.............................. 406,945 475,374 (68,429) (14.4)
---------- ---------- ---------
$1,713,958 $1,845,102 $(131,144) (7.1)
========= ========= ========
</TABLE>
Provision For Income Taxes. There was no income tax provision
recognized for financial reporting purposes during the years ended December 31,
1997, 1996, or 1995 because the Company has significant net tax operating loss
carryforwards, which approximated $19.9 million at December 31, 1997. Also,
until consistent profitability is demonstrated, deferred income tax assets
related to the Company's net tax operating loss carryforwards and temporary
differences will not be recognized. For additional information, see Note 14 of
the Notes to Consolidated Financial Statements.
Market Risk 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 to structure and price the Bank's assets and liabilities in
order 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
residential loans in the secondary market; (iii) purchasing adjustable-rate
16
<PAGE>
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.
The following table presents the difference between the Bank's
interest-earning assets and interest-bearing liabilities within specified
maturities at December 31, 1997. Data for this table 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. 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, 1997 and is not
necessarily indicative of the Bank's interest rate sensitivity at any other
time.
[intentionally blank]
17
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Anticipated Period Until Maturity or Repricing
---------------------------------------------------------------------------------
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)
Interest-earning assets:
Loans receivable and
mortgage-backed securities:
First mortgage:
Adjustable-rate $ 32,586 $ 25,954 $ 8,088 $ 15,393 $ - $ 82,021 44.9%
Fixed-rate 5,638 5,069 15,857 16,854 21,698 65,116 35.6
Second mortgage 4,427 606 1,886 1,231 337 8,487 4.6
All other 7,046 1,303 5,153 21 339 13,862 7.6
Investments 12,947 - 299 - - 13,246 7.3
------ ----------- --------- ----------- ---------- -------- -----
Total 62,644 32,932 31,283 33,499 22,374 $182,732 100.0%
======= =====
Interest-bearing liabilities:
Deposits 66,980 33,183 36,512 10,992 5,345 $153,012 86.5
Fixed-rate borrowings 12,582 6,567 2,625 100 - 21,874 12.4
Variable-rate borrowings 2,000 - - - - 2,000 1.1
------- ----------- ----------- ----------- ---------- --------- ----
Total 81,562 39,750 39,137 11,092 5,345 $176,886 100.0%
======= =====
Effect of off-balance sheet
items (1) (7,782) 4,398 779 605 1,991
-------- -------- --------- --------- -------
Maturity gap $(26,700) $ (2,420) $ (7,075) $ 23,012 $19,020
======= ======== ======== ======= ======
Cumulative gap $(26,700) $(29,120) $(36,195) $(13,183) $ 5,837
======= ======= ======= ======= =======
Cumulative gap as a percent
of total assets (13.7)% (14.9)% (18.6)% (6.8)% 3.0%
===== ===== ===== ==== ===
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 76.8% 78.8% 79.1% 93.5% 103.3%
==== ==== ==== ==== =====
</TABLE>
(1) Reflects the effect of entering into commitments with third parties to
originate and sell loans.
The Bank's one-year interest rate sensitivity gap amounted to a
negative 14.9% at December 31, 1997, which reflects the impact of shortening
deposit maturities as the Bank's deposit customers are reluctant to enter into
extended maturities in the current low interest rate environment. The negative
gap also reflects near-term maturities of higher-rate FHLB advances. The Company
will benefit from the lower cost of funds as these FHLB advances mature and may
consider extended maturities in order to mitigate the impact of an increase in
interest rates in the future. While the Company continues to emphasize
investment in adjustable-rate loan portfolios, customer demand for such loans is
lessening as borrowers demand for lower fixed-rate loans is increasing. Within
the spectrum of loan products offered by the Bank, the percentage of balloon
payment and adjustable-rate loans with longer initial adjustment terms has
increased.
In addition to monitoring its interest rate sensitivity gap, 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. The following table
presents the Bank's NPV at December 31, 1997.
18
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Net Portfolio Value NPV as % of PV of Assets
Change in ---------------------------------------- --------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
-------------- -------- -------- -------- --------- ------
+400bp $ 7,069 $(10,816) (60.48)% 3.86% (519)bp
+300bp 10,322 (7,563) (42.29) 5.51 (353)bp
+200bp 13,407 (4,477) (25.04) 7.01 (204)bp
+100bp 16,039 (1,846) (10.32) 8.23 (81)bp
Base Scenario 17,885 9.05
-100bp 18,779 894 5.00 9.41 36bp
-200bp 18,957 1,073 5.99 9.43 38bp
-300bp 19,395 1,510 8.44 9.57 52bp
-400bp 20,234 2,349 13.13 9.88 83bp
</TABLE>
The Bank's Asset and Liability Management Committee has established
limits for the impact of changes in interest rates on NPV. As of December 31,
1997, the Bank is more at risk to rising interest rate environments than
declining interest rate environments, which reflects the Bank's
liability-sensitive position. As of December 31, 1997, the Bank is outside its
NPV policy limits for increases in interest rates of 200 basis points or more.
However, computation of prospective effects of hypothetical interest rate
changes are based on many assumptions, including relative levels of market
interest rates, loan prepayments and deposits decay. They should not be relied
upon as indicative of actual results. Further, the computations do not
contemplate certain actions management could undertake in response to change in
interest rates.
Liquidity and Commitments
Liquidity refers to the Company's ability to generate sufficient cash
to meet the funding needs of current loan demand, deposit withdrawals, and to
pay operating expenses. The Company generally has no significant source of
income other than dividends from its subsidiaries. While the Company and the
Bank are no longer operating under any supervisory agreements, the Bank must
seek a letter of nonobjection from the OTS prior to making dividend payments to
the holding company.
All savings associations are required to maintain an average daily
balance of liquid assets (including cash, certain time deposits and savings
accounts, bankers' acceptances, certain government obligations and certain other
investments) 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
4%. The Bank has consistently exceeded such regulatory liquidity requirement
and, at December 31, 1997, had a liquidity ratio of 8.72%.
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 strong 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 assets as collateral for borrowings. Liquidity is
derived from liabilities by maintaining a variety of funding sources, including
deposits and advances from the FHLB.
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
19
<PAGE>
Bank requires funds which cannot be generated internally, borrowings from the
FHLB may provide an additional source of funds. At December 31, 1997, the Bank
had $23.5 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, 1997, the Bank had
outstanding commitments (including unused lines of credit) to originate and/or
purchase mortgage and non-mortgage loans of $404,000. Certificates of deposit
which are scheduled to mature within one year totaled $76.7 million at December
31, 1997, and borrowings from the FHLB that are scheduled to mature within the
same period amounted to $21.1 million. The undisbursed portions of Essex First's
construction builder loans and construction/permanent loans in process totaled
$2.9 million and $7.5 million, respectively, as of December 31, 1997.
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, 1997, the
Bank's tangible and core capital amounted to 7.86% of adjusted total assets and
the Bank's total capital amounted to 14.33% 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, 1997,
the Bank's Tier I core, Tier I risk-based, and total risk-based capital ratios
were 7.86%, 13.08%, and 14.33%, 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 $5.6 million, $8.3 million,
and $5.1 million, respectively, at December 31, 1997.
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 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
20
<PAGE>
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 assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995. Therefore, as of
December 31, 1997, the Bank's annual assessment for deposit insurance was 26
basis points of insured deposits as opposed to three basis points of insured
deposits (the assessment rate otherwise in effect 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 requires 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 began 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. Accordingly,
an additional assessment approximating 6.4 basis points is added to the regular
SAIF-assessment until December 31, 1999 in order to cover FICO debt service
payments.
Year 2000 Costs
As the millennium approaches, a company-wide task force has been
assembled to assess business risks associated with the Year 2000. These risks
arise primarily from the inability of older computer software systems to
properly recognize the year 2000 because of a predominant convention within
computer programs to shorten dates to the last two digits of any year.
Accordingly, the Company will review all internal systems and operations, as
well as strategic relationships with others (i.e., service bureaus for deposit
processing and loan servicing, forms vendors, commercial borrowers), to ensure
that any malfunction as a result of the Year 2000 will not critically impair the
Company's ability to deliver products and services to its business partners. As
a result of this assessment, the Company expects to both replace some systems
and upgrade some others. The Company is utilizing both internal and external
resources to identify, correct or reprogram and test the systems for Year 2000
compliance. It is anticipated that all reprogramming and replacement efforts
will be complete by December 31, 1998, allowing adequate time for testing and
contingency plan implementation as needed. The total cost of the project is
estimated to be $350,000 and is being funded through operating cash flows.
Maintenance or modification costs will be expensed as incurred, while the costs
of new hardware and software will be capitalized and amortized over their useful
lives. Management believes that most of the capitalized costs are associated
with technology changes that will enable the Company to provide competitive
services. The expenses incurred during the year ended December 31, 1997 were not
material. Management believes the Company can incur these costs without
adversely affecting future operating results. However, because of the complexity
of the issue and possible unidentified risks, actual costs may vary from the
estimate. Management has discussed its assessment and plans with the Board of
Directors. In addition, the OTS will periodically perform evaluations of the
Company's Year 2000 readiness.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
The above discussion contains certain forward-looking statements that
involve potential risks and uncertainties. The Company's future results could
differ materially from those discussed herein. Readers should not place undue
reliance on these forward-looking statements, which are applicable only as of
the date hereof.
21
<PAGE>
Quarterly Results of Operations
Quarterly unaudited financial data for the years ended December 31,
1997 and 1996 is presented below (dollars in thousands, except per unit data).
<TABLE>
<CAPTION>
<S> <C>
Year Ended December 31, 1997
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net interest income $1,212 $1,367 $1,353 $1,385
Provision for loan losses (22) 107 30 (1)
------- ------ ------ -------
Net interest income after
provision for loan losses 1,234 1,260 1,323 1,386
Noninterest income 603 806 521 532
Noninterest expenses 1,819 1,676 2,335 2,131
----- ----- ----- -----
Net income (loss) $ 18 $ 390 $ (491) $ (213)
======= ====== ===== =====
Net loss available to common
stockholders $ (378) $ (14) $ (903) $ (638)
====== ======= ===== =====
Basic and diluted net loss per
common share $ (.36) $ (.01) $ (.85) $ (.60)
====== ======= ===== =====
<CAPTION>
Year Ended December 31, 1996
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
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) available to
common stockholders $ 243 $(7,870) $(1,107) $ (90)
====== ====== ====== =======
Basic net income (loss) per
common share $ .23 $ (7.49) $ (1.05) $ (.09)
======= ======= ====== =======
Diluted net income (loss) per
common share equivalent $ .04 $ (7.49) $ (1.05) $ (.09)
======= ======= ====== =======
</TABLE>
22
<PAGE>
Report of Independent Accountants
February 18, 1998
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, and of cash
flows present fairly, in all material respects, the financial position of Essex
Bancorp, Inc. and its subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, 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.
PRICE WATERHOUSE LLP
23
<PAGE>
<TABLE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
<CAPTION>
1997 1996
---- ----
<S> <C>
ASSETS
Cash..................................................................... $ 2,023,197 $ 1,824,160
Interest-bearing deposits................................................ 6,261,686 1,727,091
Federal funds sold and securities purchased under agreements to resell... 2,748,000 2,644,000
------------ ------------
Cash and cash equivalents....................................... 11,032,883 6,195,251
Federal Home Loan Bank stock............................................. 1,431,000 2,540,000
Securities available for sale - cost approximates market................. 17,451 9,162
Securities held for investment - market value of $2,217,000 in 1997
and $5,890,000 in 1996................................................. 2,299,120 6,003,219
Mortgage-backed securities held for investment - market value of
$1,886,000 in 1997 and $1,869,000 in 1996.............................. 1,904,989 1,905,327
Loans, net of allowance for loan losses of $2,382,000 in 1997 and
$2,556,000 in 1996..................................................... 167,440,733 145,550,845
Loans held for sale...................................................... 2,165,074 2,462,525
Mortgage servicing rights................................................ 1,169,766 1,349,160
Foreclosed properties, net............................................... 1,511,629 2,054,213
Accrued interest receivable.............................................. 1,196,980 1,147,933
Excess of cost over net assets acquired, less accumulated
amortization of $2,078,000 in 1997 and $2,016,000 in 1996.............. 159,754 221,815
Advances for taxes, insurance, and other................................. 633,053 790,928
Premises and equipment, net.............................................. 1,926,729 2,485,122
Other assets............................................................. 2,198,598 1,551,352
------------ ------------
Total Assets.................................................... $195,087,759 $174,266,852
============ ============
(Continued)
24
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 1997 and 1996
<CAPTION>
1997 1996
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing.................................................... $ 5,055,545 $ 1,070,037
Interest-bearing....................................................... 148,871,154 129,963,341
------------ ------------
Total deposits.................................................. 153,926,699 131,033,378
Federal Home Loan Bank advances.......................................... 23,546,667 25,690,000
Notes payable............................................................ 72,102 96,142
Capital lease obligations................................................ 331,970 385,251
Mortgages payable on foreclosed properties............................... - 10,391
Other liabilities........................................................ 2,393,814 1,945,988
------------- -------------
Total Liabilities............................................... 180,271,252 159,161,150
Commitments and contingencies
SHAREHOLDERS' EQUITY
Series B preferred stock, $6.67 stated value (Note 18):
Authorized shares - 2,250,000
Issued and outstanding shares - 2,125,000 in 1997 and 1996............. 14,173,750 14,173,750
Series C preferred stock, $6.67 stated value (Note 18):
Authorized shares - 125,000
Issued and outstanding shares - 125,000 in 1997 and 1996............... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 10,000,000
Issued and outstanding shares - 1,058,136 in 1997 and 1,053,379
in 1996............................................................. 10,581 10,534
Additional paid-in capital............................................... 8,681,739 8,674,333
Accumulated deficit...................................................... (8,883,313) (8,586,665)
------------ ------------
Total Shareholders' Equity...................................... 14,816,507 15,105,702
------------ ------------
Total Liabilities and Shareholders' Equity...................... $195,087,759 $174,266,852
============ ============
See notes to consolidated financial statements.
25
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
---- ---- ----
INTEREST INCOME
Loans, including fees............................ $13,588,215 $17,881,529 $19,778,781
Federal funds sold and securities purchased
under agreements to resell..................... 150,972 319,298 279,909
Investment securities, including dividend
income......................................... 353,957 615,429 836,637
Mortgage-backed securities....................... 124,515 497,879 1,285,889
Other............................................ 329,846 558,139 365,821
---------- ---------- ----------
Total Interest Income................... 14,547,505 19,872,274 22,547,037
---------- ---------- ----------
INTEREST EXPENSE
Deposits ........................................ 7,679,314 11,945,273 13,504,940
Federal Home Loan Bank advances.................. 1,473,949 1,625,574 2,797,688
Notes payable.................................... 9,079 10,750 130,705
Subordinated capital notes....................... - 52,444 73,183
Other............................................ 67,793 130,297 120,284
---------- ---------- ----------
Total Interest Expense.................. 9,230,135 13,764,338 16,626,800
---------- ---------- ----------
Net Interest Income..................... 5,317,370 6,107,936 5,920,237
PROVISION FOR LOAN LOSSES............................ 113,467 1,410,710 2,476,903
---------- ---------- ----------
Net Interest Income After
Provision for Loan Losses............... 5,203,903 4,697,226 3,443,334
NONINTEREST INCOME
Loan servicing fees.............................. 1,312,476 1,665,768 1,765,617
Mortgage banking income, including
gain on sale of loans.......................... 458,520 577,130 504,715
Other service charges and fees................... 368,671 497,316 428,811
Net gain (loss) on sale of:
Securities..................................... - 153,188 -
Loans.......................................... (1,458) (1,018,185) 115,538
Deposits....................................... - 1,940,010 -
Other............................................ 324,596 466,519 357,309
---------- ---------- ----------
Total Noninterest Income................ 2,462,805 4,281,746 3,171,990
---------- ---------- ----------
(Continued)
26
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
---- ---- ----
NONINTEREST EXPENSE
Salaries and employee benefits................... 3,788,695 4,554,540 4,387,760
Net occupancy and equipment...................... 1,084,593 1,470,284 1,671,352
Deposit insurance premiums....................... 478,684 674,730 722,106
Amortization of intangible assets................ 530,707 7,011,288 956,257
Service bureau fees.............................. 461,217 599,207 523,526
Professional fees................................ 349,218 507,031 476,224
Foreclosed properties, net....................... 182,880 (175,055) 187,715
Other............................................ 1,087,362 1,713,958 1,845,102
----------- ----------- -----------
Total Noninterest Expense............... 7,963,356 16,355,983 10,770,042
----------- ---------- ----------
Loss Before Extraordinary
Items and Income Taxes.................. (296,648) (7,377,011) (4,154,718)
PROVISION FOR INCOME TAXES........................... - - -
EXTRAORDINARY ITEMS - FORGIVENESS
OF DEBT ........................................ - - 2,945,064
----------- ----------- -----------
Net Loss................................ $ (296,648) $(7,377,011) $(1,209,654)
=========== ========== ==========
Loss before extraordinary items available
to common shareholders (Note 2)............... $(1,932,136) $(8,823,879) $(4,522,740)
Extraordinary items.............................. - - 2,945,064
----------- ----------- -----------
Net loss available to common shareholders........ $(1,932,136) $(8,823,879) $(1,577,676)
=========== =========== ===========
Basic and diluted income (loss) per common share (Note 2):
Loss before extraordinary item................ $(1.83) $(8.39) $(4.31)
Extraordinary items........................... - - 2.81
----------- ----------- -----------
Net loss...................................... $(1.83) $(8.39) $(1.50)
=========== =========== ===========
See notes to consolidated financial statements.
27
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
Series B Series C
Common Preferred Preferred Additional
Stock, $.01 Stock, $6.67 Stock, $6.67 Paid-in Accumulated
Par Value Stated Value Stated Value Capital Deficit
--------- ------------ ------------ ------- -------
Transfer of partners' capital in
connection with the merger of
Essex Financial Partners, L.P.
into Essex Bancorp, Inc................ $10,497 $ - $ - $8,129,135 $ -
Issuance of preferred stock in connection
with the merger of Home Bancorp, Inc.
and Essex Bancorp, Inc................. - 14,173,750 833,750 538,000 -
Net increase in holding gain on
securities available for sale.......... - - - - -
Net loss.................................. - - - - (1,209,654)
------- ----------- --------- ---------- -----------
Balance, December 31, 1995................ 10,497 14,173,750 833,750 8,667,135 (1,209,654)
Common stock issued under the
Employee Stock Purchase Plan........... 37 - - 7,198 -
Net decrease in holding gain on
securities available for sale.......... - - - - -
Net loss.................................. - - - - (7,377,011)
------- ----------- --------- ---------- -----------
Balance December 31, 1996................. 10,534 14,173,750 833,750 8,674,333 (8,586,665)
Common stock issued under the
Employee Stock Purchase Plan........... 47 - - 7,406 -
Net loss.................................. - - - - (296,648)
------- ----------- --------- ---------- -----------
Balance, December 31, 1997................ $10,581 $14,173,750 $833,750 $8,681,739 $(8,883,313)
======= =========== ======== ========== ===========
Holding Gain
on Securities
Available
for Sale Total
-------- -----
Transfer of partners' capital in
connection with the merger of
Essex Financial Partners, L.P.
into Essex Bancorp, Inc................ $ - $ 8,139,632
Issuance of preferred stock in connection
with the merger of Home Bancorp, Inc.
and Essex Bancorp, Inc................. - 15,545,500
Net increase in holding gain on
securities available for sale.......... 154,174 154,174
Net loss.................................. - (1,209,654)
---------- -----------
Balance, December 31, 1995................ 154,174 22,629,652
Common stock issued under the
Employee Stock Purchase Plan........... - 7,235
Net decrease in holding gain on
securities available for sale.......... (154,174) (154,174)
Net loss.................................. - (7,377,011)
---------- -----------
Balance December 31, 1996................. - 15,105,702
Common stock issued under the
Employee Stock Purchase Plan........... - 7,453
Net loss.................................. - (296,648)
---------- -----------
Balance, December 31, 1997................ $ - $14,816,507
========== ===========
See notes to onsolidated financial statements.
28
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
---- ---- ----
OPERATING ACTIVITIES
Net loss.................................................. $ (296,648) $ (7,377,011) $ (1,209,654)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Forgiveness of debt before income taxes................. - - (2,945,064)
Provision for:
Losses on loans, foreclosed properties, and
servicing...................................... 296,808 1,415,365 2,565,297
Depreciation and amortization of premises
and equipment.................................. 419,829 538,561 490,249
Amortization (accretion) of:
Premiums and discounts on loans, investments
and mortgage-backed securities............... 77,038 211,642 376,334
Mortgage servicing rights...................... 468,647 528,444 580,295
Excess of costs over net assets acquired....... 62,061 6,482,843 375,962
Other.......................................... - (94,399) (27,576)
Mortgage banking activities:
Proceeds from loan sales........................... 40,717,559 56,311,191 50,828,101
Loan originations and purchases.................... (39,725,806) (54,961,912) (52,881,403)
Realized gains from sale of loans.................. (414,902) (548,744) (492,493)
Realized (gains) and losses from sales of:
Mortgage-backed securities available for sale...... - (153,188) -
Loans.............................................. 1,458 1,018,185 (115,538)
Deposits........................................... - (1,940,011) -
Other.............................................. (185,283) (599,062) (64,021)
Changes in operating assets and liabilities
exclusive of business acquisitions:
Accrued interest receivable.................... (49,047) 1,000,846 200,354
Other assets................................... (513,371) 325,152 372,536
Other liabilities.............................. 453,828 483,325 (771,319)
------------ ------------ -----------
Net cash provided by (used in) operating activities....... 1,312,171 2,641,227 (2,717,940)
------------ ------------ -----------
(Continued)
29
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
---- ---- ----
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions................................ (5,000,000) (17,000,000) -
Proceeds from maturities of certificates of deposit
in other financial institutions....................... 5,000,000 17,000,000 -
Purchase of Federal Home Loan Bank stock.................. (95,800) - -
Redemption of Federal Home Loan Bank stock................ 1,204,800 1,062,800 1,823,100
Purchase of securities held to maturity................... (298,406) (1,020,625) -
Proceeds from maturities of securities held to maturity... 4,000,000 3,000,000 3,000,000
Purchase of securities available for sale................. (2,508,289) (5,165,516) (9,240,201)
Proceeds from sale of securities available for sale....... 2,500,000 6,650,000 8,575,000
Principal remittances on mortgage-backed securities....... - - 2,723,925
Principal remittances on mortgage-backed securities
available for sale.................................... - 990,065 -
Proceeds from sales of mortgage-backed securities
available for sale.................................... - 10,068,189 -
Purchases of loans........................................ (22,224,143) - -
Proceeds from sales of loans.............................. - 117,509,060 8,215,597
Net (increase) decrease in net loans...................... (1,428,880) 1,834,572 8,095,445
Proceeds from sales of foreclosed properties.............. 2,146,555 5,270,509 3,797,022
Additions to foreclosed properties........................ (358,419) (174,753) (318,471)
Increase in mortgage servicing rights..................... (289,253) (243,297) -
Purchase of premises and equipment........................ (388,145) (197,281) (1,489,856)
Proceeds from sales of premises and equipment............. 601,714 1,414,705 1,984
Cash and cash equivalents of Home Bancorp
at date of acquisition................................. - - 7,459,288
----------- ----------- -----------
Net cash provided by (used in) investing activities....... (17,138,266) 140,998,428 32,642,833
----------- ----------- -----------
FINANCING ACTIVITIES
Decrease in deposits attributable to branch sales:
NOW and savings deposits............................... - (18,937,078) -
Certificates of deposit................................ - (144,669,198) -
Net increase (decrease) in NOW and savings deposits....... 13,305,806 4,898,050 (9,592,820)
Net increase in certificates of deposit................... 9,587,515 10,211,469 18,831,588
Proceeds from Federal Home Loan Bank advances............. 25,500,000 4,000,000 14,500,000
Repayment of Federal Home Loan Bank advances.............. (27,643,333) (8,143,333) (43,618,334)
Proceeds from notes payable............................... - - 1,003,893
Payments on credit facility............................... - - (894,377)
Payments on notes payable................................. (24,040) (24,061) -
Redemptions of subordinated notes......................... - (627,858) -
Payments on capital lease obligation...................... (53,281) (39,705) (56,030)
Repayments of mortgages payable on foreclosed
properties............................................. (10,391) (25,258) (164,743)
Redemption of Settlement Preferred Stock.................. (6,002) (103,385) (831,511)
Common stock issued under the Employee Stock
Purchase Plan.......................................... 7,453 7,235 -
----------- ------------ -----------
Net cash provided by (used in) financing activities....... 20,663,727 (153,453,122) (20,822,334)
----------- ------------ -----------
Increase (decrease) in cash and cash equivalents....... 4,837,632 (9,813,467) 9,102,559
Cash and cash equivalents at beginning of period....... 6,195,251 16,008,718 6,906,159
----------- ------------ -----------
Cash and cash equivalents at end of period............. $ 11,032,883 $ 6,195,251 $ 16,008,718
============ =============== ============
(Continued)
30
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
---- ---- ----
NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer from loans to foreclosed properties.............. $ 1,294,615 $ 1,865,227 $ 2,929,567
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)
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
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest.............................................. $ 9,199,677 $ 13,814,733 $ 16,628,737
Income taxes, net of refunds.......................... - (109,244) (6,252)
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1997, 1996 and 1995
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 at December 31, 1997 operates
four branches in North Carolina and Virginia. EBI is the successor by merger to
Essex Financial Partners, L.P. (the "Partnership"), a Delaware limited
partnership which was formed in 1988 to acquire the former holding company of
the Bank. The Partnership and Essex Bancorp. ("Bancorp"), 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, 1997, held loans and other assets as a result of
its past activities.
Pursuant to approvals received from the Office of Thrift Supervision ("OTS") on
August 25, 1994 and the Partnership's unitholders at a special meeting on
January 17, 1995, 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 every two
limited partnership units ("LPUs"). In addition, the general partner received
shares of EBI common stock equivalent to one percent of total shares outstanding
after the exchange.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of EBI and its subsidiaries (collectively, 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 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
32
<PAGE>
mortgage-backed securities issued by the Government National Mortgage
Association ("Ginnie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie
Mac"), or the Federal National Mortgage Association ("Fannie Mae").
Investments and Mortgage-Backed Securities: Investment securities and
mortgage-backed securities are classified upon acquisition as held for
investment or available for sale. Those securities designated as held for
investment are carried at cost adjusted for amortization of premiums and
accretion of discounts. 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 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 Standards No. 114 - Accounting by Creditors
for Impairment of a Loan ("SFAS 114"), as amended by SFAS 118, 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 recorded at fair value less
estimated selling costs upon acquisition and thereafter are carried at the lower
of cost or fair value less estimated selling costs. Revised estimates to the
fair value less selling costs are reported as adjustments to the carrying amount
of the asset provided that such adjusted value is not in excess of the carrying
amount at acquisition. Gains or losses on the sale of and revaluation
adjustments to foreclosed properties are credited or charged to expense. 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 selling costs. Costs relating to the
development or improvement of the property are capitalized to the extent these
costs increase fair value less estimated selling costs.
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
33
<PAGE>
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 in 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 determined
by commitment agreements with investors or estimates 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.
Capitalized mortgage servicing assets consist of both purchased and originated
servicing rights (collectively, "MSRs"). MSRs are amortized in proportion to,
and over the period of, the estimated future net servicing revenues of the
underlying mortgage loans. The Company's policy for assessing impairment of MSRs
is based on their fair values and is evaluated by stratifying the MSRs based on
predominant risk characteristics of the underlying loans, primarily interest
rate. Fair value is estimated based on discounted anticipated future cash flows,
taking into consideration market-based prepayment estimates.
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.
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.
Income Taxes: 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
34
<PAGE>
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.
Stock-Based Compensation Plans: Effective January 1, 1997, the Company adopted
Statement of Financial Accounting Standards No. 123 - Accounting for Stock Based
Compensation ("SFAS 123"). SFAS 123 permits either the recognition of cost for
the estimated fair value of employee stock-based compensation arrangements on
the date of grant, or disclosure in the notes to the financial statements of the
pro forma effects on net income and earnings per share, determined as if the
fair value-based method had been applied in measuring compensation cost. The
Company has adopted the disclosure option and continues to apply APB Opinion No.
25 - Accounting for Stock Issued to Employees ("APB 25") in accounting for its
plans using the intrinsic-value-based method.
Accordingly, no compensation cost has been recognized for the Company's stock
options granted during 1997.
Earnings Per Share: The Company calculates its basic and diluted earnings per
share ("EPS") in accordance with Statement of Financial Accounting Standards No.
128 - Earnings Per Share ("SFAS 128"). Accordingly, the components of the
Company's EPS calculations for the years ended December 31 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
---- ---- ----
Loss before extraordinary items $ (296,648) $(7,377,011) $(4,154,718)
Preferred stock dividends (Note 18) (1,635,488) (1,446,868) (368,022)
---------- ---------- -----------
Loss before extraordinary items
available to common shareholders (1,932,136) (8,823,879) (4,522,740)
Extraordinary items - - 2,945,064
---------- ---------- ----------
Net loss available to common shareholders $(1,932,136) $(8,823,879) $(1,577,676)
========== ========== ==========
Weighted average common shares
outstanding 1,055,776 1,051,180 1,049,684
========= ========= =========
</TABLE>
The Company's common stock equivalents are antidilutive with respect to loss
available to common shareholders for each of the years presented; therefore,
basic and diluted EPS are the same.
Reclassification: Certain 1996 and 1995 amounts have been reclassified to
conform to 1997 presentations.
NOTE 3 - EXTRAORDINARY ITEMS
Extraordinary items for the year ended December 31, 1995 consisted of the
following transactions:
o EBI issued $1.0 million in nonvoting, noncumulative preferred stock (the
"Settlement Preferred Stock") in January 1995 in accordance with a
stipulation of settlement (the "Settlement") related to litigation in which
the Partnership was a settling defendant in 1994 (the "Litigation"). 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 LPUs prior to July 27, 1994, the date on which the Settlement
was announced. Contemporaneously with the acquisition described in Note 4,
PaineWebber Capital Inc. ("PWC") and PaineWebber Inc. ("PWI"), also
35
<PAGE>
settling defendants in the Litigation, 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 in the Litigation. 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 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.
o PWC made a $200,000 loan (the "Merger Note") to EBI in order to fund the
expenses associated with the Merger because neither the Partnership nor EBI
had sufficient liquidity to fund such expenses. 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 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 $15.0 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.
36
<PAGE>
The following unaudited pro forma financial information for the year ended
December 31, 1995 assumes the acquisition was consummated on January 1, 1995 (in
thousands, except per share data):
Total interest income $25,859
Net interest income 7,568
Provision for loan losses 2,477
Noninterest income 3,195
Noninterest expense 13,218
Loss before extraordinary items (4,932)
Net loss (2,096)
Basic and diluted loss per common share
before extraordinary items (6.04)
Basic and diluted net loss per common
share (3.34)
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 $1,000 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 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.
37
<PAGE>
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. Prior to the consummation of the sale of these
branches, the Company recognized a $5.9 million write down in the net asset
value of certain of these 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.
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>
<S> <C>
1997 1996
------------------------------------------ ------------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
U.S. Treasury securities $ - $ - $ - $ - $1,003 $ - $ - $1,003
Securities of other U.S.
government agencies 2,299 - 82 2,217 5,000 - 113 4,887
----- -------- ------- ----- ----- -------- ------ -----
$2,299 $ - $ 82 $2,217 $6,003 $ - $ 113 $5,890
===== ======== ======= ===== ===== ======== ====== =====
</TABLE>
The $2.3 million of U.S. government agency securities held for investment at
December 31, 1997 consisted of a $2.0 million note issued by the Federal Home
Loan Bank ("FHLB") which matures in the year 2000 and a $299,000 note issued by
the FNMA which matures in the year 1999. No securities held for investment were
sold prior to maturity in 1997, 1996, and 1995. The U.S. government agency
security with a book value of $299,000 and a fair value of $298,000 is pledged
as collateral for public depository accounts over $100,000 at December 31, 1997.
Securities available for sale at December 31, 1997 and 1996 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.
Proceeds from the sale of securities available for sale totaled $2,500,000,
$6,650,000 and $8,575,000 in 1997, 1996 and 1995, respectively. No gains or
losses were realized on these sales.
38
<PAGE>
NOTE 7 - MORTGAGE-BACKED SECURITIES
The amortized cost and fair value of mortgage-backed securities ("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>
<S> <C>
1997 1996
------------------------------------------ ----------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
U.S. government agencies:
Floating-rate REMIC $1,905 $ - $ 19 $1,886 $1,905 $ - $ 36 $1,869
===== ======== ======= ===== ===== ======== ======= =====
</TABLE>
There were no sales of MBS held for investment in 1997, 1996 and 1995.
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. These MBS were sold in 1996 to
partially fund the sale of the Branches. Accordingly, the holding gain component
of shareholders' equity was reversed in 1996. No MBS were classified as
available for sale at December 31, 1997 and 1996.
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. Gross gains of $196,525 and gross losses of $43,337
were realized in 1996.
NOTE 8 - LOANS
Net loans at December 31 include (in thousands):
1997 1996
---- ----
Real estate:
First mortgages $130,486 $103,643
Second mortgages 8,699 12,384
Construction and development 16,583 17,190
Commercial 5,970 6,313
Consumer 5,426 5,828
Commercial - other 1,883 1,915
Secured by deposits 805 842
--------- ---------
Total Loans 169,852 148,115
Less:
Unearned loan fees and discounts 29 8
Allowance for loan losses 2,382 2,556
-------- --------
Net Loans $167,441 $145,551
======= =======
39
<PAGE>
Included in total loans at December 31, 1997 and 1996 are unamortized premiums
of $668,000 and $565,000, respectively.
At December 31, net loans included the following collateral-dependent real
estate loans (in thousands):
1997 1996
---- ----
First mortgages $611 $539
Second mortgages 79 122
Construction and development - 17
---- ----
Total collateral-dependent real estate loans 690 678
Less:
Allowance for loan losses 130 69
--- ----
Net collateral-dependent real estate loans $560 $609
=== ===
As of December 31, 1997, the Bank had outstanding commitments (including
unfunded portions of lines of credit and construction loan commitments) to fund
approximately $13.9 million in mortgage loans and $222,000 in nonmortgage loans.
In addition, the Bank's construction loan portfolio includes loans to
individuals that will convert to permanent loans upon completion of
construction. As of December 31, 1997, such commitments aggregated $2.6 million
of fixed rate mortgage loans and $15.4 million of adjustable rate mortgage
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. The Bank will also acquire residential mortgage
loans from third parties. Loans previously acquired comprised approximately 42%
and 43% of total loans at December 31, 1997 and 1996, 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, 1997 and 1996, the Company had $1.6 million and $2.9 million,
respectively, in nonaccrual loans. Interest income which would have been
recorded in accordance with the original terms of the nonaccrual loans amounted
to approximately $171,000, $291,000 and $678,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
40
<PAGE>
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
---- ---- ----
Balance at beginning of period $2,555,688 $ 5,251,295 $ 3,429,365
Allowance transferred in connection
with the Home Acquisition - - 500,000
Provision for loan losses 113,467 1,410,710 2,476,904
---------- ---------- ----------
2,669,155 6,662,005 6,406,269
Loans charged-off, net of recoveries (287,516) (4,106,317) (1,154,974)
---------- ---------- ----------
Balance at end of period $2,381,639 $ 2,555,688 $5,251,295
========= ========== =========
Loans held for sale at December 31, 1997 and 1996 consisted of first mortgage
loans originated by Essex First. As of December 31, 1997, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $944,000,
which were committed for sale to unaffiliated third parties.
NOTE 9 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
<CAPTION>
1997 1996
---- ----
Properties acquired through foreclosure $1,666,381 $2,233,150
Less allowance for losses 154,752 178,937
---------- ----------
$1,511,629 $2,054,213
========= =========
Changes in the allowance for losses on foreclosed properties for the year ended
December 31 are as follows:
<CAPTION>
1997 1996 1995
---- ---- ----
Balance at beginning of year $ 178,937 $199,145 $ 417,805
Provision for losses on
foreclosed properties 159,341 (21,345) 79,393
-------- -------- ---------
338,278 177,800 497,198
Charge-offs, net of recoveries (183,526) 1,137 (298,053)
-------- -------- ---------
Balance at end of year $ 154,752 $178,937 $ 199,145
======== ======= ========
NOTE 10 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
<CAPTION>
1997 1996
---- ----
Land $ 573,675 $ 591,766
Buildings 1,046,570 1,230,819
Furniture and equipment 2,681,370 2,675,397
Leasehold improvements 192,556 183,497
Property under capitalized lease 537,737 537,737
---------- ----------
5,031,908 5,219,216
Less accumulated depreciation
and amortization 3,105,179 2,734,094
--------- ---------
$1,926,729 $2,485,122
========= =========
</TABLE>
41
<PAGE>
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.
Future minimum lease commitments with terms in excess of one year at December
31, 1997, including cost escalation provisions, are as follows:
<TABLE>
<CAPTION>
<S> <C>
Capital Noncancelable
Lease Operating Leases
----- ----------------
1998 $119,201 $236,033
1999 119,201 243,762
2000 119,201 239,356
2001 119,201 214,754
2002 - -
Later years - -
------- -------
Total minimum lease payments 476,804 $933,905
=======
Amount representing interest 144,834
-------
Present value of net minimum capitalized
payments $331,970
=======
Rent expense for the years ended December 31, 1997, 1996, and 1995 amounted to
$435,147, $602,190 and $903,922, respectively.
NOTE 11 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
<CAPTION>
1997 1996
------------------------ -----------------------
Amount Percent Amount Percent
------ ------- ------ -------
NOW accounts -
noninterest-bearing $ 5,056 3.28% $ 1,070 .82%
Passbook and Christmas
Club 3,948 2.57 3,765 2.87
NOW accounts 3,965 2.58 4,175 3.19
Money market 25,698 16.69 16,350 12.48
Certificate accounts -
4.01% to 6.00% 87,378 56.77 80,203 61.20
6.01% to 8.00% 27,844 18.09 25,433 19.41
8.01% to 10.00% 38 .02 37 .03
------- ------ -------- ------
$153,927 100.00% $131,033 100.00%
======= ====== ======= ======
</TABLE>
A summary of certificate accounts by scheduled maturity at December 31, 1997 is
as follows (in thousands):
1998 $ 76,720
1999 18,304
2000 12,126
2001 2,750
2002 and thereafter 5,360
--------
$115,260
42
<PAGE>
Certificate accounts of $100,000 or more at December 31, 1997 and 1996 amounted
to $18.5 million and $14.8 million, respectively.
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
---------------------- ---------------------- ---------------------
Interest Rate Interest Rate Interest Rate
-------- ---- -------- ---- -------- ----
Passbook and
Christmas Club $ 133,737 3.48% $ 225,525 3.33% $ 181,926 3.33%
NOW accounts 122,773 2.83 149,324 2.80 138,251 2.85
Money Market
accounts 1,041,566 4.87 949,835 4.50 900,719 4.14
Certificate accounts 6,381,238 5.73 10,620,589 5.78 12,284,044 5.75
---------- ----------- -----------
$7,679,314 5.45 $11,945,273 5.51 $13,504,940 5.50
========== =========== ===========
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the Federal Home Loan Bank ("FHLB") at December 31 consist of
the following (in thousands):
<CAPTION>
Maturity Interest Rate 1997 1996
- -------- ------------- ----------- ----------
1997 4.01% to 8.00% $ - $16,144
1998 4.01% to 7.00% 21,139 7,138
1999 5.01% to 6.00% 1,808 1,808
2000 5.01% to 6.00% 600 600
-------- --------
$23,547 $25,690
====== ======
Weighted average rate at end of period 5.75% 6.14%
==== ====
</TABLE>
With the exception of $2.0 million and $3.0 million of FHLB advances outstanding
at December 31, 1997 and 1996, respectively, all FHLB advances outstanding at
December 31, 1997 and 1996 carried fixed rates of interest. The $2.0 million
adjustable rate FHLB advances outstanding at December 31, 1997 will mature in
1998 and the applicable rate is indexed to the FHLB overnight deposit rate. The
$3.0 million adjustable rate FHLB advance at December 31, 1996 matured in 1997.
Advances from the FHLB at December 31, 1997 are collateralized by mortgage loans
with a total principal balance of approximately $53.8 million. The unused
lendable collateral value was $20.9 million at December 31, 1997.
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.
43
<PAGE>
NOTE 14 - INCOME TAXES
The Company is subject to federal income taxes, and files a consolidated federal
income tax return with its subsidiaries. The Company's provision for income
taxes for financial reporting purposes differs from the amount computed by
applying the statutory federal tax rate to loss before extraordinary items and
income taxes for the years ended December 31 as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
------------------------ ----------------------- ----------------------
Amount % Amount % Amount %
------ - ------ - ------ -
Provision for income taxes at
statutory federal tax rate $(100,860) (34.0)% $(2,508,184) (34.0)% $(1,412,604) (34.0)%
Increase (decrease) resulting from:
Unrecognized tax benefits 91,443 30.8 991,196 13.4 1,407,828 33.9
Amortization of excess of cost
over net assets acquired 21,101 7.1 1,507,950 20.5 76,717 1.8
Other (11,684) (3.9) 9,038 0.1 (71,941) (1.7)
--------- ----- ----------- ----- ----------- -----
$ - -% $ - -% $ - -%
========= ===== =========== ===== =========== =====
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
<CAPTION>
1997 1996
---- ----
Deferred tax liabilities
FHLB stock $ 92,297 $ 231,880
Basis in acquired loans 2,114,303 2,430,234
Premises and equipment 32,331 67,610
Other 26,362 -
------------ -------------
Total deferred liabilities 2,265,293 2,729,724
Deferred tax assets
Federal net operating loss ("NOL") carryforwards 7,562,091 8,007,145
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
MSRs 78,280 97,849
Allowance for losses on loans and
foreclosed properties 596,417 659,128
Core deposit intangible 1,049,306 1,130,022
Other 383,524 137,941
------------ -------------
Total deferred assets 9,999,618 10,362,085
------------ -------------
Net deferred tax assets before valuation
allowance 7,734,325 7,632,361
Valuation allowance for net deferred tax
assets (7,734,325) (7,632,361)
------------ -------------
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 realization 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, 1997) are used for purposes other than
to absorb bad debt losses, they will be subject to federal income tax at the
then applicable rates.
44
<PAGE>
At December 31, 1997, the Company had NOL carryforwards for income tax purposes
of approximately $19.9 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. In addition, the Company had an AMT credit carryover of $330,000 at
December 31, 1997, which can be carried forward indefinitely.
NOTE 15 - MORTGAGE LOAN SERVICING
At December 31, 1997, 1996, and 1995, EBI through its subsidiaries serviced or
subserviced approximately 8,400, 13,300 and 12,400 loans, respectively, with the
following outstanding principal balances (in thousands) at December 31 and
related servicing fee income during the respective years ended December 31:
<TABLE>
<CAPTION>
<S> <C>
1997 1996 1995
-------------------------- ------------------------- ------------------------
Loan Loan Loan Loan Loan Loan
Principal Servicing Principal Servicing Principal Servicing
Balances Fee Income Balances Fee Income Balances Fee Income
-------- ---------- -------- ---------- -------- ----------
Loans owned by the
Company $128,430 $ - $ 126,373 $ - $194,736 $ -
Servicing and sub-
servicing rights owned/
participated in by the
Company 354,245 1,312,476 997,279 1,665,768 796,103 1,765,617
-------- ---------- ---------- ---------- -------- ----------
$482,675 $1,312,476 $1,123,652 $1,665,768 $990,839 $1,765,617
======== ========== ========== ========== ======== ==========
</TABLE>
Servicing fee income is net of $858,992 in 1997, $1,878,725 in 1996 and
$1,459,570 in 1995 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. Servicing
fee income for 1997 and 1996 included approximately $196,000 and $409,000,
respectively, attributable to servicing activities performed for this client. In
addition, the Company received termination fees of approximately $113,000 in
1997 related to this contract.
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, 1997, approximately $1.8 million of
such accounts were on deposit at unaffiliated banks and $4.2 of such accounts
were on deposit at the Bank.
45
<PAGE>
The fair value of MSRs was $1.2 million and $1.7 million at December 31, 1997
and 1996, respectively. There were no valuation allowances for impairment of
MSRs at December 31, 1997 and 1996. Following is an analysis of the changes in
the Company's MSRs for the years ended December 31:
Balance at January 1, 1995 $2,214,602
Amortization (580,295)
----------
Balance at December 31, 1995 1,634,307
Purchases 243,297
Amortization (528,444)
----------
Balance at December 31, 1996 1,349,160
Purchases 289,253
Amortization (468,647)
----------
Balance at December 31, 1997 $1,169,766
=========
NOTE 16 - NOTES PAYABLE
Notes payable at December 31, 1997 and 1996 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. However, in conjunction with a severance
settlement with the former employee, EBI agreed to repay this note in its
entirety in February 1998.
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. The Company
made "qualified non-elective" contributions of $38,379 and $17,635 for the plan
years ended December 31, 1997 and 1995, respectively, in order to maintain the
plan's qualified tax status. The Company did not make a contribution to the plan
for 1996.
Certain employees of EBI's subsidiaries participate in a Supplemental Executive
Retirement Plan ("SERP"). An expense of $37,808, $38,836 and $28,738 was
recognized in 1997, 1996 and 1995, 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. Participants in
the SERP as of December 31, 1997 are 100% vested. 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 4, 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 a redemption and liquidation value of $14.2 million for the Series B
preferred stock and $834,000 for the Series C preferred stock. The preferred
stock is redeemable at the option of the Company. 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
46
<PAGE>
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 $3,289,386 and $160,992,
respectively, as of December 31, 1997.
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 the related option.
SARs become exercisable only in the event of a change of control as defined in
the Second Amendment to the Option Plan. 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 granted June 30, 1995 and
their related SARs. All options granted June 30, 1995 were exercised during 1997
and 1996 under the SAR provisions of the options. The options outstanding as of
December 31, 1997 will become exercisable on May 28, 2000 and will expire on May
28, 2007.
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.
47
<PAGE>
The following table summarizes activity under the option plans for years ended
December 31, 1997, 1996 and 1995 and the status at December 31, 1997.
<TABLE>
<CAPTION>
<S> <C>
Option Plan Directors Option Plan
--------------------- -----------------------
Number of Option Number of Option
Options Price Options Price
------- ----- ------- -----
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
Granted 110,200 1.3750 1,350 5.6250
Exercised (184,292) 0.9375 -
Canceled (8,000) 1.3750 -
Rescinded for replacement (30,398) 3.2500 -
-------- ------
Options outstanding as of December 31, 1997 102,200 1.3750 4,600 0.9375-5.6250
======== =======
Options exercisable as of December 31, 1997 - 3,250 0.9375-3.8750
======== ======
Options available for future grant
as of December 31, 1997 432,553 14,400
======== ======
</TABLE>
The Company recognized $498,051, $412,743 and $37,631 during the years ended
December 31, 1997, 1996 and 1995, respectively, for the options granted June 30,
1995 under the Option Plan, which were exercised in their entirety under the SAR
provisions of the options. As of December 31, 1997, the Company had recognized
an obligation of $703,000 to its Chief Executive Officer resulting from the
exercise of his SARs in November 1997. A determination has not yet been made as
to the date and method of payment to satisfy this obligation.
Had compensation cost of the Option Plan been determined based on the fair value
at the grant date for awards made under the plan, consistent with the method of
SFAS 123, the Company's net loss and loss per share would have been $312,000 and
$1.84, respectively, for the year ended December 31, 1997 and the fair value of
the options granted during 1997 would have been $0.71 per share. The fair value
of each option granted under the Option Plan during 1997 was estimated on the
date of grant using the Black-Scholes option pricing model with the following
assumptions: risk-free rate of return of 6.29%, dividend yield of zero, expected
life of five years and volatility of 50%.
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 years ended December 31, 1997 and 1996 employees acquired
approximately 4,757 and 3,694, respectively, newly-issued shares of the
Company's common stock under the Stock Purchase Plan.
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
48
<PAGE>
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, 1997 and 1996 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
values in this Sensitivity Report are 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, 1997 and 1996. 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 MSRs 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 MSRs acquired from third parties and
loans sold to third parties is the estimated loss allocated to off-balance sheet
recourse.
49
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
December 31, 1997 December 31, 1996
---------------------------- --------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(in thousands)
Financial Assets
Cash and cash equivalents..................... $ 11,033 $ 11,033 $ 6,195 $ 6,195
FHLB stock.................................... 1,431 1,431 2,540 2,540
Securities available for sale................. 17 17 9 9
Securities held for investment................ 2,299 2,217 6,003 5,890
Mortgage-backed securities held for
investment................................. 1,905 1,886 1,905 1,869
Loans held for sale........................... 2,165 2,165 2,463 2,463
Loans held for investment, net................ 167,441 169,843 145,551 147,123
Financial Liabilities
Deposits with no stated maturity.............. $ 38,667 $ 38,667 $ 25,360 $ 25,361
Time deposits................................. 115,260 115,624 105,673 105,977
FHLB advances................................. 23,547 23,558 25,690 25,767
Notes payable................................. 72 72 96 96
Capital lease obligations..................... 332 332 385 386
Off-balance sheet commitments
and recourse obligations................... - 62 - 89
</TABLE>
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, 1997, 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, 1997 and 1996, the Bank was "well
capitalized" for PCA purposes.
50
<PAGE>
The Bank's capital amounts and ratios as of December 31, 1997 and 1996 are
presented in the following tables (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------------------ -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1997
Total capital (to
risk-weighted assets) $16,762 14.33% $9,354 8.0% $11,692 =>10.0%
Tier I capital (to
risk-weighted assets) 15,298 13.08% 4,677 4.0% 7,015 =>6.0%
Tier I capital (to
total assets) 15,298 7.86% 7,790 4.0% 9,738 =>5.0%
Tangible capital (to
total assets) 15,298 7.86% 2,921 1.5% - -
<CAPTION>
To Be Adequately
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------ ----------------- --------------
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>
Regulatory Compliance. During the third quarter of 1997, the OTS completed its
safety and soundness examination of EBI and the Bank and concluded that no
adjustments to loss allowances were required. Moreover, the Bank is no longer
considered to be an institution requiring more-than-normal supervision and EBI
and the Bank are no longer operating under any supervisory agreements.
51
<PAGE>
NOTE 22 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial information of EBI is presented below. While EBI and the
Bank are no longer operating under any supervisory agreements with the OTS, the
Bank must seek a letter of nonobjection from the OTS prior to making dividend
payments to EBI.
<TABLE>
Balance Sheets
December 31, 1997 and 1996
(in thousands)
<CAPTION>
<S> <C>
1997 1996
---- ----
ASSETS
Cash $ 190 $ 117
Investment in subsidiaries 15,638 15,458
Other 257 1
------- -------
$16,085 $15,576
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Notes payable $ 72 $ 96
Redeemable Preferred Stock redemption proceeds payable 85 90
Other 1,111 284
------- -------
Total Liabilities 1,268 470
SHAREHOLDERS' EQUITY 14,817 15,106
------- -------
$16,085 $15,576
======= =======
Statements of Operations
For the years ended December 31, 1997, 1996 and 1995
(in thousands)
<CAPTION>
1997 1996 1995
---- ---- ----
Interest expense on notes payable $ (9) $ (11) $ (113)
Stock option compensation (601) - -
Net operating income (expenses) 25 60 686
----- ------- -------
Net income (loss) before undistributed loss
of subsidiaries and extraordinary items (585) 49 573
Undistributed income (loss) of subsidiaries 288 (7,426) (4,466)
----- ------- -------
Loss before extraordinary items (297) (7,377) (3,893)
Extraordinary items - - 2,683
----- ------- -------
Net loss $(297) $ (7,377) $(1,210)
===== ======== =======
</TABLE>
52
<PAGE>
<TABLE>
Statements of Cash Flows
For the years ended December 31, 1997, 1996 and 1995
(in thousands)
<CAPTION>
<S> <C>
1997 1996 1995
---- ---- ----
OPERATING ACTIVITIES
Net loss $(297) $(7,377) $ (1,210)
Adjustments to reconcile net loss to
cash provided by operating activities:
Extraordinary items - forgiveness of debt - - (2,683)
Equity in (income) loss of subsidiaries (288) 7,426 4,466
Dividends from subsidiaries 108 - -
Decrease (increase) in other assets (256) 1 (432)
Increase (decrease) in other liabilities 827 (7) (118)
------ ------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 94 43 23
------ ------- --------
FINANCING ACTIVITIES
Proceeds from notes payable - - 1,004
Payments on notes payable (24) (24) -
Redemption of Settlement Preferred Stock (5) (104) (832)
Common stock issued under the Employee Stock
Purchase Plan 8 7 -
------ ------- --------
NET CASH (USED IN) PROVIDED BY
FINANCING ACTIVITIES (21) (121) 172
------ ------- --------
NET INCREASE (DECREASE) IN CASH 73 (78) 195
CASH AT BEGINNING OF PERIOD 117 195 -
------ ------- --------
CASH AT END OF PERIOD $ 190 $ 117 $ 195
===== ====== ========
NONCASH FINANCING ACTIVITIES
Valuation of preferred stock and warrants issued
in connection with the Home Acquisition $ - $ - $15,545
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ - $ 11 $ -
</TABLE>
As of December 31, 1997, other liabilities included a $703,000 obligation to the
Company's Chief Executive Officer resulting from the exercise of his SARs in
November 1997. A determination has not yet been made as to the date and method
of payment to satisfy this obligation. EBI's stock option compensation during
1997 reflects expense recognized at the holding company for the SARs held by the
Chief Executive Officer after the obligation was transferred from the Bank to
EBI in March 1997.
53
<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 and other borrowings 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, 1997, 1996, and 1995, predominantly all loans
originated for resale 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>
<S> <C>
Retail Mortgage
Banking Banking
Segment Segment Consolidated
------- ------- ------------
1997
Total revenue $ 5,559 $ 2,221 $ 7,780
Income (loss) before income taxes 798 (1,095) (297)
Depreciation and amortization of
premises and equipment 238 182 420
Identifiable assets 188,962 6,126 195,088
1996
Total revenue $ 7,652 $ 2,738 $ 10,390
Loss before 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
</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.
The Mortgage Banking Segment consists of the operations of Essex First, a
wholly-owned subsidiary of the Bank engaged primarily in the origination and
sale of residential mortgage loans; Essex Home 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
54
<PAGE>
in various mortgage banking activities. Furthermore, the Mortgage Banking
Segment includes the MSRs 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 MSRs.
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 Bank (excluding the impact of servicing assets and related income and
expenses), and Essex Capital Corporation.
[intentionally blank]
55
<PAGE>
INVESTOR INFORMATION
Annual Meeting of Stockholders
The Annual Meeting of Stockholders of Essex Bancorp, Inc. will be held at
The Koger Center, Building 5, First Floor Conference Room, Norfolk, Virginia on
May 28, 1998 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 1997 and 1996.
1997 1996
------------------- -----------------
Quarter High Low High Low
- ------- ---- --- ---- ---
First $ 2.1875 $1.0000 $5.0000 $2.0000
Second 1.8750 1.0000 3.2500 2.0000
Third 10.0000 1.0000 2.8125 1.5000
Fourth 7.3750 3.5000 2.3750 1.7500
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
56
<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.
Senior Vice President-Finance/Treasurer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Mary-Jo Rawson
Vice President/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
Fort Pitt Capital Management
Pittsburgh, Pennsylvania
(investment management company)
57
<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
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
58
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 2023
<INT-BEARING-DEPOSITS> 6262
<FED-FUNDS-SOLD> 2748
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17
<INVESTMENTS-CARRYING> 4204
<INVESTMENTS-MARKET> 4103
<LOANS> 169852
<ALLOWANCE> 2382
<TOTAL-ASSETS> 195088
<DEPOSITS> 153927
<SHORT-TERM> 21275
<LIABILITIES-OTHER> 2393
<LONG-TERM> 2676
0
15008
<COMMON> 11
<OTHER-SE> (202)
<TOTAL-LIABILITIES-AND-EQUITY> 195088
<INTEREST-LOAN> 13588
<INTEREST-INVEST> 478
<INTEREST-OTHER> 481
<INTEREST-TOTAL> 14548
<INTEREST-DEPOSIT> 7679
<INTEREST-EXPENSE> 9230
<INTEREST-INCOME-NET> 5317
<LOAN-LOSSES> 113
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7963
<INCOME-PRETAX> (297)
<INCOME-PRE-EXTRAORDINARY> (297)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (297)
<EPS-PRIMARY> (1.83)
<EPS-DILUTED> (1.83)
<YIELD-ACTUAL> 3.01
<LOANS-NON> 1556
<LOANS-PAST> 21
<LOANS-TROUBLED> 209
<LOANS-PROBLEM> 1787
<ALLOWANCE-OPEN> 2556
<CHARGE-OFFS> 656
<RECOVERIES> 369
<ALLOWANCE-CLOSE> 2382
<ALLOWANCE-DOMESTIC> 1938
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 444
</TABLE>
