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, 1998
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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
- -------------------------------------- -----------------------
(Title of Class) (Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
None
----
(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. [X]
The aggregate market value of the Registrant's common stock on the
American Stock Exchange on March 24, 1999 held by nonaffiliates of the
Registrant was $2,839,336.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1998 are incorporated by reference into Parts I and II hereof.
Portions of the Proxy Statement for the Annual Meeting to be held on May 27,
1999 are incorporated by reference into Part III hereof.
1
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Essex Bancorp, Inc.
Annual Report on Form 10-K for the
Year Ended December 31, 1998
Table of Contents
Page
----
Part I
- ------
Item 1 Business............................................... 3
Item 2 Properties............................................. 36
Item 3 Legal Proceedings...................................... 37
Item 4 Submission of Matters to a Vote
of Security Holders................................ 37
Part II
- -------
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters.................... 37
Item 6 Selected Financial Data................................ 38
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations.......................... 38
Item 7A Quantitative and Qualitative Disclosures
About Market Risk.................................. 38
Item 8 Financial Statements and
Supplementary Data................................. 38
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure............................... 38
Part III
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Item 10 Directors and Executive Officers
of the Registrant.................................. 39
Item 11 Executive Compensation................................. 40
Item 12 Security Ownership of Certain
Beneficial Owners and Management................... 40
Item 13 Certain Relationships and
Related Transactions............................... 40
Part IV
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Item 14 Exhibits, Financial Statement Schedules,
and Reports on Form 8-K............................ 41
2
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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, 1998. 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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|
|
|
|
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| |
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| | | |
| The Bank | | EMC |
| | | |
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| |
| |
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| 69% | 31%
- ----------------------- ---------------------
| | | |
| First Title | | Essex Home |
| | | |
- ----------------------- ---------------------
|
|
---------------------
| |
| EHADC |
| |
---------------------
</TABLE>
Unless otherwise noted, each company is owned 100% by its parent
entity.
3
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Defined Term Formal Name
- ------------ -----------
Company Essex Bancorp, Inc.
Partnership Essex Financial Partners, L.P.
Bancorp Essex Bancorp.
Bank Essex Savings Bank, F.S.B.
EMC Essex Mortgage Corporation
Essex First Essex First Mortgage, a division of the Bank
First Title First Title Insurance Agency LLC
Essex Home Essex Home Mortgage Servicing Corporation
EHADC E H Asset Disposition Corporation
The Company is a Delaware corporation that is the holding company for
the Bank, a federally-chartered savings bank which operates (i) four retail
banking branches located in North Carolina and Virginia and (ii) Essex First, a
division that engages principally in the origination and sale of residential
mortgage loans. The Company's other principal operating subsidiary is Essex
Home, a majority-owned subsidiary of the Bank that is engaged primarily in the
servicing of mortgage loans owned by the Bank, governmental agencies and third
party investors. At December 31, 1998, the Company had total assets of $231.0
million, total liabilities of $215.2 million, including total deposits of $187.6
million, and total shareholders' equity of $15.8 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. 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.
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").
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 became exercisable in September 1998 and
will expire in September 2005.
On May 28, 1998, the Company's shareholders approved an amendment of
the Company's Certificate of Incorporation whereby the Company's total
authorized capitalization increased to 30 million shares, consisting of 20
million shares of common stock and 10 million shares of preferred stock. The
4
<PAGE>
increase in authorized capitalization increases the Company's flexibility to
issue additional shares of common stock and preferred stock to enable the
Company to engage in strategic transactions, such as possible mergers or share
exchanges with other entities. However, the Company has no present plans to
issue shares in connection with any particular transaction.
Business Strategy of the Company and the Bank
General. The Company has improved its financial, operational and
competitive position over the past three years. As of December 31, 1998, the
Company is well-capitalized and profitable on a core basis, experiencing
relatively strong growth in retail deposits and postured to be competitive
within the geographic markets served and the market niches pursued. The
Company's business strategy is to raise the core earnings level through (i)
continued asset growth, (ii) an improved net interest income ratio through
continued emphasis in a broader range of loan and deposit products and (iii)
enhanced noninterest revenues through increased cross-selling and continued
growth in mortgage lending and servicing activities.
Enhancement of Bank Franchise. In 1996, 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 was that the Company
retained its most strategic branches with the greatest potential for significant
market share growth. See Note 5 on pages 36 and 37 of the Notes to Consolidated
Financial Statements of the 1998 Annual Report to Stockholders, which is
attached hereto as Exhibit 13 and incorporated herein by reference.
During this downsizing period in 1996, the Bank continued its efforts
to position itself as a service-oriented community-based institution to compete
against the large regional/national banking companies whose orientation is
towards larger accounts, centralized operations and higher service fees. To that
end, the Bank and its mortgage banking subsidiary introduced a wider range of
consumer and mortgage loan products to attract new business, maximize the
potential of its existing customer base and enhance yields. The Company
envisions further improving its franchise through emphasizing growth at existing
branches through increased cross-selling, increasing market penetration in
Tidewater and Richmond, Virginia and Northeastern North Carolina and opening
complementary branches, such as a new branch site in Ashland, Virginia. This
site was acquired in 1998 and a new retail bank branch is anticipated to be
completed in September 1999. In addition, the Bank expects to offer its deposit
customers a telephone information access system and debit cards.
Diversification of Loan Products. The Company continues to emphasize
the origination and purchase of residential construction and consumer loans
because of the shorter-term nature of such loans and the higher yields available
thereon when compared to permanent residential mortgage lending. However,
construction and consumer lending is generally considered to involve a higher
level of risk as compared to single-family residential lending. Notwithstanding
the higher risk aspect, the portfolio of residential construction loans has
grown steadily since the product's introduction in 1992 with a negligible loss
on one foreclosed property in 1998 constituting the first loss in this
portfolio. At this time, opportunities for consumer loan origination are limited
5
<PAGE>
in the Bank's markets. Therefore, the Bank continues to review consumer
portfolios in the secondary market that have acceptable credit risk and yields.
For additional information, see "- Lending Activities - Construction Loans" and
"- Consumer Loans."
Maintenance of Asset Quality. The Bank has a multi-faceted program
designed to control and continually monitor the credit risks inherent in the
loan portfolio. This program consists of, among other things, a structured loan
approval process including a loan committee, the periodic assessment of loan
classifications, an annual review of all commercial real estate and builder
relationships and the periodic evaluation of the adequacy of general loan loss
allowances. By deploying these processes and adhering to predetermined
underwriting procedures, management has been successful in reducing previously
unacceptable levels of delinquencies and nonperforming assets. As a result, the
.79% ratio of nonperforming assets to total assets at December 31, 1998 is the
lowest since the Company went public in 1989.
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 eight private investors and 47 subservicing
clients.
Through various networking and referral opportunities and advertising
efforts, Essex Home has attracted other financial institutions and mortgage
banking firms interested in outsourcing 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. Essex Home's
largest subservicing contract was terminated effective June 1, 1997, but Essex
Home has rebuilt the portfolio and its nonaffiliate servicing/subservicing
portfolio increased from 5,500 loans totaling $354.2 million as of December 31,
1997 to 12,200 loans totaling $1.1 billion as of December 31, 1998.
Containment of Operating Expenses. Historically, the Company's
operating expenses have been high relative to those of other savings
institutions of similar asset size. Significant reductions have been made in
operating expenses and the Company has achieved a level of operating expenses
that is appropriate considering the Company's activities in both loan
origination and loan servicing. 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. 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.
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) maintained higher liquidity by holding
short-term investments and cash equivalents and (iv) increased the average
maturity of the Bank's interest-bearing liabilities by utilizing long-term
advances and attempting to attract longer-term retail deposits.
6
<PAGE>
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. The Bank's one-year interest rate sensitivity gap
amounted to a negative 17.9% at December 31, 1998, which reflects the impact of
(i) the lengthening of the initial adjustment term for adjustable-rate mortgage
loans and (ii) the 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 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 1998 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 regulation by the Office of Thrift Supervision ("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 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). Because of borrowers' preferences for fixed-rate mortgage
loans during 1998, the Company also relied upon the acquisition of
adjustable-rate residential loan portfolios to supplement Essex First's
production of loans to be retained by the Bank. 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.
Lending Activities
General. At December 31, 1998, the Company's net loan portfolio
(excluding loans classified as held for sale) totaled $192.7 million,
representing approximately 83.4% of its $231.0 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
7
<PAGE>
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
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, 1998, the Bank's limit on
loans-to-one borrower was $2.6 million. The loans-to-one borrower limitation may
restrict the Bank's ability to do business with certain existing and potential
customers.
At December 31, 1998, the Bank's five largest commercial loans-to-one
borrower and their related entities amounted to $1.4 million, $1.2 million,
$789,000, $470,000 and $356,000. In addition, as of December 31, 1998, the
Bank's largest lines of credit with unaffiliated home builders consisted of one
in the amount of $2.5 million (of which no funds had been drawn as of such
date), another in the amount of $2.5 million (of which $435,000 had been drawn
upon as of such date), another in the amount of $2.4 million (of which $1.3
million had been drawn upon as of such date), another in the amount of $1.5
million (of which $361,000 had been drawn upon as of such date) and another in
the amount of $1.5 million (of which $286,000 had been drawn upon as of such
date).
At December 31, 1998, the $1.4 million commercial 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 components of this credit are (i) a commercial real estate loan of $939,000
as of December 31, 1998, 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
$433,000 as of December 31, 1998. 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, 1998, the Bank and its subsidiaries leased nine
of the mini-storage units. The property was most recently appraised in November
1992 for $915,000. As of December 31, 1998, the Bank had established a $300,000
specific reserve with respect to the loans and the remaining $1.1 million was
classified as substandard.
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Loan Portfolio Composition. The following table sets forth information
concerning the Company's loan portfolio (excluding loans held for sale) by type
of loan at the dates indicated:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------
1998 1997 1996
---- ---- ----
$ % $ % $ %
- - - - - -
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Single-family residential:
First mortgages................ $152,891 78.6% $130,486 76.8% $103,643 70.0%
Second mortgages............... 7,525 3.9 8,699 5.1 12,384 8.3
Construction and development..... 19,430 10.0 16,583 9.8 17,190 11.6
Commercial real estate........... 6,470 3.3 5,970 3.5 6,313 4.3
--------- ------ --------- ------ --------- ------
Total real estate loans........ 186,316 95.8 161,738 95.2 139,530 94.2
Commercial business loans........... 1,601 .8 1,883 1.1 1,915 1.3
Consumer loans:
Other............................ 5,984 3.1 5,426 3.2 5,828 3.9
Secured by deposits.............. 621 .3 805 .5 842 .6
---------- ----- ---------- ----- ---------- -----
Total consumer loans........... 6,605 3.4 6,231 3.7 6,670 4.5
--------- ----- --------- ----- --------- -----
Total loans.............. 194,522 100.0% 169,852 100.0% 148,115 100.0%
===== ===== =====
Less:
Unearned loan fees and discounts. 9 29 8
Allowance for loan losses........ 1,845 2,382 2,556
--------- --------- ---------
1,854 2,411 2,564
--------- --------- ---------
Net Loans................ $192,668 $167,441 $145,551
======= ======= =======
<CAPTION>
1995 1994
---- ----
$ % $ %
- - - -
Real estate:
Single-family residential:
First mortgages................ $223,531 82.1% $187,607 77.7%
Second mortgages............... 13,398 4.9 18,717 7.8
Construction and development..... 15,078 5.5 15,501 6.4
Commercial real estate........... 10,611 3.9 11,499 4.8
-------- ------ -------- ------
Total real estate loans........ 262,618 96.4 233,324 96.7
Commercial business loans........... 2,171 .8 1,824 .8
Consumer loans:
Other............................ 6,488 2.4 5,320 2.2
Secured by deposits.............. 994 .4 835 .3
---------- ----- ---------- -----
Total consumer loans........... 7,482 2.8 6,155 2.5
--------- ----- --------- -----
Total loans.............. 272,271 100.0% 241,303 100.0%
===== =====
Less:
Unearned loan fees and discounts. 388 482
Allowance for loan losses........ 5,251 3,429
--------- ---------
5,639 3,911
---------
Net Loans................ $266,632 $237,392
======= =======
</TABLE>
9
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Total loans decreased by an aggregate of $46.8 million or 19.4% from
December 31, 1994 to December 31, 1998 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 $32.3 million and $22.2 million of
adjustable rate first mortgage loans in 1998 and 1997, respectively, and $3.2
million of fixed rate home improvement loans in 1998 partially offset 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. Over the five year period ended December 31, 1998,
the Company has placed increased emphasis on single-family first mortgage loans,
which, together with construction loans secured by single-family residences,
increased from 84.1% of total loans held for investment at December 31, 1994 to
88.6% of total loans held for investment at December 31, 1998. Single-family
second mortgage loans declined substantially from 7.8% of total loans held for
investment at December 31, 1994 to 3.9% of total loans held for investment at
December 31, 1998. 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 4.8% of total loans held for investment at December
31, 1994 to 3.3% of total loans held for investment at December 31, 1998, as did
commercial business loans. Consumer loans increased from 2.5% of total loans
held for investment at December 31, 1994 to 3.47% of total loans held for
investment at December 31, 1998. The Company increased its emphasis during 1998
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, 1998. Maturities are presented on a contractual
basis. Loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less. Scheduled contractual principal repayments
do not reflect the actual maturities of loans.
<TABLE>
<CAPTION>
Commercial Commercial
Construction Real Estate Business Total
------------ ----------- -------- -----
(dollars in thousands)
<S> <C> <C> <C> <C>
Amounts due:
One year or less $17,756 $ 260 $ 706 $18,722
After one year through
five years 1,558 5,305 778 7,641
Beyond five years 116 905 117 1,138
-------- ------- ------ -------
Total $19,430 $6,470 $1,601 $27,501
====== ===== ===== ======
Interest rate terms on
amounts due after one
year:
Fixed $ 154 $2,698 $ 778 $ 3,630
======= ===== ====== =======
Adjustable $ 1,520 $3,512 $ 117 $ 5,149
====== ===== ====== =======
</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
10
<PAGE>
enabled the Bank to, among other things, increase its origination of both
consumer and mortgage loans directly through its branch network.
Mortgage Banking Activities. At December 31, 1998, 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 accepts loan applications through the Bank's branch office in Emporia,
Virginia. During the years ended December 31, 1998, 1997, and 1996, Essex First
originated $98.8 million, $65.6 million and $104.2 million of loans (consisting
primarily of both permanent and construction loans secured by single-family
residential real estate). During such periods, $33.5 million, $25.9 million and
$29.3 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. As of December 31, 1998 there were $969,000 of 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
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.
11
<PAGE>
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, 1998 and 1997, the Bank purchased $32.3 million and
$22.2 million of loans, respectively, from various financial institutions and
mortgage banking companies (other than Essex First) in the secondary market. 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, 1998, 1997, and 1996, loans classified by the Company
as held for sale amounted to $4.5 million, $2.2 million and $2.5 million,
respectively. Except for loans originated for sale in the secondary market by
Essex First, it is generally management's intention to hold originated and
purchased loans for investment. Under certain circumstances, however, the
Company may sell loans originally acquired for investment in order to address
needs regarding liquidity, regulatory capital, interest rate risk, or other
objectives. During 1996, the Bank sold first mortgage loans totaling $118.3
million in order to provide funds for the sale of the Branches. See Note 5 on
pages 36 and 37 of the Notes to Consolidated Financial Statements of the 1998
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. Whereas Essex First limits
its applications to residential mortgage loans. Residential mortgage loan
applications are generally attributable to referrals from real estate brokers
and builders, existing customers and, to a lesser extent, non-referral
customers. Essex First also obtains applications for residential mortgage loans
through 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 and closing.
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). 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 $1,000,000 require
approval by the Bank's loan committee, which consists of the aforementioned
officers and the Executive Vice President of the Bank. All secured loans greater
than $1,000,000 and all unsecured loans greater than $50,000 must be approved by
the Bank's loan committee and the Board of Directors of the Bank. In addition,
all loans committed or approved by the Bank's loan committee are reported to the
Board of Directors on a monthly basis. Management of the Bank believes that its
relatively centralized approach to approving loan applications ensures strict
adherence to the Bank's underwriting guidelines while still allowing the Bank to
approve loan applications on a timely basis.
12
<PAGE>
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. These 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 credit enhancement in the form of 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, 1998, $152.9 million
or 78.6% of the Company's total loans held for investment consisted of such
loans.
In recent years, the Company has been emphasizing for its portfolio
single-family residential mortgage adjustable-rate loans which provide for
periodic adjustments to the interest rate. 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
13
<PAGE>
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
48.3% of the permanent single-family residential loans in the Company's loan
portfolio held for investment at December 31, 1998 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 their sale 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, 1998, approximately 51.7% 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
14
<PAGE>
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.
The Company generally requires title insurance in order to secure 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.
Construction Loans. 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. More recently, the Company has expanded its
construction lending presence into the Raleigh, North Carolina, Northern
Virginia and Maryland markets. At December 31, 1998, construction loans amounted
to $19.4 million or 10.0% 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 72 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, 1998, the Company's C/P portfolio included 65 C/P loans
with an aggregate principal balance of $9.3 million (and an additional $10.1
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 (generally, at 75 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 and total exposure to other lenders. In 1998, the Company expanded its
builder construction loan portfolio to include participations, which allows the
Bank to leverage its capital in markets where Essex First does not have a mature
builder construction presence. The Company intends to pursue more participation
arrangements in the future. Although at December 31, 1998, 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.
15
<PAGE>
At December 31, 1998, the Company's builder construction loan portfolio
included 110 loans to 41 different builders with an aggregate principal balance
of $8.2 million (and an additional $37.9 million was subject to legally binding
commitments but had not been advanced as of such date). Of this $8.2 million of
builder loans, approximately $7.0 million consisted of construction loans for
which there were no contracts for sale at the time of origination. In addition,
the builder construction loan portfolio included one participation totaling $1.3
million at December 31, 1998.
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, 1998, $6.5 million or 3.3% of the Company's total loans held for
investment consisted of such loans.
Commercial real estate loans originated by the Company are primarily
secured by office buildings, retail stores, warehouses and general purpose
industrial space. Commercial real estate loans also include multi-family
residential loans, substantially all of which are secured by small apartment
buildings. At December 31, 1998, $1.2 million or 19.3% 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, which may be provided via
mortgage insurance, secondary collateral and/or personal guarantees from the
principals of the borrower.
16
<PAGE>
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. The Company attempts to minimize
its risk exposure by limiting the extent of its commercial lending. In addition,
the Company imposes stringent LTV ratios, requires conservative debt coverage
ratios, and continually monitors the operation and physical condition of the
collateral.
Commercial Business Loans. From time to time, and in connection with
its community bank activities, the Company has originated secured or unsecured
loans for commercial, corporate, business and agricultural purposes. At December
31, 1998, $1.6 million or .8% 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 continues 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 this time,
however, opportunities for consumer loan origination are limited in the Bank's
markets. Therefore, the Bank continues to review consumer portfolios in the
secondary market that have acceptable credit risks and yields. At December 31,
1998, $6.6 million or 3.4% 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 $621,000 at December 31, 1998. 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, 1998, the Company's loan
portfolio also included $1.3 million of automobile loans, $329,000 of mobile
home loans and $32,000 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
17
<PAGE>
time of the application. The Company's policy is to defer all loan origination
fees net of direct origination costs and amortize those fees over the
contractual lives of the related loans. Amortization of loan fees is included in
interest income. Nevertheless, the predominant portion of the Company's loans
are originated for resale and, consequently, related net loan fees are
recognized as mortgage banking income upon consummation of the loan sales.
When loans are sold with servicing rights released to the buyer, the
Company also recognizes current income from receipt of servicing release fees in
addition to receiving a premium or deducting a discount based on the market
value of the loan, which is dependent upon, among other things, the interest
rate and market conditions at the time the sales price is 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 $484,000, $782,000 and $1.1 million
at December 31, 1998, 1997 and 1996, respectively. For additional information
regarding the Company's servicing assets, see Note 2 of the Notes to
Consolidated Financial Statements on pages 33 through 36 of the 1998 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, 1998, approximately 15,100 loans with
principal balances of $1.2 billion were serviced or subserviced by Essex Home as
compared to approximately 8,400 loans with principal balances of $482.7 million
as of December 31, 1997. Notwithstanding the cancellation of its largest
subservicing client (with approximately 7,000 loans totaling $858.9 million as
of December 31, 1996) effective May 1997, Essex Home more than doubled its
mortgage loan subservicing portfolio during 1998. The Company intends to further
increase its servicing volume through the negotiation of new subservicing
contracts (generally for two year terms) and the acquisition of servicing
rights. Purchased mortgage servicing rights amounted to $347,000, $387,000 and
$207,000 at December 31, 1998, 1997 and 1996, respectively. There are risks,
however, associated with the acquisition of servicing rights because their value
(i.e., future servicing revenues) is dependent upon the underlying loans being
serviced. The Company amortizes its mortgage servicing rights in proportion to,
and over the period of, the estimated future net servicing revenues of the
underlying mortgage loans, taking into consideration market-based prepayment
estimates. However, there can be no assurance that impairments will not be
required in future periods if the lower interest rate environment results in the
acceleration of prepayment activity in excess of current expectations.
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.
18
<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>
December 31,
-----------------------------------------------------------------
1998 1997 1996
------------------- ------------------- --------------------
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
30-59 days..................... $ 662 .34% $ 645 .38% $1,156 .78%
60-89 days..................... 46 .02 295 .17 335 .23
90 or more days (1)............ 1,166 .60 1,577 .93 2,938 1.98
----- --- ----- ---- ----- ----
$1,874 .96% $2,517 1.48% $4,429 2.99%
===== === ===== ==== ===== ====
</TABLE>
(1) Includes $21,000 and $30,000 of loans that were accruing interest
at December 31, 1997 and 1996, respectively. There were no loans
90 days or more past due accruing interest at December 31, 1998.
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
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.
19
<PAGE>
The following table sets forth information regarding nonperforming
assets held by the Company at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------
1998 1997 1996
---- ---- ----
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Nonaccrual loans, net:
Single-family residential................ $ 697 .36% $1,203 .71% $2,513 1.70%
Construction............................. - - 133 .08 220 .15
Commercial............................... 328 .17 132 .08 22 .01
Consumer................................. 141 .07 88 .05 153 .10
------- --- ------ ---- ------ ----
Total nonaccrual loans................. 1,166 .60 1,556 .92 2,908 1.96
Accruing loans 90 days or more past due..... - - 21 .01 30 .02
Troubled debt restructurings................ 98 .05 209 .12 223 .15
------- --- ------ ---- ------ ----
Total nonperforming loans.............. 1,264 .65 1,786 1.05 3,161 2.13
Foreclosed properties, net.................. 571 .29 1,512 .89 2,054 1.39
------- --- ------ ---- ------ ----
Total nonperforming assets............. $1,835 .94% $3,298 1.94% $5,215 3.52%
===== === ===== ==== ===== ====
Nonperforming loans to total loans.......... .65% 1.05% 2.13%
Nonperforming assets to total assets........ .79 1.69 2.99
Allowance for loan losses to total loans.... .95 1.40 1.73
Allowance for loan losses to nonaccrual
loans.................................... 158.23 153.09 87.90
Allowance for loan losses to nonperforming
loans.................................... 145.97 133.37 80.86
<CAPTION>
1995 1994
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
Nonaccrual loans, net:
Single-family residential................ $ 2,959 1.09% $ 3,158 1.31%
Construction............................. 378 .14 1,253 .52
Commercial............................... 2,636 .97 2,306 .96
Consumer................................. 108 .04 57 .02
------- ---- ------- ----
Total nonaccrual loans................. 6,081 2.24 6,774 2.81
Accruing loans 90 days or more past due..... 177 .06 539 .22
Troubled debt restructurings................ 143 .05 1,049 .44
------- ---- ------- ----
Total nonperforming loans.............. 6,401 2.35 8,362 3.47
Foreclosed properties, net.................. 4,856 1.78 5,290 2.19
------- ---- ------- ----
Total nonperforming assets............. $11,257 4.13% $13,652 5.66%
====== ==== ====== ====
Nonperforming loans to total loans.......... 2.35% 3.47%
Nonperforming assets to total assets........ 3.32 4.61
Allowance for loan losses to total loans.... 1.93 1.42
Allowance for loan losses to nonaccrual
loans.................................... 86.35 50.62
Allowance for loan losses to nonperforming
loans.................................... 82.03 41.01
</TABLE>
20
<PAGE>
The decrease in nonperforming assets consisted of a $522,000 decline in
nonperforming loans and a $941,000 decline in foreclosed properties. The
decrease in nonaccrual loans was attributable to the improvement in asset
quality evidenced by the decline in delinquencies from $940,000 at December 31,
1997 to $708,000 at December 31, 1998. Gross interest income that would have
been recorded during the years ended December 31, 1998, 1997, and 1996 if the
Company's nonaccrual loans at the end of such periods had been performing in
accordance with their terms during such periods was $115,000, $171,000 and
$291,000, respectively.
The Company's decrease in foreclosed properties reflected the impact of
the continuing decline in nonperforming and delinquent loans during 1998 and the
sale of 12 of the 13 properties held at December 31, 1997.
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 7 and 8 and
Notes 8 and 9 of the Notes to Consolidated Financial Statements on pages 38
through 40 of the 1998 Annual Report to Stockholders, which is attached hereto
as Exhibit 13 and incorporated herein by reference.
Classified Assets. Federal regulations require that each insured
savings institution classify its assets on a regular basis. In addition, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. Another category designated "special mention" also must be
established and maintained for assets which do not currently expose an insured
institution to a sufficient degree of risk to warrant classification as
substandard, doubtful or loss. Assets classified as substandard or doubtful
require the institution to establish general allowances for loan losses. If an
asset or portion thereof is classified as loss, the insured institution must
either establish specific allowances for loan losses in the amount of 100% of
the portion of the asset classified loss, or charge-off such amount. General
loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's risk-based capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. Federal examiners may disagree with
an insured institution's classifications and amounts reserved.
In addition to the nonperforming assets discussed above, at December
31, 1998, the Company had classified for regulatory and internal purposes an
additional $2.0 million of assets, $1.5 million of which were classified
substandard, $152,000 of which were classified doubtful and $336,000 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
21
<PAGE>
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 38 through 40 of the 1998 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
The following table sets forth information concerning the activity in
the Company's allowance for loan losses during the years indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans, net of unearned fees and discounts:
Year-end.................................. $194,513 $169,823 $148,107 $271,883 $240,821
Average outstanding during period......... 172,760 156,217 216,803 251,108 218,806
Allowance for loan losses:
Balance, beginning of year................ $2,382 $2,556 $5,251 $3,429 $3,039
Allowance transferred in connection
with the Home Acquisition............. - - - 500 -
Provision for loan losses................. 13 113 1,411 2,477 1,604
------- ------ ----- ----- -----
2,395 2,669 6,662 6,406 4,643
Charge-offs, net of recoveries (1):
Commercial (2)........................ 40 (366) 2,892 644 -
Real estate - mortgage................ 288 535 894 494 1,255
Real estate - land.................... 133 - - - -
Consumer ............................. 89 118 320 17 (41)
------- ------ ----- ----- -----
Total (2)........................ 550 287 4,106 1,155 1,214
------- ------ ----- ----- -----
Balance, end of year...................... $1,845 $2,382 $2,556 $5,251 $3,429
===== ===== ===== ===== =====
Ratio of net charge-offs to average
outstanding loans (2)........................ .32% .18% 1.89% .46% .55%
Allowance for loan losses to year-end
total nonperforming loans.................... 145.97% 133.37% 80.86% 82.03% 41.01%
Allowance for loan losses to year-end
loans, net of unearned fees and discounts.... .95% 1.40% 1.73% 1.93% 1.42%
(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%.
The following table sets forth information concerning the allocation of
the Company's allowance for loan losses by loan categories at the dates
indicated.
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- --------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(dollars in thousands)
Residential mortgage $ 855 92.5% $1,139 91.7% $1,636 89.9% $2,607 92.5% 2,068 91.9%
Commercial (1) 560 4.1 545 4.6 505 5.6 1,530 4.7 861 5.6
Consumer 285 3.4 254 3.7 299 4.5 323 2.8 467 2.5
Unallocated 145 - 444 - 116 - 791 - 33 -
------ ---- ------ ----- ------ ----- ------ ----- ----- -----
$1,845 100.0% $2,382 100.0% $2,556 100.0% $5,251 100.0% $3,429 100.0%
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
(1) Includes commercial real estate and commercial business loans.
22
<PAGE>
The Company also maintains an allowance for losses on foreclosed
properties. The following table sets forth information concerning the activity
in the Company's allowance for losses on foreclosed properties during the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year..................... $ 155 $ 179 $199
Provision for losses on
foreclosed properties.......................... 126 159 (21)
---- ---- ----
281 338 178
Charge-offs, net of recoveries................... (167) (183) 1
---- ---- -----
Balance at end of year........................... $ 114 $ 155 $179
==== ==== ===
</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
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.
23
<PAGE>
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>
At or For the Year Ended December 31,
-------------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year............ $1,905 $1,905 $15,650
Sales................................... - - (9,915) (1)
Repayments.............................. (448) - (3,668) (2)
Amortization............................ (1) - (8)
Valuation adjustments................... - - (154)
-------- -------- -------
Balance at end of year.................. $1,456 $1,905 $ 1,905
===== ===== ======
Weighted average coupon at end
of year.............................. 5.90% 6.65% 6.40%
==== ==== ====
</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.
The Company's investment in mortgage-backed securities at December 31,
1998 consists solely of a $1.5 million Fannie Mae guaranteed adjustable rate
REMIC. 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 38 of the 1998 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.
24
<PAGE>
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 37 of the 1998 Annual Report
to Stockholders, which is attached hereto as Exhibit 13 and incorporated herein
by reference.
The following table sets forth certain information relating to the
Company's investment securities held for investment at the dates indicated:
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
----------------------- ----------------------- ------------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Government securities...... $ - $ - $ - $ - $1,003 $1,003
U.S. Government agency
securities (1)............... 2,750 2,704 2,299 2,217 5,000 4,887
FHLB stock...................... 1,549 1,549 1,431 1,431 2,540 2,540
----- ----- ----- ----- ----- -----
Total (2)................... $4,299 $4,253 $3,730 $3,648 $8,543 $8,430
===== ===== ===== ===== ===== =====
(1) The $2.8 million of U.S. Government agency securities held for
investment at December 31, 1998 consists of two notes issued by the
FHLB. A $2.0 million FHLB note adjusts semi-annually based on the
yield of three-year constant maturity treasury notes and matures in
the year 2000. A $750,000 fixed-rate FHLB note matures in the year
2002 provided the one-time call option is not exercised in October
1999.
(2) Does not include investment securities classified as available for
sale which consisted of an $18,000, $17,000 and $9,000 investment in a
money market mutual fund at December 31, 1998, 1997 and 1996,
respectively.
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, 1998 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.
<CAPTION>
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...... $750 $2,000 $ - $ - $2,750
=== ===== ====== ======= =====
Weighted average yield................. 5.03% 4.21% -% -% 4.43%
==== ====== ======= ======= =====
</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
25
<PAGE>
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, 1998, deposit accounts totaling
$4.0 million or 2.1% 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
$1.2 million at December 31, 1998, and represented a decline from the $1.9
million of such certificates at December 31, 1997. 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.
The following table sets forth the average balances and rates of the
Company's deposits for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------
1998 1997 1996
------------------- ------------------ ------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
------- ---- ------- ---- ------- ----
(dollars in thousands)
<S> <C> <C> <C> <C>
Noninterest-bearing deposits... $ 9,504 -% $ 3,143 -% $ 1,433 -%
Passbook savings............... 4,225 3.49 3,839 3.48 6,782 3.33
NOW accounts................... 4,361 2.81 4,344 2.83 5,332 2.80
Money market accounts.......... 26,845 4.91 21,401 4.87 21,104 4.50
Certificates of deposit:
Consumer................... 51,747 5.68 53,256 5.78 92,771 5.83
Mini-jumbo................. 55,524 5.65 44,932 5.65 71,269 5.69
Jumbo...................... 14,481 5.73 13,206 5.78 19,670 5.86
-------- -------- --------
$166,687 $144,121 $218,361
======= ======= =======
26
<PAGE>
The following table shows the interest rate and maturity information
for the Company's time deposits at December 31, 1998:
<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%............. $12,728 $ 462 $ 58 $ - $ 13,248
5.01% to 6.00%............. 75,572 13,912 5,790 4,881 100,155
6.01% to 7.00%............. 5,573 6,347 628 4,854 17,402
7.01% to 8.00%............. 266 2,709 - - 2,975
8.01% to 9.00%............. - 6 - - 6
------- -------- ------- ------ --------
$94,139 $23,436 $6,476 $9,735 $133,786
====== ====== ===== ===== =======
The following table shows the Company's certificates of deposit of
$100,000 or more outstanding at the dates indicated:
<CAPTION>
December 31,
---------------------------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
3 months or less........................ $ 3,914 $ 4,624 $ 2,709
Over 3 through 6 months................. 5,002 4,785 3,505
Over 6 through 12 months................ 7,698 3,747 2,625
Over 12 months ......................... 6,072 5,365 5,919
------ ------ ------
Total.......................... $22,686 $18,521 $14,758
====== ====== ======
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
calendar year, or 5% of its advances (borrowings) from the FHLB, whichever is
greater. The Bank had a $1.5 million investment in stock of the FHLB at December
31, 1998, which was in compliance with this requirement. At December 31, 1998,
the Bank had $24.9 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:
<CAPTION>
At or For the Year Ended December 31,
-------------------------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
Balance at end of period.................. $24,908 $23,547 $25,690
Weighted average interest rate
at end of period..................... 5.89% 5.75% 6.14%
Maximum amount outstanding
at any month's end................... $30,975 $28,118 $29,833
Average amount outstanding
during the period.................... $21,553 $24,885 $27,137
Weighted average interest rate
during the period.................... 5.71% 5.92% 5.99%
</TABLE>
27
<PAGE>
The outstanding FHLB advances at December 31, 1998 mature as follows
(in thousands):
1999.................................... $17,308
2000.................................... 7,600
-------
$24,908
The Company's notes payable amounted to $72,000 and $96,000 at December
31, 1997 and 1996, respectively. Notes payable on these dates consisted solely
of a note payable to the former president of an acquired savings institution and
its holding company. The note accrued interest at 9.50% per annum. Originally,
the note was 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.
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, 1998 and 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 46 and 47 of the 1998 Annual Report to Stockholders, which
is attached hereto as Exhibit 13 and incorporated herein by reference.
Year 2000 Readiness
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 Readiness" on pages 21 and 22 of the 1998
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
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.
28
<PAGE>
Employees
As of December 31, 1998, the Company employed 108 full-time employees
and 11 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
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 between a savings institution and its subsidiaries and an
affiliate. 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
29
<PAGE>
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
unless the loans are made pursuant to a benefit or compensation program that (i)
is widely available to employees of the institution and (ii) does not give
preference to any director, executive officer or principal stockholder, or
certain affiliated interests of either, over other employees of the savings
institution. Section 22(h) 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, 1998, 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.
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
30
<PAGE>
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 6.1 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
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, 1998, 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 provided 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. The merger of the
SAIF and the BIF did not occur on such date as there continue to be savings
associations. Such a merger of the SAIF and the BIF may occur in the future if
legislation containing such a provision is enacted. 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
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<PAGE>
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. OTS capital regulations require
savings institutions to satisfy minimum capital standards: risk-based capital
requirements, a leverage requirement and a tangible capital requirement. Savings
institutions must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings institution to maintain capital above the minimum capital levels.
All savings institutions are required to meet a minimum risk-based
capital requirement of total capital (core capital plus supplementary capital)
equal to 8% of risk-weighted assets (which includes the credit risk equivalents
of certain off-balance sheet items). In calculating total capital for purposes
of the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings institution is required to
maintain core capital equal to a minimum of 3% of adjusted total assets. (In
addition, under the prompt corrective action provisions of the OTS regulations,
all but the most highly-rated institutions must maintain a minimum leverage
ratio of 4% in order to be adequately capitalized. See " Prompt Corrective
Action.") A savings institution is also required to maintain tangible capital in
an amount at least equal to 1.5% of its adjusted total assets.
At December 31, 1998, the Bank's actual capital ratios and the minimum
requirements under FIRREA were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Minimum
Actual Requirement Excess
------ ----------- ------
<S> <C> <C> <C> <C> <C>
Tangible capital $16,071 6.97% $3,459 1.5% $12,612
Core capital 16,071 6.97 6,917 3.0 9,154
Risk-based capital 17,364 13.09 10,609 8.0 6,755
</TABLE>
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 49 and 50 of the 1998 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference. At December 31, 1998, the Bank exceeded all of its capital
requirements under FDICIA.
The foregoing capital requirements are viewed as minimum standards by
the OTS, and most institutions are expected to maintain capital levels well
above the minimum. In addition, the OTS regulations provide that minimum capital
levels higher than those provided in the regulations may be established by the
OTS for individual savings institutions, upon a determination that the savings
institution's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (i) a
savings institution has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk, (ii) a savings institution is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations and (iii) a savings
institution may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings institutions with
which it has significant business relationships. The Bank is not subject to any
such individual minimum regulatory capital requirement.
32
<PAGE>
In March 1999, the federal banking agencies amended their risk-based
and leverage capital standards to make uniform their regulations. In particular,
the agencies made risk-based capital treatments for construction loans on
presold residential properties, real estate loans secured by junior liens on
1-to-4 family residential properties, and investments in mutual funds consistent
among the agencies, and simplified and made uniform the agencies' Tier 1
leverage capital standards. The most highly-rated institutions must maintain a
minimum Tier 1 leverage ratio of 3%, with all other institutions required to
maintain a minimum leverage ratio of 4%. The OTS regulations now state that
higher-than-minimum capital levels may be required if warranted, and that
institutions should maintain capital levels consistent with their risk
exposures.
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
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, 1998, 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, 1998, had a liquidity ratio of
12.74%.
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
33
<PAGE>
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 31, 1998, 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.
In January 1999, the OTS amended its capital distribution regulation to
bring such regulations into greater conformity with the other bank regulatory
agencies. Under the regulation, certain savings associations would not be
required to file with the OTS. Specifically, savings associations that would be
well capitalized following a capital distribution 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. Because the Bank is a subsidiary of the Company,
the regulation, however, would require the Bank to provide notice to the OTS of
its intent to make a capital distribution, unless an application is otherwise
required.
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, 1998, the Bank had $1.5 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, 1998, the
Bank was in compliance with applicable requirements. However, because required
reserves must be maintained in the form of vault cash or a noninterest-bearing
account at a Federal Reserve Bank, the effect of this reserve requirement is to
reduce an institution's earning assets.
Safety and Soundness. Effective August 9, 1995, the federal banking
regulatory agencies jointly implemented Interagency Guidelines Establishing
Standards for Safety and Soundness ("Guidelines") for all insured depository
institutions relating to internal controls, information systems and 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
34
<PAGE>
would prohibit compensation and benefits and arrangements that are excessive or
that could lead to a material financial loss for the institution. The federal
banking regulatory agencies also adopted asset quality and earnings standards
within the Guidelines, which became effective October 1, 1996. The Interagency
Guidelines Establishing Year 2000 Standards for Safety and Soundness ("Year 2000
Guidelines") were implemented in 1998 and set forth safety and soundness
standards to ensure that insured depository institutions will be able to
successfully continue business operating after January 1, 2000. 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, 1998, the Bank was in compliance with the Guidelines and the Year 2000
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 43 and 44 of the 1998 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 and its
subsidiaries and EMC. Virginia taxable income is equal to federal taxable income
with certain adjustments. Significant modifications include the subtraction from
federal taxable income of interest or dividends on obligations or securities of
the United States that are exempt from state income taxes, and a recomputation
of the bad debt reserve deduction on reduced modified taxable income.
Because consolidated or combined income tax returns are not allowed
under North Carolina law, the Bank and its subsidiaries that conduct business in
North Carolina are separately subject to an annual corporate income tax of 7.75%
of their federal taxable income as computed under the Code, subject to certain
prescribed adjustments. In addition to the state corporate income tax, the Bank
and its subsidiaries are subject to an annual state franchise tax, which is
imposed at a rate of .15% applied to the greater of the respective entity's (i)
capital stock, surplus, and undivided profits, (ii) investments in tangible
property in North Carolina or (iii) appraised valuation of property in North
Carolina.
35
<PAGE>
Furthermore, the Company is separately subject to an annual state
franchise tax in Delaware.
Item 2. Properties
The following table sets forth information with respect to offices of
the Company and its subsidiaries as of December 31, 1998.
<TABLE>
<CAPTION>
Lease Date Total Net Book
Owned/ Expiration Date Acquired/ Office Value at
Location Leased Including Options Leased Square Ft.(1) 12/31/98 (2)
- -------- ------ ----------------- ------ -------------- ----------
<S> <C> <C> <C> <C> <C>
The Company
Executive Office:
The Koger Center Leased 01/31/02 10/96 7,328 $ 20,772
Building 9, Suite 200
Norfolk, VA 23502
The Bank
Main Office:
400 W. Ehringhaus Street Owned - 11/78 3,805 189,805
Elizabeth City, NC 27906
Branch Offices:
520 South Main Street Owned - 05/86 6,517 670,855
Emporia, VA 23847
1401 Gaskins Road Owned (3) - 09/98 6,782 663,374
Richmond, VA 23233
2825 Godwin Boulevard Owned (4) - 04/98 3,245 762,819
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 (3), (5) - 09/98 3,078 -
Richmond, VA 23233
2430 Southland Drive, 3rd Floor Leased 05/31/99 06/93 2,000 -
Chester, VA 23831
400 W. Ehringhaus Street Leased (5) - 07/94 750 -
Elizabeth City, NC 27906
Essex Home
2420 Virginia Beach Blvd. Leased 12/31/01 12/91 11,950 5,770
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) In September 1998, the Bank completed the purchase of this
previously-leased facility (since May 1995).
(4) The Bank's Suffolk, Virginia branch was relocated from a facility that had
been leased since September 1995 to a newly-constructed, Bank-owned branch
in April 1998.
(5) Leased from the Bank.
The Bank has acquired land with a carrying value of $146,516 at
December 31, 1998 for the construction of a new branch in Ashland, Virginia. The
Bank anticipates completion of construction in September 1999.
36
<PAGE>
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.
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, 1998.
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 54 of the
1998 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 31, 1999, there were 1,060,642 shares of Common Stock
outstanding, which were held by approximately 2,000 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 not operating under any supervisory agreements, the Bank must seek a
letter of nonobjection from the OTS prior to making dividend payments to the
Company.
In connection with the Home Acquisition, the Company issued 2,250,000
shares of nonvoting perpetual preferred stock with an aggregate redemption and
liquidation value of $15.0 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
37
<PAGE>
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, 1998, dividends and accrued
interest thereon in arrears on the Series B and Series C preferred stock were
$4,997,493 and $242,613, 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 became exercisable beginning in September 1998 and will
expire in September 2005.
Item 6. Selected Financial Data
The selected financial data for the five years ended December 31, 1998,
which appears on page 4 of the 1998 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 5 through 23 of the 1998 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 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained on pages 16 through 19 of the 1998 Annual
Report to Stockholders, which is attached hereto as Exhibit 13, under the
caption "Market Risk Management" is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The consolidated balance sheets of the Company as of December 31, 1998
and 1997 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, 1998, along with the related notes to consolidated financial
statements and the report of PricewaterhouseCoopers LLP, independent
accountants, are incorporated herein by reference from pages 24 through 53 of
the Company's 1998 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.
38
<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 27, 1999
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>
Name Age Title
---- --- -----
<S> <C> <C>
Earl C. McPherson 45 President of Essex First and Executive
Vice President of Loan Production and
Secondary Marketing of the Bank
Roy H. Rechkemmer, Jr. 36 Senior Vice President of Finance and Treasurer
of the Company and the Bank
Mary-Jo Rawson 45 Vice President and Chief Accounting
Officer of the Company and the Bank
</TABLE>
Earl C. McPherson. Mr. McPherson presently serves as President of Essex
First and as Executive Vice President of Loan Production and Secondary Marketing
of the Bank. Mr. McPherson served as director, President and Chief Executive
Officer of Essex First Mortgage Corporation until its merger with the Bank on
December 31, 1998. 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 and is a Chartered Financial
Analyst. 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
39
<PAGE>
to be held on May 27, 1999 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 27, 1999 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 27, 1999 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 27, 1999 under the heading "Transactions with Certain Related Persons," and
the information included therein is incorporated herein by reference.
40
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
<TABLE>
(a) 1. Financial Statements:
<CAPTION>
Page in
Annual
Report*
-------
The following documents are filed as part of this report:
<S> <C>
Report of Independent Accountants ............................... 24
Consolidated Balance Sheets at December 31, 1998
and 1997......................................................... 25
Consolidated Statements of Operations for the three
years ended December 31, 1998.................................... 27
Consolidated Statements of Shareholders' Equity for
the three years ended December 31, 1998.......................... 29
Consolidated Statements of Cash Flows for the three
years ended December 31, 1998.................................... 30
Notes to Consolidated Financial Statements.......................... 33
</TABLE>
*Incorporated by reference from the indicated pages of the
1998 Annual Report to Stockholders.
The financial statements, together with the report
thereon of PricewaterhouseCoopers LLP dated February
19, 1999, appearing on pages 24 through 53 of the
accompanying 1998 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, 7A and 8, the 1998 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.
41
<PAGE>
* 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.
3. Exhibits:
The following exhibits are either filed as part of this Part
IV or are incorporated herein by reference:
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation of Essex Bancorp, Inc., dated
June 21, 1994. Filed as Exhibit 3.1 to the Registrant's Form
S-4 Registration Statement under the Securities Act of 1933
as filed on August 15, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc., dated
August 10, 1994. Filed as Exhibit 3.2 to the Registrant's
Form S-4 Registration Statement under the Securities Act of
1933 as filed on August 15, 1994.
3.3 Certificate of Amendment to the Certificate of Incorporation
of Essex Bancorp, Inc., dated November 5, 1998. Filed as an
exhibit to this report.
3.4* 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.
42
<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 exhibit 10.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997.
10.2* First Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated June 5, 1997.
Filed as exhibit 10.2 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997.
10.3* Second Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated November 1,
1997. Filed as exhibit 10.3 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997.
10.4 Third Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated December 1,
1998. Filed as an exhibit to this report.
10.5* 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.
10.6* 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.
10.7* 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.
10.8* 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.
* 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.
43
<PAGE>
10.9* First Amendment to the Essex Bancorp, Inc. Stock Option Plan
dated as of June 29, 1995. Filed as Exhibit 10.8 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995.
10.10* Second Amendment to the Essex Bancorp, Inc. Stock Option
Plan dated as of 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.
10.11* 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.
10.12* First Amendment to the Essex Bancorp, Inc. Employee Stock
Purchase Plan dated as of 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.
10.13 Second Amendment to the Essex Bancorp, Inc. Employee Stock
Purchase Plan dated as of October 1, 1998. Filed as an
exhibit to this report.
10.14* Restated Employment Agreement dated as of January 1, 1998 by
and among Essex Bancorp, Inc., Essex Savings Bank, F.S.B.,
Essex Mortgage Corporation and Gene D. Ross. Filed as
exhibit 10.12 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
10.15 First Amendment to the Restated Executive Services Agreement
dated as of 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.
10.16 Change in Control Agreement dated as of January 1, 1998 by
and among Essex Bancorp, Inc. and Gene D. Ross. Filed as an
exhibit to this report.
10.17* Restated Executive Services Agreement dated as of January 1,
1998 by and among Essex Savings Bank, F.S.B., Essex First
Mortgage Corporation and Earl C. McPherson. Filed as exhibit
10.13 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1997.
* 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.
44
<PAGE>
10.18 First Amendment to the Restated Executive Services Agreement
dated as of 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.
10.19 Second Amendment to the Restated Executive Services
Agreement dated as of January 1, 1999 by and among Essex
Savings Bank, F.S.B., Essex First Mortgage Corporation and
Earl C. McPherson. Filed as an exhibit to this report.
10.20 Change in Control Agreement dated as of January 1, 1998 by
and among Essex Bancorp, Inc. and Earl C. McPherson. Filed
as an exhibit to this report.
10.21 First Amendment to Change in Control Agreement dated as of
January 1, 1999 by and among Essex Bancorp, Inc. and Earl C.
McPherson. Filed as an exhibit to this report.
10.22 Subservicing Agreement between Essex Home Mortgage Servicing
Corporation and Continental Capital Corp. dated as of April
15, 1998. Filed as an exhibit to this report.
13 The 1998 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 an exhibit to this
report.
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.
45
<PAGE>
(b) Reports on Form 8-K Filed in the Fourth Quarter of 1998
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]
46
<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 30, 1999
--------------
(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 30, 1999
------------------------- --------------
Gene D. Ross (Date)
Chairman, President, Chief
Executive Officer and
Principal Financial Officer
By: /s/ Mary-Jo Rawson March 30, 1999
------------------------- --------------
Mary-Jo Rawson (Date)
Chief Accounting Officer
By: /s/ Robert G. Hecht March 30, 1999
------------------------- --------------
Robert G. Hecht (Date)
Director
By: /s/ Roscoe D. Lacy, Jr. March 30, 1999
------------------------- --------------
Roscoe D. Lacy, Jr. (Date)
Director
By: /s/ Harry F. Radcliffe March 30, 1999
------------------------- --------------
Harry F. Radcliffe (Date)
Director
47
<PAGE>
Exhibit Index
Exhibit No. Description
3.1* Certificate of Incorporation of Essex Bancorp, Inc., dated
June 21, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc., dated
August 10, 1994.
3.3 Certificate of Amendment to the Certificate of Incorporation
of Essex Bancorp, Inc., dated November 5, 1998.
3.4* 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 Third Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated December 1,
1998.
- ----------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
<PAGE>
10.5* 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.
10.6* Essex Bancorp, Inc. Non-Employee Directors Stock Option
Plan.
10.7* First Amendment to the Essex Bancorp, Inc. Non-Employee
Directors Stock Option Plan dated July 29, 1995.
10.8* Essex Bancorp, Inc. Stock Option Plan.
10.9* First Amendment to the Essex Bancorp, Inc. Stock Option Plan
dated June 29, 1995.
10.10* Second Amendment to the Essex Bancorp, Inc. Stock Option
Plan dated May 23, 1996.
10.11* Essex Bancorp, Inc. Employee Stock Purchase Plan.
10.12* First Amendment to the Essex Bancorp, Inc. Employee Stock
Purchase Plan dated June 29, 1995.
10.13 Second Amendment to the Essex Bancorp, Inc. Employee Stock
Purchase Plan dated as of October 1, 1998.
10.14* 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.
10.15 First Amendment to the Restated Executive Services Agreement
dated as of January 1, 1998 by and among Essex Bancorp,
Inc., Essex Savings Bank, F.S.B., Essex Mortgage Corporation
and Gene D. Ross.
10.16 Change in Control Agreement dated as of January 1, 1998 by
and among Essex Bancorp, Inc. and Gene D. Ross.
10.17* 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.
- ----------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
<PAGE>
10.18 First Amendment to the Restated Executive Services Agreement
dated as of January 1, 1998 by and among Essex Savings Bank,
F.S.B., Essex First Mortgage Corporation and Earl C.
McPherson.
10.19 Second Amendment to the Restated Executive Services
Agreement dated as of January 1, 1999 by and among Essex
Savings Bank, F.S.B., Essex First Mortgage Corporation and
Earl C. McPherson.
10.20 Change in Control Agreement dated as of January 1, 1998 by
and among Essex Bancorp, Inc. and Earl C. McPherson.
10.21 First Amendment to Change in Control Agreement dated as of
January 1, 1999 by and among Essex Bancorp, Inc. and Earl C.
McPherson.
10.22 Subservicing Agreement between Essex Home Mortgage Servicing
Corporation and Continental Capital Corp. dated as of April
15, 1998.
13 The 1998 Annual Report is attached as Exhibit 13. Portions
of the 1998 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.
EXHIBIT 3.3
CERTIFICATE OF AMENDMENT
TO THE
CERTIFICATE OF INCORPORATION
OF
ESSEX BANCORP, INC.
Pursuant to Section 242 of the General Corporation Law of Delaware,
Essex Bancorp, Inc. (the "Corporation"), a corporation organized and existing
under the provisions of the General Corporation Law of the State of Delaware,
certifies as follows:
1. The Corporation's Certificate of Incorporation (the "Certificate of
Incorporation") was initially filed in the Office of the Secretary of State of
Delaware on June 21, 1994.
2. The following amendments to the Certificate of Incorporation were
duly adopted in accordance with Section 242 of the General Corporation Law of
Delaware:
Article IV of the Certificate of Incorporation of Essex Bancorp, Inc.
is hereby amended and restated in its entirety as follows:
ARTICLE IV
A. The Corporation shall have authority to issue thirty million
(30,000,000) shares of all classes of stock, consisting of:
1. Ten million (10,000,000) shares of preferred stock, par
value one cent ($.01) per share (the "Preferred Stock"); and
2. Twenty million (20,000,000) shares of common stock, par
value one cent ($.01) per share (the "Common Stock").
B. The Board of Directors of the Corporation is authorized, subject to
any limitations prescribed by law, to provide for the issuance of the shares of
Preferred Stock in series, and by filing a certificate pursuant to the
applicable law of the State of Delaware (each such certificate being hereinafter
referred to as a "Preferred Stock Designation"), to establish from time to time
the number of shares to be included in each such series, and to fix the
designation, powers, preferences, and rights of the shares of each such series
and any qualifications, limitations or restrictions thereof. The number of
authorized shares of Preferred Stock may be increased or decreased (but not
below the number of shares thereof then outstanding) by the affirmative vote of
the holders of a majority of the Common Stock, without a vote of the holders of
the Preferred Stock, or of any series thereof, unless a vote of any such holders
is required pursuant to the terms of any Preferred Stock Designation.
C 1. (a) Except as otherwise provided in Article IV(C)(1)(b), for a
period of three (3) years from the effective date of the Corporation's merger
with Essex Financial Partners, L.P., no record owner of any outstanding Common
Stock which is beneficially owned, directly or indirectly, as of any record date
for the determination of stockholders entitled to vote on any matter, by a
person who beneficially owns in excess of ten percent (10%) of the
then-outstanding shares of Common Stock (the "Limit"), shall be entitled or
permitted to any vote in respect of any shares of Common Stock beneficially
owned in excess of the Limit. The number of votes which may be cast by any
record owner by virtue of the provisions hereof in respect of Common Stock
beneficially owned by such person owning in excess of the Limit shall be a
number equal to the total number of shares of Common Stock constituting the
Limit multiplied by a fraction, the numerator of which is the number of shares
of Common Stock which are both owned of record by such record owner and
beneficially owned by such person owning shares in excess of the Limit and the
denominator of which is the total number of shares of Common Stock beneficially
owned by the person owning shares in excess of the Limit.
(b) A majority of the Whole Board, as that term is described
in Article V(D), may approve a transaction that results in a person becoming a
beneficial owner of shares of Common Stock in excess of the Limit prior to the
consummation of such transaction, and in such event, the voting limitation
provisions of Article IV(C)(1)(a) shall be inapplicable to such a person.
2. The following definitions shall apply to this Article
IV(C):
(a) "Affiliate" shall have the meaning ascribed to
that term in Rule 12b-2 of the General Rules and Regulations
under the Securities Act of 1934, as in effect on the date of
filing this Certificate of Incorporation.
(b) "Beneficial ownership: shall be determined
pursuant to Rule 13d- 3 of the General Rules and Regulations
under the Securities Exchange Act of 1934 (or any successor
rule or statutory provision), or, if Rule 13d-3 is rescinded
and there is no successor rule or statutory provision thereto,
"beneficial ownership" shall be determined pursuant to Rule
13d-3 as in effect on the date of filing this Certificate of
Incorporation; except that a person shall, in any event, also
be deemed the "beneficial owner" of any Common Stock:
(i) that such person or any of his or its
Affiliates beneficially owns, directly or indirectly;
or
(ii) that such person or any of his or its
Affiliates has (i) the right to acquire (whether such
right is exercisable immediately or only after the
passage of time), pursuant to any agreement,
arrangement or understanding (but such a person shall
not be deemed to be the beneficial owner of any
voting shares solely by reason of an agreement,
contract, or other arrangement with this Corporation
to effect any transaction which is described in any
clause or clauses of Article VIII(A)) or upon the
exercise of conversion rights, exchange rights,
warrants, or options or otherwise, or (ii) sole or
shared voting or investment power with respect
thereto pursuant to any agreement, arrangement,
understanding, relationship or otherwise (but such a
person shall not be deemed to be the beneficial owner
of any shares of Common Stock solely by reason of a
revocable proxy granted for a particular meeting of
stockholders, pursuant to a public solicitation of
proxies for such meeting, with respect to shares of
Common Stock of which neither such person nor any
such Affiliate is otherwise deemed the beneficial
owner); or
(iii) that are beneficially owned, directly
or indirectly, by any other person with which such
first mentioned person or any of his or its
Affiliates acts as a partnership, limited
partnership, syndicate or other group pursuant to any
agreement, arrangement or understanding for the
purpose of acquiring, holding, voting or disposing of
any shares of capital stock of this Corporation;
and provided further, however, that (x) no director or officer of this
Corporation (or any Affiliate of any such director or officer), solely by reason
of any or all of such directors or officers acting in their capacities as such,
shall be deemed, for any purposes hereof, to beneficially own any shares of
Common Stock beneficially owned by any other such director or officer (or any
Affiliate thereof) and (y) neither any employee stock ownership or similar plan
of this Corporation or any subsidiary of this Corporation, not any trustee (or
Affiliate thereof) with respect to such plan, solely by reason of the capacity
of such trustee, shall be deemed, for any purposes hereof, to beneficially own
any Common Stock held under any such plan. For purposes of computing the
percentage beneficial ownership of Common Stock of a person, the outstanding
Common Stock shall include shares deemed owned by such person through
application of this subsection but shall not include any other Common Stock
which may be issuable by this Corporation pursuant to any agreement, or upon
exercise of conversion rights, warrants or options, or otherwise. For all other
purposes, the outstanding Common Stock shall include only Common Stock then
outstanding and shall not include any Common Stock which may be issuable by this
Corporation pursuant to any agreement, or upon the exercise of conversion
rights, warrants or options, or otherwise.
(c) A "person" shall mean any individual, firm,
corporation, or other entity.
(d) The Board of Directors shall have the power to
construe and apply the provisions of this section and to make
all determinations necessary or desirable to implement such
provisions, including, but not limited to, matters with
respect to (1) the number of shares of Common Stock
beneficially owned by any person, (2) whether a person is an
Affiliate of another, (3) whether a person has an agreement,
arrangement or understanding with another as to the matters
referred to in the definition of beneficial ownership, (4) the
application of any other definition or operative provision of
the section to the given facts, or (5) any other matter
relating to the applicability or effect of this section.
3. The Board of Directors shall have the right to demand that
any person who is reasonably believed to beneficially own shares of Common Stock
in excess of the Limit (or holds of record Common Stock beneficially owned by
any other person and such other person beneficially owns shares of Common Stock
in excess of the Limit) supply the Corporation with complete information as to
(1) the record owner(s) of all shares beneficially owned by such person who is
reasonably believed to own shares of Common Stock in excess of the Limit, and
(2) any other factual matter relating to the applicability or effect of this
Article IV(C) as may reasonably be requested of such person.
4. Except as otherwise provided by law or expressly provided
in this Article IV(C), the presence, in person or by proxy, of the holders of
record of shares of capital stock of the Corporation entitling the holders
thereof to cast a majority of the votes (after giving effect, if required, to
the provisions of this section) entitled to be cast by the holders of shares of
capital stock of the Corporation entitled to vote shall constitute a quorum at
all meetings of the stockholders, and every reference in this Certificate of
Incorporation to a majority or other proportion of capital stock (or the holders
thereof) for purpose of determining any quorum requirement or any requirement
for stockholder approval shall be deemed to refer to such majority or other
proportion of the votes (or the holders thereof) then entitled to be cast in
respect of such capital stock.
5. Any constructions, applications, or determinations made by
the Board of Directors, pursuant to this Article IV(C), in good faith and on the
basis of such information and assistance as was then reasonably available for
such purpose, shall be conclusive and binding upon the Corporation and its
stockholders.
6. In the event any provision (or portion thereof) of this
Article IV(C) shall be found to be invalid, prohibited or unenforceable for any
reason, the remaining provisions (or portions thereof) of this Article IV(C)
shall remain in full force and effect, and shall be construed as if such
invalid, prohibited or unenforceable provision had been stricken herefrom or
otherwise rendered inapplicable, it being the intent of this Corporation and its
stockholders that each such remaining provision (or portion thereof) of this
Article IV(C) remain, to the fullest extent permitted by law, applicable and
enforceable as to all stockholders, including stockholders that beneficially own
shares of Common Stock in excess of the Limit, notwithstanding any such finding.
WITNESS, Essex Bancorp, Inc. has caused this Certificate of Amendment
to its Certificate of Incorporation to be signed by Gene D. Ross, its President,
this 5th day of November, 1998.
ESSEX BANCORP, INC.
By: /s/Gene D. Ross
--------------------------
Gene D. Ross
President
EXHIBIT 10.4
THIRD AMENDMENT
TO THE
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
THIS THIRD AMENDMENT TO THE ESSEX SAVINGS BANK, FSB SUPPLEMENTAL
EXECUTIVE RETIREMENT PLAN (the "Plan") is made as of the 1st day of December,
1998.
WITNESSETH:
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 December 1, 1998
as follows:
1. The definition of "Change in Control" in Article I of the Plan is
amended to add the following sentence at the end thereof:
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 December 1, 1998; (2) any
purchase, transfer or other disposition of the Series B and
Series C preferred shares of Bancorp; (3) any exercise,
conversion, transfer of warrants or options of Bancorp which
were issued prior to 1996 (and any such exercise, conversion
or transfer shall be disregarded in determining whether a
Change in Control has occurred); and/or (4) any issuance by
Bancorp of additional shares or other securities on or after
December 1, 1998.
2. Article V of the Plan is hereby amended to read in its entirety as
follows:
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 shall be fully vested in his Retirement
Account balance as of December 31, 1998 (plus all subsequent
Investment Adjustments to that December 31, 1998 balance). The
Member's vested percentage of the remainder of his Retirement
Account (i.e., any Pension Credits and Profit-Sharing Credits
for Plan Years after 1998 and Investment Adjustments
attributable to such post 1998 credits) 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 after 1998.
Complete Plan Years of
Service with Employer Forfeited
after 1998 Vested Percentage Percentage
---------------------- ----------------- ----------
1 or Fewer 0% 100%
2 0% 100%
3 or More 100% 0%
3. Except as provided above, the Plan shall continue in accordance with
its terms as in effect immediately prior to the date of this Amendment:
IN TESTIMONY WHEREOF, the Bank has caused this Third Amendment to be
executed by its duly authorized officer this 30th day of December, 1998.
ESSEX SAVINGS BANK, FSB
By: /s/Gene D. Ross
---------------------------
Its: President
EXHIBIT 10.13
SECOND AMENDMENT
TO THE
ESSEX BANCORP, INC.
EMPLOYEE STOCK PURCHASE PLAN
THIS SECOND AMENDMENT TO THE ESSEX BANCORP, INC. EMPLOYEE STOCK
PURCHASE PLAN is made as of the 1st day of October, 1998.
WITNESSETH:
WHEREAS, Essex Bancorp, Inc. (the "Corporation") maintains the Essex
Bancorp, Inc. Employee Stock Purchase Plan (the "Plan"); and
WHEREAS, it is necessary and desirable to amend the Plan to suspend
purchases of the Corporation's shares under the Plan.
NOW, THEREFORE, the Plan is hereby amended effective October 1, 1998 to
add new Section 27 to read in its entirety as follows:
27. Suspension of Plan Participation and Benefits.
Any provision herein to the contrary
notwithstanding: (a) no eligible employee may commence
participation in the Plan on or after October 1, 1998; (b) any
payroll deduction elections previously made by the Plan
participants shall automatically be terminated and no further
contributions shall be permitted under the Plan; (c) any
amounts withheld from employee pay between October 1, 1998 and
December 31, 1998 to purchase stock shall be returned to the
Plan participants from whom such amounts were withheld; and
(d) no shares of Common Stock of the Corporation shall be
purchased or issued pursuant to the Plan on or after December
30, 1998.
<PAGE>
IN TESTIMONY WHEREOF, the Corporation has caused this Second Amendment
to be executed by its duly authorized officers this 25th day of January, 1999.
ESSEX BANCORP, INC.
By: /s/Gene D. Ross
--------------------------
Its: President
EXHIBIT 10.15
FIRST AMENDMENT
TO THE
RESTATED EXECUTIVE SERVICES AGREEMENT
This FIRST AMENDMENT TO THE RESTATED EXECUTIVE SERVICES AGREEMENT is
made as of January 1, 1998 by and among Essex Bancorp, Inc. ("Bancorp"), Essex
Savings Bank, FSB (the "Bank") and Essex Mortgage Corporation (collectively, the
"Employers") and Gene D. Ross ("Employee").
WITNESSETH:
WHEREAS, Employers and the Employee entered into a Restated Employment
Agreement dated as of January 1, 1998 (the "Employment Agreement"); and
WHEREAS, the Office of Thrift Supervision, Department of United States
Treasury ("OTS"), has reviewed the Employment Agreement and requested that
certain modifications be made to the Employment Agreement; and
WHEREAS, Employers and Employee desire to amend the Employment
Agreement to comply with the OTS request.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth below, and other good and valuable consideration, the receipt of which
is hereby acknowledged, the Employers and Employee agree to amend the Employment
Agreement as follows:
1. The last sentence of Section 3.1 is amended to read as follows:
In the event the Essex Employers decline or fail to renew this
Agreement upon expiration of its Initial Term or any annual
renewal term thereafter on the same terms or terms more
favorable to the Employee, Bancorp shall be deemed to have
terminated Employee without Cause.
2. Section 3.7(b) of the Agreement is amended to read as follows:
(b) In the event a Change in Control occurs prior to or on the
date of termination of this Agreement, the Employee thereafter
shall not be entitled to any severance payment under this
Agreement but shall instead be entitled to such benefits, if
any, as are provided under the Change in Control Agreement
dated as of January 1, 1998 by and between Essex Bancorp, Inc.
and Employee. 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 25% 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 in Control has
occurred).
3. Section 3.7(c) of the Agreement is amended to read as follows:
(c) Any provision herein to the contrary notwithstanding: (i)
no severance payment under Section 11(a) shall be due to
Employee if Employer terminates Employee for Cause under
Section 3.3 or Employee resigns without Just Cause under
Section 3.2 above.
IN TESTIMONY WHEREOF, the parties have caused this First Amendment to
the Agreement to be executed as of the first day of January, 1998.
ESSEX BANCORP, INC.
By: /s/ Roscoe D. Lacy, Jr.
---------------------------------
Its: Director
ESSEX SAVINGS BANK, FSB
By: /s/ Roscoe D. Lacy, Jr.
---------------------------------
Its: Director
ESSEX MORTGAGE CORPORATION
By: /s/ Gene D. Ross
---------------------------------
Its: President
/s/ GENE D. ROSS
---------------------------------
EXHIBIT 10.16
CHANGE IN CONTROL AGREEMENT
This CHANGE IN CONTROL AGREEMENT is made as of the first day of
January, 1998, by and among Essex Bancorp, Inc. ("Bancorp") and Gene D. Ross
("Employee").
WITNESSETH
WHEREAS, certain subsidiaries of Bancorp and Employee entered into a
Restated Executive Services Agreement ("Employment Agreement") dated as of
January 1, 1998; and
WHEREAS, Bancorp and its subsidiaries desire to amend the Employment
Agreement to eliminate the obligation thereunder to pay certain benefits to
Employee upon a "Change in Control" (as defined in the Employment Agreement) and
to instead provide such payments under a separate agreement between Bancorp and
Employee only; and
WHEREAS, Employee is willing to consent to the above change to the
Employment Agreement on the condition that the Change in Control payment
provisions contained therein be continued in a separate agreement (the
"Agreement") between Bancorp and the Employee.
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, Bancorp and Employee agree as follows:
1. Change in Control Payment.
(a) In the event a Change in Control occurs prior to or on the
effective date of termination of the Employment Agreement, Bancorp shall: (1)
pay to the Employee in a lump sum within thirty (30) days of the Change in
Control an amount equal to two hundred (200%) of his highest rate of annual
Salary (as defined in the Employment Agreement) 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 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 Bancorp representing 25% 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 in Control has occurred.)
(b) Any provision herein to the contrary notwithstanding: (1)
no Change in Control payment under Section 1(a) shall be due to Employee if
Employee is terminated (with or without Cause) or resigns under the Employment
Agreement prior to a Change in Control; and (2) under no circumstances shall
Employee be entitled to a payment under both Section 3.7 of the Employment
Agreement and this Agreement.
2. Term of Agreement. This Agreement shall continue in force during the
term of the Employment Agreement and shall expire on the effective date of
termination of the Employment Agreement.
3. General Matters.
(a) This Agreement shall be governed by the substantive laws
of the Sate 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 agreements and understandings between
the parties as to such matters.
(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) 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.
<PAGE>
IN TESTIMONY WHEREOF, the parties have caused this Agreement to be
executed as of the 24th day of June, 1998.
ESSEX BANCORP, INC.
By: /s/ Roscoe D. Lacy, Jr.
-------------------------------
Its: Director
/s/ GENE D. ROSS
EXHIBIT 10.18
3
FIRST AMENDMENT
TO THE
RESTATED EXECUTIVE SERVICES AGREEMENT
This FIRST AMENDMENT TO THE RESTATED EXECUTIVE SERVICES AGREEMENT is
made as of January 1, 1998 by and among Essex Savings Bank, FSB (the "Bank") and
Essex First Mortgage Corporation, a subsidiary of the Bank (collectively, the
"Employers") and Earl McPherson ("Employee").
WITNESSETH:
WHEREAS, Employers and the Employee entered into a Restated Executive
Services Agreement dated as of January 1, 1998 (the "Employment Agreement"); and
WHEREAS, the Office of Thrift Supervision, Department of United States
Treasury ("OTS"), has reviewed the Employment Agreement and requested that
certain modifications be made to the Employment Agreement; and
WHEREAS, Employers and Employee desire to amend the Employment
Agreement to comply with the OTS request.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth below, and other good and valuable consideration, the receipt of which
is hereby acknowledged, the Employers and Employee agree to amend the Employment
Agreement as follows:
1. Section 3 of the Employment Agreement is amended to read as follows:
3. Term of Agreement. This Restated Executive Services
Agreement (the "Agreement") and Employee's employment
hereunder shall continue for a period of one (1) year from the
date hereof (the "Initial Term"), unless earlier terminated as
provided in Section 9 below. Prior to the end of the Initial
Term (or any renewal period thereafter), the Employee and the
Employers may agree in writing to renew the term of this
Agreement for a successive one (1) year period, subject to
earlier termination under Section 9, provided the Boards of
Directors of the Employers, or committees thereof, approve
such renewals based on an annual performance evaluation of
Employee. Any refusal or failure of the Employers to renew
this Agreement on the same terms or terms more favorable to
Employee (other than a failure to renew as a result of
Employee's refusal to renew the Agreement) shall be deemed to
be a termination of this Agreement and Employee's employment
hereunder by Employers for purposes of Section 9 below.
2. Section 11(b) of the Agreement is amended to read as follows:
(b) In the event a Change in Control occurs prior to or on the
effective date of termination of this Agreement, the Employee
shall not be entitled to any severance payment under this
Agreement but shall instead be entitled to such benefits, if
any, as are provided under the Change in Control Agreement
dated as of January 1, 1998 by and between Essex Bancorp, Inc.
and Employee. 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 25% 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 in Control has
occurred).
3. Section 11(c) of the Agreement is amended to read as follows:
(c) Any provision herein to the contrary notwithstanding: (i)
no severance payment under Section 11(a) 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) above.
<PAGE>
IN TESTIMONY WHEREOF, the parties have caused this First Amendment to
the Agreement to be executed as of the first day of January, 1998.
ESSEX SAVINGS BANK, FSB
By: /s/ Gene D. Ross
--------------------------------
Its: President
ESSEX FIRST MORTGAGE CORPORATION
By: /s/ Earl McPherson
--------------------------------
Its: President/CEO
/s/ EARL McPHERSON
-----------------------------------
EXHIBIT 10.19
SECOND AMENDMENT
TO THE
RESTATED EXECUTIVE SERVICES AGREEMENT
OF
EARL McPHERSON
THIS SECOND AMENDMENT TO THE RESTATED EXECUTIVE SERVICES AGREEMENT OF
EARL McPHERSON is made as of January 1, 1999, by an among ESSEX SAVINGS BANK,
FSB and ESSEX FIRST MORTGAGE CORPORATION (collectively the "Employers") and EARL
McPHERSON (the "Employee").
WITNESSETH:
WHEREAS, the Employers and the Employee entered into a Restated
Executive Services Agreement dated as of January 1, 1998 (the "Agreement"),
which Agreement was subsequently amended; and
WHEREAS, Employers and Employee desire to further amend the Agreement
to clarify the definition of a "change in control."
NOW, THEREFORE, for good and valuable consideration, the receipt of
which is hereby acknowledged, the Employers and the Employee agree to amend the
Employment Agreement as follows:
1. The last sentence of Section 11(b) of the Employment Agreement is
amended to read in its entirety as follows:
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, 1999; (2) any
purchase, transfer or other disposition of the Series B and
Series C preferred shares of Bancorp; (3) any exercise,
conversion, transfer of warrants or options of Bancorp which
were issued prior to 1996 (and any such exercise, conversion
or transfer shall be disregarded in determining whether a
Change in Control has occurred); and/or (4) any issuance by
Bancorp of additional shares or other securities on or after
January 1, 1999.
<PAGE>
2. Except as provided above, the Agreement is hereby ratified and
confirmed in all respects.
ESSEX SAVINGS BANK, FSB
By: /s/ Gene D. Ross
-----------------------------
Its: President
ESSEX FIRST MORTGAGE CORPORATION
By: /s/ Gene D. Ross
-----------------------------
Its: Chairman/Director
/s/ EARL McPHERSON
--------------------------------
EXHIBIT 10.20
CHANGE IN CONTROL AGREEMENT
This CHANGE IN CONTROL AGREEMENT is made as if the first day of
January, 1998, by and among Essex Bancorp, Inc. ("Bancorp") and Earl McPherson
("Employee").
WITNESSETH
WHEREAS, certain subsidiaries of Bancorp and Employee entered into a
Restated Executive Services Agreement ("Employment Agreement") dated as of
January 1, 1998; and
WHEREAS, Bancorp and its subsidiaries desire to amend the Employment
Agreement to eliminate the obligation thereunder to pay certain benefits to
Employee upon a "Change in Control" (as defined in the Employment Agreement) and
to instead provide such payments under a separate agreement ("Agreement")
between Bancorp and Employee only; and
WHEREAS, Employee is willing to consent to the above change to the
Employment Agreement on the condition that the Change in Control payment
provisions contained therein be continued in a separate agreement between
Bancorp and the Employee.
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, Bancorp and Employee agree as follows:
1. Change in Control Payment.
(a) In the event a Change in Control occurs prior to or on the
effective date of termination of the Employment Agreement, Bancorp shall: (1)
pay to the Employee in a lump sum within thirty (30) days of the Change in
Control an amount equal to one hundred and fifty percent (150%) of his highest
rate of annual Salary (as defined in the Employment Agreement) 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 Bancorp
representing 25% 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 in Control has occurred).
(b) Any provision herein to the contrary notwithstanding: (1)
no Change in Control payment under Section 1(a) shall be due to Employee if
Employee is terminated (with or without Cause) or resigns under the Employment
Agreement prior to a Change in Control; and (2) under no circumstances shall
Employee be entitled to a payment under both Section 11 of the Employment
Agreement and this Agreement.
2. Term of Agreement. This Agreement shall continue in force during the
term of the Employment Agreement and shall expire on the effective date of
termination of the Employment Agreement.
3. General Matters.
(a) This Agreement shall be governed by the substantive laws
of the Sate 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 agreements and understandings between
the parties as to such matters.
(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) 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.
<PAGE>
IN TESTIMONY WHEREOF, the parties have caused this Agreement to be
executed as of the 24th day of June, 1998.
ESSEX BANCORP, INC.
By: /s/ Gene D. Ross
---------------------------
Its: President
/s/ EARL McPHERSON
------------------------------
EXHIBIT 10.21
FIRST AMENDMENT
TO
CHANGE IN CONTROL AGREEMENT
THIS FIRST AMENDMENT TO CHANGE IN CONTROL AGREEMENT is made as of
January 1, 1999, by and among ESSEX BANCORP, INC. (`Bancorp") and EARL
McPHERSON, ("Employee").
WITNESSETH:
WHEREAS, Bancorp entered into a Change in Control Agreement with
Employee dated as of January 1, 1998 (the "Agreement"); and
WHEREAS, Bancorp and Employee desire to amend the Change in Control
Agreement in certain respects.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth therein, and other good and valuable consideration, the sufficiency of
which is hereby acknowledged, Bancorp and Employee agree as follows:
1. The first sentence of Section 1(a) in the Agreement is amended to
delete the figure of "one hundred and fifty percent (150%)" and to substitute in
lieu thereof the figure "two hundred percent (200%)" effective January 1, 1999.
2. The last sentence of Section 1(a) of the Agreement is amended to
read in its entirety as follows:
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, 1999; (2) any
purchase, transfer or other disposition of the Series B and
Series C preferred shares of Bancorp; (3) any exercise,
conversion, transfer of warrants or options of Bancorp which
were issued prior to 1996 (and any such exercise, conversion
or transfer shall be disregarded in determining whether a
Change in Control has occurred); and/or (4) any issuance by
Bancorp of additional shares or other securities on or after
January 1, 1999.
<PAGE>
3. Except as provided above, the Agreement is hereby ratified and
continued in all respects.
ESSEX BANCORP, INC.
By: /s/ Gene D. Ross
------------------------------
Its: President
/s/ EARL McPHERSON
---------------------------------
EXHIBIT 10.22
SUBSERVICING AGREEMENT
THIS SUBSERVICING AGREEMENT ("Agreement"), made as of the 15th day of
April, 1998, by and between Continental Capital Corp., a New York corporation
(herein, "Lender/Servicer") and Essex Home Mortgage Servicing Corporation, a
Virginia corporation (herein, "Subservicer").
RECITALS:
WHEREAS, Subservicer is engaged in the business of servicing loans
including residential mortgage loans evidenced by notes and secured by deeds of
trust, mortgages, trust deeds or like security instruments; and
WHEREAS, Lender/Servicer desires that Subservicer subservice the Loans
as hereinafter defined; and
WHEREAS, Subservicer has agreed to subservice the Loans, as hereinafter
defined.
NOW, THEREFORE, in consideration of the mutual recitals, promises and
covenants set forth herein, and other good and valuable consideration herein
receipted for, but not herein recited, the receipt of which is hereby
acknowledged, the parties hereto agree and covenant as follows:
ARTICLE I
DEFINITIONS
For purposes of this Agreement each of the following terms shall have
the meaning specified with respect thereto.
1.1 Agreement. "Agreement" shall mean this Agreement as the same may be
from time to time amended.
1.2 Borrower. "Borrower" shall mean any maker, endorser, guarantor or other
person or entity obligated for the payment of a Note in accordance with
its terms.
1.3 Deconversion Fee. The fee described in Section 4.3 below and on
Schedule II attached hereto.
1.4 Direct Cost. The term "Direct Cost" shall mean all reasonable and
customary costs incurred by Subservicer in accepting the Loans for
subservicing, including costs of travel, meals and lodging, costs of
transferring data to Subservicer from the current servicer or
subservicer and letters to Borrowers advising them of the change in
servicing.
1.5 Effective Date. "Effective Date" shall mean June 1, 1998.
1.6 FDIC. "FDIC" shall mean the Federal Deposit Insurance Corporation.
1.7 FHA. "FHA" shall mean the Federal Housing Administration.
1.8 FHLMC. "FHLMC" shall mean the Federal Home Loan Mortgage Corporation.
1.9 FNMA. "FNMA" shall mean the Federal National Mortgage Association.
1.10 GE. "GE" shall mean General Electric Credit Corporation.
1.11 GNMA. "GNMA" shall mean the Government National Mortgage Association.
1.12 Guide. The FNMA Selling Guide and the FNMA, FHLMC, GNMA, HUD, GE,
Investor, Mortgage Insurance Company Servicing Guide appropriate for
each Loan and all announcements, bulletins and exhibits thereto, all as
amended and updated from time to time.
1.13 HUD. "HUD" shall mean the Department of Housing and Urban Development.
1.14 Investor. "Investor" shall mean the owner and holder of a Note.
1.15 Lender/Servicer. "Lender/Servicer" shall mean Continental Capital Corp.
a New York corporation.
1.16 Loan Documents. "Loan Documents" shall mean all of the Notes and
Mortgages and any other documents evidencing or securing the Loans or
otherwise related to the Loans.
1.17 Loans. "Loans" shall mean the loans described on Schedule I and any
other loans made subject to this Agreement on a periodic basis. Any one
of the Loans shall be referred to herein as a "Loan".
1.18 Mortgage. "Mortgage" shall mean the original security deed, trust deed,
deed of trust, security agreement, financing statement, guaranty and/or
other document securing a Loan, including any riders, addenda,
assumption agreements, modifications and amendments thereto.
1.19 Mortgagor. "Mortgagor" or "Mortgagors" shall mean the grantors or
makers of any Mortgages, including mortgagors and trustors of trust
deeds and deeds of trust.
1.20 Note. "Note" shall mean for each Loan, the original promissory note,
bond or other evidence of indebtedness executed by a Borrower and
evidencing the indebtedness of such Borrower under such Loan and any
riders, addenda, modification or amendments thereto.
1.21 OTS. "OTS" shall mean the Office of Thrift Supervision.
1.22 Subservicer. "Subservicer" shall mean Essex Home Mortgage Servicing
Corporation, a Virginia corporation.
1.23 Prime. "Prime" shall mean the prime rate of interest published in The
Wall Street Journal or any successor publication.
1.24 Taxes. "Taxes" shall mean all real estate taxes and other taxes
assessed against property securing Loans, the nonpayment of which will
result in a lien taking priority over the Mortgage.
1.25 Termination Fee. The fee described on Schedule II that is payable to
Subservicer under Article V hereof.
1.26 VA. "VA" shall mean the Veterans Administration.
ARTICLE II
AGREEMENTS OF SUBSERVICER
2.1 General.
Subservicer hereby agrees to service each Loan pursuant and subject to
the terms of this Agreement. Lender/Servicer and Subservicer agree that this
Agreement shall be effective as of the Effective Date.
2.2 Compliance.
Subservicer will comply with, and Subservicer will use best efforts to
cause each Borrower and Mortgagor to comply with, (a) all applicable state and
federal rules and regulations, (b) the requirements of private mortgage
insurance companies for Loans insured by private mortgage insurance, including
those requiring the giving of notices, and (c) the Guide.
2.3 Procedure.
Until the principal and interest of each Note and all obligations under
each Note and Mortgage are paid in full, unless sooner terminated pursuant to
the terms hereof, Subservicer shall perform the following services in full
compliance with the Guide:
(a) Collect as they become due (i) payments of principal and
interest (ii) any sums to be held in escrow for the payment of
Taxes, assessments and other public charges that are generally
impounded, hazard and/or flood insurance premiums, FHA
insurance or private mortgage insurance premiums, condominium
association dues and fees and other sums required to be
collected and disbursed for Borrowers (collectively "Escrowed
Sums") and (iii) all other payments from Borrowers and/or
Mortgagors.
(b) Accept payments of principal and interest and impound deposits
only in accordance with the Loan Documents or information
provided by Lender/Servicer including information received
from Lender/Servicer's servicing system. Deficiencies in or
excess in payments or deposits shall be accepted and applied
in accordance with the Loan Documents or, if not covered in
such documents, in accordance with Investor or mortgage
insurer guidelines.
(c) Apply all installments and impound deposits collected by it
from the Borrower or Mortgagor, and maintain permanent
mortgage account records capable of producing, at any time and
in chronological order: the date, amount, distribution,
installment due date or other transactions affecting the
amounts due from or to the Borrower and/or Mortgagor and
indicating the latest outstanding balances of principal,
impound deposits, advances, and unapplied payments.
(d) Pending disbursement, segregate and hold by it in a custodial
account or accounts in a financial institution insured by the
FDIC ("Custodial Accounts"; each a "Custodial Account"), in
such manner as to show the custodial nature thereof, and so
that the Investor and each separate Borrower whose funds have
been contributed to such account or accounts will be
individually protected under the rules of the FDIC.
Subservicer's records shall show the respective interest of
the Investor and each Borrower in all Custodial Accounts. All
funds collected for principal and interest shall be held by
and carried in records of the Subservicer as "trustee" for the
Investor, and shall be established in such a manner as to
comply with all applicable rules and regulations of any
governmental agency insuring or guaranteeing each Loan.
(e) Maintain deposits received for the payment of Escrowed Sums in
a separate custodial account as specified in subparagraph (d)
of this section for each Borrower ("Borrower Custodial
Account"). If any federal or state statute or rule of law
requires or may require the payment of interest on such
deposits, Subservicer will pay such interest on each such
Borrower Custodial Account which it maintains or controls.
Lender/Servicer shall reimburse Subservicer for said interest
immediately upon billing. Subservicer will determine the
amount of deposits to be made by Borrowers and will furnish to
each Borrower, at least once a year, an analysis of his/her
Borrower Custodial Account and in accordance with written
instructions from the Lender/Servicer, if given.
(f) Maintain accurate records reflecting the status of Taxes,
ground rents and other recurring charges generally accepted by
the mortgage servicing industry which would become a lien on
the property given as security for the loan (the "Security
Property"). For all Loans providing for the payment to and
collection by Subservicer of any Escrowed Sums, Subservicer
shall pay such charges before any penalty date. Subservicer
assumes responsibility for the timely payment of all Escrowed
Sums and will hold harmless and indemnify Lender/Servicer and
Investor from all penalties, loss or damage resulting from
Subservicer's failure to discharge said responsibility.
(g) For all Loans which have no provisions for the payment to and
collection by Subservicer of Escrowed Sums for Taxes,
Subservicer shall, upon notification by its tax service,
promptly contact Lender/Servicer regarding the delinquency of
any such Taxes. Subservicer will pay any delinquent Taxes
pursuant to the Guide. Additionally, Subservicer shall not be
responsible for payment of ground rents or other charges for
any Loan for which it is not obligated to collect Escrowed
Sums and will pay such charges only upon receipt of
notification by Subservicer that such other charges will
result in a lien against a Security Property. Reimbursement
for any such payments will be made in accordance with
subparagraph 2.3(h) below.
(h) When Escrowed Sums held in a Borrower Custodial Account are
insufficient to pay Taxes, assessments, mortgage insurance
premiums, hazard or flood insurance premiums, or other items
due therefrom, Lender/Servicer shall reimburse Subservicer
monthly for all outstanding deficiencies, and any other
advances made by Subservicer to protect the security of
Lender/Servicer and Investor and Lender/Servicer shall wire
funds necessary to reimburse Subservicer for any advances
within five (5) business days of receipt of an invoice
therefor. Funds received after the fifth day will be subject
to a finance charge at a rate per annum equal to two percent
(2%) over Prime. Subservicer shall attempt to obtain the
necessary additional funds from each Borrower to recover such
advances made on behalf of each Borrower and Lender/Servicer.
(i) Maintain in full force and effect at all times FHA mortgage
insurance, or private mortgage insurance, as applicable, in
accordance with the type of Loan, and will assume
responsibility for the payment of the premium thereon for each
Loan, with reimbursement for such payments being made in
accordance with subparagraph 2.3(h) above.
(j) Assure that improvements on Security Property securing each
Mortgage are insured by hazard insurance issued by companies
acceptable to Investor in an amount at least equal to the
unpaid principal balance of the loan or the full insurable
value of the improvements, whichever is less, of a type at
least as protective as fire and extended coverage, and
containing a "standard" or "union" mortgage clause (without
contribution) in the form customarily used in the area in
which the Security Property is located. In all events, the
provisions of the Loan Documents shall prevail. The mortgagee
clause will be reflected as running to the benefit of
Lender/Servicer, its successors and assigns. During the course
of subservicing, the mortgagee clause in the hazard insurance
will read as follows:
Continental Capital Corp.
Its Successors and Assigns
C/O Essex Home Mortgage Servicing Corporation
P.O. Box 8068
Virginia Beach, VA 23450
Subservicer shall maintain evidence of the original insurance
policy for any Loan delivered for subservicing as provided
within Subservicer's mortgage impairment insurance policy.
2.4 Other.
Subservicer shall be responsible for further safeguarding Investor's
interest and rights in any real property, mobile home or other Security Property
under any Mortgage by performing the following services in full compliance with
the Guide:
(a) Inspecting such Security Property when any Borrower becomes
sixty (60) days or more delinquent in the payment of principal
and interest or Escrowed Sums under the Note and perform such
other inspections as prudent and sound business judgment
suggests;
(b) To the extent possible and pursuant to the Guide, securing any
such Security Property found to be vacant or abandoned, and
advising Lender/Servicer of the status thereof;
(c) Notifying Investor and Lender/Servicer whenever Subservicer
receives notice or otherwise becomes aware of any notice of
liens, bankruptcy, condemnations, probate proceeding, tax
sale, partition, local ordinance violation, condemnation or
proceeding in the nature of eminent domain or similar event
that would, in Subservicer's reasonable judgment, impair
Investor's security; and Subservicer shall assist Investor in
undertaking appropriate action to preserve its security;
(d) Advising Investor and Lender/Servicer with respect to requests
for partial releases, easements, substitutions, division,
subordination, alterations, or waivers of security instrument
terms;
(e) Advising Investor and Lender/Servicer, if requested, of any
change in ownership of such Security Property, and subject to
governing laws and regulations, comply with all instructions
from Investor with respect to the acceleration or modification
of the Note; Subservicer, at the direction of Lender/Servicer,
will forward all requests for Loan assumption immediately upon
receipt. Subservicer will, upon request, provide the initial
paperwork necessary to obtain Loan assumption information.
This information will be forwarded to Lender/Servicer and/or
Investor for approval and all necessary disclosures.
Lender/Servicer and/or Investor will prepare the necessary
assumption papers and forward to Subservicer for processing.
(f) Maintaining in force at all times a policy of errors and
omissions insurance coverage at Subservicer's sole expense.
The purpose of such coverage is to provide Lender/Servicer and
Investor protection in liquidating a Loan against net loss
that can be attributed to damage to the Security Property from
a hazard or peril required to be insured by the Investor and
that otherwise would be insured but for Subservicer's
negligence in allowing insurance coverage to lapse or failing
to keep a sufficient amount of insurance in force;
(g) Disbursing insurance loss settlements according to Investor
guidelines.
Except as otherwise provided above, all advices and notifications required to be
given in the Section 2.4 shall be provided at least monthly.
2.5 Investor Accounting.
In full compliance with the Guide, Subservicer shall:
(a) Make interest rate adjustments in compliance with applicable
regulatory adjustable loan requirements and the Note, which
reflect the applicable movements of the applicable loan rate
index. Applicable interest rate adjustments shall be
implemented in accordance with applicable adjustable loan
regulations and the Note. Subservicer shall execute and
deliver all appropriate notices required by applicable
adjustable loan regulations and the Note regarding such
interest rate adjustments including but not by way of
limitation, timely notification to Investor or to Investor's
successors or assigns, of applicable date and information
regarding such interest rate adjustment, and methods of
implementation of such interest rate adjustments, new
schedules of Investor's pro rata share of collections of
principal and interest, and of all prepayments of any Loan
hereunder by Borrower or Mortgagor.
(b) Perform such other duties, furnish such other reports and
execute such other documents in connection with its duties
hereunder as Lender/Servicer and Investor from time to time
may require consistent with requirements performed by other
servicers of loans in accordance with the Guide.
(c) Not accept any prepayment of any Loan except as specified by
law or as authorized by law and permitted by the terms of the
Loan Documents, nor waive, modify, release or consent to
postponement on the part of the Borrower or Mortgagor of any
term or provision of the Loan Documents without the written
consent of Investor; notwithstanding the foregoing, however,
Subservicer shall not be required to obtain written consent
for the waiver of any late charge or the waiver, modification,
release or consent postponement of any term or provision which
may be waived, modified, released or consented to without the
consent of the Investor under the terms of its written
instructions ("Investors Instructions") or under the Guide.
(d) Upon payment of a Loan in full, have prepared and file any
necessary release or satisfaction documents, and shall
continue subservicing of the Loan pending final settlement,
and refund any Escrowed Sums within state mandated time frames
or pay penalties associated with failure to so comply unless
such failure results from Lender/Servicer's or Investor's
delay.
(e) Where Investors require interest paid through the end of the
month although interest due from the Borrower is to the actual
date of the payoff, advance its own funds to cover any
uncollected interest due the Investor and will periodically
bill Lender/Servicer for reimbursement of such advances.
Lender/Servicer will reimburse Subservicer for said advances
immediately upon billing.
(f) Remit to the Investor, on a date and in a manner specified by
Investor, all principal and interest collected from Borrowers
or Mortgagors, retaining as compensation the fees set forth in
Schedule II attached hereto. Subservicer will remit any
guaranty fees to the appropriate Investor as required. By
mutual agreement, Subservicer will remit monthly to
Lender/Servicer the remaining portion of the gross service fee
collected.
(g) Where Investors such as FHLMC, FNMA, GNMA require the
reporting of balances and cash remittances to be reported and
remitted at one time and consolidated on the appropriate
reports, service one hundred percent (100%) of Loans which are
servicing retained by Lender/Servicer for those Investors
which follow such reporting requirements. Subservicer also
will submit all reports to Investor under Lender/Servicer's
assigned "seller/servicer" number or such other number that
Lender/Servicer and Investor may designate in writing to
Subservicer.
(h) In the event the Investor instructs Lender/Servicer to service
release any Loan(s), and Lender/Servicer shall deliver written
notice thereof to Subservicer, Subservicer shall proceed in
accordance with the Investor's Instructions. In the event
Lender/Servicer determines and instructs Subservicer not to
proceed with the Investor's Instructions, Lender/Servicer
agrees to hold Subservicer harmless from any action taken
against Subservicer by the Investor, and from any loss or
damage, including reasonable attorney fees, resulting
therefrom. With respect to servicing released Loans,
Subservicer shall be responsible to provide such information
as Investor and Lender/Servicer shall reasonably request and
shall assist Lender/Servicer in resolving routine problems and
issues with Investor.
(i) In the event Investor sells all or any part of its interest in
any Loan to a third party or parties, including the sale of
participating interests therein, and such third parties
succeed to all of the right of Investor hereunder for the Loan
interest purchased and this Agreement shall remain in full
force and effect, remit all principal and interest
installments collected under the Loan Documents directly to
such third party or parties in accordance with the terms of
the applicable servicing agreement, after deduction of the
servicing fee which is paid to the Lender/Servicer and
subservicing fees and other fees, costs and charges chargeable
by Subservicer under the terms of this Agreement. The
obligation to make direct remittances to such third party or
parties shall arise upon thirty (30) days written notice of
such assignments given by such third party(ies) to
Subservicer. Subservicer shall be entitled to and be paid an
additional One Dollar ($1.00) per Loan per remittee per month,
for each such third party remittance beyond the first one,
excluding GNMA security holders.
(j) Hold Custodial Accounts associated with the receipt,
disbursement and accumulation of principal and interest as
"trustee" for Lender/Servicer and/or Investors and each
Borrower Custodial Account as "trustee" for the benefit of
each Borrower in accordance with Investor's Instructions, and
where none apply, the Guide, with the exception of GNMA
servicing. Pursuant to GNMA's regulations, Subservicer is not
permitted to withdraw/disburse funds from Custodial Accounts
for principal and interest. Any benefit or value derived from
all demand deposits shall accrue to the benefit of the
Subservicer or Lender/Servicer as set forth on Schedule II.
(k) Subservicer shall be responsible for accurate and timely
reporting and remittance pursuant to the requirements of the
Guide as well as costs and penalties that may be incurred in
failing to meet such responsibility unless such failure is a
result of Lender/Servicer's actions or inactions.
2.6 Delinquency Control.
In full compliance with the Guide, Subservicer shall:
(a) Be responsible for protecting Investor's investment in the
Loans by maintaining the maximum possible number of Loans in a
current status, dealing quickly and effectively with Borrowers
who are delinquent or in default. Subservicer's delinquent
mortgage servicing program shall include an adequate
accounting system which will immediately and positively
indicate the existence of delinquent Loans, a procedure that
provides for sending delinquent notices, assessing late
charges, and returning inadequate payment, and a procedure for
the individual analysis of distressed or chronically
delinquent Loans. Attached to this Agreement is Schedule III
which is a minimum sample of reports required under this
Agreement.
(b) Maintain a collection department and an on-line automated
collection system. All delinquent Loans shall be serviced in
accordance with Investors Instructions or where none apply,
the Guide.
(c) Provide Lender/Servicer and Investor with a month-end
collection and delinquency report identifying and describing
the status of any delinquent Loans, and will from time to time
as the need may arise, provide Lender/Servicer and Investor
with loan service reports relating to any items of information
which Subservicer is otherwise required to provide hereunder
per Schedule IV attached hereto, or detailing any matters the
Subservicer reasonably believes should be brought to the
special attention of Lender/Servicer and Investor. The reports
as outlined in Schedule III shall be delivered to
Lender/Servicer via hard copy. All information in
Subservicer's custody and control with respect to
Lender/Servicer's Loans shall be immediately available to
Lender/Servicer and, in no event, later than five (5) business
days following receipt of a request therefor. Subservicer
shall provide a master file tape to Lender/Servicer twice
monthly.
(d) Upon the request and under the direction of Lender/Servicer
and Investor, assist in the foreclosure or other acquisition
of the Security Property pursuant to a Mortgage, the transfer
of such Security Property to the FHA or VA and the collection
of any applicable mortgage insurance, and pending completion
of these steps, protect such Security Property from waste and
vandalism. Subservicer shall be responsible for filing all
reimbursement claim forms. Subservicer will have title to such
Security Property conveyed in the name designated by Investor.
Upon receipt of billing by Subservicer, Lender/Servicer will
immediately reimburse Subservicer for all of its expenses so
incurred under this paragraph, provided that they are
reimbursable pursuant to the Guide, including court costs and
reasonable attorney's fees. In case of a voluntary deed in
lieu of foreclosure, and purchase by Investor for its account,
Subservicer will protect the Security Property while so owned.
These operations shall be on terms and as determined and
directed by Investor from time to time. Under the sale of such
Security Property, on terms as specified by Investor, if
payments are deferred and payable under contract or Mortgage,
Subservicer will service the same until completely liquidated.
2.7 Books and Records.
Upon Lender/Servicer's written request, Subservicer shall furnish a
detailed statement of its financial condition, shall give Lender/Servicer or its
authorized representative opportunity at any time during its normal business
hours to examine Subservicer's books and records, or shall cause a certified
public accountant selected and employed by it to provide Lender/Servicer not
later than ninety (90) days after the close of Subservicer's fiscal year, with a
certified statement of Subservicer's financial condition as of the close of its
fiscal year. Any additional requests for Loan audit or confirmations to be
performed by Subservicer's audit firm on Loans, shall be at Lender/Servicer's
sole expense. Subservicer will keep records satisfactory to Lender/Servicer and
Investor pertaining to each Loan, and such records shall be the property of
Lender/Servicer and upon termination of this Agreement shall be delivered to
Lender/Servicer at Lender/Servicer's expense.
Notwithstanding the foregoing, however, Subservicer at its own expense may copy
any such record before delivering it to the Lender/Servicer, so long as the
Guide does not prohibit such copying.
2.8 Insurance.
Subservicer will maintain in effect at all times and at its cost, a
blanket fidelity bond and an errors and omission policy in accordance with the
requirements of the Guide. Subservicer shall cause certificates evidencing the
existence of such coverage to be delivered to Lender/Servicer.
ARTICLE III
AGREEMENTS OF LENDER/SERVICER
3.1 Documentation.
Lender/Servicer shall provide to Subservicer at Lender/Servicers' sole
cost and expense:
(a) Any documents or records which are necessary or appropriate
for Subservicer to receive in order to service the Loans.
(b) Applicable documentation for each Loan submitted hereunder to
enable Subservicer to place and continue each Loan on its
computer system. All such documentation must be received in a
reasonable amount of time by Subservicer, prior to any
reporting due Investor.
(c) Its pro-rata portion of the fee required for any extraordinary
audit expense levied by any state or other jurisdiction.
(d) If applicable and as soon as possible, a complete listing of
any Loans where the mortgage payment is inclusive of a
personal or group insurance premium. This list will include
the name of the insurance company; type of premium coverage;
premium amount; and the name and telephone number of the
individual at Lender/Servicer's firm or affiliation
knowledgeable of such coverage. Furthermore, should
Lender/Servicer misrepresent, misinform, provide inadequate
information or no information regarding the status of such
personal or group insurance coverages (e.g., mortgage life or
disability insurance) which would cause Subservicer to incur a
loss or damage, Lender/Servicer agrees to hold Subservicer
harmless from any and all claims, liabilities, damages, and
loss, including reasonable attorneys fees, resulting
therefrom.
(e) Physical evidence that a hazard insurance policy is in force
for each Mortgage delivered to Subservicer for subservicing
and allowing Subservicer sufficient time to receive evidence
in house that all notifications shall be forwarded to
Subservicer. Further, Lender/Servicer agrees to hold
Subservicer harmless from any loss or damage caused by
insufficient evidence of hazard insurance coverage delivered
to Subservicer or any loss or damage which occurred during a
lapsed policy prior to delivery of servicing to Subservicer.
(f) Remittance by check for an amount sufficient to pay for a real
estate tax contract issued by Subservicer's tax service. If a
tax contract is in existence, pay any fees associated with a
transfer to Subservicer.
3.2 Further Notification.
Lender/Servicer shall:
(a) Advise Subservicer upon delivery of each Loan submitted
for subservicing, as to whether the Loan is in a warehouse
(unsold) status or, if sold, specific information regarding
the permanent Investor. If a Loan which has been delivered to
Subservicer in a warehouse (unsold) status is sold,
Lender/Servicer will immediately notify Subservicer of the
sale by phone and will deliver a written copy of the permanent
Investor's purchase advice or funding detailed report
immediately thereafter. In the event the permanent Investor
charges a penalty for late reporting, remittances, etc., which
were caused by Lender/Servicer's delay in notifying
Subservicer of the permanent Investor's purchase of the
Loan(s), Lender/Servicer agrees to promptly pay the penalty
and Subservicer shall have no liability on account therof.
(b) Discharge Subservicer from all liability for any advances of
principal and interest resulting from delinquent whole Loans
and delinquent Loans which are included in any pool that has
been created through "mortgage-backed pass through"
certificates or securities, as well as for all advances due to
negative amortization. Lender/Servicer will immediately
reimburse, by wire, Subservicer for such advances. Subservicer
will reimburse Lender/Servicer if and when recoveries are made
from Borrowers or Mortgagors.
3.3 Default.
In the event Lender/Servicer shall fail to pay to Subservicer any sums
due and payable to Subservicer under this Agreement when and as the same shall
be due and payable, whether as compensation, reimbursement, or otherwise,
Subservicer shall be entitled to adjust Lender/Servicer's "net service fee due"
in set-off of the amount of any sum so owing and unpaid together with any
finance charges payable in accordance with paragraph 9.12 below or as otherwise
provided herein.
ARTICLE IV
COMPENSATION
4.1 Compensation to Subservicer.
For providing the services contained in this Agreement it is agreed
that:
(a) Subservicer shall be paid in accordance with the fees
established by Schedule II, attached hereto.
(b) Any miscellaneous costs incurred by Subservicer from
extraordinary requests for items beyond the scope of those
required by the Guide shall be billed to Lender/Servicer and
promptly paid by Lender/Servicer upon receipt of billing.
(c) All monthly fees and charges (including guaranty fees on pools
of mortgage-backed securities and unrecoverable scheduled
interest and all bank charges and/or interest related to
negative balances, for example, interest charged by
Subservicer's depository bank for payments received but not
collected from Borrower's depository bank and disbursed to the
appropriate Custodial Accounts but not collected as of the
date of disbursement) shall be billed to the Lender/Servicer
and due within five (5) days of receipt of the invoice
therefor. All invoices for special services will be due within
five (5) days of receipt of the invoice therefor. Funds
received after five (5) days will be subject to a finance
charge of two percent (2%) above Prime. Subservicer reserves
the right to deduct any unpaid fees and charges from
Lender/Servicer's gross servicing fee remittance.
4.2 Insurance Commissions; Solicitation.
While Subservicer is servicing any Loan, all commissions related to
force place insurance and other fees payable for obtaining such insurance
coverage or collecting premiums and other charges, excluding all sums payable to
the insurer, shall be retained by Subservicer as ancillary income. Subservicer
warrants that subsequent to the date of this Agreement, Subservicer will not
solicit in any manner, directly or indirectly, or intentionally assist or
participate in any solicitation by a third party, whether by telephone, mail, or
direct contact, any Borrower for the purpose of refinancing or recasting any
Loan, the Servicing of which is being transferred pursuant to this Agreement.
4.3 Deconversion Fee.
If subservicing hereunder is terminated with respect to any or all of
the Loans for any reason other than foreclosure, acquisition of the Security
Property in lieu of payment or payment in full or for cause (as defined in
Section 5.2(b) below), Lender/Servicer shall pay to Subservicer the Deconversion
Fee described on Schedule II in consideration of Subservicer's work in assisting
with the transfer of servicing for any such Loans. The Deconversion Fee shall be
withheld by Subservicer from Lender/Servicer's remittance. Any amount still due
after this offset is exhausted shall be paid within five (5) business days of
receipt of an invoice therefor. If termination is made for cause (as defined in
Section 5.2(b) below), Lender/Servicer will pay all costs charged by the new
servicer for transferring data to the new servicer.
ARTICLE V
TERM AND TERMINATION
5.1 Term.
The term of this Agreement shall be for two (2) year(s) for commencing
upon the Effective Date and ending at twelve o'clock midnight on May 31, 2000.
If neither party shall terminate this Agreement by ninety (90) days written
notice to the other prior to the expiration of the initial term, this Agreement
shall renew itself and exist and continue for successive terms of two (2)
year(s) each until terminated by such notice.
5.2 Notice.
(a) In the event Lender/Servicer terminates this Agreement
during the initial two (2) year term, Lender/Servicer shall
pay Subservicer the Termination Fee and the Deconversion Fee
described in Schedule II. After the expiration of the initial
two (2) term, either party may, without cause by ninety (90)
days prior written notice to the other, terminate this
Agreement as to any or all Loans then being subserviced.
Termination for "cause" is described in subparagraphs 5.2(b)
and 5.2(c) below). If any termination of subservicing for 75%
or more of the Loans occurs at any time during the initial
term of this Agreement, Lender/Servicer shall pay Subservicer
the Termination Fee and Deconversion Fee.
(b) At Lender/Servicer's option, this Subservicing Agreement shall
immediately terminate for cause after fifteen (15) days
written notice to Subservicer. The term "for cause" as applied
to termination of Subservicer shall mean (i) the occurrence of
any event which constitutes a material breach on the part of
the Subservicer of its servicing obligations and covenants
described in Articles II, VII, VIII and IX (ii) a material
change in Subservicer's financial circumstances which would
adversely affect Subservicer's ability to perform its
obligations under this Agreement, (iii) any breach of such
servicing obligations that may result in immediate or
irreparable harm, or (iv) if any representation or warranty of
Subservicer under Article VII is inaccurate or untrue in any
material respect. If terminated pursuant to this Section
5.2(b), Lender/Servicer shall be entitled to all remedies
available at law.
(c) This Subservicing Agreement shall immediately terminate, at
Subservicer's option, upon fifteen (15) days written notice
after the occurrence of any event which constitutes a breach
on the part of the Lender/Servicer of the obligations and
covenantsdescribed in Articles III, VI, VIII, and IX or in the
event of any breach of such obligations that may result in
immediate or irreparable harm as determined by the Subservicer
or upon Subservicer's determination that any representation or
warranty of Lender/Servicer under Article VI is inaccurate or
untrue in any material respect. If terminated pursuant to this
Section 5.2(c), Subservicer shall be entitled to receive a
Termination Fee and Deconversion Fee with respect to all
Loans.
(d) Notwithstanding the provisions of paragraphs 5.2(b) and 5.2(c)
above, any party receiving notice of termination under those
paragraphs shall have thirty (30) days to cure any breach of a
covenant (other than a covenant to make payments hereunder
which shall be made in strict accordance with the terms
hereof), or to correct any untrue or inaccurate facts, unless
curing any such failure requires acts to be done or conditions
to be removed which cannot, by their nature, be performed,
done or removed, as the case may be, within such thirty (30)
day period, in which event, the curing party may avoid
termination so long as such curing party shall have commenced
curing such failure within fifteen (15) days from the receipt
of said notice and shall diligently prosecute the cure to
completion, provided that the curing party shall in any event
complete such cure within forty-five (45) days after written
notice of termination and termination shall become effective
upon such date if the cure has not been completed at the
expiration of such forty-five (45) day period.
5.3 Subservicer's Contingencies.
Subservicer's obligations and duties hereunder shall be contingent upon
(a) Lender/Servicer providing the information and documents described in
paragraphs 3.1 and 3.2(a) above, (b) receipt by Subservicer of letters or other
documents from all Investors approving this Agreement and Subservicer as a
servicer of such Loans and (c) receipt by Subservicer of certified copies of the
Lender/Servicer's audited financial statements for 1997.
5.4 Reimbursement of Servicing Released Loans.
Subservicer's right to reimbursement for actual expenses, and
reimbursement for any advances of principal and interest and escrow made on
behalf of Lender/Servicer in accordance with the terms of this Agreement shall
also apply to any Loans sold by Lender/Servicer as an Investor to a new Investor
on a "servicing released" basis.
5.5 Accounting.
Upon termination of this Agreement under this section, Subservicer will
account for and turn over to Lender/Servicer, Lender/Servicer's designee, or the
Investor or Investor's designee, all funds collected under each Note and
Mortgage, less the compensation and any fees then due Subservicer, and deliver
to Lender/Servicer, Lender/Servicer's designee, Investor or Investor's designee
all records and documents relating to each Loan then subserviced and will advise
Borrowers that their Loans will henceforth be serviced by Lender/Servicer,
Lender/Servicer's designee, Investor or Investor's designee in accordance with
the Guide.
ARTICLE VI
REPRESENTATION, WARRANTIES AND COVENANTS OF LENDER/SERVICER
6.1 Assistance.
Lender/Servicer warrants and represents to, and covenants and agrees
with Subservicer that, to the extent possible, Lender/Servicer shall cooperate
with and assist Subservicer as requested by Subservicer, in carrying out
Subservicer's covenants, agreements, duties and responsibilities under this
Agreement and in connection therewith shall execute and deliver all such papers,
documents and instruments as may be necessary and appropriate in furtherance
therof.
6.2 Notice of Breach.
Lender/Servicer shall immediately notify Subservicer (i) of any failure
or anticipated failure on its part to observe and perform any covenant or
agreement required to be observed and performed by it as a Lender/Servicer and
(ii) if any representation or warranty of Lender/Servicer made in connection
with this Agreement is untrue or inaccurate in any material respect.
6.3 Taxes.
As of the Effective Date, Lender/Servicer warrants that to the best of
their knowledge all Taxes have been paid prior to the tax delinquent date.
Lender/Servicer will indemnify and hold Subservicer harmless of and from any tax
penalties and interest which arose or accrued prior to the Effective Date and
for any other claims, demands, costs fees or expenses, including reasonable
attorneys' fees, resulting from any failure to pay such Taxes in a timely
manner.
6.4 Authority; Prior Servicing.
Lender/Servicer is a duly organized and validly existing corporation in
good standing under the laws of its state of incorporation and has all requisite
power and authority to enter into this Agreement and the persons executing this
Agreement on behalf of Lender/Servicer are duly authorized so to do.
Lender/Servicer is the owner of all servicing rights for all Loans and
represents and warrants that all information contained in any database or
document related to Loans is true, accurate and correct in every respect.
6.5 Financial Statements.
Lender/Servicer shall provide Subservicer with copies of its audited
financial statements on an annual basis within thirty (30) days following the
date of their issuance but in no event later than one hundred twenty (120) days
following the end of its fiscal year.
ARTICLE VII
REPRESENTATIONS, WARRANTIES AND COVENANTS OF SUBSERVICER
Subservicer warrants and represents to, and covenants and agrees with,
Lender/Servicer as follows:
7.1 Notice of Breach.
Subservicer shall immediately notify Lender/Servicer (i) of any failure
or anticipated failure on its part to observe and perform any covenant or
agreement required to be observed and performed by it as Subservicer and (ii) if
any representation or warranty of Subservicer made in connection with this
Agreement is untrue or inaccurate in any material respect.
7.2 Agency Approvals.
Subservicer is an approved Servicer for FHLMC, FNMA, HUD, GE and GNMA.
7.3 Authority.
Subservicer is a duly organized and validly existing corporation in
good standing under the laws of its state of incorporation and has all requisite
power and authority to enter into this Agreement and the persons executing this
Agreement on behalf of Subservicer are duly authorized so to do.
7.4 Financial Statements.
Subservicer shall provide Lender/Servicer with copies of its audited
financial statements on an annual basis within thirty (30) days following the
date of their issuance but in no event later than one hundred twenty (120) days
following the end of its fiscal year. Subservicer has delivered to
Lender/Servicer their financial statements for the year 1997.
7.5 Approvals.
To the extent reasonably necessary for Subservicer to fulfill its
obligations hereunder and so long as the cost of obtaining same is reasonable,
Subservicer shall obtain any approvals from government entities, Investors
and/or mortgage insurance companies that are necessary to effectuate
transactions to be undertaken hereunder.
7.6 Compliance; No Violations; Litigation.
Subservicer is in compliance with, and will continue to comply with,
the Guide in all material respects. Subservicer is not in violation or breach of
any agreement and not a party to any pending or threatened litigation which
would have a material adverse effect upon Subservicer's ability to perform this
Agreement.
ARTICLE VIII
INDEPENDENCE OF PARTIES; INDEMNIFICATION SURVIVAL
8.1 Independence of Parties.
The following terms shall govern the relationship between
Lender/Servicer and Subservicer:
(a) Subservicer shall have the status of and act as an
independent contractor. Nothing herein contained shall be
construed to create a partnership or joint venture between
Lender/Servicer and Subservicer.
(b) Subservicer shall not be responsible for representations,
warranties or contractual obligations in connection with (1)
sale to an Investor of any of the Loans, or (2) the servicing
of any such Loans prior to the assumption of subservicing of
the Loans pursuant to this Agreement.
(c) Anything herein contained in this Article VIII or elsewhere in
this Agreement to the contrary notwithstanding, the
representations and warranties of Subservicer contained in
this Agreement shall not be construed as a warranty or
guarantee by Subservicer as to future payments by any Borrower
or Mortgagor.
(d) Anything herein contained in this Article VIII or elsewhere in
this Agreement to the contrary notwithstanding, Subservicer
shall not be responsible for performance or compliance under
any loan repurchase agreements, representations or warranties
of an origination nature, or those servicing representations
and warranties directly or indirectly related to the
origination process made between Lender/Servicer and any
Investor, either prior or subsequent to this Agreement.
8.2 Indemnification by Subservicer.
Except as otherwise stated herein, Subservicer indemnifies and holds
harmless Lender/Servicer from any liabilities, claims, losses, damages, actions,
claims, fees, costs and expenses including reasonable attorneys' fees, directly
or indirectly resulting from or arising out of Subservicer's failure to observe
or perform any or all of Subservicer's covenants, agreements, warranties or
representations contained in this Agreement.
8.3 Indemnification by Lender/Servicer.
Lender/Servicer indemnifies and holds harmless the Subservicer from any
liabilities, claims, losses, damages, actions, claims, fees, expenses and costs,
including reasonable attorneys' fees, directly or indirectly resulting from or
arising out of (i) Lender/Servicer's failure to observe or perform any or all of
Lender/Servicer's covenants, agreements, warranties or representations contained
in this Agreement, (ii) the performance, negligence, actions or failure to act
of any Servicer or subservicer of the Loans, other than Subservicer, (iii) any
inaccuracies in any information provided by Lender/Servicer and (iv) the untruth
or inaccuracy of any of the representations and warranties set for in paragraphs
6.4 and the following additional representations and warranties to the best of
Lender/Servicer's knowledge:
(a) Each Loan, the Note and Mortgage, any insurance policy,
certificate of coverage, or other contract or agreement
relating to each Loan is in every respect genuine; is complete
in all respects; is the legal, valid, binding and enforceable
obligation of the Borrower thereunder in accordance with its
terms and is free from all claims, defenses, rights of
rescission, any discount, allowance, set-off, counterclaim,
presently pending bankruptcy or other defenses or contingent
liability by any Borrower which could adversely affect the
value or collectibility of any Loan; none of the Notes or
Mortgages nor anything contained in the Loan Documents, is
forged or has affixed thereto any unauthorized signature or
has been entered into by any persons without the required
legal capacity; and no foreclosure or any other legal action
has been brought by any Servicer in connection therewith
except as identified on Schedule I.
(b) The applicable Loan Documents have been duly and properly
executed by the Borrower, acknowledged, and recorded. Each
Loan is valid and complies with all applicable lending laws
and regulations, including the Truth-In-Lending Act, Real
Estate Settlement and Procedures Act, Equal Credit Opportunity
Act, Fair Housing and Disclosure Act and Regulation Z (the
"Acts"). The Loan Documents have been duly executed on the
dates indicated and in due and proper form.
(c) In connection with the creation, acquisition, ownership,
servicing, execution and content of all Loans, all applicable
federal and state laws, rules and regulations have been, and
are being, complied with by each Servicer thereof. All
information requested to be disclosed to the Borrower by the
Acts has been properly and accurately disclosed to the
Borrower by each Servicer thereof, in full compliance and in
accordance with the Acts. The Borrower has duly executed
appropriate documents or evidence indicating that the Borrower
has received the disclosure materials as required by
applicable law and regulations, including the Acts and such
evidence is located among the Loan Documents.
(d) The servicing and collection procedures used by each Servicer
and subservicer (other than Subservicer) with respect to each
Loan have been in all respects legal, proper and prudent.
(e) All of the terms, conditions and provisions of the interest
rate adjustments, payment adjustments and adjustments of the
outstanding principal balance are enforceable and all
adjustments have been timely and properly made, including, but
not limited to all required notices, and any adjustments so
made will not affect the enforceability of each Note.
8.4 Survival.
The indemnifications, representations and warranties set forth herein
shall survive the termination of this Agreement.
ARTICLE IX
MISCELLANEOUS
9.1 Changes in Practices.
The parties hereto acknowledge that the standard practices and
procedures of the mortgage servicing industry change or may change over a period
of time. To accommodate these changes, Subservicer may from time to time notify
Lender/Servicer of such changes in practices and procedures. Should any such
proposed changes, made in good faith by Subservicer, be unacceptable to
Lender/Servicer, then Subservicer shall have no further obligation to continue
to accept subservicing under the terms of this Agreement, and may terminate this
Agreement in accordance with Article V.
9.2 Assignment.
This Agreement may be assigned only after obtaining prior written
consent of both Lender/Servicer and Subservicer.
9.3 Prior Agreements.
If any provision of this Agreement is inconsistent with any prior
Agreements between the parties, oral or written, the terms of this Agreement
shall prevail, and after the effective date of this Agreement, the relationship
and agreements between Lender/Servicer and Subservicer shall be governed in
accordance with the terms of this Agreement.
9.4 Entire Agreement.
This Agreement contains the entire agreement between the parties hereto
and cannot be modified in any respect except by an amendment in writing signed
by both parties.
9.5 Invalidity.
The invalidity of any portion of this Agreement shall in no way affect
the remaining portions hereof.
9.6 Effect.
Except as otherwise stated herein, this Agreement shall remain in
effect until Lender/Servicer's interest in all of the Loans including the
underlying security, are liquidated completely, unless sooner terminated
pursuant to the terms hereof.
9.7 Applicable Law.
This Agreement shall be governed by and construed in accordance with
the laws of the State of Virginia.
9.8 Notices.
All notices, requests, demands and other communications which are
required or permitted to be given under this Agreement shall be in writing and
shall be deemed to have been duly given upon the delivery or mailing thereof, as
the case may be, sent by registered or certified mail, return receipt requested
to the address set forth on the signature page hereof.
9.9 Waivers.
Either Lender/Servicer or Subservicer may, upon mutual written consent
of both parties, by written notice to the other:
(a) Waive compliance with any of the terms, conditions or
covenants required to be complied with by the other hereunder;
and
(b) Waive or modify performance of any of the obligations of the
other hereunder.
The waiver by either party hereto of a breach of any provision of this
Agreement shall not operate or be construed as a waiver of any other subsequent
breach.
9.10 Binding Effect.
This Agreement shall inure to the benefit of and be binding upon the
parties hereto and their successors and assigns.
9.11 Headings; Certain Terms.
Headings of the Articles and Sections in this Agreement are for
reference purposes only and shall not be deemed to have any substantive effect.
The term "include" or "including" shall mean without limitation by reason of
enumeration. References herein to "paragraphs," "sections" and other
subdivisions without a reference to document are to designated paragraphs,
sections and other subdivisions of this Agreement. The words "herein," "hereof,"
"hereunder" and other words of similar import refer to this Agreement as a whole
and not to any particular provision. All personal pronouns used in this
Agreement, whether used in the masculine, feminine or neuter gender, shall
include all genders, the singular shall include the plural and vice versa.
9.12 Due Date of Payments.
Unless otherwise stated herein, all fees, payments, charges, expenses,
advances and any other sums payable to Subservicer by Lender/Servicer hereunder,
shall be due and payable within five (5) business days from date of
subservicer's invoice and thereafter, all sums shall be subject to a finance
charge at a rate per annum equal to two percent (2%) over Prime.
9.13 Multiple Counterparts.
This Agreement may be executed in multiple counterparts, each of which
shall constitute an original, but all of which when taken together shall
constitute one and the same Agreement. Any signature page from one counterpart
may be appended to another counterpart to create a fully executed counterpart
hereof.
IN WITNESS WHEREOF, each party has caused this instrument to be signed
in its corporate name on its behalf by its proper officials duly authorized as
of the day, month and year first above written.
Subservicer:
Essex Home Mortgage Servicing Corporation
By: /s/ Stephen K. Sager
--------------------------------
Stephen K. Sager
Vice President
P.O. Box 8068
Virginia Beach, VA 23450
Lender/Servicer:
Continental Capital Corp.
By: /s/ Michael J. Wallace, Jr.
--------------------------------
Michael J. Wallace, Jr.
Chief Executive Officer
1841 New York Avenue
Huntington Station, NY 11746
<PAGE>
SCHEDULE INDEX
SCHEDULE I - List of Loans
SCHEDULE II - Subservicing Fee Schedule for Schedule I Loans
SCHEDULE III - Investor Accounting Reports
SCHEDULE IV - Default Reports
EXHIBIT 13
ESSEX
BANCORP, INC.
1998 ANNUAL REPORT
<PAGE>
ESSEX
BANCORP, INC.
Table of Contents
Page
----
Report to Our Stockholders 1
Five Year Financial Summary 4
Management's Discussion and Analysis 5
Report of Independent Accountants 24
Consolidated Financial Statements 25
Notes to Consolidated Financial Statements 33
Investor Information 54
Directors and Officers 55
Corporate Information 56
<PAGE>
Forward-Looking Statements
From time to time, the Company may publish forward-looking statements, such as
the ones included in this Annual Report, relating to such matters as anticipated
financial performance, business prospects, and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that a variety of factors could cause the Company's
actual results and experience to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
Some of the risks and uncertainties that may affect the operations, performance,
development and results of the Company's business include but are not limited to
the following:
a. Deterioration in local economic conditions;
b. Deterioration in national or global economic conditions;
c. Significant changes in laws and regulations affecting the financial
services industry; and
d. Significant changes in the markets in which our businesses compete.
<PAGE>
ESSEX BANCORP, INC. LOGO
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
I am pleased to report that Essex Bancorp, Inc. ("Essex") reported earnings of
$1.0 million in 1998. This is the first year, since the change in management in
1992, that Essex has achieved core profitability from operations and recognized
a portion of the tax benefits associated with historical losses because of
favorable expectations in the near term. While we are pleased with the progress,
we will not be satisfied until Essex is identified as a high performance
financial institution when compared with similar-type franchises and core
profitability exceeds the accrued dividends on our preferred stock.
During 1998, Essex experienced improved fundamentals in many areas. For example,
(i) total assets of $231 million at December 31, 1998 reflects an increase of
approximately 19% from 1997, (ii) non-performing assets declined by
approximately 44% to a ratio to total assets of .79% - the lowest in Essex's
history, (iii) our Suffolk, Virginia full-service branch, reported in last
year's message, accomplished growth in deposits of $11 million or 94%, and (iv)
Essex's regulatory relationship and overall risk profile, discussed frequently
in previous years, has strengthened and improved significantly from 1997. 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
Essex's performance during 1998.
1
<PAGE>
Management's ability to concentrate on developing business opportunities without
being distracted by past problems is contributing to the overall franchise value
and a more productive company. Essex Savings Bank grew its deposit base $34
million, representing 22% growth, from its four existing branches. Both our
mortgage division and loan servicing operations also had excellent years. Essex
First Mortgage originated residential mortgage loans totaling $78.1 million and
construction permanent loan commitments of $27.7 million and funded $19.6
million for builder construction loans. Essex Home Mortgage Servicing
Corporation increased its third-party loan servicing portfolio from 5,480 loans
with principal balances of $354 million at the end of 1997 to 12,155 loans with
principal balances of $1.1 billion. The 122% increase in total loans serviced
for nonaffiliates is especially notable in view of the loss in 1997 of Essex's
largest contract, representing 7,400 loans.
1999 will be a challenging year for Essex's management. Our business plan calls
for continued emphasis on each of our three principal lines of business: retail
community banking, mortgage banking, and loan servicing. However, within each of
those areas we are developing strategies to enhance existing revenues and at the
same time pursue new sources of revenues. While the business plan provides for a
sluggish first quarter in 1999, it is anticipated that projected loan growth in
higher- yielding loan products, such as construction loans, will ultimately
enhance Essex's core profitability in 1999. Management is focused on the future
and the opportunities that a rapidly changing marketplace creates. In this
regard, Essex is well positioned in growth markets and should benefit from
further consolidations in the financial services industry and the increasing
disenchantment of consumers with large banking institutions. We have worked hard
to transition to community banking over the past several years and our
deliberateness in targeting our markets is reflected in our growing customer
bases. Soon we will break ground on another new full-service branch in Ashland,
Virginia. We are excited about opportunities in this market because we have
already established a presence through our retail deposit products and our
builder construction loan relationships in our Richmond, Virginia branch.
Looking back, 1998 was clearly a year of performance and accomplishments.
Successes don't just happen; they are the result of planning and the hard work
of Essex's directors, officers and
2
<PAGE>
employees. We appreciate their dedication and the support of our customers and
shareholders.
/s/ Gene D. Ross
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 31, 1999
3
<PAGE>
<TABLE>
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
<CAPTION>
At or For the Year Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets......................... $231,040 $195,088 $174,267 $338,724 $296,231
Net loans ........................... 192,668 167,441 145,551 266,632 237,392
Deposits ........................... 187,632 153,927 131,033 283,497 222,462
Federal Home Loan Bank advances...... 24,908 23,547 25,690 29,833 58,952
Notes payable........................ - 72 96 120 2,691
Shareholders' equity and total
partners' capital.................. 15,835 14,817 15,106 22,630 8,140
Nonperforming assets................. 1,835 3,298 5,215 11,257 13,652
Allowance for loan losses............ 1,845 2,382 2,556 5,251 3,429
OPERATIONS DATA:
Interest income...................... $ 15,430 $ 14,547 $ 19,872 $ 22,547 $ 22,966
Interest expense..................... 9,778 9,230 13,764 16,627 15,956
Net interest income.................. 5,652 5,317 6,108 5,920 7,010
Provision for loan losses............ 13 113 1,411 2,477 1,604
Noninterest income................... 2,713 2,463 4,282 3,172 4,068
Noninterest expense:
Amortization....................... 503 531 7,011 956 1,360
Other.............................. 7,354 7,433 9,345 9,814 15,619
Income (loss) before cumulative
effect of change in accounting
principle, extraordinary items,
and income taxes................... 495 (297) (7,377) (4,155) (7,505)
Cumulative effect of change in
accounting principle............... - - - - 179
Extraordinary items, net of tax...... - - - 2,945 (1) 20,416 (2)
Provision for (benefit from) income
taxes.............................. (518) - - - -
Net income (loss).................... 1,013 (297) (7,377) (1,210) 13,090
Net income (loss) available to
common stockholders................ (777) (1,932) (8,824) (1,578) 13,090
Basic and diluted net loss per
common share....................... (.73) (1.83) (8.39) (1.50) -
Pro forma basic and diluted net
income (loss) per common
share.............................. - - - - 12.47
OTHER DATA:
Return on average assets............. .49% (.16)% (2.73)% (.39)% (1) 3.88% (2)
Return on average capital............ 6.71% (1.96)% (39.51)% (10.59)% (3)
Average capital to average assets.... 7.28% 8.13% 6.92% 3.67% (4)
Net interest spread.................. 2.54% 2.69% 2.20% 2.00% 2.46%
Net interest margin.................. 2.93% 3.01% 2.41% 2.01% 2.20%
Nonperforming assets as a percent
of total assets at end of year..... .79% 1.69% 2.99% 3.32% 4.61%
Allowance for loan losses as a
percent of total loans at end
of year ........................... .95% 1.40% 1.73% 1.93% 1.42%
Net charge-offs as a percent of
average total loans................ .32% .18% 1.89% .46% .55%
Retail banking offices............... 4 4 4 12 8
</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) Ratio exceeds (100.00)%. (4) Ratio is less than 0.00%.
4
<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 (i) four
retail banking branches in North Carolina and Virginia and (ii) Essex First, a
division that engages principally in the origination and sale of residential
mortgage loans. The Company's other principal operating subsidiary is Essex Home
Mortgage Servicing Corporation ("Essex Home"), a majority-owned subsidiary of
the Bank that is engaged primarily in the servicing of mortgage loans owned by
the Bank, governmental agencies, and third party investors. Essex Mortgage
Corporation ("EMC") is also a subsidiary of the Company that was formerly
engaged in mortgage banking activities and, at December 31, 1998, 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, the Company sold nine of the
Bank's 13 branches. 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 positioned itself to maintain 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 post-1996 operating expenses were reduced due to the elimination of
the amortization of goodwill and the operating expenses associated with the
Branches.
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, 1998 were $231.0
million as compared to $195.1 million at December 31, 1997, an increase of
approximately $35.9 million or 18.4%. The increase in assets was primarily
attributable to (i) a $6.9 million increase in cash and cash equivalents
resulting primarily from an increase in escrow deposits maintained by Essex Home
at the Bank, (ii) a $25.2 million increase in loans held for investment, which
reflected the Company's strategy of investing funds provided by the growth in
deposits into higher yielding loans, (iii) a $2.3 million increase in loans held
for sale, which reflected the impact of the lower interest rate environment on
5
<PAGE>
the production of residential loans held for sale in the secondary market and
(iv) a $1.3 million increase in premises and equipment resulting from the Bank's
completion of a newly-constructed branch in Suffolk, Virginia for the relocation
of an existing branch, the acquisition of the Bank's previously-leased branch in
Richmond, Virginia and the acquisition of land for the Bank's expansion into
Ashland, Virginia, as well as the Company's investment in technology
enhancements such as the implementation of a wide area network.
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 $6.9 million or
62.7% during 1998 due to the excess liquidity maintained at December 31, 1998
resulting from an increase in noninterest-bearing escrow deposits maintained by
Essex Home at the Bank.
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 agency obligations, Federal Home
Loan Bank ("FHLB") stock, and mutual fund investments. During the year ended
December 31, 1998, investment securities increased $570,000 or 15.2%. The
increase during 1998 was attributable to (i) the purchase of $118,000 of FHLB
stock in order to satisfy the minimum investment requirements for FHLB
membership, which increased because of the Bank's loan growth in 1998 and (ii)
the utilization of funds from the maturity of a $300,000 callable U.S.
government agency security in 1998 for the acquisition of a $750,000 U.S.
government agency security, which has been pledged to secure public deposits at
December 31, 1998.
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 1998.
Loans. Net loans (including loans classified as held for sale)
increased by $27.5 million or 16.2% during 1998 resulting from secondary market
purchases of adjustable-rate first mortgage loan portfolios totaling $32.3
million and fixed-rate home improvement loans totaling $3.2 million, which were
partially offset by a decline in the Company's fixed-rate first and second
mortgage loans. The Company relied on acquisitions of adjustable-rate portfolios
during 1998 because customer demand during the period of low interest rates has
emphasized fixed rate loans, which the Company sells in the secondary market.
6
<PAGE>
Nonperforming Assets. The Company's nonperforming assets, net of
specific reserves for collateral-dependent real estate loans ("CDRELs") and
foreclosed properties, decreased from $3.3 million at December 31, 1997 to $1.8
million at December 31, 1998, and consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
<S> <C> <C> <C> <C>
Nonaccrual loans, net:
First and second mortgages................ $ 697 .36% $1,203 .71%
Construction and development.............. - - 133 .08
Commercial................................ 328 .17 132 .08
Consumer.................................. 141 .07 88 .05
Accruing loans 90 days or more past due..... - - 21 .01
Troubled debt restructurings................ 98 .05 209 .12
------- --- ------ ----
Total nonperforming loans............... 1,264 .65 1,786 1.05
Foreclosed properties, net.................. 571 .29 1,512 .89
------- --- ------ ----
Total nonperforming assets.............. $1,835 .94% $3,298 1.94%
===== === ===== ====
Nonperforming assets to total assets........ .79% 1.69%
Nonperforming loans to total loans.......... .65 1.05
Allowance for loan losses to
total loans............................... .95 1.40
Allowance for loan losses to
nonaccrual loans.......................... 158.23 153.09
Allowance for loan losses to
nonperforming loans....................... 145.97 133.37
</TABLE>
The decrease in nonperforming assets consisted of a $522,000 decline in
nonperforming loans and a $941,000 decline in foreclosed properties. The
decrease in nonaccrual loans was attributable to the improvement in asset
quality evidenced by the decline in delinquencies from $940,000 at December 31,
1997 to $708,000 at December 31, 1998. Gross interest income that would have
been recognized for the years ended December 31, 1998, 1997 and 1996 if
nonaccrual loans at the respective dates had been performing in accordance with
their original terms approximated $115,000, $171,000 and $291,000, 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 continuing decline in nonperforming and delinquent loans during 1998 and the
sale of 12 of the 13 properties held at December 31, 1997. The $571,000 of
foreclosed properties included in nonperforming assets at December 31, 1998 is
reported net of related reserves totaling $114,000. In addition, approximately
$246,000 of losses and write-downs have been previously recognized on foreclosed
properties held at December 31, 1998.
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):
1998 1997
---- ----
Residential real estate development
projects $ - $ 485
Single-family residential real estate 486 770
Land and subdivisions 85 257
------ ------
$571 $1,512
=== =====
7
<PAGE>
In addition to the $1.8 million of nonperforming assets at December 31,
1998, the Company had classified for regulatory purposes an additional $1.6
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
$3.3 million of nonperforming assets and $1.8 million of classified assets at
December 31, 1997. 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. However, during the third quarter of 1998, the Office of Thrift
Supervision ("OTS") completed its safety and soundness examination of the
Company and the Bank and did not require any changes to the classification of
assets.
Mortgage Servicing Rights and Loan Premiums. As of December 31, 1998
and 1997, the Company reported $831,000 and $1.2 million, respectively, of
purchased and originated mortgage servicing rights (collectively, "MSRs") and
$951,000 and $668,000, respectively, of capitalized loan premiums. The increase
in loan premiums was attributable to secondary market purchases of loan
portfolios during 1998. The decrease in MSRs was attributable to amortization
during 1998, which included a $54,000 increase in the valuation allowance in
order to reduce the carrying value of MSRs to the estimated fair value at
December 31, 1998. 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, 1998, 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
current expectations.
Deposits. Deposits, the primary source of the Company's funds,
increased by $33.7 million or 21.9% during the year ended December 31, 1998. The
increase in deposits was attributable to (i) an $11.7 million increase in
noninterest-bearing accounts largely because of the increase in Essex Home's
servicing escrow accounts maintained at the Bank and (ii) an $18.5 million
increase in certificates of deposit predominantly at the Suffolk and Richmond,
Virginia branches, which experienced deposit growth of 91.5% and 25.5%,
respectively.
Borrowings. The Company's borrowings consist primarily of advances from
the FHLB. FHLB advances increased by $1.4 million or 5.8% during the year ended
December 31, 1998. At December 31, 1998, the unused lendable collateral value
for additional FHLB advances was $31.6 million.
Shareholders' Equity. Total shareholders' equity at December 31, 1998
was $15.8 million, an increase of $1.0 million from shareholders' equity of
$14.8 million at December 31, 1997. This change reflects the Company's net
income of $1.0 million for the year ended December 31, 1998, which is further
described under Results of Operations.
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 $5.2 million at December 31, 1998. Because the Company's
income is not yet sufficient to cover the cumulative dividends on the Series B
and C preferred stock, the equity of the holders of the Company's common and
preferred stock will continue to be affected. Accordingly, the Company's Board
of Directors and the Committee continue to evaluate profitability enhancements
and possibilities for corporate restructurings.
On May 28, 1998, the Company's shareholders approved an amendment of
the Company's Certificate of Incorporation whereby the total authorized
8
<PAGE>
capitalization increased to 30 million shares, consisting of 20 million shares
of common stock and 10 million shares of preferred stock. The increase in
authorized capitalization increases the Company's flexibility to issue
additional shares of common stock and preferred stock to enable the Company to
engage in strategic transactions, such as possible mergers or share exchanges
with other entities. However, the Company has no present plans to issue shares
in connection with any particular transaction.
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 (including the amortization of purchased loan premiums) on
interest-earning assets, primarily loans, and interest expense on
interest-bearing liabilities, primarily deposits and FHLB advances. 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 and the level of its
noninterest expenses, such as salaries and employee benefits, net occupancy and
equipment costs, amortization of MSRs, deposit insurance premiums and expenses
associated with the administration of nonperforming and other classified assets.
The Company's major business activities 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, (ii) the origination by Essex First of real estate
mortgage loans for sale to third parties predominantly on a servicing-released
basis in order to generate higher income and (iii) the servicing of mortgage
loans by Essex Home in order to generate fee income. As of December 31, 1998,
Essex Home serviced approximately 12,200 loans totaling $1.1 billion for
nonaffiliated servicing clients. For additional segment information, refer to
Note 23 of the Notes to Consolidated Financial Statements.
General. The Company's net income for the year ended December 31, 1998
totaled $1.0 million, compared to a net loss of $297,000 for the year ended
December 31, 1997 and a net loss of $7.4 million for the year ended December 31,
1996.
The Company's net income for the year ended December 31, 1998 included
a $550,000 tax benefit resulting from the recognition of a deferred tax asset
for a portion of the Company's net operating tax loss ("NOL") carryforwards. The
recognition of this NOL benefit was made possible by the Company's return to and
projected maintenance of core profitability. Excluding this NOL benefit
recognized in 1998 and excluding nonrecurring items in 1997 for the aggregate
gain of $97,000 on the sale of vacant branch facilities, termination fees
approximating $113,000 received by Essex Home in connection with the
cancellation of a subservicing client's contract and a $498,000 charge for stock
option compensation, the Company's net income effectively improved $472,000 in
1998. This improvement occurred as a result of (i) an increase in net interest
income resulting from an increase in interest-earning assets, the benefit of
which was partially offset by a decline in the net interest margin, (ii) a
decline in the provision for loan losses resulting from a reduction in
nonperforming assets during 1998, (iii) an increase in mortgage banking income
resulting from an increase in residential loan originations coupled with sales
in the secondary market and (iv) an increase in other noninterest income
resulting from service charges and fees on the higher servicing volume at Essex
Home and higher deposit levels at the Bank. These increases were partially
offset by (i) a decrease in loan servicing fees resulting from a lower average
servicing portfolio in the first half of 1998, (ii) an increase in noninterest
expenses associated with the increase in the Company's loan origination and
servicing volumes and deposit levels and (iii) state income tax expense.
9
<PAGE>
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.
Refer to Note 5 of the Notes to Consolidated Financial Statements for a detailed
description of the sale of the Branches.
Net Interest Income. Net interest income totaled $5.7 million, $5.3
million and $6.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively. In addition, the net interest margin was 2.93%, 3.01% and 2.41%
for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in net interest income from 1997 to 1998 reflected the
favorable impact of the increase in the ratio of average interest-earning assets
to average interest-bearing liabilities coupled with a decline in the Company's
cost of funds resulting from the lower interest rate environment during 1998.
However, there was an eight basis point decline in the net interest margin
resulting from the impact of the lower interest rate environment in 1998 on the
volume of refinancings to lower fixed rate loans, rate decreases on
adjustable-rate mortgages and secondary market purchases at lower market yields.
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. 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, balloon payment and adjustable-rate loans
with longer initial adjustment terms predominate.
The decrease in net interest income from 1996 to 1997 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
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 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.
10
<PAGE>
<TABLE>
<CAPTION>
1998 1997
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)...................... $178,078 $14,608 8.20% $159,370 $13,588 8.53%
Investment securities.......... 3,902 226 5.79 6,457 354 5.48
Mortgage-backed securities (2). 1,871 122 6.50 1,905 124 6.54
Federal funds sold and securities
purchased under agreements
to resell.................... 2,069 111 5.37 2,757 151 5.48
Other.......................... 6,835 363 5.29 6,024 330 5.48
-------- -------- -------- --------
Total interest-earning assets 192,755 15,430 8.00 176,513 14,547 8.24
Cash.............................. 4,615 2,065
Other, less allowance for loan losses 9,866 7,831
-------- --------
Total assets................... $207,236 $186,409
======= =======
Interest-bearing liabilities:
Time deposits.................. $121,752 6,904 5.67% $111,394 6,381 5.73%
Other deposits................. 35,431 1,587 4.48 29,584 1,298 4.39
-------- ------- -------- -------
Total deposits.............. 157,183 8,491 5.40 140,978 7,679 5.45
Notes payable.................. 8 1 9.32 96 9 9.50
FHLB advances.................. 21,553 1,230 5.71 24,885 1,474 5.92
Subordinated capital notes..... - - - - - -
Other.......................... 303 56 18.30 360 68 18.29
--------- --------- --------- -------- --
Total interest-bearing
liabilities.............. 179,047 9,778 5.46 166,319 9,230 5.55
------ -------
Demand deposits................... 9,504 3,143
Other............................. 3,589 1,795
--------- --------- -
Total liabilities.............. 192,140 171,257
Shareholders' equity.............. 15,096 15,152
-------- --------
Total liabilities and
shareholders' equity........ $207,236 $186,409
======= =======
Net interest earnings............. $ 5,652 $ 5,317
====== =======
Net interest spread............... 2.54% 2.69%
==== ====
Net interest margin (3)........... 2.93% 3.01%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities.................... 107.66% 106.13%
====== ======
<CAPTION>
1996
-------------------------------
Average Yield/
Balance Interest Rate
------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $221,215 $17,882 8.08%
Investment securities.......... 11,012 615 5.59
Mortgage-backed securities (2). 6,320 498 7.95
Federal funds sold and securities
purchased under agreements
to resell.................... 6,094 319 5.24
Other.......................... 10,094 558 5.38
-------- --------
Total interest-earning assets 254,735 19,872 7.80
Cash.............................. 3,083
Other, less allowance for loan losses 11,944
--------
Total assets................... $269,762
=======
Interest-bearing liabilities:
Time deposits.................. $183,710 10,620 5.78%
Other deposits................. 33,218 1,325 3.99
-------- -------
Total deposits.............. 216,928 11,945 5.51
Notes payable.................. 113 11 9.50
FHLB advances.................. 27,137 1,626 5.99
Subordinated capital notes..... 399 52 13.15
Other.......................... 405 130 18.32
--------- --------
Total interest-bearing
liabilities.............. 244,982 13,764 5.60
------
Demand deposits................... 1,433
Other............................. 4,675
---------
Total liabilities.............. 251,090
Shareholders' equity.............. 18,672
--------
Total liabilities and
shareholders' equity........ $269,762
=======
Net interest earnings............. $ 6,108
=======
Net interest spread............... 2.20%
====
Net interest margin (3)........... 2.41%
====
Average interest-earning assets
to average interest-bearing
liabilities.................... 103.98%
======
</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) 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>
Increase (Decrease) From Increase (Decrease) From
1997 to 1998 Due to 1996 to 1997 Due to
------------------- -------------------
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans (1) $(529) $1,549 1,020 $934 $(5,228) $(4,294)
Investment securities 19 (147) (128) (11) (250) (261)
Mortgage-backed securities - (2) (2) (77) (297) (374)
Federal funds sold and securities
purchased under agreements
to resell (3) (37) (40) 14 (182) (168)
Other interest-earning assets (11) 44 33 9 (237) (228)
----- ------- ------- ----- ------- -------
Total interest income (2) (524) 1,407 883 869 (6,194) (5,325)
---- ----- ------ --- ------ ------
Interest expense on:
Time deposits (65) 588 523 (96) (4,143) (4,239)
Other deposits 27 262 289 126 (153) (27)
Notes payable - (8) (8) - (2) (2)
FHLB advances (53) (191) (244) (18) (134) (152)
Subordinated capital notes - - - (26) (26) (52)
Other interest-bearing
liabilities - (12) (12) - (62) (62)
------- ------- ------- ------- -------- --------
Total interest expense (91) 639 548 (14) (4,520) (4,534)
----- ------ ------ ----- ------ ------
Net interest income $(433) $ 768 $ 335 $883 $(1,674) $ (791)
==== ====== ====== === ====== =======
</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, 1998, 1997 and 1996, provisions for
loan losses amounted to $13,000, $113,000 and $1.4 million, respectively. At
December 31, 1998, total nonperforming assets as a percentage of total assets
were .79% as compared to 1.69% at December 31, 1997. In addition, nonperforming
assets totaled $1.8 million at December 31, 1998 as compared to $3.3 million at
December 31, 1997. These measures reflect the highest level of credit quality in
the Company's history as a public company. Based on the favorable trends in
12
<PAGE>
nonperforming assets and the coverage of the general loan loss reserves,
management considered the loan loss allowance sufficient to absorb losses and
provided for minimal additional losses during the year ended December 31, 1998.
The lower provision for loan losses during 1997 as compared to 1996 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.
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 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.
However, upon the completion of its safety and soundness examination during the
third quarter of 1998, the OTS did not require any adjustments to loss
allowances.
Noninterest Income. The following table sets forth information
regarding noninterest income for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Loan servicing fees......................... $1,222,478 $1,312,476 $ 1,665,768
Mortgage banking income..................... 755,450 458,520 577,130
Other service charges and fees.............. 466,135 368,671 497,316
Net gain (loss) on sales of:
Securities............................. - - 153,188
Loans.................................. - (1,458) (1,018,185)
Deposits............................... - - 1,940,010
Other....................................... 268,890 324,596 466,519
---------- ---------- -----------
$2,712,953 $2,462,805 $ 4,281,746
========= ========= ==========
</TABLE>
Total noninterest income amounted to $2.7 million during the year ended
December 31, 1998, a $250,000 or 10.2% increase from the $2.5 million recognized
during the year ended December 31, 1997. However, 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. Excluding
the impact of these nonrecurring transactions in 1997, noninterest income
effectively increased $460,000 or 20.4% during 1998 as a result of a $297,000
increase in mortgage banking income, a $97,000 increase in other service charges
and fees and a $154,000 increase in other noninterest income. The increase in
mortgage banking income resulted from the impact of the lower interest rate
environment in 1998 on Essex First's production of residential loans sold in the
secondary market. The increase in other service charges and fees occurred
primarily at the Bank in service charges on deposit accounts, which reflected
the impact of a 19.1% growth in the number of deposit accounts. The increase in
other noninterest income resulted from higher insurance commissions and
administrative fees at Essex Home, which has more than doubled its mortgage loan
subservicing portfolio during 1998.
The increases in noninterest income for the year ended December 31,
1998 were partially offset by lower loan servicing fees during the first half of
1998 resulting from the nonrenewal of a significant subservicing contract in
1997. However, new contracts negotiated in 1998 provide for servicing a
substantial number of loans, which have begun to generate servicing and
ancillary fee income in 1998 to significantly mitigate the impact of the lost
servicing volume in 1997.
13
<PAGE>
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. As previously described,
noninterest income during 1997 included $210,000 of nonrecurring income.
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.
Noninterest Expense. The following table sets forth information
regarding noninterest expense for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Salaries and employee benefits.............. $3,476,785 $3,788,695 $ 4,554,540
Net occupancy and equipment................. 954,804 1,084,593 1,470,284
Deposit insurance premiums.................. 497,081 478,684 674,730
Amortization of intangible assets........... 503,148 530,707 7,011,288
Service bureau fees......................... 513,826 461,217 599,207
Professional fees........................... 296,295 349,218 507,031
Foreclosed properties, net.................. 150,461 182,880 (175,055)
Other....................................... 1,464,473 1,087,362 1,713,958
--------- --------- -----------
$7,856,873 $7,963,356 $16,355,983
========= ========= ==========
</TABLE>
Total noninterest expense declined $1065,000 or 1.3% from $7.96 million
during the year ended December 31, 1997 to $7.86 million during the year ended
December 31, 1998. Noninterest expense as a percent of average assets was 3.8%
for 1998 as compared to 4.3% for 1997. The improvement in this ratio reflects
the impact of asset growth coupled with cost containment.
Salaries and employee benefits declined $312,000 or 8.2% during 1998.
This decrease resulted primarily from nonrecurring personnel expenses during
1997 for (i) a $136,500 severance settlement with the former president of an
acquired savings institution and its holding company and (ii) $498,000 of stock
option compensation. Excluding these nonrecurring transactions, salaries and
benefits increased $323,000 during 1998. This increase was attributable to an
increase in total full-time and part-time employees from 99 as of December 31,
1997 to 119 as of December 31, 1998. The growth in personnel positions occurred
as loan origination and servicing volumes increased.
Net occupancy and equipment expense declined $130,000 or 12.0% during
1998. This decrease reflected the impact of the Bank (i) opening a Bank-owned
retail bank branch in Suffolk, Virginia, which had previously been located in a
leased facility and (ii) exercising a purchase option for the Richmond, Virginia
retail bank branch, which had previously been a leased facility. Occupancy and
equipment expense also benefited from lower depreciation expense in 1998.
However, depreciation in future periods will reflect the impact of the Company's
investment in technology enhancements such as the implementation of a wide area
network.
Deposit insurance premiums increased $18,000 or 3.8% during 1998. This
increase reflects an increase in the deposit assessment base resulting from
14
<PAGE>
deposit growth. Refer to "Regulatory Capital" below for a discussion of matters
impacting the Company's deposit assessment in the future. Likewise, service
bureau fees increased $53,000 or 11.4% during 1998. This increase was primarily
attributable to the increases in (i) loan servicing volume from 8,400 loans at
December 31, 1997 to 15,100 loans at December 31, 1998 and (ii) the number of
deposit accounts, which increased 19.1% during 1998.
Amortization of intangible assets declined $28,000 or 5.2% during 1998.
Notwithstanding this decrease, amortization during 1998 included a $54,000
increase in the MSR valuation allowance in order to reduce the carrying value of
the Company's MSRs to the estimated fair value at December 31, 1998. No
assurance can be made that further adjustments to the MSR valuation allowance
will not be required in future periods if the lower interest rate environment
results in the acceleration of prepayment activity in excess of current
expectations.
Professional fees declined $53,000 or 15.2% during 1998. This decrease
was attributable to nonrecurring legal fees incurred in 1997 in connection with
a severance settlement with the former president of an acquired savings
institution and its holding company.
Foreclosed properties expense declined $32,000 or 17.7% during 1998,
which was attributable to the decline in foreclosed properties from $1.5 million
at December 31, 1997 to $571,000 at December 31, 1998.
The significant components of the increase in other miscellaneous
noninterest expense for the years ended December 31, 1998 and 1997 are presented
below and reflect the impact of the increase in the Company's loan origination
and servicing volumes and deposit levels on general operating expenses:
<TABLE>
<CAPTION>
Change
1998 1997 Amount Percent
---- ---- ------ -------
<S> <C> <C> <C> <C>
Loan expense....................... $ 211,092 $ 150,457 $ 60,635 40.3
Telephone.......................... 249,770 175,474 74,296 42.3
Postage and courier................ 185,819 153,349 32,470 21.2
Stationery and supplies............ 115,111 99,545 15,566 15.6
Advertising and marketing.......... 198,399 155,654 42,745 27.5
Corporate insurance................ 100,630 116,882 (16,252) (13.9)
Officers life insurance............ 30,692 (41,082) 71,774 100.0+
Travel............................. 62,060 47,453 14,607 30.8
Year 2000 readiness................ 48,270 510 47,760 93.7
Other.............................. 262,630 229,120 33,510 14.6
---------- ---------- --------
$1,464,473 $1,087,362 $377,111 34.7
========= ========= =======
</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. In addition to the $7.6 million impact of the sale of the
Branches on the decline in noninterest expense during 1997, there were further
decreases in (i) salaries and employee benefits resulting from the impact of the
Company's downsizing efforts, (ii) net occupancy and equipment expense resulting
from the relocation of the Company's headquarters to a smaller more economical
facility and (iii) deposit insurance premiums resulting from the improvement in
the Bank's risk classification for insurance assessment purposes. The only
category of noninterest expense to increase during 1997 was foreclosed
properties expense, 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.
15
<PAGE>
The significant components of the decrease in other miscellaneous
noninterest expense for the years ended December 31, 1997 and 1996 are presented
below and reflect the impact of the sale of the Branches during 1996 on general
operating expenses in 1997:
<TABLE>
<CAPTION>
Change
1997 1996 Amount Percent
---- ---- ------ -------
<S> <C> <C> <C> <C>
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>
Provision For Income Taxes. As a result of historical losses prior to
1998, the Company accumulated net deferred tax assets of $7.7 million as of
December 31, 1997, the largest component of which was the deferred tax benefit
of net operating loss carryforwards. The Company had established a valuation
allowance for the net deferred tax assets in their entirety because the ultimate
realization of the tax benefit within the carryforward periods available under
the tax law could not be assured. This resulted in the recognition of no income
tax provision or benefit during the years ended December 31, 1997 and 1996. In
December 1998, however, the Company partially reduced the deferred tax valuation
allowance, thus recognizing a deferred tax asset of $550,000. This reduction was
predicated upon the Company's favorable trends in actual and projected core
profitability. Continuation of these favorable trends in core profitability
would support further reductions in the deferred tax valuation allowance in
future periods. However, there can be no assurance that these trends will
continue or that the net deferred tax assets will be realized. For additional
information, refer to 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, such as 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 an Asset and Liability Management Committee ("ALCO") 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
16
<PAGE>
of changes in interest rates. The ALCO implements and maintains 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 may
undertake 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 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, 1998. 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, 1998 and is not
necessarily indicative of the Bank's interest rate sensitivity at any other
time.
[intentionally blank]
17
<PAGE>
<TABLE>
<CAPTION>
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)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable and
mortgage-backed securities:
First mortgage:
Adjustable-rate $27,662 $45,104 $ 7,148 $ 13,445 $ - $ 93,359 43.7%
Fixed-rate 6,544 5,944 19,015 14,438 35,873 81,814 38.3
Second mortgage 3,462 511 1,562 992 809 7,336 3.4
All other 5,792 855 3,860 3,254 422 14,183 6.7
Investments 16,116 - - 750 - 16,866 7.9
------ ------ ------- ------- ------- -------- ------
Total 59,576 52,414 31,585 32,879 37,104 $213,558 100.0%
======= =====
Interest-bearing liabilities:
Deposits 58,429 65,731 37,407 13,500 9,262 $184,329 88.0%
Fixed-rate borrowings 9,530 5,300 7,850 - - 22,680 10.8
Variable-rate borrowings 2,500 - - - - 2,500 1.2
------ ------ ------- ------- ------- -------- ------
Total 70,459 71,031 45,257 13,500 9,262 $209,509 100.0%
======= =====
Effect of off-balance sheet
items (1) (11,579) 664 3,244 1,497 6,176
------ ------ ------- ------- -------
Maturity gap $(22,462) $(17,953) $(10,428) $ 20,876 $34,018
======= ======= ======= ====== ======
Cumulative gap $(22,462) $(40,415) $(50,843) $(29,967) $ 4,051
======= ======= ======= ======= =======
Cumulative gap as a percent
of total assets (9.9)% (17.9)% (22.5)% (13.3)% 1.8%
==== ===== ===== ===== ===
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 84.6% 79.2% 76.9% 88.1% 101.9%
==== ==== ==== ==== =====
(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 17.9% at December 31, 1998, 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 FHLB advances. The Company will
benefit from the lower cost of funds as these FHLB advances mature and will
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 loans, customer demand for such loans has
decreased as borrowers' demand for fixed-rate loans has increased. Within the
spectrum of loan products offered by the Bank, balloon payment and
adjustable-rate loans with longer initial adjustment terms predominate.
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 tables
present the Bank's NPV at December 31, 1998 and 1997.
18
<PAGE>
As of December 31, 1998
<CAPTION>
Net Portfolio Value NPV as % of PV of Assets
Change in ------------------------------------------- ------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
-------------- -------- -------- -------- --------- ------
+400bp $ 9,282 $(9,444) (50.43)% 4.20% (378)bp
+300bp 12,577 (6,149) (32.84) 5.59 (239)bp
+200bp 15,392 (3,334) (17.80) 6.72 (126)bp
+100bp 17,510 (1,216) (6.49) 7.54 (44)bp
Base Scenario 18,726 7.98
-100bp 19,198 472 2.52 8.12 14bp
-200bp 19,645 919 4.91 8.25 27bp
-300bp 20,570 1,844 9.85 8.55 57bp
-400bp 21,268 2,542 13.58 8.76 78bp
As of December 31, 1997
<CAPTION>
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 ALCO has established limits for the impact of changes in interest
rates on NPV. As of December 31, 1998, 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, 1998, the
Bank's sensitivity of NPV was within internal policy limits, which reflects an
improvement over December 31, 1997 when the Bank was outside its 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 changes 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 not 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, 1998, had a liquidity ratio of 12.74%.
19
<PAGE>
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. If the Bank requires funds which cannot be
generated internally, borrowings from the FHLB may provide an additional source
of funds. At December 31, 1998, the Bank had $24.9 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, 1998, the Bank had
outstanding commitments (including unused lines of credit) to originate and/or
purchase mortgage and non-mortgage loans of $4.7 million. The undisbursed
portions of construction builder loans and construction/permanent loans in
process totaled $6.2 million and $10.1 million, respectively, as of December 31,
1998. Certificates of deposit which are scheduled to mature within one year
totaled $94.1 million at December 31, 1998, and borrowings from the FHLB that
are scheduled to mature within the same period amounted to $17.3 million.
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 or leverage 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, 1998,
the Bank's tangible and core capital amounted to 6.97% of adjusted total assets
and the Bank's total capital amounted to 13.09% 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 or leverage
capital, Tier I risk-based capital, and total risk-based capital. At December
31, 1998, the Bank's Tier I, Tier I risk-based, and total risk-based capital
ratios were 6.97%, 12.12%, and 13.09%, 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, Tier I risk-based, and risk-based
regulatory capital under FDICIA totaled $4.5 million, $8.1 million, and $4.1
million, respectively, at December 31, 1998.
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
20
<PAGE>
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
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, 1998, 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). In addition, 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 6.1 basis points is added to the regular
SAIF-assessment until December 31, 1999 in order to cover FICO debt service
payments.
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. The merger of the
SAIF and BIF did not occur on such date as there continue to be savings
associations. Such a merger of the SAIF and the BIF may occur in the future if
legislation containing such a provision is enacted. 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.
Year 2000 Readiness
As previously reported, the Company has established a company-wide task
force to assess and remediate business risks associated with the Year 2000. This
task force has developed and implemented a seven-phase Year 2000 plan consisting
of the following components:
o Awareness - communication of the Year 2000 issue throughout the Company,
including the Company's board of directors and senior management;
o Assessment - development of inventories and analysis and evaluation of
hardware, software, services, forms, agencies and business partnerships and
the assignment of rankings of business risk (the highest being
"mission-critical") associated with each;
o Planning - development of comprehensive strategies and timelines for
correcting non-compliant items, testing and documenting results,
implementing and migrating enhancements and monitoring implementation
results;
o Renovation - implementation of the required software and hardware changes,
systems and interface modifications and conversions to replacement systems;
21
<PAGE>
o Validation - completion of formal unit, system and integration testing and
documentation of results;
o Implementation - integration of all corrected and validated items into the
production environment;
o Post-Implementation - monitoring implementation results and responding to
situations that invalidate corrections as implemented.
The Company has completed the awareness, assessment and planning phases
of its Year 2000 plan and is now proceeding with the renovation phase.
Substantially all reprogramming and replacement efforts were complete by
December 31, 1998. Because the Company outsources substantially all of its data
processing for loans, deposits and loan servicing, a significant component of
the Year 2000 plan entails working with external vendors to test and certify
their systems as Year 2000 compliant. The Company plans to complete its
validation of mission-critical internal and external systems and operations by
March 31, 1999. Concurrently with the readiness measures described above, the
Company is developing contingency plans intended to mitigate the possible
disruption in business operations that may result from the Year 2000 issue.
The total cost of the Year 2000 project (including the capitalized cost
of new hardware and software approximating $280,000) is estimated to be $350,000
and is being funded through operating cash flows. This estimate does not include
any costs associated with the implementation of contingency plans, which are in
the process of being developed. Most of the capitalized costs are associated
with technology changes that will enhance the Company's ability to provide
competitive services. During the year ended December 31, 1998, the Company
recognized $48,000 of expense associated with this project. This amount does not
include the implicit costs associated with the reallocation of internal staff
hours to the Year 2000 project. Management believes the Company can incur Year
2000 project 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. Furthermore, the Year 2000 compliance
status of integral third party suppliers and networks, which could adversely
impact the Company's mission critical applications, cannot be fully known. As a
result, the Company is unable to determine the impact that any system
interruption would have on its results of operations, financial position and
cash flows. However, such impact could be material.
Inability to reach substantial Year 2000 compliance in the Company's
systems and integral third party systems could result in interruption of
telecommunications services, interruption or failure of the Company's ability to
service customers, failure of operating and other information systems and
failure of certain date-sensitive equipment. Such failures could result in loss
of revenue due to service interruption, delays in the Company's ability to
service its customers accurately and timely and increased expenses associated
with stabilization of operations following such failures or execution of
contingency plans.
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.
22
<PAGE>
Quarterly Results of Operations
Quarterly unaudited financial data for the years ended December 31,
1998 and 1997 is presented below (in thousands, except per share data). The most
significant factor impacting operating results for the fourth quarter of 1998
was the recognition of a $550,000 income tax benefit for the partial reversal of
the deferred tax valuation allowance based on favorable trends in the Company's
actual and projected core profitability.
<TABLE>
<CAPTION>
Year Ended December 31, 1998
--------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net interest income $1,385 $1,425 $1,407 $1,435
Provision for loan losses - - - 13
------ ------ ------ ------
Net interest income after
provision for loan losses 1,385 1,425 1,407 1,422
Noninterest income 552 619 765 776
Noninterest expenses 1,839 1,907 2,014 2,097
------ ------ ------ ------
Income before provision for
(benefit from) income taxes 98 137 158 101
Provision for (benefit from)
income taxes - - 29 (547)
------ ------ ------ ------
Net income $ 98 $ 137 $ 129 $ 648
====== ====== ====== ======
Basic and diluted net income
(loss) available to common
stockholders $ (335) $ (304) $ (321) $ 182
====== ====== ====== ======
Net income (loss) per common share:
Basic $ (.32) $ (.29) $ (.30) $ .17
====== ====== ====== ======
Diluted $ (.32) $ (.29) $ (.30) $ .04
====== ====== ====== ======
Weighted average shares
outstanding:
Basic 1,058 1,059 1,059 1,060
===== ===== ===== =====
Diluted 1,058 1,059 1,059 5,030
===== ===== ===== =====
<CAPTION>
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)
====== ====== ====== ======
Basic and diluted net loss
available to common
stockholders $ (378) $ (14) $ (903) $ (638)
====== ====== ====== ======
Basic and diluted net loss
per common share $ (.36) $ (.01) $ (.85) $ (.60)
====== ====== ====== ======
Basic and diluted weighted
average shares outstanding 1,053 1,055 1,057 1,058
===== ===== ===== =====
</TABLE>
23
<PAGE>
Report of Independent Accountants
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, 1998
and 1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, 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.
PricewaterhouseCoopers LLP
Virginia Beach, Virginia
February 19, 1999
24
<PAGE>
<TABLE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
<CAPTION>
1998 1997
---- ----
ASSETS
<S> <C> <C>
Cash..................................................................... $ 5,315,805 $ 2,023,197
Interest-bearing deposits................................................ 11,314,478 6,261,686
Federal funds sold and securities purchased under agreements to resell... 1,314,397 2,748,000
------------- -------------
Cash and cash equivalents....................................... 17,944,680 11,032,883
Federal Home Loan Bank stock............................................. 1,548,800 1,431,000
Securities available for sale - cost approximates market................. 18,406 17,451
Securities held for investment - market value of $2,704,000 in 1998
and $2,217,000 in 1997................................................. 2,750,089 2,299,120
Mortgage-backed securities held for investment - market value of
$1,454,000 in 1998 and $1,886,000 in 1997.............................. 1,455,738 1,904,989
Loans, net of allowance for loan losses of $1,845,000 in 1998 and
$2,382,000 in 1997..................................................... 192,667,763 167,440,733
Loans held for sale...................................................... 4,486,271 2,165,074
Mortgage servicing rights................................................ 831,197 1,169,766
Foreclosed properties, net............................................... 571,294 1,511,629
Accrued interest receivable.............................................. 1,250,349 1,196,980
Excess of cost over net assets acquired, less accumulated
amortization of $2,140,000 in 1998 and $2,078,000 in 1997.............. 97,692 159,754
Advances for taxes, insurance, and other................................. 1,572,225 633,053
Premises and equipment, net.............................................. 3,183,577 1,926,729
Other assets............................................................. 2,661,487 2,198,598
------------- -------------
Total Assets.................................................... $231,039,568 $195,087,759
=========== ===========
(Continued)
25
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 1998 and 1997
<CAPTION>
1998 1997
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing.................................................... $ 16,791,063 $ 5,055,545
Interest-bearing....................................................... 170,841,193 148,871,154
----------- -----------
Total deposits.................................................. 187,632,256 153,926,699
Federal Home Loan Bank advances.......................................... 24,908,333 23,546,667
Notes payable............................................................ - 72,102
Capital lease obligations................................................ 268,123 331,970
Other liabilities........................................................ 2,395,768 2,393,814
------------- -------------
Total Liabilities............................................... 215,204,480 180,271,252
COMMITMENTS AND CONTINGENCIES (Notes 8, 10 and 15)
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 1998 and 1997............. 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 1998 and 1997............... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 20,000,000 in 1998 and 10,000,000 in 1997
Issued and outstanding shares - 1,060,642 in 1998 and 1,058,136
in 1997............................................................. 10,606 10,581
Additional paid-in capital............................................... 8,687,772 8,681,739
Accumulated deficit...................................................... (7,870,790) (8,883,313)
------------ ------------
Total Shareholders' Equity...................................... 15,835,088 14,816,507
------------ ------------
Total Liabilities and Shareholders' Equity...................... $231,039,568 $195,087,759
=========== ===========
See notes to consolidated financial statements.
26
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
INTEREST INCOME
Loans, including fees............................ $14,608,478 $13,588,215 $17,881,529
Federal funds sold and securities purchased
under agreements to resell..................... 111,054 150,972 319,298
Investment securities, including dividend
income......................................... 226,042 353,957 615,429
Mortgage-backed securities....................... 121,643 124,515 497,879
Other............................................ 362,943 329,846 558,139
----------- ----------- -----------
Total Interest Income................... 15,430,160 14,547,505 19,872,274
----------- ----------- -----------
INTEREST EXPENSE
Deposits ........................................ 8,491,101 7,679,314 11,945,273
Federal Home Loan Bank advances.................. 1,229,741 1,473,949 1,625,574
Notes payable.................................... 792 9,079 10,750
Subordinated capital notes....................... - - 52,444
Other............................................ 56,858 67,793 130,297
----------- ----------- -----------
Total Interest Expense.................. 9,778,492 9,230,135 13,764,338
----------- ----------- -----------
Net Interest Income..................... 5,651,668 5,317,370 6,107,936
PROVISION FOR LOAN LOSSES............................ 12,699 113,467 1,410,710
----------- ----------- -----------
Net Interest Income After
Provision for Loan Losses............... 5,638,969 5,203,903 4,697,226
NONINTEREST INCOME
Loan servicing fees.............................. 1,222,478 1,312,476 1,665,768
Mortgage banking income, including
gain on sale of loans.......................... 755,450 458,520 577,130
Other service charges and fees................... 466,135 368,671 497,316
Net gain (loss) on sale of:
Securities..................................... - - 153,188
Loans.......................................... - (1,458) (1,018,185)
Deposits....................................... - - 1,940,010
Other............................................ 268,890 324,596 466,519
----------- ----------- -----------
Total Noninterest Income................ 2,712,953 2,462,805 4,281,746
----------- ----------- -----------
(Continued)
27
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1998, 1997 and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
NONINTEREST EXPENSE
Salaries and employee benefits................... 3,476,785 3,788,695 4,554,540
Net occupancy and equipment...................... 954,804 1,084,593 1,470,284
Deposit insurance premiums....................... 497,081 478,684 674,730
Amortization of intangible assets................ 503,148 530,707 7,011,288
Service bureau fees.............................. 513,826 461,217 599,207
Professional fees................................ 296,295 349,218 507,031
Foreclosed properties, net....................... 150,461 182,880 (175,055)
Other............................................ 1,464,473 1,087,362 1,713,958
----------- ----------- ----------
Total Noninterest Expense............... 7,856,873 7,963,356 16,355,983
----------- ----------- ----------
Income (Loss) Before Income Taxes....... 495,049 (296,648) (7,377,011)
NET BENEFIT FROM INCOME TAXES........................ (517,474) - -
----------- ----------- ----------
Net Income (Loss)....................... $ 1,012,523 $ (296,648) $(7,377,011)
=========== =========== ==========
Net Loss Available to Common
Shareholders (Note 4).......................... $ (777,204) $(1,932,136) $(8,823,879)
=========== ========== ==========
Basic and Diluted Loss Per Common
Share (Note 4)................................. $(.73) $(1.83) $(8.39)
==== ===== =====
See notes to consolidated financial statements.
28
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1998, 1997 and 1996
<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
--------- ------------ ------------ ------- -------
Balance, January 1, 1996.................. $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 -
Comprehensive loss (Note 3):
Net loss............................... - - - - (7,377,011)
Other comprehensive loss:
Reclassification adjustment for
gains on securities available for
sale included in net loss........ - - - - -
Total comprehensive loss............... - - - - -
------- ----------- -------- ---------- -----------
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 -
Comprehensive net loss.................... - - - - (296,648)
------- ----------- -------- ---------- -----------
Balance, December 31, 1997................ 10,581 14,173,750 833,750 8,681,739 (8,883,313)
Common stock issued under the
Employee Stock Purchase Plan........... 25 - - 6,033 -
Comprehensive net income.................. - - - - 1,012,523
------- ----------- -------- ---------- -----------
Balance, December 31, 1998................ $10,606 $14,173,750 $833,750 $8,687,772 $(7,870,790)
====== ========== ======= ========= ==========
<CAPTION>
Accumulated
Other
Comprehensive
Income (Loss) Total
------------- -----
Balance, January 1, 1996................. $154,174 $22,629,652
Common stock issued under the
Employee Stock Purchase Plan.......... - 7,235
Comprehensive loss (Note 3):
Net loss.............................. -
Other comprehensive loss:
Reclassification adjustment for
gains on securities available fo
sale included in net loss....... (154,174)
Total comprehensive loss.............. - (7,531,185)
-------- -----------
Balance December 31, 1996................ - 15,105,702
Common stock issued under the
Employee Stock Purchase Plan.......... - 7,453
Comprehensive net loss................... - (296,648)
-------- -----------
Balance, December 31, 1997............... - 14,816,507
Common stock issued under the
Employee Stock Purchase Plan.......... - 6,058
Comprehensive net income................. - 1,012,523
-------- -----------
Balance, December 31, 1998............... $ - $15,835,088
======= ==========
See notes to consolidated financial statements.
29
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1998, 1997 and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES
Net income (loss)......................................... $ 1,012,523 $ (296,648) $ (7,377,011)
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Provision for:
Losses on loans, foreclosed properties, and
servicing...................................... 163,038 296,808 1,415,365
Depreciation and amortization of premises
and equipment.................................. 368,838 419,829 538,561
Amortization (accretion) of:
Premiums and discounts on loans, investments
and mortgage-backed securities............... 130,161 77,038 211,642
Mortgage servicing rights...................... 441,087 468,647 528,444
Excess of costs over net assets acquired....... 62,062 62,061 6,482,843
Other.......................................... - - (94,399)
Mortgage banking activities:
Proceeds from loan sales........................... 63,636,477 40,717,559 56,311,191
Loan originations and purchases.................... (65,277,646) (39,725,806) (54,961,912)
Realized gains from sale of loans.................. (680,028) (414,902) (548,744)
Realized (gains) and losses from sales of:
Mortgage-backed securities available for sale...... - - (153,188)
Loans.............................................. - 1,458 1,018,185
Deposits........................................... - - (1,940,011)
Other.............................................. (70,377) (185,283) (599,062)
Changes in operating assets and liabilities exclusive
of business acquisitions:
Accrued interest receivable........................ (53,369) (49,047) 1,000,846
Advances for taxes, insurance and other............ (963,172) 133,875 (214,597)
Other assets....................................... (462,889) (647,246) 539,749
Other liabilities.................................. 2,666 453,828 483,325
----------- ------------ ------------
Net cash provided by (used in) operating activities....... (1,690,629) 1,312,171 2,641,227
----------- ------------ ------------
(Continued)
30
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued) For the years ended December 31,
1998, 1997 and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions................................ (4,000,000) (5,000,000) (17,000,000)
Proceeds from maturities of certificates of deposit
in other financial institutions....................... 4,000,000 5,000,000 17,000,000
Purchase of Federal Home Loan Bank stock.................. (117,800) (95,800) -
Redemption of Federal Home Loan Bank stock................ - 1,204,800 1,062,800
Purchase of securities held to maturity................... (750,023) (298,406) (1,020,625)
Proceeds from maturities of securities held to maturity... 300,000 4,000,000 3,000,000
Purchase of securities available for sale................. (955) (2,508,289) (5,165,516)
Proceeds from sale of securities available for sale....... - 2,500,000 6,650,000
Principal remittances on mortgage-backed securities....... 448,012 - -
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........................................ (35,514,557) (22,224,143) -
Proceeds from sales of loans.............................. - - 117,509,060
Net (increase) decrease in net loans...................... 9,550,071 (1,428,880) 1,834,572
Proceeds from sales of foreclosed properties.............. 1,547,763 2,146,555 5,270,509
Additions to foreclosed properties........................ (69,026) (358,419) (174,753)
Increase in mortgage servicing rights..................... (102,518) (289,253) (243,297)
Purchase of premises and equipment........................ (1,625,686) (388,145) (197,281)
Proceeds from sales of premises and equipment............. 525 601,714 1,414,705
----------- ----------- -----------
Net cash provided by (used in) investing activities....... (26,334,194) (17,138,266) 140,998,428
----------- ----------- -----------
FINANCING ACTIVITIES
Net increase in NOW and savings deposits.................. 15,179,844 13,305,806 4,898,050
Net increase in certificates of deposit................... 18,525,713 9,587,515 10,211,469
Proceeds from Federal Home Loan Bank advances............. 46,000,000 25,500,000 4,000,000
Repayment of Federal Home Loan Bank advances.............. (44,638,334) (27,643,333) (8,143,333)
Payments on notes payable................................. (72,102) (24,040) (24,061)
Payments on capital lease obligation...................... (63,847) (53,281) (39,705)
Repayments of mortgages payable on foreclosed
properties............................................. - (10,391) (25,258)
Redemption of Settlement Preferred Stock.................. (712) (6,002) (103,385)
Common stock issued under the Employee Stock
Purchase Plan.......................................... 6,058 7,453 7,235
Decrease in deposits attributable to branch sales:
NOW and savings deposits............................... - - (18,937,078)
Certificates of deposit................................ - - (144,669,198)
Redemptions of subordinated notes......................... - - (627,858)
----------- ----------- ------------
Net cash provided by (used in) financing activities....... 34,936,620 20,663,727 (153,453,122)
----------- ----------- ------------
Increase (decrease) in cash and cash equivalents....... 6,911,797 4,837,632 (9,813,467)
Cash and cash equivalents at beginning of period....... 11,032,883 6,195,251 16,008,718
----------- ------------- --------------
Cash and cash equivalents at end of period............. $ 17,944,680 $ 11,032,883$ 6,195,251
=========== =========== ==============
(Continued)
31
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued) For the years ended December 31,
1998, 1997 and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer from loans to foreclosed properties.............. $ 594,888 $ 1,294,615 $ 1,865,227
Termination of Essex Mortgage Trust I REMIC............... - - 2,678,222
Increase (decrease) in mortgages payable on
foreclosed properties................................. - - 10,391
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest.............................................. $ 9,827,556 $ 9,199,677 $ 13,814,733
Income taxes, net of refunds.......................... 29,526 - (109,244)
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1998, 1997 and 1996
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, 1998 operates
(i) four retail banking branches located in North Carolina and Virginia and (ii)
Essex First, a division of the Bank ("Essex First"), that engages principally in
the origination and sale of residential mortgage loans. EBI's other principal
operating subsidiary is Essex Home Mortgage Servicing Corporation ("Essex
Home"), a majority-owned subsidiary of the Bank that is engaged primarily in the
servicing of mortgage loans owned by the Bank, governmental agencies, and third
party investors. Essex Mortgage Corporation ("EMC") is also a subsidiary of EBI
that was formerly engaged in mortgage banking activities and, at December 31,
1998, held loans and other assets as a result of its past activities.
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
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 other comprehensive
income within 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.
33
<PAGE>
Derivatives: On June 15, 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133 - Accounting
for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999 (January 1, 2000 for the Company). SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. The Company's
management anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS 133 will not have a significant effect on its results of
operations or its financial position.
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.
SFAS No. 114 - Accounting by Creditors for Impairment of a Loan, as amended by
SFAS 118 - Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosures, 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 provided 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.
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
34
<PAGE>
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. Cash
receipts from an impaired loan, whether designated as principal or interest, are
applied to reduce the carrying value of the loan. When future collection of the
loan balance is expected, interest income may be recognized on a cash basis.
Mortgage Banking Activities: Loans held for sale are carried 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. If the carrying
value of the MSRs exceeds the estimated fair value, a valuation allowance is
established. Changes to the valuation allowance are charged against or credited
to amortization of MSRs.
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 SFAS 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. The Company applies the provisions of SFAS No. 109 -
Accounting for Income Taxes ("SFAS 109"), which requires an asset and liability
approach for determining income taxes. Under SFAS 109, deferred income taxes are
recognized for the estimated tax effects of differences between the basis of
assets and liabilities for financial reporting and income tax purposes. Deferred
tax assets are only recognized when, in the judgment of management, it is more
likely than not that they will be realized.
35
<PAGE>
Stock-Based Compensation Plans: Effective January 1, 1997, the Company adopted
SFAS 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 1998 and 1997.
NOTE 3 - COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130 - Reporting Comprehensive Income
("SFAS 130"), which establishes standards for reporting and displaying
comprehensive income and its components. Comprehensive income is the total of
all components of comprehensive income, including net income and other
comprehensive income. Other comprehensive income represents revenues, expenses,
gains and losses that are included in comprehensive income but excluded from net
income under generally accepted accounted principles. SFAS 130 became effective
in 1998 and requires that comparative financial statements for earlier periods
be reclassified to reflect application of the provisions of SFAS 130.
Accordingly, the Company adopted SFAS 130 in 1998. Because there were no items
of other comprehensive income for the years ended December 31, 1998 and 1997,
the Company is not providing a report of comprehensive income for those periods.
Comprehensive income for the year ended December 31, 1996 consisted of a net
loss of $7.4 million and a $154,000 reclassification adjustment for gains on
securities available for sale included in the net loss for 1996.
NOTE 4 - EARNINGS PER SHARE
The Company calculates its basic and diluted earnings per share ("EPS") in
accordance with SFAS 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>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $ 1,012,523 $ (296,648) $(7,377,011)
Preferred stock dividends (Note 18) (1,789,727) (1,635,488) (1,446,868)
---------- ---------- ----------
Net loss available to common shareholders $ (777,204) $(1,932,136) $(8,823,879)
=========== ========== ==========
Weighted average common shares
outstanding 1,059,138 1,055,776 1,051,180
========= ========= =========
</TABLE>
The Company's outstanding options and warrants (Note 19) are antidilutive with
respect to loss available to common shareholders for each of the years
presented; therefore, basic and diluted EPS are the same.
NOTE 5 - SALES OF BRANCHES
In January 1996, the Company formed a Strategic Evaluation 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.
36
<PAGE>
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 the sales are summarized
below.
In the aggregate, the Bank sold deposits and related accrued interest totaling
$167.5 million, along with loans and related accrued interest totaling $204,000,
premises and equipment totaling $1.2 million, and other assets totaling $69,000.
The sale of the Branches required cash of $162.0 million, which was funded by
the sale of fixed-rate and adjustable-rate first mortgage loans totaling $118.3
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 net loss of $1.0 million and a gain of $153,000 from the sale of
loans and mortgage-backed securities, respectively. In the aggregate, the Bank
recognized net gains of $1.9 million and $216,000 on the sale of deposits and
premises and equipment, respectively, during 1996. 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 certain of the Branches. The Company
recognized a $5.9 million write-down in the net asset value of these branches
prior to the consummation of their sale.
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>
1998 1997
------------------------------------------ ------------------------------------------
Amortized Gross Unrealized Fair Amortized Gross Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities of U.S. govern-
ment agencies other than
the U.S. Treasury $2,750 $ - $ 46 $2,704 $2,299 $ - $ 82 $2,217
===== ======== ======= ===== ===== ======== ======= =====
</TABLE>
The $2.8 million of U.S. government agency securities held for investment at
December 31, 1998 consisted of a $2.0 million note issued by the Federal Home
Loan Bank ("FHLB") which matures in the year 2000 and a $750,000 note issued by
the FHLB which matures in the year 2002 provided a one-time call option is not
exercised in October 1999. The U.S. government agency security with a book value
of $750,000 and a fair value of $743,000 is pledged as collateral for public
depository accounts over $100,000 at December 31, 1998. The U.S. government
agency security with a book value of $2.0 million and a fair value of $1.96
million at December 31, 1998 is pledged as collateral for FHLB advances. No
securities held for investment were sold in 1998, 1997, and 1996.
Securities available for sale at December 31, 1998 and 1997 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. There
were no sales of securities available for sale in 1998. Proceeds from the sale
of securities available for sale totaled $2,500,000 and $6,650,000 in 1997 and
1996, respectively. No gains or losses were realized on these sales.
37
<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>
1998 1997
------------------------------------------ ------------------------------------------
Amortized Gross Unrealized Fair Amortized Gross Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government agencies:
Floating-rate REMIC $1,456 $ - $ 2 $1,454 $1,905 $ - $ 19 $1,886
===== ======== ======= ===== ===== ======== ======= =====
The REMIC is pledged as collateral for FHLB advances at December 31, 1998. There
were no sales of MBS held for investment in 1998, 1997 and 1996.
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. No
MBS were classified as available for sale at December 31, 1998 and 1997.
NOTE 8 - LOANS
Net loans at December 31 include (in thousands):
<CAPTION>
1998 1997
---- ----
Real estate:
First mortgages $152,891 $130,486
Second mortgages 7,525 8,699
Construction and development 19,430 16,583
Commercial 6,470 5,970
Consumer 5,984 5,426
Commercial - other 1,601 1,883
Secured by deposits 621 805
---------- ---------
Total Loans 194,522 169,852
Less:
Unearned loan fees and discounts 9 29
Allowance for loan losses 1,845 2,382
--------- ---------
Net Loans $192,668 $167,441
======= =======
Included in total loans at December 31, 1998 and 1997 are unamortized premiums
of $951,000 and $668,000, respectively.
At December 31, net loans included the following collateral-dependent real
estate loans (in thousands):
<CAPTION>
1998 1997
---- ----
First mortgages $298 $611
Second mortgages - 79
----- ----
Total collateral-dependent real estate loans 298 690
Less:
Allowance for loan losses 37 130
---- ---
Net collateral-dependent real estate loans $261 $560
=== ===
</TABLE>
38
<PAGE>
As of December 31, 1998, the Bank had outstanding commitments (including
unfunded portions of lines of credit and construction loan commitments) to fund
approximately $20.5 million in mortgage loans and $435,000 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, 1998, such commitments aggregated $1.3 million
of fixed rate mortgage loans and $20.3 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 44%
and 42% of total loans at December 31, 1998 and 1997, 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, 1998 and 1997, the Company had $1.2 million and $1.6 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 $115,000, $171,000 and $291,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of period $2,381,639 $2,555,688 $ 5,251,295
Provision for loan losses 12,699 113,467 1,410,710
----------- ---------- ----------
2,394,338 2,669,155 6,662,005
Loans charged-off, net of recoveries (549,043) (287,516) (4,106,317)
---------- ---------- ----------
Balance at end of period $1,845,295 $2,381,639 $ 2,555,688
========= ========= ==========
</TABLE>
Loans held for sale at December 31, 1998 and 1997 consisted of first mortgage
loans originated by Essex First. As of December 31, 1998, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $1.7
million, which were committed for sale to unaffiliated third parties.
Essex First sells substantially all conventional loans without recourse so that
losses incurred as a result of nonperformance with respect to the loans sold
become the responsibility of the purchaser of the loan as of the date of the
closing. On occasion, however, Essex First will sell conventional loans in the
secondary market with recourse. As of December 31, 1998, there were $969,000 of
loans outstanding which were previously originated and sold by Essex First in
the secondary market with recourse.
39
<PAGE>
NOTE 9 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Properties acquired through foreclosure $684,900 $1,666,381
Less allowance for losses 113,606 154,752
------- ----------
$571,294 $1,511,629
======= =========
Changes in the allowance for losses on foreclosed properties for the year ended
December 31 are as follows:
<CAPTION>
1998 1997 1996
---- ---- ----
Balance at beginning of year $ 154,752 $ 178,937 $199,145
Provision for losses on
foreclosed properties 126,338 159,341 (21,345)
------- -------- --------
281,090 338,278 177,800
Charge-offs, net of recoveries (167,484) (183,526) 1,137
-------- -------- ---------
Balance at end of year $ 113,606 $ 154,752 $178,937
======== ======== =======
NOTE 10 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
<CAPTION>
1998 1997
---- ----
Land $ 842,190 $ 573,675
Buildings 2,051,194 1,046,570
Furniture and equipment 3,027,647 2,681,370
Leasehold improvements 194,254 192,556
Property under capitalized lease 537,737 537,737
---------- ----------
6,653,022 5,031,908
Less accumulated depreciation
and amortization 3,469,445 3,105,179
--------- ---------
$3,183,577 $1,926,729
========= =========
</TABLE>
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.
40
<PAGE>
Future minimum lease commitments with terms in excess of one year at December
31, 1998, including cost escalation provisions, are as follows:
Capital Noncancelable
Lease Operating Leases
1999 $119,201 $251,546
2000 119,201 249,381
2001 119,201 219,279
2002 - 16,848
2003 - -
Later years - -
----------- ------------
Total minimum lease payments 357,603 $737,054
=======
Amount representing interest 89,480
-------
Present value of net minimum capitalized
payments $268,123
=======
Rent expense for the years ended December 31, 1998, 1997 and 1996 amounted to
$342,496, $435,147 and $602,190, respectively.
NOTE 11 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
------------------------ -----------------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
NOW accounts -
noninterest-bearing $ 16,791 8.95% $ 5,056 3.28%
Passbook and Christmas
Club 4,385 2.34 3,948 2.57
NOW accounts 4,792 2.55 3,965 2.58
Money market 27,878 14.86 25,698 16.69
Certificate accounts -
4.01% to 6.00% 113,403 60.44 87,378 56.77
6.01% to 8.00% 20,377 10.86 27,844 18.09
8.01% to 10.00% 6 .00 38 .02
------- ------ ------- ------
$187,632 100.00% $153,927 100.00%
======= ====== ======= ======
</TABLE>
A summary of certificate accounts by scheduled maturity at December 31, 1998 is
as follows (in thousands):
1999 $ 94,139
2000 23,436
2001 6,476
2002 5,518
2003 and thereafter 4,217
--------
$133,786
========
Certificate accounts of $100,000 or more at December 31, 1998 and 1997 amounted
to $22.7 million and $18.5 million, respectively.
41
<PAGE>
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- ---------------------- ----------------------
Interest Rate Interest Rate Interest Rate
-------- ---- -------- ---- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Passbook and
Christmas Club $ 147,405 3.49% $ 133,737 3.48% $ 225,525 3.33%
NOW accounts 122,330 2.81 122,773 2.83 149,324 2.80
Money Market
accounts 1,317,156 4.91 1,041,566 4.87 949,835 4.50
Certificate accounts 6,904,210 5.67 6,381,238 5.73 10,620,589 5.78
--------- --------- ----------
$8,491,101 5.40% $7,679,314 5.45% $11,945,273 5.51%
========= ========= ==========
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the FHLB at December 31 consist of the following (in thousands):
<CAPTION>
Maturity Interest Rate 1998 1997
- -------- ------------- ----------- ----------
1998 4.01% to 7.00% $ - $21,139
1999 5.01% to 6.00% 17,308 1,808
2000 4.01% to 6.00% 7,600 600
------- --------
$24,908 $23,547
====== ======
Weighted average rate at end of period 5.89% 5.75%
==== ====
</TABLE>
With the exception of $2.5 million and $2.0 million of FHLB advances outstanding
at December 31, 1998 and 1997, respectively, all FHLB advances outstanding at
December 31, 1998 and 1997 carried fixed rates of interest. The $2.5 million
adjustable rate FHLB advances outstanding at December 31, 1998 will mature in
1999 and the applicable rate is indexed to the FHLB overnight deposit rate. The
$2.0 million adjustable rate FHLB advance at December 31, 1997 matured in 1998.
Advances from the FHLB at December 31, 1998 are collateralized by (i) mortgage
loans with a total principal balance of approximately $64.2 million, (ii)
investment securities with a book value of $2.0 million and (iii) MBS with a
book value of $1.5 million. The unused lendable collateral value was $31.6
million at December 31, 1998.
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.
42
<PAGE>
NOTE 14 - INCOME TAXES
The Company is subject to federal and state 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>
1998 1997 1996
------------------------ ----------------------- ------------------------
Amount % Amount % Amount %
------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C>
Provision for (benefit from) income taxes
at statutory federal tax rate $ 168,317 34.0% $(100,860) (34.0)% $(2,508,184) (34.0)%
Increase (decrease) resulting from:
Unrecognized (recognized) tax benefits (192,437) (38.8) 91,443 30.8 991,196 13.4
Future benefit of net deferred tax assets
not previously recognized (550,000) (111.1) - - - -
State income taxes 21,467 4.3 - - - -
Amortization of excess of cost
over net assets acquired 21,101 4.3 21,101 7.1 1,507,950 20.5
Other 14,078 2.8 (11,684) (3.9) 9,038 0.1
--------- ------ --------- ---- ------------ ----
$(517,474) (104.5)% $ - -% $ - -%
======== ====== ========= ==== ========== ====
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
1998 1997
---- ----
Deferred tax liabilities
FHLB stock $ 92,297 $ 92,297
Basis in acquired loans 1,776,015 2,114,303
Premises and equipment (4,424) 32,331
Other 31,282 26,362
------------ ------------
Total deferred liabilities 1,895,170 2,265,293
Deferred tax assets
Net operating loss ("NOL") carryforwards7,252,973 7,562,091
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
MSRs 58,710 78,280
Allowance for losses on loans and
foreclosed properties 449,908 596,417
Core deposit intangible 968,590 1,049,306
Other 364,462 383,524
----------- -----------
Total deferred assets 9,424,643 9,999,618
---------- ----------
Net deferred tax assets before valuation
allowance 7,529,473 7,734,325
Valuation allowance for net deferred tax
assets (6,979,473) (7,734,325)
---------- ----------
Net deferred tax assets $ 550,000 $ -
=========== ==========
</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 a
significant portion of the Company's deferred tax assets and liabilities
because, based on management's assessment, their ultimate realization cannot be
assured. In 1998, the Company recorded net deferred tax assets of $550,000 on
the basis of improvements in profitability and management's expectation that
sufficient taxable income will be generated to utilize a portion of the
Company's NOLs and reversing temporary differences. It is possible that the
43
<PAGE>
Company's financial position and management's assessment of its ability to
generate taxable income will change in the near term and result in a material
adjustment to the valuation allowance.
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, 1998) are used for purposes other than
to absorb bad debt losses, they will be subject to federal income tax at the
then applicable rates.
At December 31, 1998, the Company had NOL carryforwards for income tax purposes
of approximately $19.1 million expiring in the years 2007 through 2011. The
utilization of such NOL carryforwards may be limited by the Internal Revenue
Code in certain circumstances, including a change in ownership of the Company's
common stock. In addition, the Company had an AMT credit carryover of $330,000
at December 31, 1998, which can be carried forward indefinitely.
NOTE 15 - MORTGAGE LOAN SERVICING
At December 31, 1998, 1997, and 1996, the Company serviced or subserviced
approximately 15,100, 8,400 and 13,300 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>
1998 1997 1996
------------------------- ------------------------- ------------------------
Loan Loan Loan Loan Loan Loan
Principal Servicing Principal Servicing Principal Servicing
Balances Fee Income Balances Fee Income Balances Fee Income
-------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Loans owned by the
Company $ 144,602 $ - $128,430 $ - $ 126,373 $ -
Servicing and sub-
servicing rights owned/
participated in by the
Company 1,056,677 1,222,478 354,245 1,312,476 997,279 1,665,768
--------- --------- ------- --------- ---------- ---------
$1,201,279 $1,222,478 $482,675 $1,312,476 $1,123,652 $1,665,768
========= ========= ======= ========= ========= =========
</TABLE>
Servicing fee income is net of $1,088,046 in 1998, $858,992 in 1997 and
$1,878,725 in 1996 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, 1998, approximately $10.6 million
of such accounts were on deposit at unaffiliated banks and $15.7 million of such
accounts were on deposit at the Bank.
The fair value of MSRs was $831,000 and $1.2 million at December 31, 1998 and
1997, respectively. As a result of accelerated mortgage loan prepayment activity
44
<PAGE>
during 1998, the Company recognized a valuation allowance in order to reduce the
carrying value of its MSRs to the estimated fair value at December 31, 1998.
There were no valuation allowances for MSRs at December 31, 1997. Following is
an analysis of the changes in the Company's MSRs for the years ended December
31:
Carrying Valuation
Value Allowance
----- ---------
Balance at January 1, 1996 $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 -
Purchases 102,518 -
Amortization (387,545) (53,542)
---------- ------
Balance at December 31, 1998 $ 884,739 $(53,542)
========== ======
Advances for taxes, insurance and other disbursements consist of advances on
behalf of investors and advances on behalf of certain investors that have
requested the Company to perform special collection and administrative services.
In addition, certain investors have recourse against the Company in the event of
default on loans which are serviced under a regular servicing option. A
valuation allowance has been established for advances for taxes, insurance and
other disbursements and for the Company's recourse obligations to provide for
future losses related to the Company's servicing portfolio.
NOTE 16 - NOTES PAYABLE
Notes payable at December 31, 1997 consisted solely of a note payable to the
former president of an acquired savings institution and its holding company. The
note accrued interest at 9.50% per annum. Originally, the note was 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. In 1998, the
Company initiated a 25% match for employee contributions of up to 6.00% of
compensation as defined by the plan, which resulted in a $35,829 matching
contribution by the Company for the plan year ended December 31, 1998. The
Company made a "qualified non-elective" contribution of $38,379 for the plan
year ended December 31, 1997 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 $38,808, $37,808 and $38,836 was
recognized in 1998, 1997 and 1996, respectively, in connection with employee
vesting in the SERP. The SERP provides deferred compensation of 5% to 10% of a
covered employee's salary. Deferred compensation in excess of 5% is
discretionary and subject to the approval of EBI's Executive Compensation
Committee. Participants in the SERP as of December 31, 1998 are 100% vested.
45
<PAGE>
NOTE 18 - PREFERRED STOCK
On September 15, 1995, EBI merged with Home Bancorp, Inc. ("Home Bancorp") and
its wholly-owned subsidiary Home Savings Bank, F.S.B., a Norfolk, Virginia-based
savings institution (the "Home Acquisition"). 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 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 $4,997,493 and $242,613, respectively, as of December 31, 1998.
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 became exercisable in September 1998 and will 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, 1998 consist of the following: 102,200 exercisable on May 28, 2000
that will expire on May 28, 2007; 6,000 exercisable on February 17, 2001 that
will expire on February 17, 2008; and, 20,000 exercisable on March 31, 2001 that
will expire on March 31, 2008.
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.
46
<PAGE>
The following table summarizes activity under the option plans for years ended
December 31, 1998, 1997 and 1996 and the status at December 31, 1998.
<TABLE>
<CAPTION>
Option Plan Directors Option Plan
----------- ---------------------
Number of Option Number of Option
Options Price Options Price
------- ----- ------- -----
<S> <C> <C> <C> <C>
Options outstanding, January 1, 1996 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
Granted 6,000 5.8750 1,350 2.2500
Granted 20,000 4.8750 - -
--------- ----------
Options outstanding as of December 31, 1998 128,200 1.3750-5.8750 5,950 0.9375-5.6250
======== =====
Options exercisable as of December 31, 1998 - 4,600
======== =====
Options available for future grant
as of December 31, 1998 406,553 13,050
======= ======
</TABLE>
The Company recognized compensation expense of $498,051 and $412,743 during the
years ended December 31, 1997 and 1996, 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, 1998, the Company
continued to recognize 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 income (loss) and loss per share would have been
$969,000 and $.77 for the year ended December 31, 1998 and $(312,000) and $1.84
for the year ended December 31, 1997. The weighted average fair value of the
options granted during 1998 and 1997 would have been $2.58 per share and $0.71
per share, respectively. The fair value of each option granted under the Option
Plan during 1998 and 1997 was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: risk-free
rates of return of 5.61% in 1998 and 6.29% in 1997 and a dividend yield of zero,
expected life of five years and volatility of 50% for 1998 and 1997.
Stock Purchase Plan: In 1995, the Company adopted the Essex Bancorp, Inc.
Employee Stock Purchase Plan (the "Stock Purchase Plan"), which was submitted to
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, 1998, 1997 and 1996 employees acquired
approximately 2,506, 4,757 and 3,694, respectively, newly-issued shares of the
Company's common stock under the Stock Purchase Plan. Effective October 1998,
the Company suspended purchases of the Company's common stock under the Stock
Purchase Plan.
47
<PAGE>
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 - Disclosure About Fair
Value of Financial Instruments ("SFAS 107"), requires the disclosure of
estimated fair values for financial instruments. Quoted market prices, if
available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company's financial instruments, the fair value of such instruments has been
based on assumptions, which management believes to be reasonable, with respect
to future economic conditions, the amount and timing of future cash flows and
estimated discount rates. Different assumptions could significantly affect these
estimates. Because these estimates do not necessarily represent actual purchases
or sales of financial instruments, the market value could be materially
different from the estimates presented below. In addition, the estimates are
only indicative of individual financial instruments' value and should not be
considered an indication of the fair value of the Company taken as a whole.
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments. Much of the
information used to determine fair value is highly subjective and judgmental in
nature, and therefore, the results may not be precise. The subjective factors
utilized include, among other things, estimates of cash flows, risk
characteristics, credit quality, and interest rates, all of which are subject to
change. In addition, the calculation of estimated fair values is based on market
conditions at December 31, 1998 and 1997 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, 1998 and 1997. 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 and FHLB advances 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.
48
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------- ---------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(in thousands)
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents..................... $ 17,945 $ 17,945 $ 11,033 $ 11,033
FHLB stock.................................... 1,549 1,549 1,431 1,431
Securities available for sale................. 18 18 17 17
Securities held for investment................ 2,750 2,704 2,299 2,217
Mortgage-backed securities held for
investment................................. 1,456 1,454 1,905 1,886
Loans held for sale........................... 4,486 4,486 2,165 2,165
Loans held for investment, net................ 192,668 197,288 167,441 169,843
Financial Liabilities
Deposits with no stated maturity.............. $ 53,846 $ 53,846 $ 38,667 $ 38,667
Time deposits................................. 133,786 134,895 115,260 115,624
FHLB advances................................. 24,908 25,030 23,547 23,558
Notes payable................................. - - 72 72
Capital lease obligations..................... 268 269 332 332
Off-balance sheet commitments
and recourse obligations................... - 71 - 62
</TABLE>
NOTE 21 - REGULATORY MATTERS
The Bank is required pursuant to the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") and the Office of Thrift Supervision ("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 or leverage capital requirement, and a risk-based capital
requirement. At December 31, 1998, 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 or leverage capital, Tier I risk-based
capital, and total risk-based capital. As of December 31, 1998 and 1997, the
Bank was "well capitalized" for PCA purposes.
49
<PAGE>
The Bank's capital amounts and ratios as of December 31, 1998 and 1997 are
presented in the following tables (dollars in thousands):
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------ ----------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total risk-based capital $17,364 13.09% $10,609 8.0% $13,261 =>10.0%
Tier I risk-based capital 16,071 12.12% 5,304 4.0% 7,957 =>6.0%
Tier I (core) capital 16,071 6.97% 9,223 4.0% 11,529 =>5.0%
Tangible equity 16,071 6.97% 3,459 1.5% - -
As of December 31, 1997
Total risk-based capital $16,762 14.33% $9,354 8.0% $11,692 =>10.0%
Tier I risk-based capital 15,298 13.08% 4,677 4.0% 7,015 =>6.0%
Tier I (core) capital 15,298 7.86% 7,790 4.0% 9,738 =>5.0%
Tangible equity 15,298 7.86% 2,921 1.5% - -
NOTE 22 - PARENT COMPANY ONLY Financial Information
Condensed financial information of EBI is presented below. While EBI and the
Bank are not 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.
<CAPTION>
Balance Sheets
December 31, 1998 and 1997
(in thousands)
<CAPTION>
1998 1997
---- ----
ASSETS
Cash $ 92 $ 190
Investment in subsidiaries 16,646 15,638
Other 260 257
-------- --------
$16,998 $16,085
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Notes payable $ - $ 72
Redeemable Preferred Stock redemption proceeds payable 84 85
Other 1,079 1,111
------- -------
Total Liabilities 1,163 1,268
SHAREHOLDERS' EQUITY 15,835 14,817
------ ------
$16,998 $16,085
====== ======
</TABLE>
50
<PAGE>
<TABLE>
Statements of Operations
For the years ended December 31, 1998, 1997 and 1996
(in thousands)
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Interest expense on notes payable $ (1) $ (9) $ (11)
Stock option compensation - (601) -
Net operating income 5 25 60
------- ----- -------
Net income (loss) before undistributed
income (loss) of subsidiaries 4 (585) 49
Undistributed income (loss) of subsidiaries 1,009 288 (7,426)
----- ---- ------
Net income (loss) $1,013 $(297) $(7,377)
===== ==== ======
Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
(in thousands)
<CAPTION>
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES
Net income (loss) $ 1,013 $(297) $(7,377)
Adjustments to reconcile net income (loss)
to cash (used in) provided by operating
activities:
Equity in (income) loss of subsidiaries (1,009) (288) 7,426
Dividends from subsidiaries - 108 -
Decrease (increase) in other assets (3) (256) 1
Increase (decrease) in other liabilities (32) 827 (7)
-------- ---- -------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (31) 94 43
-------- ----- ------
FINANCING ACTIVITIES
Payments on notes payable (72) (24) (24)
Redemption of Settlement Preferred Stock (1) (5) (104)
Common stock issued under the Employee Stock
Purchase Plan 6 8 7
-------- ------ -------
NET CASH USED IN FINANCING
ACTIVITIES (67) (21) (121)
------- ----- -----
NET INCREASE (DECREASE) IN CASH (98) 73 (78)
Cash at beginning of period 190 117 195
------- ---- -----
CASH AT END OF PERIOD $ 92 $ 190 $ 117
======= ==== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ 13 $ - $ 11
</TABLE>
As of December 31, 1998 and 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.
51
<PAGE>
NOTE 23 - SEGMENT INFORMATION
The Company adopted SFAS No. 131 - Disclosures about Segments of an Enterprise
and Related Information ("SFAS 131"), as required for this Annual Report. SFAS
131 requires companies to report information about the revenues derived from the
enterprise's segments, about the geographical divisions in which the enterprise
earns revenues and holds assets and about major customers.
The Company operates through three primary business segments: retail community
banking, mortgage banking and mortgage loan servicing. These segments are
evaluated based primarily on revenues from customers and pre-tax profit
contribution to the total Company. Segment revenues from customers consist of
(i) net interest income, which represents the difference between interest earned
on loans and investments and interest paid on deposits and other borrowings and
(ii) noninterest income, which consists primarily of mortgage loan servicing
fees, mortgage banking income (primarily gains on the sale of loans) and service
charges and fees (primarily on deposits and the loan servicing portfolio). All
inter-segment transactions are eliminated to arrive at the total Company revenue
and pre-tax income (loss). In addition, the impact of the sales of the Branches
recognized by the Company in 1996 are not allocated to the segments and are
presented separately. Segment revenues and pre-tax income (loss) are determined
using accounting policies consistent with those applied in the preparation of
the consolidated financial statements.
<TABLE>
<CAPTION>
Retail Mortgage
Community Mortgage Loan Corporate/ Sales of
Banking Banking Servicing Eliminations Branches Total
------- ------- --------- ------------ -------- -----
(in thousands)
1998 Segment Information
<S> <C> <C> <C> <C> <C> <C>
Customer revenues $ 4,047 $ 2,672 $ 1,565 $ 81 $ - $ 8,365
Affiliate revenues - 497 443 (940) - -
Depreciation and amortizaion 99 63 81 126 - 369
Pre-tax income (loss) 1,008 1,552 158 (2,223) - 495
Total assets 207,189 23,710 9,063 (8,922) - 231,040
1997 Segment Information
Customer revenues 3,666 2,158 1,511 445 - 7,780
Affiliate revenues - 385 536 (921) - -
Depreciation and amortizaion 70 87 94 169 - 420
Pre-tax income (loss) 422 1,037 543 (2,299) - (297)
Total assets 181,072 18,865 6,683 (11,532) - 195,088
1996 Segment Information
Customer revenues 5,394 2,051 1,567 87 1,291 10,390
Affiliate revenues - 456 711 (1,167) - -
Depreciation and amortizaion 134 101 121 183 - 539
Pre-tax income (loss) (421) 573 700 (3,640) (4,589) (7,377)
Total assets 159,622 19,096 6,732 (11,183) - 174,267
</TABLE>
Retail Community Banking. The Company provides retail community banking services
through the Bank, which operates four retail banking branches located in North
Carolina and Virginia. The Bank is a savings association that attracts deposits
from the general public in its primary market area, which, together with
borrowings from the FHLB, fund the Bank's investment predominately in real
estate mortgage loans.
Mortgage Banking. The Company engages in mortgage banking activities through
Essex First, which conducts its operations out of four offices located in North
Carolina and Virginia. Essex First was established primarily to originate loans
for sale to private investors in the secondary market in order to generate fee
income while avoiding the interest rate and credit risk associated with holding
long-term fixed-rate mortgage loans in its portfolio. In addition, the majority
52
<PAGE>
of the Bank's loan product is currently originated by Essex First. 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 in
order to enhance fee income. Substantially all of the loans originated by Essex
First and not sold with servicing released to third party investors are sold to
the Bank on a whole loan basis. In addition to its secondary marketing
activities, Essex First derives interest revenue from its residential
construction loan programs for individuals and builders. Construction lending
activities generally are limited to Essex First's primary market, with
particular emphasis in the greater Richmond, Virginia market, the Tidewater,
Virginia area and counties in northeastern North Carolina. More recently, Essex
First has expanded its construction lending into the Raleigh, North Carolina,
Northern Virginia and Maryland markets. Revenues and pre-tax income for the
mortgage banking segment are presented before cost of funds allocation.
Mortgage Loan Servicing. The Company provides mortgage loan servicing through
Essex Home, which conducts its operations out of a leased operations facility in
Virginia Beach, Virginia. Revenues generated by Essex Home consist primarily of
loan servicing fees, late charges and other ancillary fees. In addition to
servicing loans for the Bank and Essex First and being licensed by Fannie Mae,
Freddie Mac and Ginnie Mae, Essex Home services and subservices loans for
approximately eight private investors and 47 subservicing clients. While Essex
Home services mortgage loans secured by residential real estate throughout the
United States, approximately 83% of its mortgage loan servicing portfolio is
concentrated among New York, California, Virginia, North Carolina, New Jersey,
Maryland, Florida, South Carolina and the District of Columbia. As of December
31, 1998, Essex Home serviced for affiliates and nonaffiliates in the aggregate
approximately 15,100 loans totaling $1.2 billion.
[intentionally blank]
53
<PAGE>
<TABLE>
ESSEX
BANCORP, INC.
INVESTOR INFORMATION
<S> <C>
Annual Meeting of Stockholders Annual Report on Form 10-K and
Additional Information
The Annual Meeting of Stockholders of Essex
Bancorp, Inc. will be held at The Koger Center, A copy of Form 10-K as filed with the
Building #5, First Floor Conference Room, Norfolk, Securities and Exchange Commission is available
Virginia on May 27, 1999 at 1:00 p.m. without charge to stockholders upon written
request. Requests for this or other financial
Stock Price Information information about Essex Bancorp, Inc. should be
directed to:
Essex Bancorp, Inc.'s common stock is listed
on the American Stock Exchange ("AMEX") under the Jennifer L. DeAngelo, Corporate Secretary
symbol "ESX." The table below sets forth the high Essex Bancorp, Inc.
and low sales prices of the common stock, as The Koger Center, Building #9, Suite 200
reported by the AMEX during 1998 and 1997. Norfolk, Virginia 23502
Telephone (757) 893-1326
1998 1997
---------------- ------------------ Independent Accountants
Quarter High Low High Low
- ------- ---- --- ---- --- PricewaterhouseCoopers LLP
First $6.7500 $3.9375 $ 2.1875 $1.0000 One Columbus Center, Suite 400
Second 5.1250 3.0000 1.8750 1.0000 Virginia Beach, Virginia 23462
Third 3.2500 1.9375 10.0000 1.0000 Telephone (757) 493-7700
Fourth 2.3750 1.3125 7.3750 3.5000
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:
Continental Stock Transfer and Trust Co.
2 Broadway
New York, NY 10004
Telephone (212) 509-4000
54
<PAGE>
ESSEX
BANCORP, INC.
DIRECTORS AND OFFICERS
EXECUTIVE OFFICERS DIRECTORS
Gene D. Ross Gene D. Ross
Chairman, President and Chief Executive Chairman, President and Chief Executive
Officer Officer
Essex Bancorp, Inc., Essex Bancorp, Inc.
Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing Roscoe D. Lacy, Jr.
Corporation Vice President and General Manager
Miles Jennings, Inc.
Roy H. Rechkemmer, Jr. Elizabeth City, North Carolina
Senior Vice President-Finance/Treasurer (industrial supply company)
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B. Robert G. Hecht
Chief Executive Officer
Mary-Jo Rawson Trumbull Corporation
Vice President/Chief Accounting Officer Pittsburgh, Pennsylvania
Essex Bancorp, Inc. and (highway construction company)
Essex Savings Bank, F.S.B.
Harry F. Radcliffe
Earl C. McPherson President and Chief Executive Officer
President Fort Pitt Capital Management
Essex First Mortgage, a Division of Pittsburgh, Pennsylvania
Essex Savings Bank, F.S.B. (investment management company)
55
<PAGE>
ESSEX
BANCORP, INC.
CORPORATE INFORMATION
Executive Offices Essex Savings Bank, F.S.B.
Retail Banking Offices
The Koger Center
Building #9, Suite 200 Virginia
Norfolk, Virginia 23502 520 South Main Street
Telephone (757) 893-1300 Emporia, Virginia 23847
Subsidiaries of Essex Bancorp, Inc. 1401 Gaskins Road
Richmond, Virginia 23233
Essex Savings Bank, F.S.B.
The Koger Center 2825 Godwin Boulevard
Building #9, Suite 200 Suffolk, Virginia 23434
Norfolk, Virginia 23502
Telephone (757) 893-1300 North Carolina
400 W. Ehringhaus Street
Essex Home Mortgage Servicing Elizabeth City, North Carolina 27909
Corporation
2420 Virginia Beach Boulevard, Suite 109 Essex First Mortgage, a Division of Essex
Virginia Beach, Virginia 23454 Savings Bank, F.S.B.
Telephone (757) 631-4240 Mortgage Loan Production Offices
Virginia
1401 Gaskins Road
Richmond, Virginia 23233
2430 Southland Drive, 3rd Floor
Chester, Virginia 23831
The Koger Center
Building #9, Suite 100
Norfolk, Virginia 23502
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
</TABLE>
56
EXHIBIT NO. 21
SUBSIDIARIES OF REGISTRANT
As Updated December 31, 1998
Essex Mortgage Corporation
(State of Incorporation - Virginia)
Essex Savings Bank, F.S.B.
(State of Incorporation - North Carolina)
First Title Insurance Agency LLC
(State of Organization - Virginia)
Essex Home Mortgage Servicing Corporation
(State of Incorporation - Virginia)
E H Asset Disposition Corporation
(State of Incorporation - Virginia)
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 5316
<INT-BEARING-DEPOSITS> 11314
<FED-FUNDS-SOLD> 1314
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 18
<INVESTMENTS-CARRYING> 4206
<INVESTMENTS-MARKET> 4158
<LOANS> 194522
<ALLOWANCE> 1845
<TOTAL-ASSETS> 231040
<DEPOSITS> 187632
<SHORT-TERM> 17385
<LIABILITIES-OTHER> 2396
<LONG-TERM> 7791
0
15008
<COMMON> 11
<OTHER-SE> 817
<TOTAL-LIABILITIES-AND-EQUITY> 231040
<INTEREST-LOAN> 14608
<INTEREST-INVEST> 348
<INTEREST-OTHER> 474
<INTEREST-TOTAL> 15430
<INTEREST-DEPOSIT> 8491
<INTEREST-EXPENSE> 9778
<INTEREST-INCOME-NET> 5652
<LOAN-LOSSES> 13
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7857
<INCOME-PRETAX> 495
<INCOME-PRE-EXTRAORDINARY> 1013
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1013
<EPS-PRIMARY> (0.73)
<EPS-DILUTED> (0.73)
<YIELD-ACTUAL> 2.93
<LOANS-NON> 1264
<LOANS-PAST> 0
<LOANS-TROUBLED> 98
<LOANS-PROBLEM> 1628
<ALLOWANCE-OPEN> 2382
<CHARGE-OFFS> 561
<RECOVERIES> 11
<ALLOWANCE-CLOSE> 1845
<ALLOWANCE-DOMESTIC> 1700
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 145
</TABLE>
