<PAGE>
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, 1999
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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.
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(Exact name of registrant as specified in its charter)
Delaware 54-1721085
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(State of organization) (I.R.S. Employer
Identification No.)
Interstate Corporate 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. [ ]
The aggregate market value of the Registrant's common stock on the
American Stock Exchange on March 22, 2000 held by nonaffiliates of the
Registrant was $2,179,025.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1999 are incorporated by reference into Parts I and II hereof.
Portions of the Proxy Statement for the Annual Meeting to be held on June 16,
2000 are incorporated by reference into Part III hereof.
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Essex Bancorp, Inc.
Annual Report on Form 10-K for the
Year Ended December 31, 1999
Table of Contents
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<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Part I
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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
- --------
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
- -------
Item 14 Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................. 41
</TABLE>
2
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PART I
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Item 1. Business
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Organization and Background
General. The following organizational chart depicts Essex Bancorp,
Inc. and its subsidiaries as of December 31, 1999. 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
|--------------|
| The Company |
|--------------|
|
|
|------|-------|
| |
| The Bank |
|--------------|
|
|
|--------------|---------------|
| |
|--------|--------| |---------|--------|
| | | |
| First Title | | Essex Home |
|-----------------| |------------------|
|
|
|---------|--------|
| |
| EHADC |
|------------------|
Each company is owned 100% by its parent entity.
3
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<TABLE>
<CAPTION>
Defined Term Formal Name
- ------------ -----------
<S> <C>
Company Essex Bancorp, Inc.
Partnership Essex Financial Partners, L.P.
Bancorp Essex Bancorp.
Bank Essex Savings Bank, F.S.B.
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
</TABLE>
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, as well as the origination of residential construction loans to
individuals and builders. The Company's other principal operating subsidiary is
Essex Home, a wholly-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, 1999, the Company had total assets of
$277.7 million, total liabilities of $259.7 million, including total deposits of
$212.2 million, and total shareholders' equity of $18.0 million.
In January 1995, following approval by the holders of the Partnership's
limited partnership units, both the Partnership and Bancorp were merged with and
into the Company (collectively, the "Merger"), which resulted in a single
holding company structure for the Bank and the other subsidiaries of the
Company. As a 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 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 increase in
authorized capitalization increased 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.
4
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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, 1999, 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) higher net interest income 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.
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 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 the spring of 2000. In
addition, the Bank implemented a telephone information access system for its
deposit customers in 1999.
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 negligible losses on two
foreclosed properties in 1999 and one foreclosed property in 1998 constituting
the only losses in this portfolio. At this time, 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 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,
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management has been successful in reducing previously unacceptable levels of
delinquencies and nonperforming assets. As a result, the .48% ratio of
nonperforming assets to total assets at December 31, 1999 surpasses the previous
record of credit quality levels for the Company.
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 77 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 nonaffiliated servicing/subservicing
portfolio increased from 5,500 loans totaling $354.2 million as of December 31,
1997 to 15,300 loans totaling $1.5 billion as of December 31, 1999.
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, fixed-rate single-family residential loans (loans with initial
fixed rate terms of up to seven years), (ii) sold longer-term, fixed-rate
single-family residential loans in the secondary market, (iii) originated and
purchased adjustable or short-term construction and development loans, (iv)
maintained higher liquidity by holding short-term investments and cash
equivalents and (v) focused marketing efforts on increasing term deposits
maturing beyond one year and noninterest-sensitive deposits.
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 19.0% at December 31, 1999, which resulted from increases
in (i) fixed rate assets, which include adjustable-rate loans with initial
repricing periods in excess of five years and (ii) adjustable-rate borrowings
from the FHLB, the impact of which was partially offset by (i) an increase in
adjustable-rate assets, which include construction loan participations and (ii)
the lengthening of average customer deposit maturities. While the Company
continues to emphasize investment in adjustable-rate loans, customer demand for
such loans is not strong because of the current rising interest rate
environment. Consequently, within the spectrum of loan products offered by the
Bank, the
6
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percentage of balloon payment and adjustable-rate loans with longer initial
adjustment terms predominate. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Market Risk Management" on pages
16 through 18 of the 1999 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 1999, the Company also relied upon (i) the acquisition of
adjustable-rate residential loan portfolios to supplement Essex First's
production of loans to be retained by the Bank and (ii) the acquisition of
construction loan participations and consumer loans in order to improve the
Company's net interest margin over the long-term partially through higher-
yielding and adjustable-rate assets. Moreover, in order to provide a full range
of services to its customers, the Company continues to promote 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, 1999, the Company's net loan portfolio (excluding
loans classified as held for sale) totaled $238.9 million, representing
approximately 86.0% of its $277.7 million of total assets at that date. The
principal categories of loans in the Company's portfolio are residential real
estate loans, which are secured by single-family (one-to-four units) residences;
loans for the construction of single-family properties; commercial real estate
loans, which are secured by multi-family (over five units) residential and
commercial real estate; commercial business loans; and consumer loans.
Substantially all of the Company's mortgage loan portfolio consists of
conventional mortgage loans, which are loans that are neither insured by the
Federal Housing Administration ("FHA") nor partially guaranteed by the Veterans
Administration ("VA").
As a federally chartered savings institution, the Bank has general
authority to originate and purchase loans secured by real estate located
throughout the United States. The Company currently originates substantially
all of its loans within Virginia and North Carolina. Nevertheless, the Company
continues to purchase from time to time loans secured by properties located
outside of its market area and continues to hold a relatively diversified
portfolio.
Federal regulations permit the Bank to invest without limitation in
residential mortgage loans and up to four times its capital in loans secured by
non-residential or commercial real estate. The Bank is also permitted to invest
in secured and unsecured consumer loans in an
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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, 1999, the Bank's limit on
loans-to-one borrower was approximately $2.9 million. The loans-to-one borrower
limitation may restrict the Bank's ability to do business with certain existing
and potential customers. Partially because of this limitation, the Bank
increased its use of participations in order to expand its builder construction
loan program during 1999. See "-Construction Loans."
At December 31, 1999, the Bank's five largest commercial loans-to-one
borrower and their related entities amounted to $1.3 million, $1.1 million,
$491,000, $487,000 and $440,000. The $1.3 million commercial loan was
classified as of December 31, 1999 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 $916,000 as of December 31, 1999, 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 $422,000 as of December 31,
1999. 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, 1999, the Bank and its subsidiaries leased nine of the mini-storage units.
The property was last appraised in November 1992 for $915,000. As of December
31, 1999, the Bank had established a $300,000 specific reserve with respect to
the loans and the remaining $1.0 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,
---------------------------------------------------------
1999 1998 1997
---------------- -------------------- -----------------
$ % $ % $ %
-------- ------ --------- --------- --------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Single-family residential:
First mortgages.................. $173,372 72.0% $152,891 78.6% $130,486 76.8%
Second mortgages................. 4,268 1.8 7,525 3.9 8,699 5.1
Construction and development...... 42,477 17.7 19,430 10.0 16,583 9.8
Commercial real estate............ 4,645 1.9 6,470 3.3 5,970 3.5
-------- ----- -------- -------- -------- -----
Total real estate loans.......... 224,762 93.4 186,316 95.8 161,738 95.2
Commercial business loans.......... 1,626 .7 1,601 .8 1,883 1.1
Consumer loans:
Other............................. 13,464 5.6 5,984 3.1 5,426 3.2
Secured by deposits............... 731 .3 621 .3 805 .5
-------- ----- -------- -------- -------- -----
Total consumer loans............ 14,195 5.9 6,605 3.4 6,231 3.7
-------- ----- -------- -------- -------- -----
Total loans.................. 240,583 100.0% 194,522 100.0% 169,852 100.0%
===== ======== =====
Less:
Unearned loan fees and discounts.. 4 9 29
Allowance for loan losses......... 1,697 1,845 2,382
-------- -------- --------
1,701 1,854 2,411
-------- -------- --------
Net Loans.................... $238,882 $192,668 $167,441
======== ======== ========
<CAPTION>
1996 1995
------------------ -------------------
$ % $ %
-------- ----- -------- --------
<S> <C> <C> <C> <C>
Real estate:
Single-family residential:
First mortgages.................. $103,643 70.0% $223,531 82.1%
Second mortgages................. 12,384 8.3 13,398 4.9
Construction and development...... 17,190 11.6 15,078 5.5
Commercial real estate............ 6,313 4.3 10,611 3.9
-------- -------- -------- --------
Total real estate loans.......... 139,530 94.2 262,618 96.4
Commercial business loans.......... 1,915 1.3 2,171 .8
Consumer loans:
Other............................. 5,828 3.9 6,488 2.4
Secured by deposits............... 842 .6 994 .4
-------- -------- -------- --------
Total consumer loans............ 6,670 4.5 7,482 2.8
-------- -------- -------- --------
Total loans.................. 148,115 100.0% 272,271 100.0%
======== ========
Less:
Unearned loan fees and discounts.. 8 388
Allowance for loan losses...... 2,556 5,251
-------- --------
2,564 5,639
-------- --------
Net Loans.................... $145,551 $266,632
======== ========
</TABLE>
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Total loans decreased by an aggregate of $31.7 million or 11.6% from
December 31, 1995 to December 31, 1999 primarily due to the sale of loans in
connection with the sale of the Branches in 1996. The acquisition of $31.3
million, $32.3 million and $22.2 million of adjustable rate first mortgage loans
in 1999, 1998 and 1997, respectively, and 7.2 million and $3.2 million of fixed
rate home improvement loans in 1999 and 1998, respectively, 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, 1999,
the Company has placed increased emphasis on single-family first mortgage loans,
which, together with construction loans and participations secured by single-
family residences, increased from 87.6% of total loans held for investment at
December 31, 1995 to 89.7% of total loans held for investment at December 31,
1999. Single-family second mortgage loans declined substantially from 4.9% of
total loans held for investment at December 31, 1995 to 1.8% of total loans held
for investment at December 31, 1999. 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 3.9% of total loans held for
investment at December 31, 1995 to 1.9% of total loans held for investment at
December 31, 1999, as did commercial business loans. Consumer loans increased
from 2.8% of total loans held for investment at December 31, 1995 to 5.9% of
total loans held for investment at December 31, 1999. The Company increased its
emphasis during 1999 and 1998 on the origination and purchase of various types
of consumer loans in order to enable the Company the reposition its balance
sheet to improve its net interest income.
The following table presents the maturity distribution and interest
sensitivity of selected loan categories (excluding residential mortgage and
consumer loans) at December 31, 1999. 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 $42,268 $ 14 $ 286 $42,568
After one year through
five years 209 3,480 1,340 5,029
Beyond five years - 1,151 - 1,151
------- ------ ------ -------
Total $42,477 $4,645 $1,626 $48,748
======= ====== ====== =======
Interest rate terms on
amounts due after one
year:
Fixed $ 40 $1,210 $ - $ 1,250
======= ====== ====== =======
Adjustable $ 169 $3,421 $1,340 $ 4,930
======= ====== ====== =======
</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-
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service retail facilities, which has enabled the Bank to, among other things,
increase its (i) origination of both consumer and mortgage loans directly
through its branch network and (ii) deposit share in its primary markets.
Mortgage Banking Activities. At December 31, 1999, 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, 1999, 1998, and 1997, Essex First originated $87.8
million, $98.8 million and $65.6 million of loans (consisting primarily of both
permanent and construction/permanent loans secured by single-family residential
real estate and excluding builder loan advances). During the same periods,
$32.1 million, $33.5 million and $25.9 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 Essex First currently originates the majority of the Bank's loan
product, 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, 1999 there were $919,000 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. For additional information, see "- 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 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 single-family mortgage loans
from Essex First, 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, 1999, 1998 and 1997, the Bank purchased $38.5 million, $32.3
million and $22.2 million of loans, respectively, from various nonaffiliated
financial institutions and mortgage banking companies in the secondary market.
In addition, during the year ended December 31, 1999, the Company's construction
loan participations increased $20.8 million. Acquisition of these
participations is strategically designed to draw upon the construction lending
expertise at Essex First.
At December 31, 1999, 1998, and 1997, loans classified by the Company as
held for sale amounted to $917,000, $4.5 million and $2.2 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.
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.
Essex First also maintains 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 nonaffiliated
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, Executive Vice President or the Senior Underwriter are
authorized to approve secured loans of up to $300,000 and unsecured loans of up
to $25,000. When the Senior Underwriter acts together with the Chief Executive
Officer or the Executive Vice President, 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. 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. All financial institutions are 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 ("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. In 1999, the
regulatory agencies issued a joint release of Interagency Guidelines on High LTV
Residential Real Estate Lending, which provides guidance on how financial
institutions should manage high loan-to-value ("LTV") residential real estate
loan programs and how they should be treated under the Lending Guidelines. 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 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 of commercial, multi-family and nonresidential properties (80%);
improved property (85%); and permanent one-to-four family residential (owner
occupied) and home equity loans (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). The Company's loan
underwriting guidelines with respect to LTV ratios are no less stringent than
the Lending Guidelines set forth above.
Single-Family Residential Real Estate Loans. At December 31, 1999, $173.4
million or 72.0% of the Company's total loans held for investment consisted of
permanent loans secured by first liens on single-family residential real estate,
as compared to $152.9 million or 78.6% at December 31, 1998. The decline in the
concentration of such loans occurred because the lower interest rate
environment, in particular during 1998 and the first half of 1999, resulted in
significant refinancings to lower fixed rate loans with terms to maturity of
over seven years. The Company generally sells such loans in the secondary
market as market conditions permit.
13
<PAGE>
In recent years, the Company has been emphasizing for its portfolio single-
family residential mortgage adjustable-rate loans, which provide for periodic
adjustments to the interest rate. These loans have up to 30-year terms and
interest rates which adjust annually in accordance with a designated index after
a specified period has elapsed. Depending on the loan product selected by the
borrower, this period can range from one year to seven years. In order to be
competitive and generate production, the ARMs offered by the Company provide for
initial rates of interest below the rates that 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 45.3% of the
permanent single-family residential loans in the Company's loan portfolio held
for investment at December 31, 1999 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 that 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, 1999, approximately 54.7% of the
permanent single-family residential loans held by the Company for investment
consisted of loans that provide for fixed rates of interest in excess of five
years. Although these loans provide for repayments of principal over a fixed
period of up to 30 years, it is the Company's experience that such loans remain
outstanding for a substantially shorter period of time.
The Company is generally permitted to lend up to 100% of the appraised
value of the real property securing a residential loan (referred to as the LTV
ratio); however, if the amount of a residential loan originated or refinanced
exceeds 90% of the appraised value, the Company is required by federal
regulations to obtain appropriate credit enhancement in the form of either
mortgage insurance or readily marketable collateral. Pursuant to underwriting
guidelines adopted by the Board of Directors, the Company will lend up to 95% of
the appraised value of the property securing an owner-occupied single-family
residential loan, and generally requires borrowers to obtain private mortgage
insurance on loans that have a principal amount that
14
<PAGE>
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 there under.
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, 1999, construction loans,
including participations, amounted to $42.5 million or 17.7% 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 89 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, 1999, the Company's C/P portfolio included 65 C/P loans
with an aggregate principal balance of $8.9 million (and an additional $9.0
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 1999 and 1998, the Company
15
<PAGE>
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, 1999,
the Company did not participate in a significant amount of real estate
acquisition and development loans in its portfolio, the Company may in the
future, on a case-by-case basis, participate in a limited amount of additional
real estate acquisition and development loans.
At December 31, 1999, the Company's builder construction loan portfolio
included 116 loans to 60 different builders with an aggregate principal balance
of $11.2 million (and an additional $37.8 million was subject to legally binding
commitments but had not been advanced as of such date). Of this $11.2 million
of builder loans, approximately $8.9 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 participations totaling $22.1
million at December 31, 1999 (and an additional $16.9 million was subject to
legally binding commitments but had not been advanced as of such date).
The Company intends to maintain 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, 1999, $4.6 million or 1.9% 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, 1999, $916,000 or 19.7% of the Company's total
commercial real estate loans were comprised of multi-family residential loans.
Although terms vary, commercial real estate loans generally are amortized
over a period of up to 20 years and mature in seven years or less. The Company
will originate these loans either with fixed interest rates or with interest
rates that 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
16
<PAGE>
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.
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,
1999, $1.6 million or .7% 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,
1999, $14.2 million or 5.9% of the Company's total loans held for investment
consisted of consumer loans. The consumer loans offered by the Company include
home improvement, automobile loans, boat and recreational vehicle loans, mobile
home loans, loans secured by deposit accounts and unsecured personal 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 affected 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,
17
<PAGE>
the interest rate and market conditions at the time the loan application is
taken. These fees are in addition to appraisal and other fees paid by the
borrower to the Company at the time of the application. The Company's policy is
to defer all loan origination fees net of direct origination costs and amortize
those fees over the contractual lives of the related loans. Amortization of loan
fees is included in interest income. Nevertheless, the predominant portion of
the Company's loans are originated for resale and, consequently, related net
loan fees are recognized as mortgage banking income upon consummation of the
loan sales.
When loans are sold with servicing rights released to the buyer, the
Company also recognizes current income from receipt of servicing release fees in
addition to receiving a premium or deducting a discount based on the market
value of the loan, which is dependent upon, among other things, the interest
rate and market conditions at the time the sales price is 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 $272,000, $484,000
and $782,000 at December 31, 1999, 1998 and 1997, respectively. For additional
information regarding the Company's servicing assets, see Note 12 of the Notes
to Consolidated Financial Statements on pages 41 through 42 of the 1999 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, 1999, approximately 18,200 loans with
unpaid principal balances of $1.7 billion were serviced or subserviced by Essex
Home as compared to approximately 15,100 loans with unpaid principal balances of
$1.2 billion as of December 31, 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 ("PMSRs") amounted to $1.7 million, $347,000
and $387,000 at December 31, 1999, 1998 and 1997, respectively. The increase in
PMSRs during 1999 was attributable to purchases of servicing rights during 1999
for 1,920 loans with unpaid principal balances totaling $159.6 million. 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 prepayment activity exceeds 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.
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<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,
----------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent
------ -------- ------ -------- ------ --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
30-59 days........... $ 703 .29% $ 662 .34% $ 645 .38%
60-89 days (1)....... 564 .23 46 .02 295 .17
90 or more days (2).. 736 .31 1,166 .60 1,577 .93
------ --- ------ --- ------ ----
$2,003 .83% $1,874 .96% $2,517 1.48%
====== === ====== === ====== ====
</TABLE>
(1) Includes $148,000 of loans that were in nonaccrual status at December
31, 1999.
(2) Includes $21,000 of loans that were accruing interest at December 31,
1997. There were no loans 90 days or more past due accruing interest
at December 31, 1999 or 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.
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<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,
-----------------------------------------------
1999 1998 1997
-------------- --------------- --------------
% 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.................. $ 350 .14% $ 697 .36% $1,203 .71%
Construction............................... - - - - 133 .08
Commercial................................. 377 .16 328 .17 132 .08
Consumer................................... 157 .07 141 .07 88 .05
------ ----- ------- ----- ------ -----
Total nonaccrual loans.................... 884 .37 1,166 .60 1,556 .92
Accruing loans 90 days or more past due..... - - - - 21 .01
Troubled debt restructurings................ - - 98 .05 209 .12
------ ----- ------- ----- ------ -----
Total nonperforming loans................. 884 .37 1,264 .65 1,786 1.05
Foreclosed properties, net.................. 446 .19 571 .29 1,512 .89
------ ----- ------- ----- ------ -----
Total nonperforming assets................ $1,330 .56% $ 1,835 .94% $3,298 1.94%
====== ===== ======= ===== ====== =====
Nonperforming loans to total loans.......... .37% .65% 1.05%
Nonperforming assets to total assets........ .48 .79 1.69
Allowance for loan losses to total loans.... .71 .95 1.40
Allowance for loan losses to nonaccrual
loans...................................... 182.88 158.23 153.09
Allowance for loan losses to nonperforming
loans...................................... 182.88 145.97 133.37
<CAPTION>
1996 1995
------------ --------------
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------- -----
<S> <C> <C> <C> <C>
Nonaccrual loans, net:
Single-family residential.................. $2,513 1.70% $ 2,959 1.09%
Construction............................... 220 .15 378 .14
Commercial................................. 22 .01 2,636 .97
Consumer................................... 153 .10 108 .04
------ ----- ------- -----
Total nonaccrual loans.................... 2,908 1.96 6,081 2.24
Accruing loans 90 days or more past due..... 30 .02 177 .06
Troubled debt restructurings................ 223 .15 143 .05
------ ----- ------- -----
Total nonperforming loans................. 3,161 2.13 6,401 2.35
Foreclosed properties, net.................. 2,054 1.39 4,856 1.78
------ ----- ------- -----
Total nonperforming assets................ $5,215 3.52% $11,257 4.13%
====== ===== ======= =====
Nonperforming loans to total loans.......... 2.13% 2.35%
Nonperforming assets to total assets........ 2.99 3.32
Allowance for loan losses to total loans.... 1.73 1.93
Allowance for loan losses to nonaccrual
loans...................................... 87.90 86.35
Allowance for loan losses to nonperforming
loans...................................... 80.86 82.03
</TABLE>
20
<PAGE>
For additional information about the Company's nonperforming assets, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Nonperforming Assets" on pages 6 and 7 and
Notes 6 and 7 of the Notes to Consolidated Financial Statements on pages 35 and
36 of the 1999 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,
1999, the Company had classified for regulatory and internal purposes an
additional $1.7 million of assets, $1.4 million of which were classified
substandard, $35,000 of which were classified doubtful and $322,000 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 that
are charged against income. While management uses the best information
available to make such evaluations, future adjustments to the allowance may be
necessary if economic conditions differ substantially from the assumptions used
in making the evaluations. For additional information, see Notes 6 and 7 of the
Notes to Consolidated Financial Statements on pages 35 and 36 of the 1999 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
21
<PAGE>
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,
-----------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans, net of unearned fees and discounts:
Year-end................................... $240,579 $194,513 $169,823 $148,107 $271,883
Average outstanding during period.......... 212,354 172,760 156,217 216,803 251,108
Allowance for loan losses:
Balance, beginning of year................. 1,845 $ 2,382 $ 2,556 $ 5,251 $ 3,429
Allowance transferred in connection
with the Home Acquisition............... - - - - 500
Provision for loan losses.................. 149 13 113 1,411 2,477
-------- -------- -------- -------- --------
1,994 2,395 2,669 6,662 6,406
Charge-offs, net of recoveries (1):
Commercial (2).......................... 65 40 (366) 2,892 644
Real estate - mortgage.................. 9 288 535 894 494
Real estate - land...................... (14) 133 - - -
Consumer................................ 237 89 118 320 17
-------- -------- -------- -------- --------
Total (2)............................. 297 550 287 4,106 1,155
-------- -------- -------- -------- --------
Balance, end of year....................... $ 1,697 $ 1,845 $ 2,382 $ 2,556 $ 5,251
======== ======== ======== ======== ========
Ratio of net charge-offs to average
outstanding loans (2)...................... .14% .32% .18% 1.89% .46%
Allowance for loan losses to year-end
total nonperforming loans.................. 182.88% 145.97% 133.37% 80.86% 82.03%
Allowance for loan losses to year-end
loans, net of unearned fees and discounts.. .71% .95% 1.40% 1.73% 1.93%
</TABLE>
(1) Except as noted in (2) below, recoveries of prior loan charge-offs were
not significant for the periods presented.
(2) Charge-offs during 1997 include a $329,000 recovery on a loan guarantee
associated with a Richmond, Virginia multi-family 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 a Richmond, Virginia multi-family
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.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential mortgage $ 632 91.5 $ 855 92.5% $1,139 91.7% $1,636 89.9% $2,607 92.5%
Commercial (1) 576 2.6 560 4.1 545 4.6 505 5.6 1,530 4.7
Consumer 489 5.9 285 3.4 254 3.7 299 4.5 323 2.8
Unallocated - - 145 - 444 - 116 - 791 -
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$1,697 100.0% $1,845 100.0% $2,382 100.0% $2,556 100.0% $5,251 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</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,
-----------------------
1999 1998 1997
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year.... $ 114 $ 155 $ 179
Provision for losses on
foreclosed properties.......... 14 126 159
----- ----- -----
128 281 338
Charge-offs, net of recoveries.. (94) (167) (183)
----- ----- -----
Balance at end of year.......... $ 34 $ 114 $ 155
===== ===== =====
</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 that
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 that 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,
----------------------------------------
1999 1998 1997
------------ ------------ ------------
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year.... $1,456 $1,905 $1,905
Repayments...................... (974) (448) -
Amortization.................... (2) (1) -
------ ------ ------
Balance at end of year.......... $ 480 $1,456 $1,905
====== ====== ======
Weighted average coupon at end
of year........................ 6.65% 5.90% 6.65%
====== ====== ======
</TABLE>
The Company's investment in mortgage-backed securities at December 31, 1999
consists solely of a Fannie Mae guaranteed adjustable rate REMIC. The Company's
mortgage-backed securities are carried in accordance with generally accepted
accounting principles. See Note 5 of the Notes to Consolidated Financial
Statements on page 34 of the 1999 Annual Report to Stockholders, which is
attached hereto as Exhibit 13 and incorporated herein by reference.
Investment Securities. Federally-chartered savings institutions have
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various Federal agencies and of state and
municipal governments, certificates of deposit at federally-insured banks and
savings and loan associations, certain bankers' acceptances and Federal funds.
Subject to various restrictions, federally-chartered savings institutions may
also invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally-chartered savings institutions are otherwise authorized to make
directly.
The Bank's investment securities portfolio is managed by the Treasurer of the
Bank in accordance with a comprehensive investment policy which addresses
strategies, types and levels of allowable investments and which is reviewed and
approved by the Board of Directors on an annual basis and by the Asset and
Liability Management Committee as circumstances warrant. The Bank currently
emphasizes lending activities in order to increase the weighted average yield on
the Bank's interest-earning assets. The Bank's investment securities are
carried in accordance
24
<PAGE>
with generally accepted accounting principles. See Note 4 of the Notes to
Consolidated Financial Statements on page 34 of the 1999 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,
----------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
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 agency
securities (1)........ $2,750 $2,713 $2,750 $2,704 $2,299 $2,217
FHLB stock.............. 2,230 2,230 1,549 1,549 1,431 1,431
------ ------ ------ ------ ------ ------
Total (2)............ $4,980 $4,943 $4,299 $4,253 $3,730 $3,648
====== ====== ====== ====== ====== ======
</TABLE>
(1) The $2.8 million of U.S. Government agency securities held for investment
at December 31, 1999 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.
(2) Does not include investment securities classified as available for sale
that consisted of an $19,000, $18,000 and $17,000 investment in a money
market mutual fund at December 31, 1999, 1998 and 1997, 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, 1999 is presented below. FHLB stock is
neither a debt nor an equity security because its ownership is restricted and it
lacks a market. FHLB stock can be sold at its par of $100 per share only to the
FHLBs or to another member institution.
<TABLE>
<CAPTION>
One Year After One to After Five to Over 10
or Less Five Years 10 Years Years Total
-------- ----------- ------------- -------------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
U.S. Government agency securities.. $2,000 $ 750 $ - $ - $2,750
====== ===== ============ ============= ======
Weighted average yield............. 4.77% 5.03% -% -% 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 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
25
<PAGE>
greater than $100,000) certificates of deposit and individual retirement
accounts. A significant component of total noninterest-bearing deposits is
derived from mortgage loan servicing related escrow deposits maintained by Essex
Home at the Bank. The balance of these accounts has increased proportionately
with the increase in the servicing volume at Essex Home.
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, 1999, deposit accounts
totaling $4.4 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 $692,000 at December 31, 1999, and represented a decline from the
$1.2 million of such certificates at December 31, 1998. 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,
-------------------------------------------------
1999 1998 1997
--------------- --------------- ---------------
Average Average Average
Balance Rate Balance Rate Balance Rate
-------- ----- -------- ----- -------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing deposits.. $ 16,691 -% $ 9,504 -% $ 3,143 -%
Passbook savings.............. 4,753 3.49 4,225 3.49 3,839 3.48
NOW accounts.................. 5,179 2.81 4,361 2.81 4,344 2.83
Money market accounts......... 33,799 4.72 26,845 4.91 21,401 4.87
Certificates of deposit:
Consumer................... 74,211 5.43 51,747 5.68 53,256 5.78
Mini-jumbo................. 50,483 5.45 55,524 5.65 44,932 5.65
Jumbo...................... 15,954 5.44 14,481 5.73 13,206 5.78
-------- -------- --------
$201,070 $166,687 $144,121
======== ======== ========
</TABLE>
The following table shows the interest rate and maturity information for the
Company's time deposits at December 31, 1999:
<TABLE>
<CAPTION>
Maturity Date
-----------------------------------------------------
One Year Over
or Less 1-2 Years 2-3 Years 3 Years Total
-------- --------- ------------- ------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
4.01% to 5.00%.. $23,109 $ 1,870 $ 154 $ - $ 25,133
5.01% to 6.00%.. 55,028 34,661 5,378 8,888 103,955
6.01% to 7.00%.. 6,317 2,012 7,969 149 16,447
7.01% to 8.00%.. 2,563 - - - 2,563
8.01% to 9.00%.. 6 - - - 6
------- ------- ------- ------ --------
$87,023 $38,543 $13,501 $9,037 $148,104
======= ======= ======= ====== ========
</TABLE>
26
<PAGE>
The following table shows the Company's certificates of deposit of
$100,000 or more outstanding at the dates indicated:
<TABLE>
<CAPTION>
December 31,
-------------------------
1999 1998 1997
------- ------- -------
(dollars in thousands)
<S> <C> <C> <C>
3 months or less.......... $ 4,698 $ 3,914 $ 4,624
Over 3 through 6 months... 5,988 5,002 4,785
Over 6 through 12 months.. 6,696 7,698 3,747
Over 12 months............ 10,946 6,072 5,365
------- ------- -------
Total................ $28,328 $22,686 $18,521
======= ======= =======
</TABLE>
The ability of the Company to attract and maintain deposits and the
Company's cost of funds on these deposit accounts have been, and will continue
to be, significantly affected by economic and competitive conditions.
Borrowings. The Bank is a member of the FHLB System, which consists
of 12 regional FHLBs subject to supervision and regulation by the Federal
Housing Finance Board. The FHLBs provide a central credit facility primarily
for member institutions. The Bank, as a member of the FHLB of Atlanta, is
required to hold shares of common stock in that FHLB in an amount at least equal
to 1% of the aggregate principal amount of its unpaid residential mortgage loans
and mortgage-backed securities, 3/10 of 1% of total assets at the end of the
calendar year, or 5% of its advances (borrowings) from the FHLB, whichever is
greater. The Bank had a $2.2 million investment in stock of the FHLB at
December 31, 1999, which was in compliance with this requirement.
The following table presents certain information regarding the
Company's FHLB advances at the dates and for the periods indicated:
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
----------------------------------------
1999 1998 1997
------------ ------------ ------------
(dollars in thousands)
<S> <C> <C> <C>
Balance at end of period.................................................... $44,600 $24,908 $23,547
Weighted average interest rate
at end of period.......................................................... 4.72% 5.89% 5.75%
Maximum amount outstanding
at any month's end........................................................ 44,600 $30,975 $28,118
Average amount outstanding
during the period......................................................... 29,233 $21,553 $24,885
Weighted average interest rate
during the period.......................................................... 5.42% 5.71% 5.92%
The outstanding FHLB advances at December 31, 1999 mature as follows (in thousands):
2000............................................................................. $ 7,600
2001............................................................................. 37,000
-------
$44,600
=======
</TABLE>
Other Liabilities. As of December 31, 1999 and 1998, 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 15 of the Notes to Consolidated
Financial Statements on pages 43 and 44 of the 1999 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference.
27
<PAGE>
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 Status" on pages 20 and 21 of the 1999 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. A major reform hurdle was eliminated with the
passage of financial modernization legislation in 1999 that made it possible for
all financial services to be sold in concert, which coupled with the evolution
of the Internet as a marketing and delivery mechanism for financial products and
services, will impact how effectively the Company competes in the future. The
Company introduced a web site in 1999 to promote its products and services to a
broad base of consumers through the Internet. While the Company's plans for the
near term do not include expansion into online banking, the Company is assessing
the viability of online banking within the context of the market characteristics
of its customer base.
The Company's 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 deposits depends
not only on its ability to provide a rate of return, liquidity and risk
comparable to that offered by competing investment opportunities, but also on
the Company's ability to promote these products by remote access.
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.
Employees
As of December 31, 1999, the Company employed 115 full-time-equivalent
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 that 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
28
<PAGE>
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 that 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 that 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
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, 1999, 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
29
<PAGE>
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 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 that 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
30
<PAGE>
divided into subgroups that are based on supervisory evaluations by the
institution's primary federal regulator, resulting in nine assessment
classifications.
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 in 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
FDIC notified the Bank 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 paid its assessments
through 1999 at the assessment rate schedule in effect as of June 30, 1995. The
Bank's annual assessment for deposit insurance was 26 basis points of insured
deposits during 1999, but a rate of three basis points of insured deposits (the
assessment rate otherwise charged to "well capitalized" savings institutions
such as the Bank) became effective for the Bank on January 1, 2000. 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 5.9 basis points was added to the regular SAIF assessment during
1999. Effective January 1, 2000, the FICO assessment rate for the SAIF began to
be assessed at the same rate as the BIF, effectively reducing the Bank's FICO
assessment to approximately two basis points.
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 was a savings association on that date. The merger of the SAIF and
the BIF did not occur on such date because 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. 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, 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%. A savings institution is
also required to maintain tangible capital in an amount at least equal to 1.5%
of its adjusted total assets.
31
<PAGE>
At December 31, 1999, 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 $17,353 6.25% $ 4,166 1.5% $13,187
Core capital 17,353 6.25 11,109 4.0 6,244
Risk-based capital 18,273 11.44 12,782 8.0 5,491
</TABLE>
For further information regarding the Bank's actual capital ratios and minimum
requirements under FDICIA, see Note 17 of the Notes to Consolidated Financial
Statements on page 46 of the 1999 Annual Report to Stockholders, which is
attached hereto as Exhibit 13 and incorporated herein by reference. At December
31, 1999, 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.
Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
FDICIA, each federal banking agency was required to implement a system of prompt
corrective action for institutions that it regulates. Under the regulations
adopted by the OTS, 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 there under 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, 1999, the Bank was considered a
"well capitalized" institution under the prompt corrective action provisions of
FDIA.
32
<PAGE>
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, 1999, had a liquidity ratio of 10.10%.
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 there
under in order to avoid certain restrictions on their operations. A savings
association that does not meet the QTL test set forth in the HOLA and
implementing regulations must either convert to a bank charter or comply with
the following restrictions on its operations: (i) the association may not engage
in any new activity or make any new investment, directly or indirectly, unless
such activity or investment is permissible for a national bank, (ii) the
branching powers of the association shall be restricted to those of a national
bank, (iii) the association shall not be eligible to obtain any advances from
its FHLB and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the
expiration of three years from the date the association ceases to be a QTL, it
must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
Under applicable regulations, any savings institution is a QTL if (i) it
qualifies as a domestic building and loan association under Section 7701(a)(19)
of the Code (which generally requires that at least 60% of the institution's
assets constitute housing-related and other qualifying assets) or (ii) at least
65% of the institution's "portfolio assets" (as defined) consist of certain
housing and consumer-related assets on a monthly average basis in at least nine
out of every 12 months. At December 31, 1999, 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, requires 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.
33
<PAGE>
As a member, the Bank is required to purchase and maintain stock in the FHLB
in an amount at least equal to 1% of its aggregate unpaid residential mortgage
loans, home purchase contracts or similar obligations, 3/10 of 1% of total
assets at the end of the calendar year, or 5% of its advances from the FHLB,
whichever is greater. At December 31, 1999, the Bank had $2.2 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, 1999,
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.
Financial Modernization. On November 12, 1999, the Gramm-Leach-Bliley Act
(the "Act") of 1999, financial modernization legislation, was signed into law.
The Act amends numerous banking laws including, but not limited to, (i)
repealing Sections 20 and 32 of the Banking Act of 1933 (Glass-Steagall Act),
which prohibited bank affiliations with securities firms, and amending the Bank
Holding Company Act of 1956 to allow affiliations between insured depository
institutions and any "financial" company, (ii) streamlining the supervision of
bank holding companies, including the creation of "financial holding companies"
as described below, (iii) clarifying national banks' authorization to conduct
financial activities through subsidiaries, (iv) restricting the sale of existing
unitary thrift holding companies to financial companies and limiting the
granting of new unitaries charters to financial companies, (v) permitting
federal savings associations converting to national or state banks to retain the
term "federal" in their names and (vi) repealing the SAIF special reserve for
return to the general reserve. Further, the Act established (i) "financial
holding companies" to engage in, through affiliates, insurance and securities
underwriting, merchant banking, portfolio investment and title insurance
activities, (ii) the National Association of Registered Agents and Brokers to
set uniform licensing and qualification standards for insurance producers on a
multistate basis, (iii) terms and conditions for a mutual insurance company to
reorganize into a mutual holding company, (iv) the scope of bank disclosure and
sharing of customers' non-public information with nonaffiliated third parties
with an opt-out provision, (v) federal criminal penalties for individuals
seeking to obtain customer financial information through fraud or deceit by
pretext calling and (vi) that all banking agencies must use "plain language" in
proposed and final rulemaking after January 1, 2000.
Specifically, Title V of the Act contains the most comprehensive financial
consumer privacy restrictions ever written into federal law. Banks and all
other institutions dealing in financial products and services are required to
have a privacy policy and to disclose it to their customers. They also must
give customers the right to "opt out" of having nonpublic personal information
shared with certain unaffiliated third parties. The privacy provisions impose
new administrative and regulatory burdens. But the extent and severity of these
burdens will not be known until the regulators publish new rules and standards
for compliance with the Act, which are due in May 2000. Further, the Act states
that if state law affords greater consumer protections than federal law in the
area of third-party information sharing, the state law will supersede federal
law. As the Bank awaits new rules and standards for compliance with the Act,
the Bank has introduced its privacy principles on the Company's Internet web
site and the Company's board of directors has adopted a corporate policy on
privacy and accuracy of personal customer information.
Safety and Soundness. The federal banking regulatory agencies have jointly
implemented Interagency Guidelines Establishing Standards for Safety and
Soundness ("Guidelines") for all insured depository institutions relating to
internal controls, information
34
<PAGE>
systems and internal audit systems, loan documentation, credit underwriting,
interest rate risk exposure, asset growth, compensation, fees and benefits, and
employment contracts and other compensation arrangements of executive officers,
employees, directors and principal stockholders of insured depository
institutions that would prohibit compensation and benefits and arrangements that
are excessive or that could lead to a material financial loss for the
institution. The federal banking regulatory agencies have also adopted asset
quality and earnings standards within the Guidelines. 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 would be able to
successfully continue business operating after January 1, 2000. At December 31,
1999, 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 that
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 11 of the Notes to Consolidated Financial Statements on pages
39 and 40 of the 1999 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.
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.
Furthermore, the Company is separately subject to an annual state franchise
tax in Delaware.
35
<PAGE>
Item 2. Properties
----------
The following table sets forth information with respect to offices of the
Company and its subsidiaries as of December 31, 1999.
<TABLE>
<CAPTION>
Lease Date Total Net Book
Owned/ Expiration Date Acquired/ Office Value at
Location Leased Including Options Leased Square Ft. (1) 12/31/99 (2)
- --------------------------------- --------- ----------------- --------- ------------- ------------
<S> <C> <C> <C> <C> <C>
The Company
Executive Office:
Interstate Corporate Center Leased 01/31/02 10/96 7,328 $ 13,615
Building 9, Suite 200
Norfolk, VA 23502
The Bank
Main Office:
400 W. Ehringhaus Street Owned - 11/78 3,805 177,860
Elizabeth City, NC 27906
Branch Offices:
520 South Main Street Owned - 05/86 6,517 656,384
Emporia, VA 23847
1401 Gaskins Road Owned - 09/98 6,782 646,004
Richmond, VA 23233
2825 Godwin Boulevard Owned - 04/98 3,245 745,147
Suffolk, VA 23434
9695 Sliding Hill Road Owned - 08/98 3,150 431,705(3)
Ashland VA 23005
Essex First
Interstate Corporate Center Leased 01/31/02 10/96 5,554 -
Building 9, Suite 200
Norfolk, VA 23502
1401 Gaskins Road Leased (4) - 09/98 3,078 -
Richmond, VA 23233
2430 Southland Drive, 3rd Floor Leased 06/01/00 06/93 2,000 -
Chester, VA 23831
400 W. Ehringhaus Street Leased (4) - 07/94 750 -
Elizabeth City, NC 27906
Essex Home
2420 Virginia Beach Blvd. Leased 12/31/01 12/91 11,950 2,759
Virginia Beach, VA 23454
</TABLE>
(1) Total office square feet excludes leased common area.
(2) Consists of the net book value of land and buildings if owned, or leasehold
improvements if leased.
(3) The Bank's Ashland, Virginia branch is under construction as of December 31,
1999 with a projected opening in the spring of 2000. The net book value at
December 31, 1999 represents land and construction costs incurred through
December 31, 1999.
(4) Leased from the Bank.
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, 1999.
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 51 of the
1999 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 30, 2000, there were 1,060,642 shares of Common Stock
outstanding, which were held by approximately 1,700 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
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. The Company does not anticipate the payment of dividends on the Common
Stock in the foreseeable future.
In connection with the Home Acquisition, the Company issued 2,250,000
shares of nonvoting perpetual preferred stock with an aggregate redemption and
liquidation value of $15.0 million in exchange for all of the outstanding stock
of Home Bancorp. The preferred stock is redeemable at the option of the
Company. The 2,125,000 shares of Series B preferred stock bear a cumulative
annual dividend rate of 9.5% (based on redemption value) and the 125,000 shares
of Series C preferred stock bear a cumulative annual dividend rate of 8.0%
(based on redemption value). The Series C preferred stock is senior to Series B
preferred stock with respect to the payment of dividends, and the holders of the
Series C preferred stock may, in their discretion, from time to time in whole or
in part, elect to convert such shares of Series C preferred stock into a like
amount of Series B preferred stock. At December 31, 1999, dividends and accrued
interest thereon in arrears on the Series B and Series C preferred stock were
$6,867,869 and $330,763, respectively.
37
<PAGE>
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, 1999,
which appears on page 4 of the 1999 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 22 of the 1999 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 18 of the 1999 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, 1999
and 1998 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, 1999, along with the related notes to consolidated financial
statements and the report of PricewaterhouseCoopers LLP, independent
accountants, are incorporated herein by reference from pages 23 through 50 of
the Company's 1999 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 June 16, 2000
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 46 President of Essex First and Executive
Vice President of Loan Production and
Secondary Marketing of the Bank
Roy H. Rechkemmer, Jr. 37 Senior Vice President of Finance and Treasurer
of the Company and the Bank
Mary-Jo Rawson 46 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.
39
<PAGE>
Information regarding compliance with Section 16(a) of the Securities Exchange
Act is included in the Company's Proxy Statement for the Annual Meeting to be
held on June 16, 2000 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 June 16, 2000 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 June 16, 2000 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
June 16, 2000 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>
<CAPTION>
Page in
Annual
Report*
-------
<S> <C>
(a) 1. Financial Statements:
The following documents are filed as part of this report:
Report of Independent Accountants............................ 23
Consolidated Balance Sheets at December 31, 1999
and 1998.................................................... 24
Consolidated Statements of Operations for the three
years ended December 31, 1999............................... 25
Consolidated Statements of Shareholders' Equity for
the three years ended December 31, 1999..................... 27
Consolidated Statements of Cash Flows for the three
years ended December 31, 1999............................... 28
Notes to Consolidated Financial Statements................... 30
</TABLE>
*Incorporated by reference from the indicated pages of the 1999
Annual Report to Stockholders.
The financial statements, together with the report thereon of
PricewaterhouseCoopers LLP dated February 18, 2000, appearing on
pages 23 through 50 of the accompanying 1999 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 1999 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>
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 Exhibit 3.3 to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1998.
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.
42
* 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.
<PAGE>
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.
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 Exhibit 10.4 to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998.
10.5 Fourth Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated October
27, 1999. Filed as an exhibit to this report.
10.6* 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.
43
* 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.
<PAGE>
10.7* 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.
10.8* 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.
10.9* Essex Bancorp, Inc. Stock Option Plan. Filed as
Exhibit 10.19 to the Registrant's Form 10-K for the
year ended December 31, 1994.
10.10* 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.
10.11* 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.
10.12* 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.
10.13* 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.
10.14* Second Amendment to the Essex Bancorp, Inc. Employee
Stock Purchase Plan dated as of October 1, 1998.
Filed as Exhibit 10.13 to the Registrant's Annual
Report on Form 10-K for the year ended December 31,
1998.
10.15* 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.
44
* 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.
<PAGE>
10.16* 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 Exhibit 10.14 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1998.
10.17 Second Amendment to the Restated Employment
Agreement dated as of October 1, 1999 by and among
Essex Bancorp, Inc., Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing Corporation (successor
to Essex Mortgage Corporation) and Gene D. Ross.
Filed as an exhibit to this report.
10.18* Change in Control Agreement dated as of January 1,
1998 by and among Essex Bancorp, Inc. and Gene D.
Ross. Filed as Exhibit 10.16 to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1998.
10.19 Restated Change in Control Agreement dated as of
October 1, 1999 by and among Essex Bancorp, Inc. and
Gene D. Ross. Filed as an exhibit to this report.
10.20* 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.
10.21* 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 Exhibit
10.18 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
10.22* 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 Exhibit
10.19 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
10.23* Change in Control Agreement dated as of January 1,
1998 by and among Essex Bancorp, Inc. and Earl C.
McPherson. Filed as Exhibit 10.20 to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998.
45
* 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.
<PAGE>
10.24* 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 Exhibit 10.21
to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1998.
10.25 Restated Change in Control Agreement dated as of
November 22, 1999 by and among Essex Bancorp, Inc.
and Earl C. McPherson. Filed as an exhibit to this
report.
10.26* Subservicing Agreement between Essex Home Mortgage
Servicing Corporation and Continental Capital Corp.
dated as of April 15, 1998. Filed as Exhibit 10.22
to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1998.
11 Statement re Computation of Per Share Earnings.
Filed as an exhibit to this report.
13 The 1999 Annual Report is attached as Exhibit 13.
Portions of the 1999 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.
46
<PAGE>
(b) Reports on Form 8-K Filed in the Fourth Quarter of 1999
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]
47
<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, 2000
--------------
(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, 2000
---------------- --------------
Gene D. Ross (Date)
Chairman, President, Chief
Executive Officer and
Principal Financial Officer
By: /s/ Mary-Jo Rawson March 30, 2000
------------------ --------------
Mary-Jo Rawson (Date)
Chief Accounting Officer
By: /s/ Robert G. Hecht March 30, 2000
------------------- --------------
Robert G. Hecht (Date)
Director
By: /s/ Roscoe D. Lacy, Jr. March 30, 2000
----------------------- --------------
Roscoe D. Lacy, Jr. (Date)
Director
By: /s/ Harry F. Radcliffe March 30, 2000
---------------------- --------------
Harry F. Radcliffe (Date)
Director
48
<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, dated August 26, 1993.
- -----------------------------------------------------------------------------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference
E-1
<PAGE>
Exhibit Index
-------------
Exhibit No. Description
----------- -----------
10.2* First Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan, dated June 5,
1997.
10.3* Second Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan, dated November
1, 1997.
10.4* Third Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan, dated December
1, 1998.
10.5 Fourth Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan, dated October
27, 1999.
10.6* 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.
10.7* Essex Bancorp, Inc. Non-Employee Directors Stock Option
Plan.
10.8* First Amendment to the Essex Bancorp, Inc. Non-Employee
Directors Stock Option Plan, dated July 29, 1995.
10.9* Essex Bancorp, Inc. Stock Option Plan.
10.10* First Amendment to the Essex Bancorp, Inc. Stock Option
Plan, dated as of June 29, 1995.
10.11* Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan, dated as of May 23, 1996.
10.12* Essex Bancorp, Inc. Employee Stock Purchase Plan.
- -----------------------------------------------------------------------------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference
E-2
<PAGE>
Exhibit Index
-------------
Exhibit No. Description
----------- -----------
10.13* First Amendment to the Essex Bancorp, Inc. Employee
Stock Purchase Plan, dated as of June 29, 1995.
10.14* Second Amendment to the Essex Bancorp, Inc. Employee
Stock Purchase Plan, dated as of October 1, 1998.
10.15* Restated Employment Agreement by and among Essex
Bancorp, Inc., Essex Savings Bank, F.S.B., Essex
Mortgage Corporation and Gene D. Ross, dated as of
January 1, 1998.
10.16* First Amendment to the Restated Executive Services
Agreement by and among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation and
Gene D. Ross, dated as of January 1, 1998.
10.17 Second Amendment to the Restated Executive Services
Agreement by and among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation and
Gene D. Ross, dated as of October 1, 1999.
10.18* Change in Control Agreement by and among Essex Bancorp,
Inc. and Gene D. Ross, dated as of January 1, 1998.
10.19 Restated Change in Control Agreement by and among Essex
Bancorp, Inc. and Gene D. Ross, dated as of October 1,
1999.
10.20* Restated Executive Services Agreement by and among
Essex Savings Bank, F.S.B., Essex First Mortgage
Corporation and Earl C. McPherson, dated as of January
1, 1998.
- -----------------------------------------------------------------------------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference
E-3
<PAGE>
Exhibit Index
-------------
Exhibit No. Description
----------- -----------
10.21* First Amendment to the Restated Executive Services
Agreement by and among Essex Savings Bank, F.S.B.,
Essex First Mortgage Corporation and Earl C. McPherson,
dated as of January 1, 1998.
10.22* Second Amendment to the Restated Executive Services
Agreement by and among Essex Savings Bank, F.S.B.,
Essex First Mortgage Corporation and Earl C. McPherson,
dated as of January 1, 1999.
10.23* Change in Control Agreement by and among Essex Bancorp,
Inc. and Earl C. McPherson, dated as of January 1,
1998.
10.24* First Amendment to the Change in Control Agreement by
and among Essex Bancorp, Inc. and Earl C. McPherson,
dated as of January 1, 1999.
10.25 Restated Change in Control Agreement by and among Essex
Bancorp, Inc. and Earl C. McPherson, dated as of
November 22, 1999.
10.26* Subservicing Agreement between Essex Home Mortgage
Servicing Corporation and Continental Capital Corp.,
dated as of April 15, 1998.
11 Statement re Computation of Per Share Earnings.
13 The 1999 Annual Report is attached as Exhibit 13.
Portions of the 1999 Annual Report are incorporated by
reference into this Form 10-K.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.
- -----------------------------------------------------------------------------
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference
E-4
<PAGE>
EXHIBIT 10.5
FOURTH AMENDMENT
TO THE
ESSEX SAVINGS BANK, FSB
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
THIS FOURTH AMENDMENT TO THE ESSEX SAVINGS BANK, FSB SUPPLEMENTAL
EXECUTIVE RETIREMENT PLAN (the "Plan") is made as of the 1st day of January,
1999.
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 January 1, 1999
as follows:
1. Article V of the Plan is hereby amended to add the following
sentence at the end thereof:
Any provision herein to the contrary notwithstanding, the
Retirement Accounts of Gene D. Ross and Earl McPherson shall be fully
(100%) vested at all times.
2. 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 Fourth Amendment to be
executed by its duly authorized officer this 27th day of October, 1999.
ESSEX SAVINGS BANK, FSB
By: /s/ Gene D. Ross
------------------
Its: President
--------------
1
<PAGE>
EXHIBIT 10.17
SECOND AMENDMENT
TO
RESTATED EMPLOYMENT AGREEMENT
This SECOND AMENDMENT is made as of October 1, 1999 by and among Essex
Bancorp, Inc. ("Bancorp"), Essex Savings Bank, FSB (the "Bank") and Essex Home
Mortgage Servicing Corporation (collectively, the "Employers") and Gene D. Ross
("Employee").
WITNESSETH:
WHEREAS, Bancorp, certain Bancorp subsidiaries and the Employee
entered into a Restated Employment Agreement dated as of January 1, 1998 (the
"Employment Agreement"), which Employment Agreement was subsequently amended;
and
WHEREAS, Employers and Employee desire to further amend the
Employment Agreement in certain respects.
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 2.1 of the Agreement is amended to insert the phrase ", or
such higher rate of salary as the Board of Directors of Bancorp approves," after
the phrase "$189,000 per year" and before the phrase "(the "Salary")."
2. Section 3.7(a) of the Agreement is amended to insert at the end of
the last sentence thereof the phrase "(with Employee to pay for that portion of
the cost of coverage, if any, charged to active, continuing employees of the
Employer with similar coverage)."
3. Section 3.7(d) of the Agreement is deleted and former Section
3.7(e) is redesignated as new Section 3.7(d).
4. Essex Home Mortgage Servicing Corporation is hereby added as an
additional Employer under the Employment Agreement in place of Essex Mortgage
Corporation.
[Remainder of page intentionally left blank]
1
<PAGE>
IN TESTIMONY WHEREOF, the parties have caused this First Amendment to
the Agreement to be executed as of the first day of October, 1999.
ESSEX BANCORP, INC.
By: /s/ Roscoe D. Lacy, Jr.
-----------------------
Its: Director
--------
ESSEX SAVINGS BANK, FSB
By: /s/ Roscoe D. Lacy, Jr.
-----------------------
Its: Director
--------
ESSEX HOME MORTGAGE SERVICING CORPORATION
By: /s/ Roscoe D. Lacy, Jr.
-----------------------
Its: Director
--------
/s/ Gene D. Ross
----------------
2
<PAGE>
EXHIBIT 10.19
RESTATED
CHANGE IN CONTROL AGREEMENT
This RESTATED CHANGE IN CONTROL AGREEMENT is made as of the first day
of October, 1999, by and among Essex Bancorp, Inc. ("Bancorp") and Gene D. Ross
("Employee").
WITNESSETH
WHEREAS, Employee, Bancorp and certain subsidiaries of Bancorp entered
into a Restated Employment Agreement dated as of January 1, 1998 (the
"Employment Agreement"); and
WHEREAS, it is expected that any future sale or other change in
ownership of Bancorp would be attributable in large part to efforts and services
of Employee beyond those required under his Employment Agreement;
WHEREAS, Bancorp and Employee entered into a Change in Control
Agreement ("Agreement") dated as of January 1, 1998 to provide Employee with
additional compensation for such services; and
WHEREAS, Bancorp and Employee desire to amend and restate the
Agreement.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth herein, the additional efforts and services of Employee that would
have to be rendered by Employee to effect a change in ownership of Bancorp, and
other good and valuable consideration, the adequacy of which is hereby
acknowledged, Bancorp and Employee hereby amend and restate the Agreement to
read in its entirety as follows:
1. Change in Control Payment.
-------------------------
(a) Subject to reduction under Section 1(d) and Section 2 below,
Bancorp shall provide Employee with the following payments and benefits
(collectively "Change in Control Payment") in the event a Change in Control (as
defined in Section 1(b) below) occurs while Employee is employed by Bancorp or
occurs within one hundred and eighty (180) days after the effective date of: (i)
termination of Employee by Bancorp without "Cause" ( as defined in the
Employment Agreement), (ii) Employee's resignation for "Just Cause" ( as defined
in the Employment Agreement), or (iii) non-renewal of the Employment Agreement
as a result of Bancorp's refusal without "Cause" to extend the term thereof.
The Change in Control Payment shall consist of the following three components:
(1) Bancorp shall pay to the Employee in a lump sum within thirty
(30) days of the Change in Control an amount equal to two hundred percent (200%)
1
<PAGE>
of the sum of (i) 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, plus (ii) the highest annual bonus
paid to Employee by Bancorp for any calendar year ending after 1997;
(2) Bancorp shall pay to Employee an additional $225,000 if the
Change in Control occurs before October 1, 2000; and
(3) If Employee is still employed by Bancorp on the date of the
Change in Control, Bancorp shall 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. Such coverage shall be of the same type
and amount as was in effect immediately prior to the Change in Control, or as is
later provided to Bancorp's employees generally, with Employee to pay for that
portion of the cost of continuing coverage, if any, charged to other continuing
employees of the Employer with comparable coverage.
(b) For purposes of this Agreement, a "Change in Control" shall occur
if and only if after October 1, 1999 a "person" or "group" (as such term is used
in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934), directly or
indirectly, first becomes the "beneficial owner" (as defined in Rule 13d-3 under
the Securities Exchange Act of 1934) of securities of Bancorp representing
twenty-five percent (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 October 1, 1999; (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).
(c) Any provision herein to the contrary notwithstanding, no Change in
Control Payment under Section 1(a) shall be owed to Employee if Employee is
terminated by Bancorp for "Cause" (as defined under the Employment Agreement) or
Employee resigns without "Just Cause" (as defined in the Employment Agreement)
prior to the date of a Change in Control. Bancorp shall be obligated for the
Change in Control Payment only if Employee is still employed by Bancorp on the
date of the Change in Control or if Employee's employment with Bancorp ceased
within one hundred and eighty (180) days prior to the Change in Control on
account of termination without "Cause" by Bancorp, resignation by Employee with
"Just Cause" or non-renewal of the Employee's Employment Agreement by Bancorp
without "Cause."
(d) Any provision herein to the contrary notwithstanding, the Change
in Control Payment otherwise due under this Section 1 shall be reduced by any
severance payment or severance benefit made to Employee under the Employment
Agreement as a result of his termination prior to a Change in Control. Once a
Change in Control occurs which triggers Employee's entitlement to a Change in
Control Payment, no subsequent Change in Control shall entitle Employee to a
second Change in Control Payment.
2
<PAGE>
2. Limitation on Change in Control Payment.
---------------------------------------
(a) It is intended that all amounts payable hereunder, together with
all other amounts payable to Employee upon or in connection with a Change in
Control, are reasonable compensation for Employee's service to Bancorp and its
subsidiaries. Notwithstanding the foregoing, should Bancorp determine, based
upon the opinion of the independent accounting advisors of Bancorp immediately
prior to the Change in Control ("Accounting Firm"), that any or all of the
Change in Control Payment provided under this Agreement, together with any other
amounts received by Employee that must be included in such determination, would
result in the payment of an "excess parachute payment" as defined in Section
280G of the Internal Revenue Code of 1986, as amended (the "Code"), then Bancorp
will reduce the amount otherwise due and owing to Employee under this Agreement
to the maximum amount that would permit a determination that Employee has not
received an excess parachute payment under Code Section 4999 if, and only if,
the amount of such reduction does not exceed Forty Thousand Dollars ($40,000).
If the amount of reduction necessary to avoid "excess parachute payment"
treatment would exceed Forty Thousand Dollars ($40,000), no reduction shall be
made and the provisions of Section 3 below shall instead apply.
(b) Bancorp may reduce the Change in Control Payments pursuant to
Section 2(a) only if within sixty (60) days of a Change in Control it provides
Employee with an opinion of the Accounting Firm that Employee will be considered
to have received "excess parachute payments" as defined in Code Section 280G if
he were to receive the full amounts owing pursuant to this Agreement and all
other amounts owed to him by Bancorp. Such opinion shall be based upon the
proposed regulations under Code Sections 280G and 4999 or substantial authority
within the meaning of Code Section 6661, and shall set forth with particularity
the smallest amount by which the payment due Employee hereunder would have to be
reduced to avoid the imposition of any excise tax or the denial of any deduction
pursuant to Code Sections 280G and 4999 and shall demonstrate the relation of
such amount to the amounts set forth in Section 2(a) above. Employee shall, if
he agrees with the determination of Bancorp, notify Bancorp in writing of the
payments and/or benefits that he wishes to have reduced in order to comply with
the provisions of this Section 2. In the event that Employee fails to designate
an order of priority for the application of any such reduction, such reduction
shall be made in the order of priority determined by Bancorp. In the event that
Employee does not agree with the opinion or calculation presented and he is
unable to resolve any dispute with Bancorp regarding such disagreement within a
period of thirty (30) days of receipt of the opinion referenced above, Employee
may submit the resolution of this matter to arbitration pursuant to Section 4
below or take such other steps as he may deem advisable to enforce his position.
3. Gross-Up Amount.
----------------
(a) In addition to the Change in Control Payment described in Section
1 above, Bancorp shall pay to Employee an amount (the "Gross-Up Amount") equal
to the excise tax under Section 4999 of the Code, if any, incurred by Employee
on the payments and benefits owed under this Agreement, and/or under all other
plans, agreements or understandings between Employee and Bancorp (collectively
"Golden Parachute Payments") constituting excess parachute payments under Code
Section 280G, plus all excise taxes and federal, state and local income taxes
3
<PAGE>
incurred by Employee with respect to receipt of the Gross-Up Amount. The
parties intend that the Gross-Up Amount be in an amount such that after payment
by the Employee of all taxes (including income taxes, excise taxes under Code
Section 4999 interest and penalties), imposed upon the Gross-Up Amount, the
Employee will retain a portion of the Gross-Up Amount equal to the Code Section
4999 excise tax imposed on the Golden Parachute Payments. Attached hereto as
Exhibit A is an example of the computation of the Gross-Up Amount.
(b) All determinations required to be made under this Section 3,
including whether a Gross-Up Payment is required and the amount of any Gross-Up
Amount, shall be made by the Accounting Firm, which shall provide detailed
support calculations to Bancorp and Employee. In computing taxes, the
Accounting Firm shall use the highest marginal federal, state and local income
tax rates applicable to the Employee and shall assume the full deductibility of
state and local income taxes for purposes of computing federal income tax
liability, unless the Employee demonstrates that the will not in fact be
entitled to such a deduction for the year of payment.
(c) The Gross-Up Amount, computed assuming all of the Golden Parachute
Payments constitute "excess parachute payments" as defined in Code Section 280G,
shall be paid to the Employee with the Change in Control Payment (or as soon
thereafter as is practicable) unless Bancorp at the same time as the payment of
the Change in Control Payment provides the Employee with an opinion of the
Accounting Firm that Employee will not incur an excise tax on part or all of the
Golden Parachute Payments. Any such opinion shall be based upon the proposed
regulations under Code Sections 280G and 4999 or substantial authority within
the meaning of Code Section 6661. If such opinion applies only to part of the
Golden Parachute Payment, Bancorp shall pay Employee the Gross-Up Amount with
respect to that part of the Golden Parachute Payment not covered by the opinion.
(d) The Gross-Up Amount shall be subject to adjustment so as to avoid
either an overpayment or underpayment of the Gross-Up Amount to Employee. As a
result of the uncertainty in the application of Section 4999 of the Code at the
time of the initial determination by the Accounting Firm hereunder, it is
possible that Gross-Up Amounts which should have been paid by Bancorp will not
have been paid ("Underpayment"), consistent with the calculations required to be
made hereunder. In the event that Bancorp exhausts its remedies pursuant to
Section 3(e) below and the Employee thereafter is required to make a payment of
any additional excise tax under Code Section 4999, the Accounting Firm shall
determine the amount of the Underpayment that has occurred and any such
Underpayment shall be promptly paid by Bancorp to or for the benefit of the
Employee.
(e) The Employee shall notify Bancorp in writing of any claim by the
Internal Revenue Service that, if successful, would require the payment by
Bancorp of an addition Gross-Up Amount. Such notification shall be given as
soon as practicable but no later than ten (10) business days after the Employee
knows of such claim and shall apprise Bancorp of the nature of such claim and
the date on which such claim is requested to be paid. The Employee shall not
pay such claim prior to the expiration of the thirty (30) day period following
the date on which he gives such notice to Bancorp (or such shorter period ending
on the date that any payment of taxes with respect to such claim is due). If
4
<PAGE>
Bancorp notifies the Employee in writing prior to the expiration of such period
that it desires to contest such claim, the Employee shall:
(1) Give Bancorp any information reasonably requested by Bancorp
relating to such claim,
(2) Take such action in connection with contesting such claim as
Bancorp shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such claim by
an attorney reasonably selected by Bancorp,
(3) Cooperate with Bancorp in good faith in order effectively to
contest such claim, and
(4) Permit Bancorp to participate in any proceedings relating to
such claim; provided, however, that Bancorp shall bear and pay directly all
costs and expenses (including additional interest and penalties) incurred in
connection with such contest and shall indemnify and hold the Employee harmless,
on an after-tax basis, for any tax (including income taxes, excise tax under
Code Section 4999, interest and penalties with respect thereto), imposed as a
result of such representation and payment of costs and expenses. Without
limitation on the foregoing provisions of this Section 3(e), Bancorp shall
control all proceedings taken in connection with such contest and, at its sole
option, may pursue or forego any and all administrative appeals, proceedings,
hearings and conferences with the taxing authority in respect of such claim and
may, at its sole option, either direct the Employee to pay the tax claimed and
sue for a refund or contest the claim in any permissible manner, and the
Employee agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or more
appellate courts, as Bancorp shall determine; provided, however, that if Bancorp
directs the Employee to pay such claim and sue for a refund, Bancorp shall
advance the amount of such payment to the Employee, on an interest-free basis
and shall indemnify and hold the Employee harmless, on an after-tax basis, from
any tax (including income taxes, excise taxes under Code Section 4999, interest
and penalties with respect thereto) imposed with respect to such advance or with
respect to any imputed income with respect to such advance; and further provided
that any extension of the statute of limitations relating to payment of taxes
for the taxable year of the Employee with respect to which such contested amount
is claimed to be due is limited solely to such contested amount. Furthermore,
Bancorp's control of the contest shall be limited to issues with respect to
which a Gross-Up Amount would be payable hereunder and the Employee shall be
entitled to settle or contest, as the case may be, any other issue raised by the
Internal Revenue Service or any other taxing authority.
(f) If, after the receipt by the Employee of an amount paid or
advanced by Bancorp pursuant to Section 3(c) or Section 3(e), the Employee
becomes entitled to receive from any taxing authority a refund with respect to
such amount advanced, the Employee shall promptly pay to Bancorp the amount of
such refund (together with any interest paid or credited thereon after taxes
applicable thereto). If, after the receipt by the Employee of an amount
advanced by Bancorp pursuant to Section 3(e), a determination is made that the
Employee shall not be entitled to any refund with respect to such claim and
Bancorp does not notify the Employee in writing of its intent to contest such
5
<PAGE>
denial of refund prior to the expiration of thirty (30) days after such
determination, then such advance shall be forgiven and shall not be required to
be repaid and the amount of such advance shall offset, to the extent thereof,
the amount of Gross-Up Amount required to be paid.
4. Arbitration. In the event of a dispute regarding the terms of this
-----------
Agreement, Employee may elect, in lieu of litigation, to have the dispute
decided by arbitration. All arbitrations pursuant to this Agreement shall be
determined in accordance with the rules of the American Arbitration Association
then in effect, by a single arbitrator if the parties shall agree upon one, or
otherwise by three arbitrators, one appointed by each party, and a third
arbitrator appointed by the two arbitrators selected by the parties,
5. Term of Agreement. This Agreement shall expire at 11:59 p.m. on the
-----------------
one hundred and eightieth (180th) day following the effective date of
termination of the Employment Agreement; provided, however, that the provisions
of Sections 2, 3 and 4 of the Agreement shall survive termination of the
Agreement if a Change in Control occurs within one hundred and eighty (180) days
after the date of termination of the Employment Agreement.
6. General Matters.
---------------
(a) This Agreement shall be governed by the substantive laws of the
State of Virginia and shall be construed in accordance therewith. This
Agreement constitutes the entire agreement between the parties as to the matters
described herein and supersedes all prior 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.
(g) This Agreement shall be binding on Bancorp and any purchaser
thereof or successor thereto.
6
<PAGE>
IN TESTIMONY WHEREOF, the parties have caused this Agreement to be executed
as of the 1st day of October, 1999.
ESSEX BANCORP, INC.
By: /s/ Roscoe D. Lacy, Jr.
-----------------------
Its: Director
--------
/s/ Gene D. Ross (SEAL)
-----------------------
7
<PAGE>
EXHIBIT A
Example of Computation of Gross-Up Amount
-----------------------------------------
(For illustration purposes only)
Assumptions
- -----------
1. Excess Parachute Payment (IRC (S) 280G(b)(1)) before Gross-Up Amount is
$462,537.
2. Tax Rates are 39.6% (federal income tax), 5.75% (state income tax) and
20.0% federal excise tax under IRC (S) 4999. Total tax rate equals 65.35%
("Tax Rate").
3. No federal income tax deduction for state income tax on payments.
4. No interest or penalties.
Calculation of Gross-Up Amount
- ------------------------------
1. 20% Code Section 4999 excise tax on Golden Parachute Payments before gross-
up equals $92,507.40 ($462,537 x 20%).
2. Amount necessary to provide Employee with an additional $92,507.40
after-tax gross-up equals $92,507.40 divided by (i) one minus (ii) the Tax
Rate. Tax Rate is 65.35% under above assumptions. Therefore, Gross-Up
Amount equals (i) $92,507.40 divided by (ii) 1.0 minus 0.6535, which equals
$266,976.62 ($92,507.40).3465).
8
<PAGE>
EXHIBIT 10.25
RESTATED
CHANGE IN CONTROL AGREEMENT
This RESTATED CHANGE IN CONTROL AGREEMENT is made as of the first day
of October, 1999, by and among Essex Bancorp, Inc. ("Bancorp") and Earl
McPherson ("Employee").
WITNESSETH
WHEREAS, Employee, Bancorp and certain subsidiaries of Bancorp entered
into a Restated Executive Services Agreement dated as of January 1, 1998 (the
"Employment Agreement"), which Employment Agreement was subsequently amended;
and
WHEREAS, Bancorp and Employee also entered into a Change in Control
Agreement ("Agreement"), dated as of January 1, 1998, which Agreement has been
subsequently modified; and
WHEREAS, Bancorp and Employee desire to further
amend and restate the Agreement.
NOW, THEREFORE, in consideration of the premises and mutual covenants
set forth herein, and other good and valuable consideration, the adequacy of
which is hereby acknowledged, Bancorp and Employee hereby amend and restate the
Agreement to read in its entirety as follows:
1. Change in Control Payment.
-------------------------
(a) Subject to reduction under Section 1(d) and Section 2 below,
Bancorp shall provide Employee with the following payments and benefits
(collectively "Change in Control Payment") in the event a Change in Control (as
defined in Section 1(b) below) occurs while Employee is employed by Bancorp or
occurs within one hundred and eighty (180) days after the effective date of: (i)
termination of Employee by Bancorp without "Cause" ( as defined in the
Employment Agreement), (ii) Employee's resignation for "Just Cause" ( as defined
in the Employment Agreement), or (iii) non-renewal of the Employment Agreement
as a result of Bancorp's refusal without "Cause" to extend the term thereof.
The Change in Control Payment shall consist of the following three components:
(1) Bancorp shall pay to the Employee in a lump sum within thirty (30)
days of the Change in Control an amount equal to two hundred percent (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;
(2) Bancorp shall pay to Employee an additional $113,949 if the
Change in Control occurs before October 1, 2000; and
1
<PAGE>
EXHIBIT 10.25
(3) If Employee is still employed by Bancorp on the date of the Change
in Control, Bancorp shall 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. Such coverage shall be of the same type and amount as
was in effect immediately prior to the Change in Control, or as is later
provided to Bancorp's employees generally, with Employee to pay for that portion
of the cost of continuing coverage, if any, charged to other continuing
employees of the Employer with comparable coverage.
(b) For purposes of this Agreement, a "Change in Control" shall occur
if and only if after October 1, 1999 a "person" or "group" (as such term is used
in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934), directly or
indirectly, first becomes the "beneficial owner" (as defined in Rule 13d-3 under
the Securities Exchange Act of 1934) of securities of Bancorp representing
twenty-five percent (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 October 1, 1999; (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).
(c) Any provision herein to the contrary notwithstanding, no Change in
Control Payments under Section 1(a) shall be owed to Employee if Employee is
terminated by Bancorp for "Cause" (as defined under the Employment Agreement) or
Employee resigns without "Just Cause" (as defined in the Employment Agreement)
prior to the date of a Change in Control. Bancorp shall be obligated for the
Change in Control Payment only if Employee is still employed by Bancorp on the
date of the Change in Control or if Employee's employment with Bancorp ceased
within one hundred and eighty (180) days prior to the Change in Control on
account of termination without "Cause" by Bancorp, resignation by Employee with
"Just Cause" or non-renewal of the Employee's Employment Agreement by Bancorp
without "Cause."
(d) Any provision herein to the contrary notwithstanding, the Change
in Control Payment otherwise due under this Section 1 shall be reduced by any
severance payment or severance benefit made to Employee under the Employment
Agreement as a result of his termination prior to a Change in Control. Once a
Change in Control occurs which triggers Employee's entitlement to a Change in
Control Payment, no subsequent Change in Control shall entitle Employee to a
second Change in Control Payment.
2. Limitation on Change in Control Payment.
---------------------------------------
(a) It is intended that all amounts payable hereunder, together with
all other amounts payable to Employee upon or in connection with a Change in
2
<PAGE>
EXHIBIT 10.25
Control, are reasonable compensation for Employee's service to Bancorp and its
subsidiaries. Notwithstanding the foregoing, should Bancorp determine, based
upon the opinion of the independent accounting advisors of Bancorp immediately
prior to the Change in Control ("Accounting Firm"), that any or all of the
Change in Control Payment provided under this Agreement, together with any other
amounts received by Employee that must be included in such determination, would
result in the payment of an "excess parachute payment" as defined in Section
280G of the Internal Revenue Code of 1986, as amended (the "Code"), then Bancorp
will reduce the amount otherwise due and owing to Employee under this Agreement
to the maximum amount that would permit a determination that Employee has not
received an excess parachute payment under Code Section 4999 if, and only if,
the amount of such reduction does not exceed Ten Thousand Dollars ($10,000). If
the amount of reduction necessary to avoid "excess parachute payment" treatment
would exceed Ten Thousand Dollars ($10,000), no reduction shall be made and the
provisions of Section 3 below shall instead apply.
(b) Bancorp may reduce the Change in Control Payments pursuant to this
Section 2(a) only if within sixty (60) days of a Change in Control it provides
Employee with an opinion of the Accounting Firm that Employee will be considered
to have received "excess parachute payments" as defined in Code Section 280G if
he were to receive the full amounts owing pursuant to this Agreement and all
other amounts owed to him by Bancorp. Such opinion shall be based upon the
proposed regulations under Code Sections 280G and 4999 or substantial authority
within the meaning of Code Section 6661, and shall set forth with particularity
the smallest amount by which the payment due Employee hereunder would have to be
reduced to avoid the imposition of any excise tax or the denial of any deduction
pursuant to Code Sections 280G and 4999 and shall demonstrate the relation of
such amount to the amounts set forth in Section 2(a) above. Employee shall, if
he agrees with the determination of Bancorp, notify Bancorp in writing of the
payments and/or benefits that he wishes to have reduced in order to comply with
the provisions of this Section 2. In the event that Employee fails to designate
an order of priority for the application of any such reduction, such reduction
shall be made in the order of priority determined by Bancorp. In the event that
Employee does not agree with the opinion or calculation presented and he is
unable to resolve any dispute with Bancorp regarding such disagreement within a
period of thirty (30) days of receipt of the opinion referenced above, Employee
may submit the resolution of this matter to arbitration pursuant to Section 4
below or take such other steps as he may deem advisable to enforce his position.
3. Gross-Up Amount.
----------------
(a) In addition to the Change in Control Payment described in Section
1 above, Bancorp shall pay to Employee an amount (the "Gross-Up Amount") equal
to the excise tax under Section 4999 of the Code, if any, incurred by Employee
on the payments and benefits owed under this Agreement, and/or under all other
plans, agreements or understandings between Employee and Bancorp (collectively
"Golden Parachute Payments") constituting excess parachute payments under Code
Section 280G, plus all excise taxes and federal, state and local income taxes
3
<PAGE>
EXHIBIT 10.25
incurred by Employee with respect to receipt of the Gross-Up Amount. The parties
intend that the Gross-Up Amount be in an amount such that after payment by the
Employee of all taxes (including income taxes, excise taxes under Code Section
4999 interest and penalties), imposed upon the Gross-Up Amount, the Employee
will retain a portion of the Gross-Up Amount equal to the Code Section 4999
excise tax imposed on the Golden Parachute Payments. Attached hereto as Exhibit
A is an example of the computation of the Gross-Up Amount.
(b) All determinations required to be made under this Section 3,
including whether a Gross-Up Payment is required and the amount of any Gross-Up
Amount, shall be made by the Accounting Firm, which shall provide detailed
support calculations to Bancorp and Employee. In computing taxes, the
Accounting Firm shall use the highest marginal federal, state and local income
tax rates applicable to the Employee and shall assume the full deductibility of
state and local income taxes for purposes of computing federal income tax
liability, unless the Employee demonstrates that the will not in fact be
entitled to such a deduction for the year of payment.
(c) The Gross-Up Amount, computed assuming all of the Golden Parachute
Payments constitute "excess parachute payments" as defined in Code Section 280G,
shall be paid to the Employee with the Change in Control Payment (or as soon
thereafter as is practicable) unless Bancorp at the same time as the payment of
the Change in Control Payment provides the Employee with an opinion of the
Accounting Firm that Employee will not incur an excise tax on part or all of the
Golden Parachute Payments. Any such opinion shall be based upon the proposed
regulations under Code Sections 280G and 4999 or substantial authority within
the meaning of Code Section 6661. If such opinion applies only to part of the
Golden Parachute Payment, Bancorp shall pay Employee the Gross-Up Amount with
respect to that part of the Golden Parachute Payment not covered by the opinion.
(d) The Gross-Up Amount shall be subject to adjustment so as to avoid
either an overpayment or underpayment of the Gross-Up Amount to Employee. As a
result of the uncertainty in the application of Section 4999 of the Code at the
time of the initial determination by the Accounting Firm hereunder, it is
possible that Gross-Up Amounts which should have been paid by Bancorp will not
have been paid ("Underpayment"), consistent with the calculations required to be
made hereunder. In the event that Bancorp exhausts its remedies pursuant to
Section 3(e) below and the Employee thereafter is required to make a payment of
any additional excise tax under Code Section 4999, the Accounting Firm shall
determine the amount of the Underpayment that has occurred and any such
Underpayment shall be promptly paid by Bancorp to or for the benefit of the
Employee.
(e) The Employee shall notify Bancorp in writing of any claim by the
Internal Revenue Service that, if successful, would require the payment by
Bancorp of an addition Gross-Up Amount. Such notification shall be given as
soon as practicable but no later than ten (10) business days after the Employee
knows of such claim and shall apprise Bancorp of the nature of such claim and
the date on which such claim is requested to be paid. The Employee shall not
pay such claim prior to the expiration of the thirty (30) day period following
the date on which he gives such notice to Bancorp (or such shorter period ending
on the date that any payment of taxes with respect to such claim is due). If
4
<PAGE>
EXHIBIT 10.25
Bancorp notifies the Employee in writing prior to the expiration of such period
that it desires to contest such claim, the Employee shall:
(1) Give Bancorp any information reasonably requested by
Bancorp relating to such claim,
(2) Take such action in connection with contesting such claim as
Bancorp shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such claim by
an attorney reasonably selected by Bancorp,
(3) Cooperate with Bancorp in good faith in order effectively to
contest such claim, and
(4) Permit Bancorp to participate in any proceedings relating to such
claim; provided, however, that Bancorp shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Employee harmless, on an
after-tax basis, for any tax (including income taxes, excise tax under Code
Section 4999, interest and penalties with respect thereto), imposed as a result
of such representation and payment of costs and expenses. Without limitation on
the foregoing provisions of this Section 3(e), Bancorp shall control all
proceedings taken in connection with such contest and, at its sole option, may
pursue or forego any and all administrative appeals, proceedings, hearings and
conferences with the taxing authority in respect of such claim and may, at its
sole option, either direct the Employee to pay the tax claimed and sue for a
refund or contest the claim in any permissible manner, and the Employee agrees
to prosecute such contest to a determination before any administrative tribunal,
in a court of initial jurisdiction and in one or more appellate courts, as
Bancorp shall determine; provided, however, that if Bancorp directs the Employee
to pay such claim and sue for a refund, Bancorp shall advance the amount of such
payment to the Employee, on an interest-free basis and shall indemnify and hold
the Employee harmless, on an after-tax basis, from any tax (including income
taxes, excise taxes under Code Section 4999, interest and penalties with respect
thereto) imposed with respect to such advance or with respect to any imputed
income with respect to such advance; and further provided that any extension of
the statute of limitations relating to payment of taxes for the taxable year of
the Employee with respect to which such contested amount is claimed to be due is
limited solely to such contested amount. Furthermore, Bancorp's control of the
contest shall be limited to issues with respect to which a Gross-Up Amount would
be payable hereunder and the Employee shall be entitled to settle or contest, as
the case may be, any other issue raised by the Internal Revenue Service or any
other taxing authority.
(f) If, after the receipt by the Employee of an amount paid or
advanced by Bancorp pursuant to Section 3(c) or Section 3(e), the Employee
becomes entitled to receive from any taxing authority a refund with respect to
such amount advanced, the Employee shall promptly pay to Bancorp the amount of
5
<PAGE>
EXHIBIT 10.25
such refund (together with any interest paid or credited thereon after taxes
applicable thereto). If, after the receipt by the Employee of an amount
advanced by Bancorp pursuant to Section 3(e), a determination is made that the
Employee shall not be entitled to any refund with respect to such claim and
Bancorp does not notify the Employee in writing of its intent to contest such
denial of refund prior to the expiration of thirty (30) days after such
determination, then such advance shall be forgiven and shall not be required to
be repaid and the amount of such advance shall offset, to the extent thereof,
the amount of Gross-Up Amount required to be paid.
4. Arbitration. In the event of a dispute regarding the terms of
his Agreement, Employee may elect, in lieu of litigation, to have the dispute
decided by arbitration. All arbitrations pursuant to this Agreement shall be
determined in accordance with the rules of the American Arbitration Association
then in effect, by a single arbitrator if the parties shall agree upon one, or
otherwise by three arbitrators, one appointed by each party, and a third
arbitrator appointed by the two arbitrators selected by the parties,
5. Term of Agreement. This Agreement shall expire at 11:59 p.m. on
the one hundred and eightieth (180th) day following the effective date of
termination of the Employment Agreement; provided, however, that the provisions
of Sections 2, 3 and 4 of the Agreement shall survive termination of the
Agreement if a Change in Control occurs within one hundred and eighty (180) days
after the date of termination of the Employment Agreement.
6. General Matters.
(a) This Agreement shall be governed by the substantive laws of the
State of Virginia and shall be construed in accordance therewith. This
Agreement constitutes the entire agreement between the parties as to the matters
described herein and supersedes all prior 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.
6
<PAGE>
EXHIBIT 10.25
(g) This Agreement shall be binding on Bancorp and any purchaser
thereof or successor thereto.
IN TESTIMONY WHEREOF, the parties have caused
this Agreement to be executed as of the 22nd day of November, 1999.
ESSEX BANCORP, INC.
By: /s/ Gene D. Ross
----------------
Its: President
----------------
/s/ Earl McPherson (SEAL)
-----------------
7
<PAGE>
EXHIBIT 10.25
EXHIBIT A
Example of Computation of Gross-Up Amount
-----------------------------------------
(For illustration purposes only)
Assumptions
- -----------
1. Excess Parachute Payment (IRC (S) 280G(b)(1)) before Gross-Up Amount is
$50,000.
2. Tax Rates are 39.6% (federal income tax), 5.75% (state income tax) and
20.0% federal excise tax under IRC (S) 4999. Total tax rate equals 65.35%
("Tax Rate").
3. No federal income tax deduction for state income tax on payments.
4. No interest or penalties.
Calculation of Gross-Up Amount
- ------------------------------
1. 20% Code Section 4999 excise tax on Golden Parachute Payments before gross-
up equals $10,000.00 ($50,000 x 20%).
2. Amount necessary to provide Employee with an additional $10,000.00 after-
tax gross-up equals $10,000.00 divided by (i) one minus (ii) the Tax Rate.
Tax Rate is 65.35% under above assumptions. Therefore, Gross-Up Amount
equals (i) $10,000.00 divided by (ii) 1.0 minus 0.6535, which equals
$28,860.03 ($10,000.00 ) .3465).
8
<PAGE>
EXHIBIT 11
COMPUTATION OF PER SHARE EARNINGS
Quarterly Unaudited Computation of Per Share Earnings
<TABLE>
<CAPTION>
Year Ended December 31, 1999
--------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Net income $ 30 $ 106 $ 608 $1,416
Preferred stock dividends (475) (482) (491) (511)
------ ------ ------ ------
Net (loss) income available
to common shareholders $ (445) $ (376) $ 117 $ 905
====== ====== ====== ======
Weighted average common
shares outstanding:
Basic 1,061 1,061 1,061 1,061
Diluted 1,061 1,061 5,094 4,129
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31, 1998
------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C>
Net income $ 98 $ 137 $ 129 $ 648
Preferred stock dividends (433) (441) (450) (466)
------ ------ ------ ------
Net (loss) income available
to common shareholders $ (335) $ (304) $ (321) $ 182
====== ====== ====== ======
Weighted average common
shares outstanding:
Basic 1,058 1,059 1,059 1,060
Diluted 1,058 1,059 1,059 5,030
</TABLE>
1
<PAGE>
EXHIBIT 13
ESSEX
BANCORP, INC.
1999 ANNUAL REPORT
<PAGE>
ESSEX
BANCORP, INC.
Table of Contents
<TABLE>
<CAPTION>
Page
--------
<S> <C>
Message to Our Stockholders 1
Five Year Financial Summary 4
Management's Discussion and Analysis 5
Report of Independent Accountants 23
Consolidated Financial Statements 24
Notes to Consolidated Financial Statements 30
Investor Information 51
Directors and Officers 52
Corporate Information 53
</TABLE>
<PAGE>
ESSEX
BANCORP, INC.
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
I am pleased to announce that Essex Bancorp, Inc. ("Essex") achieved a net
income of $2.2 million for the fiscal year ending December 31, 1999, which
includes the recognition of a portion of the tax benefits associated with
historical losses. Recognition of these tax benefits is a reflection of the
increasing trend in core profitability and favorable expectations of income in
the near term. We are pleased with the development, but we will not be satisfied
until Essex is recognized as a high performance financial institution when
compared with similar-type franchises and our profitability consistently exceeds
the annual dividends on our preferred stock.
Today, we believe Essex has the strongest balance sheet in its history. During
1999, Essex improved fundamentals in several areas. For example, (i) total
assets increased by approximately 20.2% from 1998 to $277.7 million at December
31, 1999, (ii) total deposits increased approximately 13.1% from 1998 to $212.2
million at December 31, 1999, (iii) non-performing assets declined by
approximately 27.5% to a ratio to total assets of .48% - the lowest in Essex's
history, (iv) loan loss coverage, expressed as the ratio of the allowance for
loan losses to non-performing loans, increased 25.3% from the end of 1998 to
182.9% at December 31, 1999 and (v) servicing levels for non-affiliates have
reached historical highs of 15,300 loans with unpaid principal balances totaling
$1.5 billion at December 31, 1999. Further, Essex's regulatory relationship and
overall risk profile has strengthened and improved yet again in 1999. Mid-year,
Essex completed the simplification of its organization structure. As a result,
Essex directly owns just one subsidiary, Essex Savings Bank, F.S.B., which also
1
<PAGE>
operates a mortgage loan origination division and owns two subsidiaries, a
mortgage loan servicing operation and a title agency. This structure is
extremely simple to understand, operate and communicate to those parties with
whom we do business. I encourage you to read the Management's Discussion and
Analysis of Financial Condition and Results of Operations, in order to enhance
your understanding of Essex's overall performance and its major lines-of-
business in 1999.
In 1999, the company diverted a considerable amount of management time to
ensuring that the Year 2000 transition went smoothly. Based on the extensive
testing following January 1, 2000, Essex was very successful in its three-year
effort to prepare for the Year 2000 date change. We noted no significant
problems for any of our systems, which operated normally through the century and
the leap year date changes.
As we enter fiscal year 2000, we have never been more optimistic about our
future or more excited about our prospects for building shareholder value. While
we have made great strides in transitioning to community-services banking, we
must remain competitive and responsive to our customers' needs. That means
knowing our customers, anticipating their needs and increasing the efficiency
with which we deliver our products and services. We are currently directing our
efforts toward evaluating cost effective ways to utilize technology, such as the
Internet, to promote and deliver more products and services to our customers. In
addition, we have made substantial progress toward the projected opening of a
new full service branch in Ashland, Virginia in May. We are excited about this
market, as we have already established a presence in the Richmond, Virginia area
through our retail deposit products and our builder construction loan
relationships in our existing Richmond branch.
As always, we are faced with many challenges. We are addressing the predominant
trends affecting our businesses and the markets in which we operate, the
continuing convergence in the financial services industry, and the growing use
of the Internet and e-commerce. The recent increase in interest rates is already
2
<PAGE>
putting pressure on our net interest margin and our ability to attract funds in
order to continue to leverage our capital through balance sheet growth. The
progress we are making in emphasizing fee income should mitigate much of the
impact of rising interest rates.
I would like to thank our directors, officers and employees for their efforts in
making this a most successful year in Essex's history. We all look forward with
great anticipation to next year's opportunities.
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 30, 2000
3
<PAGE>
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
1999 1998 1997 1996 1995
-------- -------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets ................ $ 277,739 $ 231,040 $ 195,088 $ 174,267 $ 338,724
Net loans ................... 238,882 192,668 167,441 145,551 266,632
Deposits .................... 212,209 187,632 153,927 131,033 283,497
Federal Home Loan Bank
advances .................. 44,600 24,908 23,547 25,690 29,833
Notes payable ............... -- -- 72 96 120
Shareholders' equity ........ 17,995 15,835 14,817 15,106 22,630
Nonperforming assets ........ 1,330 1,835 3,298 5,215 11,257
Allowance for loan losses ... 1,697 1,845 2,382 2,556 5,251
OPERATIONS DATA:
Interest income ............. $ 17,458 $ 15,430 $ 14,547 $ 19,872 $ 22,547
Interest expense ............ 11,184 9,778 9,230 13,764 16,627
Net interest income ......... 6,274 5,652 5,317 6,108 5,920
Provision for loan losses ... 149 13 113 1,411 2,477
Noninterest income .......... 3,331 2,713 2,463 4,282 3,172
Noninterest expense:
Amortization ............... 587 503 531 7,011 956
Other ...................... 8,098 7,354 7,433 9,345 9,814
Income (loss) before
extraordinary
items and income taxes ..... 771 495 (297) (7,377) (4,155)
Extraordinary items, net
of tax ..................... -- -- -- -- 2,945(1)
Benefit from income taxes ... 1,389 518 -- -- --
Net income (loss) ........... 2,160 1,013 (297) (7,377) (1,210)
Net income (loss)
available to
common stockholders ........ 202 (777) (1,932) (8,824) (1,578)
Net income (loss) per
common share:
Basic ...................... .19 (.73) (1.83) (8.39) (1.50)
Diluted .................... .07 (.73) (1.83) (8.39) (1.50)
OTHER DATA:
Return on average
assets ..................... .87% .49% (.16)% (2.73)% (.39)%(1)
Return on average
capital .................... 13.28% 6.71% (1.96)% (39.51)% (10.59)%
Average capital to
average assets ............ 6.55% 7.28% 8.13% 6.92% 3.67%
Net interest spread ......... 2.29% 2.54% 2.69% 2.20% 2.00%
Net interest margin ......... 2.71% 2.93% 3.01% 2.41% 2.01%
Nonperforming assets
as a percent of total
assets at end of year ...... .48% .79% 1.69% 2.99% 3.32%
Allowance for loan
losses as a percent
of total loans at end
of year .................... .71% .95% 1.40% 1.73% 1.93%
Net charge-offs as a
percent of average
total loans ................ .14% .32% .18% 1.89% .46%
Retail banking offices ...... 4 4 4 4 12
</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.
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
Mortgage ("Essex First"), a division of the Bank, that engages principally in
the origination and sale of residential mortgage loans, as well as the
origination of residential construction loans to individuals and builders. The
Company's other principal operating subsidiary is Essex Home Mortgage Servicing
Corporation ("Essex Home"), a wholly-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.
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, 1999 were $277.7
million as compared to $231.0 million at December 31, 1998, an increase of
approximately $46.7 million or 20.2%. The predominant factor contributing to
the increase in total assets was the growth in loans held for investment, which
increased $46.2 million or 24.0%. This growth resulted from (i) secondary market
purchases of residential first mortgage loans in order to replenish this segment
of the portfolio, which experienced significant accelerated prepayments during
the first half of 1999 as a result of the lower interest rate environment and
(ii) the purchase of construction loan participations and consumer loans in
order to improve the Company's net interest margin over the long-term partially
through higher-yielding and adjustable-rate assets. The increase in loans held
for investment was funded through deposit growth and an increase in borrowings
from the Federal Home Loan Bank ("FHLB").
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 $1.0 million or 5.6% during
1999 as a result of the Company's Year 2000 liquidity management plan, which
provided for excess liquidity in anticipation of stronger customer demand for
cash during the Year 2000 rollover.
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, FHLB stock
and mutual fund investments. During the year ended December 31, 1999,
investment securities increased $682,000 or 15.8%. The increase during 1999 was
attributable to the purchase of $681,000 of FHLB stock in order to satisfy the
minimum investment requirements for FHLB membership, which increased because of
the growth in FHLB advances in 1999.
5
<PAGE>
Mortgage-Backed Securities. During the year ended December 31, 1999,
mortgage-backed securities decreased $976,000 or 67.0% as a result of the impact
of the lower interest rate environment during the first half of 1999 on
prepayments of the underlying mortgage loans. 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 1999.
Loans. Net loans (including loans classified as held for sale) increased
by $42.6 million or 21.6% during 1999 resulting from secondary market purchases
of first mortgage loan portfolios totaling $31.3 million and fixed-rate home
improvement loans totaling $7.2 million. In addition, the Company expanded its
builder construction loan program through the acquisition of participations in
such loans from nonaffiliated financial institutions. During the year ended
December 31, 1999, the Company's construction loan participations increased
$20.8 million. Acquisition of these participations is strategically designed to
draw upon the construction lending expertise at the Bank. Increases in these
segments of the loan portfolio were partially offset by a $3.6 million decline
in loans held for sale as customer demand has declined during the recent trend
of rising interest rates.
Nonperforming Assets. The Company's nonperforming assets, net of specific
reserves for collateral-dependent real estate loans ("CDRELs") and foreclosed
properties, decreased from $1.8 million at December 31, 1998 to $1.3 million at
December 31, 1999, and consisted of the following (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
-------------- --------------
% of % of
Total Total
Amount Loans Amount Loans
------ ------ ------ ------
<S> <C> <C> <C> <C>
Nonaccrual loans, net:
First and second mortgages.............. $ 350 .14% $ 697 .36%
Commercial.............................. 377 .16 328 .17
Consumer................................ 157 .07 141 .07
Accruing loans 90 days or more past due.. - - - -
Troubled debt restructurings............. - - 98 .05
------ --- ------ ---
Total nonperforming loans............. 884 .37 1,264 .65
Foreclosed properties, net............... 446 .19 571 .29
------ --- ------ ---
Total nonperforming assets............ $1,330 .56% $1,835 .94%
====== === ====== ===
Nonperforming assets to total assets..... .48% .79%
Nonperforming loans to total loans....... .37 .65
Allowance for loan losses to
total loans............................. .71 .95
Allowance for loan losses to
nonaccrual loans........................ 182.88 158.23
Allowance for loan losses to
nonperforming loans..................... 182.88 145.97
</TABLE>
The decrease in nonperforming assets consisted of a $380,000 decline in
nonperforming loans and a $125,000 decline in foreclosed properties. Gross
interest income that would have been recognized for the years ended December 31,
1999, 1998 and 1997 if nonaccrual loans at the respective dates had been
performing in accordance with their original terms approximated $70,000,
$115,000 and $171,000, 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 loans during 1999. The $446,000 of
foreclosed properties included in nonperforming assets at December 31, 1999 is
reported net of related reserves totaling $34,000. In addition, approximately
6
<PAGE>
$294,000 of losses and write-downs have been previously recognized on foreclosed
properties held at December 31, 1999.
The following table sets forth the types of properties that comprise the
Company's foreclosed properties (net of related reserves) at December 31 (in
thousands):
<TABLE>
<CAPTION>
1999 1998
----- -----
<S> <C> <C>
Single-family residential real estate $ 361 $ 486
Land and subdivisions 85 85
----- -----
$ 446 $ 571
===== =====
</TABLE>
In addition to the $1.3 million of nonperforming assets at December 31,
1999, the Company had classified for regulatory purposes an additional $1.4
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
$1.8 million of nonperforming assets and $1.6 million of classified assets at
December 31, 1998. 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. During the fourth quarter of
1999, 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, 1999 and
1998, the Company reported $2.0 million and $831,000, respectively, of purchased
and originated mortgage servicing rights (collectively, "MSRs") and $742,000 and
$951,000, respectively, of capitalized loan premiums. The impact of secondary
market purchases during 1999 on loan premiums was generally neutral with
premiums paid on the higher-yielding consumer loan portfolios significantly
offsetting the discounts on the lower-yielding residential loan portfolios.
However, loan premiums declined during 1999 because the lower interest rate
environment precipitated an acceleration of the prepayment of the underlying
mortgages, resulting in premium impairments totaling $156,000 in 1999. The
increase in MSRs was attributable to purchases of servicing rights during 1999
for 1,920 loans with unpaid principal balances totaling $159.6 million, which
will enhance the Company's fee income in the form of servicing fees, late
charges, insurance commissions and administrative fees. 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, 1999, 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.
Deposits. Deposits, the primary source of the Company's funds, increased
by $24.6 million or 13.1% during the year ended December 31, 1999. The increase
in deposits was attributable to (i) a $2.8 million increase in noninterest-
bearing accounts largely because of the increase in Essex Home's servicing
escrow accounts maintained at the Bank and (ii) a $14.3 million increase in
certificates of deposit and a $6.4 million increase in money market accounts
predominantly at the Suffolk and Richmond, Virginia branches, which experienced
total deposit growth of 35.6% and 17.1%, respectively.
7
<PAGE>
Borrowings. The Company's borrowings consist primarily of advances from
the FHLB. FHLB advances increased by $19.7 million or 79.1% during the year
ended December 31, 1999. At December 31, 1999, the unused lendable collateral
value for additional FHLB advances was $17.3 million.
Shareholders' Equity. Total shareholders' equity at December 31, 1999 was
$18.0 million, an increase of $2.2 million from shareholders' equity of $15.8
million at December 31, 1998. This change reflects the Company's net income of
$2.2 million for the year ended December 31, 1999, which is further described
under Results of Operations.
As part of the Bank's acquisition of Home Bancorp, Inc. ("Home Bancorp")
and its wholly-owned subsidiary Home Savings Bank, F.S.B. on September 15, 1995
(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 $7.2 million at December 31, 1999. Because the Company's income
has not been 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 may continue to be affected. Accordingly, the Company's Board of
Directors and its Strategic Evaluation Committee continue to evaluate
profitability enhancements and possibilities for corporate restructuring.
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) the Bank attracting
deposits from the general public and using such deposits, together with
borrowings in the form of advances from the FHLB, for reinvestment in real
estate mortgages, other loans and investments, (ii) the origination by Essex
First of (a) real estate mortgage loans for sale to third parties predominantly
on a servicing-released basis in order to generate higher fee income and (b)
residential construction loans to individuals and builders in order to generate
interest revenue and (iii) the servicing of mortgage loans by Essex Home in
order to generate fee income. As of December 31, 1999, Essex Home serviced
approximately 15,300 loans with unpaid principal balances totaling $1.5 billion
for nonaffiliated servicing clients. For additional segment information, refer
to Note 19 of the Notes to Consolidated Financial Statements.
General. The Company's net income for the year ended December 31, 1999
totaled $2.2 million, compared to net income of $1.0 million for the year ended
December 31, 1998 and a net loss of $297,000 for the year ended December 31,
1997.
The Company's net income for the year ended December 31, 1999 included a
$1.4 million tax benefit, as compared to a $518,000 tax benefit in 1998,
reflecting the recognition of $1.85 million in 1999 and $550,000 in 1998 of the
Company's net operating tax loss ("NOL") carryforwards. The recognition of
8
<PAGE>
these NOL benefits was made possible by the Company's return to and projected
maintenance of core profitability. On a pre-tax basis, the Company had
consolidated earnings of $771,000 for the year ended December 31, 1999 as
compared to $495,000 for the year ended December 31, 1998. The Company's 1999
overall results reflected increases in (i) net interest income resulting from an
increase in interest-earning assets, the benefit of which was partially offset
by the impact of changes in interest rates on its net income margin, (ii) the
provision for loan losses based on management's assessment of the allowance for
loan losses in relation to growth in the loan portfolio, (iii) loan servicing
fees resulting from a 43% increase during 1999 in the unpaid principal balance
of Essex Home's mortgage loan servicing portfolio, (iv) other noninterest income
resulting from service charges and fees on the higher servicing volume at Essex
Home and (v) noninterest expenses associated with the increase in the Company's
loan servicing volumes and deposit levels. In addition, the Company's mortgage
banking income declined during 1999 because of the negative impact of rising
interest rates during 1999 on the volume of residential mortgage loan
originations.
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 NOL carryforwards. 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.
Net Interest Income. Net interest income totaled $6.3 million, $5.7
million and $5.3 million for the years ended December 31, 1999, 1998 and 1997,
respectively. In addition, the net interest margin was 2.71%, 2.93% and 3.01%
for the years ended December 31, 1999, 1998 and 1997, respectively.
The increase in net interest income from 1998 to 1999 reflected the
favorable impact of an 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 most of
1999. However, the Company's net interest margin continued to decline in 1999
because the lower interest rate environment, in particular during 1998 and the
first half of 1999, continued to result in significant refinancings to lower
fixed rate loans, rate decreases on adjustable-rate mortgages and secondary
market purchases of residential loans 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, as occurred throughout 1998 and the first half of 1999, the
Company experiences an increase in the volume of refinancings to lower fixed-
rate loans. The Company continued to emphasize investment in adjustable-rate
loan portfolios, but customer demand shifted to fixed-rate loans during this
period. Accordingly, within the residential loan product line offered by the
Bank, the percentage of balloon payment and adjustable-rate loans with longer
9
<PAGE>
initial adjustment terms has increased. While the Company will continue to
emphasize the origination and secondary market purchase of residential first
mortgage loans, it has expanded its loan growth focus to construction and
consumer loans, which are generally higher yielding and more interest rate
sensitive than residential loans.
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.
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.
[intentionally blank]
10
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
--------------------------- --------------------------- ---------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- ------- -------- -------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)................................ $215,897 $16,645 7.71% $178,078 $14,608 8.20% $159,370 $13,588 8.53%
Investment securities.................... 4,523 259 5.74 3,902 226 5.79 6,457 354 5.48
Mortgage-backed securities............... 798 46 5.77 1,871 122 6.50 1,905 124 6.54
Federal funds sold and securities
purchased under agreements
to resell............................... 1,365 67 4.90 2,069 111 5.37 2,757 151 5.48
Other.................................... 8,888 441 4.96 6,835 363 5.29 6,024 330 5.48
-------- ------- -------- ------- -------- -------
Total interest-earning assets.......... 231,471 17,458 7.54 192,755 15,430 8.00 176,513 14,547 8.24
Cash....................................... 5,850 4,615 2,065
Other, less allowance for loan losses...... 11,041 9,866 7,831
------- ------- -----
Total assets............................. $248,362 $207,236 $186,409
======== ======== ========
Interest-bearing liabilities:
Time deposits............................ $140,648 7,651 5.44% $121,752 6,904 5.67% $111,394 6,381 5.73%
Other deposits........................... 43,731 1,907 4.36 35,431 1,587 4.48 29,584 1,298 4.39
-------- ------- -------- ------- -------- -------
Total deposits......................... 184,379 9,558 5.18 157,183 8,491 5.40 140,978 7,679 5.45
Notes payable............................ - - - 8 1 9.32 96 9 9.50
FHLB advances............................ 29,233 1,583 5.42 21,553 1,230 5.71 24,885 1,474 5.92
Other.................................... 231 43 18.46 303 56 18.30 360 68 18.29
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities........................... 213,843 11,184 5.25 179,047 9,778 5.46 166,319 9,230 5.55
------- ------- -------
Demand deposits............................ 16,691 9,504 3,143
Other...................................... 1,566 3,589 1,795
-------- -------- --------
Total liabilities........................ 232,100 192,140 171,257
Shareholders' equity....................... 16,262 15,096 15,152
-------- -------- --------
Total liabilities and
shareholders' equity................... $248,362 $207,236 $186,409
======== ======== ========
Net interest earnings...................... $ 6,274 $ 5,652 $ 5,317
======= ======= =======
Net interest spread........................ 2.29% 2.54% 2.69%
===== ===== =====
Net interest margin (2).................... 2.71% 2.93% 3.01%
===== ===== =====
Average interest-earning assets
to average interest-bearing
liabilities.............................. 108.24% 107.66% 106.13%
======= ======= =======
</TABLE>
(1) Nonaccrual loans and loans classified as held for sale are included in the
average balance of loans.
(2) 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
1998 to 1999 Due to 1997 to 1998 Due to
------------------------------- ---------------------------
Rate Volume Net Rate Volume Net
--------- ---------- -------- -------- -------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans (1) $(920) $2,957 $2,037 $(529) $1,549 1,020
Investment securities (2) 35 33 19 (147) (128)
Mortgage-backed securities (13) (63) (76) - (2) (2)
Federal funds sold and securities
purchased under agreements
to resell (9) (35) (44) (3) (37) (40)
Other interest-earning assets (24) 102 78 (11) 44 33
------ ------ ------ ----- ------ ------
Total interest income (2) (968) 2,996 2,028 (524) 1,407 883
----- ------ ------ ----- ------ ------
Interest expense on:
Time deposits (290) 1,037 747 (65) 588 523
Other deposits (43) 363 320 27 262 289
Notes payable - (1) (1) - (8) (8)
FHLB advances (65) 418 353 (53) (191) (244)
Other interest-bearing
liabilities - (13) (13) - (12) (12)
----- ------ ------ ----- ------ ------
Total interest expense (398) 1,804 1,406 (91) 639 548
----- ------ ------ ----- ------ ------
Net interest income $(570) $1,192 $ 622 $(433) $ 768 $ 335
===== ====== ====== ===== ====== ======
</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, 1999, 1998 and 1997, provisions for loan
losses amounted to $149,000, $13,000 and $113,000, respectively. At December
31, 1999, total nonperforming assets as a percentage of total assets were .48%
as compared to .79% at December 31, 1998. In addition, nonperforming assets
totaled $1.3 million at December 31, 1999 as compared to $1.8 million at
December 31, 1998. Loan loss reserve coverage, expressed as the ratio of the
allowance for loan losses to nonperforming loans, increased from 145.97% as of
December 31, 1998 to 182.88% as of December 31, 1999. Notwithstanding these
favorable trends in nonperforming assets, management's assessment of the
allowance for loan losses in relation to growth in the loan portfolio during
1999 resulted in a $149,000 provision for loan losses. During the year ended
12
<PAGE>
December 31, 1998, management considered the loan loss allowance, which
benefited from a $329,000 recovery on a loan guarantee at the end of 1997,
sufficient to absorb losses and provided for minimal additional losses during
the year ended December 31, 1998.
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. Upon the
completion of its safety and soundness examination during the fourth quarter of
1999, 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>
1999 1998 1997
---------- ---------- -----------
<S> <C> <C> <C>
Loan servicing fees............. $1,620,919 $1,222,478 $1,312,476
Mortgage banking income......... 499,886 755,450 458,520
Other service charges and fees.. 611,621 466,135 368,671
Net loss on sales of loans...... - - (1,458)
Other........................... 598,399 268,890 324,596
---------- ---------- ----------
$3,330,825 $2,712,953 $2,462,805
========== ========== ==========
</TABLE>
Noninterest income during the year ended December 31, 1999 totaled
$3.3 million, a $618,000 or 22.8% increase over $2.7 million during the year
ended December 31, 1998. This increase was primarily attributable to increases
in loan servicing fees, other service charges and fees and other noninterest
income because of the increase in Essex Home's nonaffiliated mortgage loan
servicing portfolio from 12,200 loans totaling $1.1 billion as of December 31,
1998 to 15,300 loans totaling $1.5 billion as of December 31, 1999. These
increases were partially offset by a decline in mortgage banking income, which
occurred primarily in the last half of 1999 as the volume of originations of
residential mortgage loans to be sold in the secondary market diminished because
of rising interest rates.
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
increases in (i) mortgage banking income resulting from the impact of the lower
interest rate environment in 1998 on Essex First's production of residential
loans sold in the secondary market, (ii) other service charges and fees
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 and (iii) other
noninterest income resulting from higher insurance commissions and
administrative fees at Essex Home, which more than doubled its mortgage loan
subservicing portfolio during 1998. These increases during 1998 were partially
offset by lower loan servicing fees in particular during the first half of 1998
resulting from the nonrenewal of a significant subservicing contract in 1997.
However, new contracts negotiated in 1998 provided for servicing a substantial
13
<PAGE>
number of loans, the impact of which had begun to generate servicing and
ancillary fee income later in 1998 to significantly mitigate the impact of the
lost servicing volume in 1997.
Noninterest Expense. The following table sets forth information regarding
noninterest expense for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Salaries and employee benefits..... $4,075,559 $3,476,785 $3,788,695
Net occupancy and equipment........ 898,410 954,804 1,084,593
Deposit insurance premiums......... 591,983 497,081 478,684
Amortization of intangible assets.. 586,593 503,148 530,707
Service bureau fees................ 584,563 513,826 461,217
Professional fees.................. 262,997 296,295 349,218
Foreclosed properties, net......... 17,139 150,461 182,880
Other.............................. 1,667,918 1,464,473 1,087,362
---------- ---------- ----------
$8,685,162 $7,856,873 $7,963,356
========== ========== ==========
</TABLE>
Total noninterest expense increased $828,000 or 10.5% from $7.9 million
during the year ended December 31, 1998 to $8.7 million during the year ended
December 31, 1999. Noninterest expense as a percent of average assets was 3.5%
for 1999 as compared to 3.8% for 1998. The improvement in this ratio reflects
the impact of asset growth coupled with cost containment. The increase in
noninterest expense was primarily attributable to increases in (i) salaries and
employee benefits because of (a) the increase in the number of full-time
equivalent employees coupled with the impact of low unemployment levels on
average salaries required to attract qualified employees and (b) lower deferral
of fixed loan origination costs resulting from the decline in loan originations
during 1999, (ii) deposit insurance premiums because of the growth in deposit
balances on which the premiums are based, (iii) amortization of intangible
assets resulting from acquisitions of MSRs in 1999, (iv) service bureau expense
resulting predominantly from the higher loan servicing volume and (v) other
noninterest expense. The significant components of the increase in other
noninterest expense are presented below and reflect (i) the impact of technology
enhancements on telephone expense and (ii) the impact of the increase in the
Company's servicing volumes and deposit levels on general operating expenses.
<TABLE>
<CAPTION>
Change
1999 1998 Amount Percent
---------- ---------- --------- --------
<S> <C> <C> <C> <C>
Loan expense................ $ 254,381 $ 211,092 $ 43,289 20.5
Telephone................... 379,800 249,770 130,030 52.1
Postage and courier......... 213,880 185,819 28,061 15.1
Stationery and supplies..... 146,129 115,111 31,018 26.9
Advertising and marketing... 137,044 198,399 (61,355) (30.9)
Franchise and other taxes... 110,999 47,119 63,880 100.0+
Corporate insurance......... 82,353 100,630 (18,277) (18.2)
Travel...................... 57,700 62,060 (4,360) (7.0)
Provision for other losses.. 73,017 24,000 49,017 100.0+
Other....................... 212,615 270,473 (57,858) (21.4)
---------- ---------- --------
$1,667,918 $1,464,473 $203,445 13.9
========== ========== ========
</TABLE>
The increases in noninterest expense during 1999 were partially offset by
decreases in (i) net occupancy and equipment expense resulting from lower
facilities rent because of the acquisition of the previously-leased retail
banking and mortgage loan production branch in Richmond, Virginia, as well as
lower depreciation expense, which will increase in future periods because of the
Company's investment in technology enhancements such as the implementation of a
wide area network and (ii) foreclosed properties expense resulting from lower
provisions for losses and higher net gains on disposals in 1999.
14
<PAGE>
Total noninterest expense declined $106,000 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. A portion of the decrease in noninterest
expense during 1998 was attributable to nonrecurring expenses during 1997 for a
$136,500 severance settlement with a former employee and a $498,000 stock option
expense. In addition to these items, there were decreases during 1998 in (i)
net occupancy and equipment expense resulting from opening a Bank-owned retail
bank branch in Suffolk, Virginia, which had previously been located in a leased
facility, and exercising a purchase option for the Richmond, Virginia retail
bank branch, which had previously been a leased facility, (ii) amortization of
intangible assets resulting from valuation adjustments to the carrying value of
MSRs, (iii) professional fees resulting from nonrecurring legal fees incurred in
1997 in connection with a severance settlement with a former employee and (iv)
foreclosed properties expense resulting from the decline in foreclosed
properties. These decreases were partially offset by increases in (i) salaries
and employee benefits resulting from an increase in the number of personnel in
order to accommodate the increase in loan origination and servicing volumes,
(ii) deposit insurance premiums reflecting an increase in the deposit assessment
base resulting from deposit growth, (iii) service bureau expense resulting from
the increase in loan servicing volume and the number of deposit accounts and
(iv) other noninterest expense. The significant components of the increase in
other noninterest expense for the year ended December 31, 1998 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>
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 year ended December 31, 1997. During the
years ended December 31, 1999 and 1998, however, the Company partially reduced
the deferred tax valuation allowance, thus recognizing a deferred tax asset of
$1.85 million and $550,000, respectively. 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 11 of the Notes to Consolidated Financial Statements.
15
<PAGE>
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
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, fixed-rate single-family
residential loans (loans with initial fixed rate terms of up to seven years),
(ii) selling long-term, fixed-rate single-family residential loans in the
secondary market, (iii) originating and purchasing adjustable or short-term
construction and development loans, (iv) purchasing adjustable-rate mortgage-
backed securities, (v) maintaining higher liquidity by holding short-term
investments and cash equivalents and (vi) 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, 1999. 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
16
<PAGE>
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, 1999 and is not necessarily indicative
of the Bank's interest rate sensitivity at any other time.
<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
--------- --------- -------- ------- ------ ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Interest-earning assets:
Loans receivable and
mortgage-backed securities:
First mortgage:
Adjustable-rate $ 50,852 $ 38,203 $ 10,656 $ 21,264 $ - $120,975 47.4%
Fixed-rate 5,565 5,232 18,526 15,793 49,709 94,825 37.2
Second mortgage 2,667 244 800 405 - 4,116 1.6
All other 5,078 1,447 5,575 4,140 3,542 19,782 7.8
Investments 14,561 - 750 - - 15,311 6.0
-------- -------- -------- -------- ------- -------- -----
Total 78,723 45,126 36,307 41,602 53,251 $255,009 100.0%
-------- -------- -------- -------- ------- ======== =====
Interest-bearing liabilities:
Deposits 74,740 48,503 61,437 13,819 10,555 $209,054 82.3%
Fixed-rate borrowings 5,472 2,320 - - - 7,792 3.1
Variable-rate borrowings 37,000 - - - - 37,000 14.6
-------- -------- -------- -------- ------- -------- -----
Total 117,212 50,823 61,437 13,819 10,555 $253,846 100.0%
-------- -------- -------- -------- ------- ======== =====
Effect of off-balance sheet
items (1) (12,143) 3,502 1,738 1,410 5,499
-------- -------- -------- -------- -------
Maturity gap $(50,632) $ (2,195) $(23,392) $ 29,193 $48,195
======== ======== ======== ======== =======
Cumulative gap $(50,632) $(52,827) $(76,219) $(47,026) $ 1,169
======== ======== ======== ======== =======
Cumulative gap as a percent
of total assets (18.2)% (19.0)% (27.5)% (16.9)% 0.4%
======== ======== ======== ======== =======
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 67.2% 73.7% 69.8% 82.9% 100.5%
======== ======== ======== ======== =======
</TABLE>
(1) Reflects the effect of entering into commitments with third parties to
originate and sell loans.
The Bank's one-year interest rate sensitivity gap amounted to a negative
19.0% at December 31, 1999, up slightly from negative 17.9% at December 31,
1998. The increase in the negative gap measure resulted from increases in (i)
fixed rate assets, which include adjustable-rate loans with initial repricing
periods in excess of five years and (ii) adjustable-rate borrowings from the
FHLB, the impact of which was partially offset by (i) an increase in adjustable
rate assets, which include construction loan participations and (ii) the
lengthening of average customer deposit maturities. The Company will consider
extending FHLB advance 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 is not
strong during the current rising interest rate environment. 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
17
<PAGE>
flows from assets, liabilities, and off-balance sheet contracts. The following
tables present the Bank's NPV at December 31, 1999 and 1998.
<TABLE>
<CAPTION>
As of December 31, 1999
- -------------------------
Net Portfolio Value NPV as % of PV of Assets
Change in --------------------------------------- --------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
- ------------------------- -------- ------------------- -------- ------------ ----------
<S> <C> <C> <C> <C> <C>
+300bp $12,938 $(9,720) (42.90) 4.80% (323)bp
+200bp 16,812 (5,846) (25.80) 6.13 (190)bp
+100bp 20,160 (2,498) (11.03) 7.23 (80)bp
Base Scenario 22,658 8.03
-100bp 24,046 1,388 6.13 8.44 41bp
-200bp 24,509 1,851 8.17 8.55 52bp
-300bp 25,013 2,355 10.39 8.66 63bp
As of December 31, 1998
- -------------------------
Net Portfolio Value NPV as % of PV of Assets
Change in --------------------------------------- ------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
- ------------------------- -------- ------------------- -------- ------------ ----------
+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
</TABLE>
The ALCO has established limits for the impact of changes in interest rates
on NPV. As of December 31, 1999, 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, 1999, the Bank's
sensitivity of NPV was within internal policy limits. However, computations 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, 1999, had a liquidity ratio of 10.10%.
18
<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 demands 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 provide an additional source of
funds. At December 31, 1999, the Bank had $44.6 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. However, the Bank independently solicits deposits by
posting its deposit rates on national computerized bulletin boards.
The Bank anticipates that it will have sufficient funds available to meet
its current loan commitments. At December 31, 1999, the Bank had outstanding
commitments (including unused lines of credit) to originate and/or purchase
mortgage and non-mortgage loans of $4.5 million. The undisbursed portions of
construction builder loans and construction/permanent loans in process totaled
$19.6 million and $7.5 million, respectively, as of December 31, 1999.
Certificates of deposit which are scheduled to mature within one year totaled
$87.0 million at December 31, 1999 and borrowings from the FHLB that are
scheduled to mature within the same period amounted to $7.6 million.
Regulatory Capital
The Bank is required pursuant to the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and OTS regulations promulgated
there under 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, 1999,
the Bank's tangible and core capital amounted to 6.25% of adjusted total assets
and the Bank's total capital amounted to 11.44% 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, 1999, the
Bank's Tier I, Tier I risk-based, and total risk-based capital ratios were
6.25%, 10.86%, and 11.44%, 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 $3.5 million, $7.8 million, and $2.3 million,
respectively, at December 31, 1999.
19
<PAGE>
Deposits of the Bank are currently insured by the Savings Association
Insurance Fund ("SAIF"). Both the SAIF and the Bank Insurance Fund ("BIF"), the
deposit insurance fund that covers most commercial bank deposits, are
statutorily required to be recapitalized to a ratio of 1.25% of insured reserve
deposits. The BIF has achieved the required reserve ratio, and as a result, the
FDIC reduced the average deposit insurance premium paid by BIF-insured banks to
a level substantially below the average premium paid by savings institutions.
Banking legislation was enacted on September 30, 1996 to eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions.
The legislation provided that all insured depository institutions with SAIF-
assessable deposits as of March 31, 1995 pay a special one-time assessment to
recapitalize the SAIF. Pursuant to this legislation, the FDIC promulgated a
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 FDIC notified the Bank 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) and
continued to pay assessments through 1999 at the assessment rate schedule in
effect as of June 30, 1995. Therefore, through December 31, 1999, 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), which became
effective for the Bank on January 1, 2000. 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 5.9 basis points
was added to the regular SAIF-assessment during 1999. Effective January 1,
2000, the FICO assessment rate for the SAIF is assessed at the same rate as the
BIF, effectively reducing the Bank's annual FICO assessment to approximately
two basis points.
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 was a savings association on that date. The merger of the SAIF and
BIF did not occur on such date because 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. 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 Status
As previously reported, the Company established a task force to assess and
remediate business risks associated with the Year 2000. This task force
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;
20
<PAGE>
o Renovation - implementation of the required software and hardware changes,
----------
systems and interface modifications and conversions to replacement systems;
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; and
o Post-Implementation - monitoring implementation results and responding to
-------------------
situations that invalidate corrections as implemented.
As of December 31, 1999, the Company had completed all phases of its Year
2000 readiness plan through the implementation phase for all mission-critical
internal and external systems and operations. Based on the results of testing
following January 1, 2000, management has noted no significant problems with
respect to the Company's in-house or third party products or systems. Post-
implementation monitoring is an ongoing process that will continue into the Year
2000. Because the Company outsources substantially all of its data processing
for loans, deposits and loan servicing, the Company will continue to monitor its
external vendors' status throughout 2000 to ensure that no systems-related
problems arise.
The total cost of the Year 2000 project (including the capitalized cost of
new hardware and software approximating $280,000) approximated $350,000 and was
funded through operating cash flows. Capitalized costs are associated with
technology changes that will enhance the Company's ability to provide
competitive services. During 1999, the Company recognized $9,500 of expense
associated with this project, which brought the total expense incurred by the
Company since beginning this project to $58,100. This amount does not include
the implicit costs associated with the reallocation of internal staff hours to
the Year 2000 project.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
The above discussion contains certain forward-looking statements (as
defined in the Private Securities Litigation Reform Act of 1995) involving
potential risks and uncertainties that could cause the Company's actual results
and experience to differ materially from those discussed herein. 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:
o Deterioration in local economic conditions;
o Deterioration in national or global economic conditions;
o Significant changes in laws and regulations affecting the financial services
industry; and
o Significant changes in the markets in which our businesses compete.
Readers should not place undue reliance on these forward-looking statements,
which are applicable only as of the date hereof.
21
<PAGE>
Quarterly Results of Operations
Quarterly unaudited financial data for the years ended December 31, 1999
and 1998 is presented below (in thousands, except per share data). The most
significant factor impacting operating results for the fourth quarter of 1999
was the recognition of a $1.35 million 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, 1999
--------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net interest income $1,439 $1,435 $1,653 $ 1,747
Provision for loan losses - - - 149
------ ------ ------ -------
Net interest income after
provision for loan losses 1,439 1,435 1,653 1,598
Noninterest income 784 779 757 1,011
Noninterest expenses 2,219 2,104 2,135 2,228
------ ------ ------ -------
Income before income taxes 4 110 275 381
Provision for (benefit from)
income taxes (26) 4 (333) (1,035)
------ ------ ------ -------
Net income $ 30 $ 106 $ 608 $ 1,416
====== ====== ====== =======
Basic and diluted net (loss)
income available to common
stockholders $ (445) $ (376) $ 117 $ 905
====== ====== ====== =======
Net (loss) income per
common share:
Basic $ (.42) $ (.35) $ .11 $ .85
====== ====== ====== =======
Diluted $ (.42) $ (.35) $ .02 $ .22
====== ====== ====== =======
Weighted average shares
outstanding:
Basic 1,061 1,061 1,061 1,061
====== ====== ====== =======
Diluted 1,061 1,061 5,094 4,129
====== ====== ====== =======
Year Ended December 31, 1998
------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
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 income taxes 98 137 158 101
Provision for (benefit from)
income taxes - - 29 (547)
------ ------ ------ -------
Net income $ 98 $ 137 $ 129 $ 648
====== ====== ====== =======
Basic and diluted net (loss)
income available to common
stockholders $ (335) $ (304) $ (321) $ 182
====== ====== ====== =======
Net (loss) income 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
====== ====== ====== =======
</TABLE>
22
<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, 1999 and
1998, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States. 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 auditing standards generally accepted in the United States 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 18, 2000
23
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Cash.................................................................... $ 6,902,398 $ 5,315,805
Interest-bearing deposits............................................... 9,820,129 11,314,478
Federal funds sold and securities purchased under agreements to resell.. 2,228,596 1,314,397
------------ ------------
Cash and cash equivalents.......................................... 18,951,123 17,944,680
Federal Home Loan Bank stock............................................ 2,230,000 1,548,800
Securities available for sale - cost approximates market................ 19,331 18,406
Securities held for investment - market value of $2,713,000 in 1999
and $2,704,000 in 1998................................................. 2,750,116 2,750,089
Mortgage-backed securities held for investment - market value of
$479,000 in 1999 and $1,454,000 in 1998................................ 479,861 1,455,738
Loans, net of allowance for loan losses of $1,697,000 in 1999 and
$1,845,000 in 1998..................................................... 238,881,926 192,667,763
Loans held for sale..................................................... 916,753 4,486,271
Mortgage servicing rights............................................... 1,985,462 831,197
Foreclosed properties, net.............................................. 445,577 571,294
Accrued interest receivable............................................. 1,544,665 1,250,349
Advances for taxes, insurance, and other................................ 981,365 1,572,225
Premises and equipment, net............................................. 3,399,745 3,183,577
Other assets............................................................ 5,152,986 2,759,179
------------ ------------
Total Assets....................................................... $277,738,910 $231,039,568
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing.................................................... $ 19,630,014 $ 16,791,063
Interest-bearing....................................................... 192,579,360 170,841,193
------------ ------------
Total deposits..................................................... 212,209,374 187,632,256
Federal Home Loan Bank advances......................................... 44,600,000 24,908,333
Capital lease obligations............................................... 191,613 268,123
Other liabilities....................................................... 2,742,741 2,395,768
------------ ------------
Total Liabilities.................................................. 259,743,728 215,204,480
COMMITMENTS AND CONTINGENCIES (Notes 6, 8 and 12)
SHAREHOLDERS' EQUITY
Series B preferred stock, $6.67 stated value (Note 14):
Authorized shares - 2,250,000
Issued and outstanding shares - 2,125,000 in 1999 and 1998............. 14,173,750 14,173,750
Series C preferred stock, $6.67 stated value (Note 14):
Authorized shares - 125,000
Issued and outstanding shares - 125,000 in 1999 and 1998............... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 20,000,000
Issued and outstanding shares - 1,060,642 in 1999 and 1998............. 10,606 10,606
Additional paid-in capital.............................................. 8,687,770 8,687,772
Accumulated deficit..................................................... (5,710,694) (7,870,790)
------------ ------------
Total Shareholders' Equity......................................... 17,995,182 15,835,088
------------ ------------
Total Liabilities and Shareholders' Equity......................... $277,738,910 $231,039,568
============ ============
</TABLE>
See notes to consolidated financial statements.
24
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ------------
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees........................ $16,645,322 $14,608,478 $13,588,215
Federal funds sold and securities purchased
under agreements to resell.................. 66,864 111,054 150,972
Investment securities, including dividend
income...................................... 259,399 226,042 353,957
Mortgage-backed securities................... 46,035 121,643 124,515
Other........................................ 440,755 362,943 329,846
----------- ----------- -----------
Total Interest Income................... 17,458,375 15,430,160 14,547,505
----------- ----------- -----------
INTEREST EXPENSE
Deposits..................................... 9,558,224 8,491,101 7,679,314
Federal Home Loan Bank advances.............. 1,583,360 1,229,741 1,473,949
Notes payable................................ - 792 9,079
Other........................................ 42,692 56,858 67,793
----------- ----------- -----------
Total Interest Expense.................. 11,184,276 9,778,492 9,230,135
----------- ----------- -----------
Net Interest Income..................... 6,274,099 5,651,668 5,317,370
PROVISION FOR LOAN LOSSES...................... 148,728 12,699 113,467
----------- ----------- -----------
Net Interest Income After
Provision for Loan Losses............... 6,125,371 5,638,969 5,203,903
NONINTEREST INCOME
Loan servicing fees.......................... 1,620,919 1,222,478 1,312,476
Mortgage banking income, including
gain on sale of loans....................... 499,886 755,450 458,520
Other service charges and fees............... 611,621 466,135 368,671
Net loss on sale of loans.................... - - (1,458)
Other........................................ 598,399 268,890 324,596
----------- ----------- -----------
Total Noninterest Income................ 3,330,825 2,712,953 2,462,805
----------- ----------- -----------
</TABLE>
(Continued)
25
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
NONINTEREST EXPENSE
Salaries and employee benefits.......... 4,075,559 3,476,785 3,788,695
Net occupancy and equipment............. 898,410 954,804 1,084,593
Deposit insurance premiums.............. 591,983 497,081 478,684
Amortization of intangible assets....... 586,593 503,148 530,707
Service bureau fees..................... 584,563 513,826 461,217
Professional fees....................... 262,997 296,295 349,218
Foreclosed properties, net.............. 17,139 150,461 182,880
Other................................... 1,667,918 1,464,473 1,087,362
---------- ---------- -----------
Total Noninterest Expense.......... 8,685,162 7,856,873 7,963,356
---------- ---------- -----------
Income (Loss) Before Income Taxes.. 771,034 495,049 (296,648)
NET BENEFIT FROM INCOME TAXES............. 1,389,062 517,474 -
---------- ---------- -----------
Net Income (Loss).................. $2,160,096 $1,012,523 $ (296,648)
========== ========== ===========
Net Income (Loss) Available to Common
Shareholders (Note 3).................. $ 201,569 $ (777,204) $(1,932,136)
========== ========== ===========
Basic Income (Loss) Per Common
Share (Note 3)......................... $.19 $(.73) $(1.83)
========== ========== ===========
Diluted Income (Loss) Per Common
Share (Note 3)......................... $.07 $(.73) $(1.83)
========== ========== ===========
</TABLE>
See notes to consolidated financial statements.
26
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<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 Total
----------- ------------ ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997........ $10,534 $14,173,750 $833,750 $8,674,333 $(8,586,665) $15,105,702
Common stock issued under the
Employee Stock Purchase Plan... 47 - - 7,406 - 7,453
Net loss........................ - - - - (296,648) (296,648)
------- ----------- ---------- ---------- ----------- -----------
Balance, December 31, 1997...... 10,581 14,173,750 833,750 8,681,739 (8,883,313) 14,816,507
Common stock issued under the
Employee Stock Purchase Plan... 25 - - 6,033 - 6,058
Net income...................... - - - - 1,012,523 1,012,523
------- ----------- ---------- ---------- ----------- -----------
Balance, December 31, 1998...... 10,606 14,173,750 833,750 8,687,772 (7,870,790) 15,835,088
Fractional share payouts under
the Employee Stock Purchase
Plan........................... - - - (2) - (2)
Net income...................... - - - - 2,160,096 2,160,096
------- ----------- ---------- ---------- ----------- -----------
Balance, December 31, 1999...... $10,606 $14,173,750 $833,750 $8,687,770 $(5,710,694) $17,995,182
======= =========== ========== ========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) .............. $ 2,160,096 $ 1,012,523 $ (296,648)
Adjustments to reconcile
net income (loss) to
cash provided by
(used in) operating
activities:
Provision for losses on
loans, foreclosed
properties and
servicing .................... 236,012 163,038 296,808
Depreciation and
amortization of
premises and
equipment .................... 344,744 368,838 419,829
Amortization of:
Premiums and discounts
on loans, investments
and mortgage-backed
securities .................. 236,755 130,161 77,038
Mortgage servicing
rights ...................... 524,532 441,087 468,647
Other ........................ 62,061 62,062 62,061
Mortgage banking
activities:
Proceeds from loan
sales ....................... 59,710,175 63,636,477 40,717,559
Loan originations and
purchases ................... (55,701,070) (65,277,646) (39,725,806)
Realized gains from
sale of loans ............... (439,587) (680,028) (414,902)
Realized (gains) and
losses from sales of:
Loans ........................ - - 1,458
Other ........................ (63,129) (70,377) (185,283)
Changes in operating
assets and liabilities:
Accrued interest
receivable .................. (294,316) (53,369) (49,047)
Advances for taxes,
insurance and other ......... 517,843 (963,172) 133,875
Deferred income taxes ........ (1,386,062) (550,000) --
Other assets ................. (1,069,806) 87,111 (647,246)
Other liabilities ............ 351,884 2,666 453,828
------------ ------------ ------------
Net cash provided by
(used in) operating
activities ................... 5,190,132 (1,690,629) 1,312,171
------------ ------------ ------------
INVESTING ACTIVITIES
Purchase of certificates
of deposit in other
financial institutions ....... - (4,000,000) (5,000,000)
Proceeds from maturities
of certificates of
deposit in other
financial institutions ...... - 4,000,000 5,000,000
Purchase of Federal Home
Loan Bank stock ............... (681,200) (117,800) (95,800)
Redemption of Federal
Home Loan Bank stock .......... - - 1,204,800
Purchase of securities
held to maturity .............. (27) (750,023) (298,406)
Proceeds from
maturities of
securities held
to maturity ................... - 300,000 4,000,000
Purchase of securities
available for sale ............ (925) (955) (2,508,289)
Proceeds from sale
of securities available
for sale ...................... - - 2,500,000
Principal remittances on
mortgage-backed
securities .................... 974,119 448,012 -
Purchases of loans and
participations ................ (59,287,144) (35,514,557) (22,224,143)
Net (increase) decrease
in net loans .................. 12,380,966 9,550,071 (1,428,880)
Proceeds from sales of
foreclosed properties ......... 514,990 1,547,763 2,146,555
Additions to foreclosed
properties .................... (32,121) (69,026) (358,419)
Increase in mortgage
servicing rights ............. (1,678,797) (102,518) (289,253)
Purchase of
and equipment ................ (560,912) (1,625,686) (388,145)
Proceeds from
sales of premises and equipment - 525 601,714
------------ ------------ ------------
Net cash used in
investing activities .......... (48,371,051) (26,334,194) (17,138,266)
------------ ------------ ------------
</TABLE>
(Continued)
28
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net increase in NOW and
savings deposits .............. 10,259,059 15,179,844 13,305,806
Net increase in
certificates of deposit ....... 14,318,059 18,525,713 9,587,515
Proceeds from Federal
Home Loan Bank advances ....... 93,000,000 46,000,000 25,500,000
Repayment of Federal
Home Loan Bank advances ....... (73,308,333) (44,638,334)
Payments on notes payable ...... - (72,102) (24,040)
Payments on capital
lease obligation .............. (76,510) (63,847) (53,281)
Repayments of mortgages
payable on foreclosed
properties .................... - - (10,391)
Redemption of Settlement
Preferred Stock ................ (4,911) (712) (6,002)
Common stock issued
under the Employee Stock
Purchase Plan, net of
fractional share
pay-outs ..................... (2) 6,058 7,453
------------ ------------ ------------
Net cash provided by
financing activities .......... 44,187,362 34,936,620 20,663,727
------------ ------------ ------------
Increase in cash and
cash equivalents ............. 1,006,443 6,911,797 4,837,632
Cash and cash
equivalents at
beginning of period .......... 17,944,680 11,032,883 6,195,251
------------ ------------ ------------
Cash and cash
equivalents at end of
period ....................... $ 18,951,123 $ 17,944,680 $ 11,032,883
============ ============ ============
NONCASH INVESTING AND
FINANCING ACTIVITIES
Transfer from loans to
foreclosed properties ......... $ 308,290 $ 594,888 $ 1,294,615
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest ...................... $ 11,182,532 $ 9,827,556 $ 9,199,677
Income taxes, net of refunds .. - 29,526 -
</TABLE>
See notes to consolidated financial statements.
29
<PAGE>
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1999, 1998 and 1997
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, 1999 operates
(i) four retail banking branches located in North Carolina and Virginia and (ii)
Essex First Mortgage ("Essex First"), a division of the Bank, that engages
principally in the origination and sale of residential mortgage loans, as well
as the origination of residential construction loans to individuals and
builders. EBI's other principal operating subsidiary is Essex Home Mortgage
Servicing Corporation ("Essex Home"), a wholly-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.
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 is based
upon valuations obtained from brokers and their market analyses and management
estimates.
30
<PAGE>
Derivatives: In June 1999, the Financial Accounting Standards Board ("FASB")
- -----------
issued Statement of Financial Accounting Standards ("SFAS") No. 137 - Accounting
for Derivative Instruments and Hedging Activities-Deferral of the Effective Date
of FASB Statement No. 133 ("SFAS 137"). SFAS 137 deferred the effective date of
SFAS No. 133 - Accounting for Derivative Instruments and Hedging Activities
("SFAS 133") to fiscal years beginning after June 15, 2000 (January 1, 2001 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 No. 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 fair 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 or
characteristics of the loan portfolio.
31
<PAGE>
Loan Income: Income on loans is derived from interest, the sale of loans and
- -----------
various fees. Interest on loans, including amortization of premiums and
accretion of discounts, is computed using methods that result in level rates of
return on principal amounts outstanding. Loan origination fees and direct loan
origination costs are deferred and amortized over the contractual lives of the
related loans using methods that result in a constant effective yield on
principal amounts outstanding.
The accrual of interest on loans is discontinued based on delinquency status, an
evaluation of the related collateral, and on the borrower's ability to repay the
loan. Generally, loans past due more than 90 days are placed in nonaccrual
status; however, in instances where the borrower has demonstrated an ability to
make timely payments, loans past due more than 90 days may be returned to an
accruing status provided two criteria are met: (1) all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within a reasonable period, and (2) there is a sustained period of
repayment performance (generally a minimum of six months) by the borrower. 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
32
<PAGE>
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.
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 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 1999, 1998 or 1997.
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, 1999, 1998 or
1997, the Company is not providing a report of comprehensive income for those
periods.
NOTE 3 - 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>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net income (loss) $ 2,160,096 $ 1,012,523 $ (296,648)
Preferred stock dividends (Note 14) (1,958,527) (1,789,727) (1,635,488)
----------- ----------- -----------
Net income (loss) available to
common shareholders $ 201,569 $ (777,204) $(1,932,136)
=========== =========== ===========
Weighted average common shares
outstanding:
Basic 1,060,642 1,059,138 1,055,776
=========== =========== ===========
Diluted 2,835,973 1,059,138 1,055,776
=========== =========== ===========
</TABLE>
Basic income (loss) per share is computed based on income (loss) available to
common shareholders divided by the average number of common shares outstanding
for each period. The Company's outstanding options and warrants (Note 15),
collectively common stock equivalents, are dilutive with respect to income
available to common shareholders for the year ended December 31, 1999 and
diluted income per share is computed under the treasury stock method. The
Company's common stock equivalents are antidilutive for the years ended December
31, 1998 and 1997; therefore, basic and diluted loss per common share are the
same for those periods.
33
<PAGE>
NOTE 4 - INVESTMENT SECURITIES
The amortized cost and fair value of securities held for investment at December
31 were as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------------- -----------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
--------- ------- ------- ------ --------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities of U.S. govern-
ment agencies other than
the U.S. Treasury $2,750 $ - $37 $2,713 $2,750 $ - $46 $2,704
====== ======= ======= ====== ========= ======= ======= ======
</TABLE>
The $2.8 million of U.S. government agency securities held for investment at
December 31, 1999 consisted of a $2.0 million note issued by the Federal Home
Loan Bank ("FHLB") that matures in the year 2000 and a $750,000 note issued by
the FHLB that matures in the year 2002. The U.S. government agency security
with a book value of $750,000 and a fair value of $725,000 is pledged as
collateral for public depository accounts over $100,000 at December 31, 1999.
The U.S. government agency security with a book value of $2.0 million and a fair
value of $1.99 million at December 31, 1999 is pledged as collateral for Federal
Reserve Bank advances. No securities held for investment were sold in 1999,
1998 or 1997.
Securities available for sale at December 31, 1999 and 1998 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 1999 or 1998. Proceeds from
the sale of securities available for sale totaled $2,500,000 in 1997. No gains
or losses were realized on these sales.
NOTE 5 - 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>
1999 1998
---------------------------------- -----------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
--------- ------- ------- ------ --------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government agencies:
Floating-rate REMIC $480 $ - $1 $479 $1,456 $ - $2 $1,454
==== ======= ======= ===== ========= ======= ======= ======
</TABLE>
The REMIC is pledged as collateral for FHLB advances at December 31, 1999.
There were no sales of MBS held for investment in 1999, 1998 or 1997. No MBS
were classified as available for sale at December 31, 1999 or 1998.
34
<PAGE>
NOTE 6 - LOANS
Net loans at December 31 include (in thousands):
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Real estate:
First mortgages $173,372 $152,891
Second mortgages 4,268 7,525
Construction and development 42,477 19,430
Commercial 4,645 6,470
Consumer 13,464 5,984
Commercial - other 1,626 1,601
Secured by deposits 731 621
-------- --------
Total Loans 240,583 194,522
Less:
Unearned loan fees and discounts 4 9
Allowance for loan losses 1,697 1,845
-------- --------
Net Loans $238,882 $192,668
======== ========
</TABLE>
Included in total loans at December 31, 1999 and 1998 are unamortized premiums
of $742,000 and $951,000, respectively.
At December 31, net loans included the following impaired collateral-dependent
real estate loans (in thousands):
<TABLE>
<CAPTION>
1999 1998
----- -----
<S> <C> <C>
First mortgages $ 115 $ 298
Second mortgages 36 -
----- -----
Total collateral-dependent real estate loans 151 298
Less:
Allowance for loan losses 43 37
----- -----
Net collateral-dependent real estate loans $ 108 $ 261
===== =====
</TABLE>
As of December 31, 1999, the Bank had outstanding commitments (including
unfunded portions of lines of credit and construction loan commitments) to fund
approximately $31.3 million in mortgage loans and $284,000 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, 1999, such commitments aggregated $14.0
million of fixed rate mortgage loans and $4.5 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 counter party.
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, consumer loans and construction loan participations from third parties.
Acquired loans comprised approximately 48% and 44% of total loans at December
31, 1999 and 1998, respectively. The Bank requires collateral on all
residential mortgage loans and, at origination, generally requires that loan-to-
35
<PAGE>
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, 1999 and 1998, the Company had $928,000 and $1.2 million,
respectively, in nonaccrual loans. Interest income that would have been
recorded in accordance with the original terms of the nonaccrual loans amounted
to approximately $70,000, $115,000 and $171,000 for the years ended December 31,
1999, 1998 and 1997, respectively.
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of period $1,845,295 $2,381,639 $2,555,688
Provision for loan losses 148,728 12,699 113,467
---------- ---------- ----------
1,994,023 2,394,338 2,669,155
Loans charged-off, net of recoveries (297,157) (549,043) (287,516)
---------- ---------- ----------
Balance at end of period $1,696,866 $1,845,295 $2,381,639
========== ========== ==========
</TABLE>
Loans held for sale at December 31, 1999 and 1998 consisted of first mortgage
loans originated by Essex First. As of December 31, 1999, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $215,000,
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, 1999, there were $919,000 of
loans outstanding that were previously originated and sold by Essex First in the
secondary market with recourse.
NOTE 7 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
<TABLE>
<CAPTION>
1999 1998
-------- ---------
<S> <C> <C>
Properties acquired
through foreclosure $479,767 $684,900
Less allowance for losses 34,190 113,606
-------- --------
$ 445,57 $571,294
======== ========
Changes in the allowance
for losses on foreclosed
properties for the year
ended December 31 are as
follows:
1999 1998 1997
--------- --------- ---------
Balance at beginning of
year $ 113,606 $ 154,752 $ 178,937
Provision for losses on
foreclosed properties 14,267 126,338 159,341
--------- --------- ---------
127,873 281,090 338,278
Charge-offs, net of recoveries (93,683) (167,484) (183,526)
--------- --------- ---------
Balance at end of year $ 34,190 $ 113,606 $ 154,752
========= ========= =========
</TABLE>
36
<PAGE>
NOTE 8 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Land $ 842,080 $ 842,190
Buildings 2,324,052 2,051,194
Furniture and equipment 3,306,719 3,027,647
Leasehold improvements 194,254 194,254
Property under capitalized lease 537,737 537,737
---------- ----------
7,204,842 6,653,022
Less accumulated depreciation
and amortization 3,805,097 3,469,445
---------- ----------
$3,399,745 $3,183,577
========== ==========
</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.
Future minimum lease commitments with terms in excess of one year at December
31, 1999, including cost escalation provisions, are as follows:
<TABLE>
<CAPTION>
Capital Noncancelable
Lease Operating Leases
-------- ----------------
<S> <C> <C>
2000 $119,201 $237,458
2001 119,201 221,571
2002 - 18,756
2003 - -
2004 - -
Later years - -
-------- --------
Total minimum lease payments 238,402 $477,785
========
Amount representing interest 46,789
--------
Present value of net minimum capitalized
payments $191,613
========
</TABLE>
Rent expense for the years ended December 31, 1999, 1998 and 1997 amounted to
$302,828, $342,496 and $435,147, respectively.
37
<PAGE>
NOTE 9 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
-------------------- ------------------
Amount Percent Amount Percent
--------- --------- --------- --------
<S> <C> <C> <C> <C>
NOW accounts -
noninterest-bearing $ 19,630 9.25% $ 16,791 8.95%
Passbook and Christmas
Club 4,819 2.27 4,385 2.34
NOW accounts 5,359 2.53 4,792 2.55
Money market 34,297 16.16 27,878 14.86
Certificate accounts -
4.01% to 6.00% 129,088 60.83 113,403 60.44
6.01% to 8.00% 19,010 8.96 20,377 10.86
8.01% to 10.00% 6 .00 6 .00
-------- ------ -------- ------
$212,209 100.00% $187,632 100.00%
======== ====== ======== ======
A summary of certificate accounts by scheduled maturity at December 31, 1999 is as
follows (in thousands):
2000 $ 87,023
2001 38,543
2002 13,501
2003 5,700
2004 and thereafter 3,337
--------
$148,104
========
</TABLE>
Certificate accounts of $100,000 or more at December 31, 1999 and 1998 amounted
to $28.3 million and $22.7 million, respectively.
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------------- ----------------- -----------------
Interest Rate Interest Rate Interest Rate
---------- ----- ---------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Passbook and
Christmas Club $ 166,090 3.49% $ 147,405 3.49% $ 133,737 3.48%
NOW accounts 145,473 2.81 122,330 2.81 122,773 2.83
Money Market
accounts 1,595,513 4.72 1,317,156 4.91 1,041,566 4.87
Certificate accounts 7,651,148 5.44 6,904,210 5.67 6,381,238 5.73
---------- ---------- ----------
$9,558,224 5.18% $8,491,101 5.40% $7,679,314 5.45%
========== ==========
</TABLE>
38
<PAGE>
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the FHLB at December 31 consist of the following (in thousands):
<TABLE>
<CAPTION>
Maturity Interest Rate 1999 1998
- -------- -------------- ------- -------
<S> <C> <C> <C>
1999 5.01% to 6.00% $ - $17,308
2000 4.01% to 6.00% 7,600 7,600
2001 4.01% to 6.00% 37,000 -
------- -------
$44,600 $24,908
======= =======
Weighted average rate at end of period 4.72%(1) 5.89%
======= =======
</TABLE>
(1) The average rate on adjustable-rate FHLB borrowings was abnormally low on
December 31, 1999 due to annually high levels of market liquidity and is not
representative of the average rate on any other day during 1999.
With the exception of $37.0 million and $2.5 million of FHLB advances
outstanding at December 31, 1999 and 1998, respectively, all FHLB advances
outstanding at December 31, 1999 and 1998 carried fixed rates of interest. The
$37.0 million adjustable rate FHLB advances outstanding at December 31, 1999
will mature in 2001 and the applicable rate is indexed to the FHLB overnight
deposit rate. The $2.5 million adjustable rate FHLB advance at December 31,
1998 matured in 1999.
Advances from the FHLB at December 31, 1999 are collateralized by (i) mortgage
loans with a total principal balance of approximately $79.3 million and (ii) MBS
with a book value of $480,000. The unused lendable collateral value was $17.3
million at December 31, 1999. Advances are subject to application approval by
the FHLB.
NOTE 11 - 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 (benefit from) income taxes for financial reporting purposes
differs from the amount computed by applying the statutory federal tax rate to
income (loss) before income taxes for the years ended December 31 as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------- -------------------- -------------------
Amount % Amount % Amount %
------------ -------- ---------- -------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Provision for (benefit from) income taxes
at statutory federal tax rate 262,152 34.0% $ 168,317 34.0% $(100,860) (34.0)%
Increase (decrease) resulting from:
Unrecognized (recognized) tax benefits 188,169 24.4 (192,437) (38.8) 91,443 30.8
Future benefit of net deferred tax assets
not previously recognized (1,850,000) (239.9) (550,000) (111.1) - -
State income taxes (3,000) (.4) 21,467 4.3 - -
Amortization of excess of cost
over net assets acquired 21,101 2.7 21,101 4.3 21,101 7.1
Other (7,484) (1.0) 14,078 2.8 (11,684) (3.9)
----------- ------- --------- ------- --------- ------
$(1,389,062) (180.2)% $(517,474) (104.5)% $ - -%
=========== ======= ========= ======= ========== ======
</TABLE>
39
<PAGE>
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Deferred tax liabilities
FHLB stock $ 92,297 $ 92,297
Basis in acquired loans 1,420,812 1,776,015
Other - 31,282
----------- -----------
Total deferred liabilities 1,513,109 1,899,594
Deferred tax assets
Net operating loss ("NOL") carryforwards 6,754,344 7,252,973
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
MSRs 60,566 58,710
Allowance for losses on loans and
foreclosed properties 343,401 449,908
Core deposit intangible 887,875 968,590
Premises and equipment 23,703 4,424
Other 350,583 364,462
----------- -----------
Total deferred assets 8,750,472 9,429,067
----------- -----------
Net deferred tax assets before valuation
allowance 7,237,363 7,529,473
Valuation allowance for net deferred tax
assets (5,301,301) (6,979,473)
----------- -----------
Net deferred tax assets $ 1,936,062 $ 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 1999 and 1998, the Company recorded net deferred tax assets of $1.9
million and $550,000, respectively, 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 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, 1999) 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, 1999, the Company had NOL carryforwards for income tax purposes
of approximately $17.8 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, 1999, which can be carried forward indefinitely.
40
<PAGE>
NOTE 12 - MORTGAGE LOAN SERVICING
At December 31, 1999, 1998, and 1997, the Company serviced or subserviced
approximately 18,200, 15,100 and 8,400 loans, respectively, with the following
outstanding principal balances (in thousands) at December 31 and related
servicing fee income during the respective years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- --------------------- ---------------------
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 $ 146,621 $ - $ 144,602 $ - $128,430 $ -
Servicing and sub-
servicing rights owned/
participated in by the
Company 1,509,113 1,620,919 1,056,677 1,222,478 354,245 1,312,476
---------- ---------- ---------- ---------- -------- ----------
$1,655,734 $1,620,919 $1,201,279 $1,222,478 $482,675 $1,312,476
========== ========== ========== ========== ======== ==========
</TABLE>
Servicing fee income is net of $1,964,595 in 1999, $1,088,046 in 1998 and
$858,992 in 1997 paid to unaffiliated subservicing clients.
As an 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, 1999,
approximately $12.7 million of such accounts were on deposit at unaffiliated
banks and $17.8 million of such accounts were on deposit at the Bank.
The fair value of MSRs was $1.99 million and $831,000 at December 31, 1999 and
1998, respectively. As a result of fluctuations in mortgage loan prepayment
activity, the Company maintains a valuation allowance in order to reduce the
carrying value of its MSRs to the estimated fair value at December 31, 1999 and
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:
<TABLE>
<CAPTION>
Carrying Valuation
Value Allowance
----------- ----------
<S> <C> <C>
Balance at January 1, 1997 $1,349,160 $ -
Purchases 289,253 -
Amortization (468,647) -
---------- --------
Balance at December 31, 1997 1,169,766 -
Purchases 102,518 -
Amortization (387,545) -
Valuation adjustments - impairment - (53,542)
---------- --------
Balance at December 31, 1998 884,739 (53,542)
Purchases 1,678,797 -
Amortization (521,631) -
Valuation adjustments:
Impairment - (31,456)
Recapture - 28,555
---------- --------
Balance at December 31, 1999 $2,041,905 $(56,443)
========== ========
</TABLE>
41
<PAGE>
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 that 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 $1.7 million of recourse obligations
to provide for future losses related to the Company's servicing portfolio.
NOTE 13 - 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 1999 and
1998, the Company matched 30% and 25%, respectively, of employee contributions
of up to 6.00% of compensation as defined by the plan, which resulted in a
$39,213 and $35,829 matching contribution by the Company for the plan years
ended December 31, 1999 and 1998, respectively. 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.
Certain employees of EBI's subsidiaries participate in a Supplemental Executive
Retirement Plan ("SERP"). An expense of $33,291, $38,808 and $37,808 was
recognized in 1999, 1998 and 1997, 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, 1999 are 100% vested
with respect to cumulative pension credits through December 31, 1998. Vesting
periods for post-1998 pension credits vary among the participants and range from
immediate vesting to full vesting on December 31, 2001.
NOTE 14 - 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 $6,867,869 and $330,763, respectively, as of
December 31, 1999.
42
<PAGE>
NOTE 15 - 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 that 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. The options
outstanding as of December 31, 1999 consist of the following: 52,000
exercisable on May 28, 2000 that will expire on May 28, 2007; 5,000 exercisable
on June 1, 2002 that will expire on June 1 2009; 1,500 exercisable on July 12,
2002 that will expire on July 12, 2009; and 80,000 exercisable on September 10,
2002 that will expire on September 10, 2009.
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 that can be granted
with respect to EBI common stock under the Directors Option Plan to 20,000
shares. Similar to the Option Plan, SARs may be issued in tandem with options
granted under the Directors Option Plan.
The following table summarizes activity under the option plans for years ended
December 31, 1999, 1998 and 1997 and the status at December 31, 1999.
<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, 1997 214,690 0.9375-3.2500 3,250 0.9375-3.8750
Granted 110,200 1.3750 1,350 5.5625
Exercised (184,292) 0.9375 - -
Canceled (8,000) 1.3750 - -
Rescinded (30,398) 3.2500 - -
-------- ------
Options outstanding as of December 31, 1997 102,200 1.3750 4,600 0.9375-5.5625
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 0.9375-5.5625
Granted 5,000 2.2500 1,350 1.7500
Granted 1,500 2.1250 - -
Granted 80,000 1.2500 - -
Canceled (50,200) 1.3750 - -
Rescinded (6,000) 5.8750 - -
Rescinded (20,000) 4.8750 (1,350) 5.5625
-------- ------
Options outstanding as of December 31, 1999 138,500 1.3750-2.2500 5,950 0.9375-3.8750
======== ======
Options exercisable as of December 31, 1999 - 4,600
======== ======
Options available for future grant
as of December 31, 1999 396,253 13,050
======= ======
</TABLE>
43
<PAGE>
The Company recognized compensation expense of $498,051 during the year ended
December 31, 1997 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, 1999, the Company had an obligation of $703,000 to its Chief
Executive Officer resulting from the exercise of his SARs in November 1997,
which amount is included in other liabilities. 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 income (loss) per share would have
been $2.1 million and $.15 (basic EPS) and $0.06 (diluted EPS), $969,000 and
$(.77), and $(312,000) and $(1.84) for the years ended December 31, 1999, 1998
and 1997, respectively. The weighted average fair value of the options granted
during 1999, 1998 and 1997 would have been $0.68 per share, $2.58 per share and
$0.71 per share, respectively. The fair value of each option granted under the
Option Plan during 1999, 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 5.94% in 1999, 5.61% in 1998 and 6.29% in 1997, a
dividend yield of zero, expected life of five years and volatility of 50%.
Stock Purchase Plan: In 1995, the Company adopted the Essex Bancorp, Inc.
- -------------------
Employee Stock Purchase Plan (the "Stock Purchase Plan"), which was submitted 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 and 1997 employees acquired
approximately 2,506 and 4,757, 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.
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 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, 1999 and 1998 and may not be reflective of
current or future fair values.
44
<PAGE>
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, 1999 and 1998. For nonperforming loans, the estimated fair value
is not greater than the estimated fair value of the underlying collateral.
Financial Liabilities. The fair value of demand deposits, savings accounts, and
money market deposits is the amount payable on demand at the reporting date.
The fair values of fixed maturity certificates of deposit, FHLB advances and
capitalized lease obligations 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 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.
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
---------------------- --------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----------- --------- -------- ---------
(in thousands)
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents............ $ 18,951 $ 18,951 $ 17,945 $ 17,945
FHLB stock........................... 2,230 2,230 1,549 1,549
Securities available for sale........ 19 19 18 18
Securities held for investment....... 2,750 2,713 2,750 2,704
Mortgage-backed securities held for
investment......................... 480 479 1,456 1,454
Loans held for sale.................. 917 917 4,486 4,486
Loans held for investment, net....... 238,882 237,505 192,668 197,288
Financial Liabilities
Deposits with no stated maturity..... $ 64,105 $ 64,105 $ 53,846 $ 53,846
Time deposits........................ 148,104 146,992 133,786 134,895
FHLB advances........................ 44,600 44,239 24,908 25,030
Capital lease obligations............ 192 191 268 269
Off-balance sheet commitments
and recourse obligations........... 17 17 - 71
</TABLE>
45
<PAGE>
NOTE 17 - 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 there under 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, 1999, 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, 1999 and 1998, the
Bank was "well capitalized" for PCA purposes.
The Bank's capital amounts and ratios as of December 31, 1999 and 1998 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, 1999
- -----------------------
Total risk-based capital $18,273 11.44% $12,782 8.0% $15,978 (greater than or equal to) 10.0%
Tier I risk-based capital 17,353 10.86% 6,391 4.0% 9,587 (greater than or equal to) 6.0%
Tier I (core) capital 17,353 6.25% 11,109 4.0% 13,886 (greater than or equal to) 5.0%
Tangible equity 17,353 6.25% 4,166 1.5% - -
As of December 31, 1998
- -----------------------
Total risk-based capital $17,364 13.09% $10,609 8.0% $13,261 (greater than or equal to) 10.0%
Tier I risk-based capital 16,071 12.12% 5,304 4.0% 7,957 (greater than or equal to) 6.0%
Tier I (core) capital 16,071 6.97% 9,223 4.0% 11,529 (greater than or equal to) 5.0%
Tangible equity 16,071 6.97% 3,459 1.5% - -
</TABLE>
46
<PAGE>
NOTE 18 - 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.
Balance Sheets
--------------
December 31, 1999 and 1998
--------------------------
(in thousands)
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
ASSETS
Cash $ 81 $ 92
Investment in subsidiaries 18,891 16,646
Other 260 260
------- -------
$19,232 $16,998
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Redeemable Preferred Stock redemption proceeds payable $ 79 84
Other 1,158 1,079
------- -------
Total Liabilities 1,237 1,163
SHAREHOLDERS' EQUITY 17,995 15,835
------- -------
$19,232 $16,998
======= =======
</TABLE>
Statements of Operations
------------------------
For the years ended December 31, 1999, 1998 and 1997
----------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- ------
<S> <C> <C> <C>
Interest expense on notes payable $ - $ (1) $ (9)
Stock option compensation - - (601)
Net operating (expense) income (85) 5 25
------ ------ -----
Net (loss) income before undistributed
income of subsidiaries (85) 4 (585)
Undistributed income of subsidiaries 2,245 1,009 288
------ ------ -----
Net income (loss) $2,160 $1,013 $(297)
====== ====== =====
</TABLE>
47
<PAGE>
Statements of Cash Flows
------------------------
For the years ended December 31, 1999, 1998 and 1997
----------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- ------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 2,160 $ 1,013 $(297)
Adjustments to reconcile net income (loss)
to cash (used in) provided by operating
activities:
Equity in income of subsidiaries (2,245) (1,009) (288)
Dividends from subsidiaries - - 108
Increase in other assets - (3) (256)
Increase (decrease) in other liabilities 79 (32) 827
------- ------- -----
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (6) (31) 94
------- ------- -----
FINANCING ACTIVITIES
Payments on notes payable - (72) (24)
Redemption of Settlement Preferred Stock (5) (1) (5)
Common stock issued under the Employee Stock
Purchase Plan - 6 8
------- ------- -----
NET CASH USED IN FINANCIN
ACTIVITIES (5) (67) (21)
------- ------- -----
NET (DECREASE) INCREASE IN CASH (11) (98) 73
CASH AT BEGINNING OF PERIOD 92 190 117
------- ------- -----
CASH AT END OF PERIOD $ 81 $ 92 $ 190
======= ======= =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ - $ 13 $ -
</TABLE>
NOTE 19 - SEGMENT INFORMATION
SFAS No. 131 - Disclosures about Segments of an Enterprise and Related
Information 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). Segment revenues and pre-tax income (loss) are
determined using accounting policies consistent with those applied in the
preparation of the consolidated financial statements.
48
<PAGE>
<TABLE>
<CAPTION>
Retail Mortgage
Community Mortgage Loan Corporate/
Banking Banking Servicing Eliminations Total
--------- -------- --------- ------------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
1999 Segment Information
Customer revenues $ 3,761 $ 3,318 $2,524 $ 2 $ 9,605
Affiliate revenues - 456 475 (931) -
Depreciation and amortization 113 56 80 96 345
Pre-tax income (loss) 567 1,984 586 (2,366) 771
Total assets 229,848 43,696 7,579 (3,384) 277,739
1998 Segment Information
Customer revenues $ 4,047 $ 2,672 $1,565 $ 81 $ 8,365
Affiliate revenues - 497 443 (940) -
Depreciation and amortization 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 amortization 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
</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. Revenues and pre-tax income for the retail community
banking segment are presented before cost of funds allocation to its mortgage
banking division.
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, Essex First
currently originates the majority of the Bank's loan product. 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, as well as builder loan participations
acquired from nonaffiliated financial institutions. 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 and through its builder loan
participations it has expanded indirectly into South Carolina, Alabama, Florida,
Georgia, Nevada and Texas. Revenues and pre-tax income for the mortgage banking
segment are presented before cost of funds allocation.
49
<PAGE>
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 77 subservicing clients. While Essex
Home services mortgage loans secured by residential real estate throughout the
United States, approximately 85% of its mortgage loan servicing portfolio is
concentrated among New York, Florida, New Jersey, Virginia, Texas, California
and North Carolina. As of December 31, 1999, Essex Home serviced for affiliates
and nonaffiliates in the aggregate approximately 18,200 loans totaling $1.7
billion.
[intentionally blank]
50
<PAGE>
ESSEX BANCORP, INC.
INVESTOR INFORMATION
Annual Meeting of Stockholders
The Annual Meeting of Stockholders of Essex Bancorp, Inc. will be held at
Interstate Corporate Center, Building #5, First Floor Conference Room, Norfolk,
Virginia on June 16, 2000 at 1:00 p.m.
Stock Price Information
Essex Bancorp, Inc.'s common stock is listed on the American Stock Exchange
("AMEX") under the symbol "ESX." The table below sets forth the high and low
sales prices of the common stock, as reported by the AMEX during 1999 and 1998.
<TABLE>
<CAPTION>
1999 1998
---------------- ----------------
Quarter High Low High Low
- --------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
First $3.7500 $1.3750 $6.7500 $3.9375
Second 3.0000 2.0625 5.1250 3.0000
Third 2.1250 1.2500 3.2500 1.9375
Fourth 2.0625 1.1250 2.3750 1.3125
</TABLE>
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
Web Site www.continentalstock.com
Annual Report on Form 10-K and Additional Information
A copy of Form 10-K as filed with the Securities and Exchange Commission is
available without charge to stockholders upon written request. Requests for
this or other financial information about Essex Bancorp, Inc. should be directed
to:
Jennifer L. DeAngelo, Corporate Secretary
Essex Bancorp, Inc.
Interstate Corporate Center
Building #9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1326
Independent Accountants
PricewaterhouseCoopers LLP
One Columbus Center, Suite 400
Virginia Beach, Virginia 23462
Telephone (757) 493-7700
Web Site
For additional information about Essex Bancorp, Inc.'s financial performance,
products and services, please visit our web site at www.essexbancorp.com.
51
<PAGE>
ESSEX BANCORP, INC.
DIRECTORS AND OFFICERS
EXECUTIVE OFFICERS
Gene D. Ross
Chairman, President and Chief Executive Officer
Essex Bancorp, Inc.,
Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing Corporation
Roy H. Rechkemmer, Jr.
Senior Vice President-Finance/Treasurer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Mary-Jo Rawson
Vice President/Chief Accounting Officer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Earl C. McPherson
President
Essex First Mortgage, a Division of
Essex Savings Bank, F.S.B.
DIRECTORS
Gene D. Ross
Chairman, President and Chief Executive Officer
Essex Bancorp, Inc.
Roscoe D. Lacy, Jr.
Vice President and General Manager
Miles Jennings, Inc.
Elizabeth City, North Carolina
(industrial supply company)
Robert G. Hecht
Chief Executive Officer
Trumbull Corporation
Pittsburgh, Pennsylvania
(highway construction company)
Harry F. Radcliffe
President and Chief Executive Officer
Fort Pitt Capital Management
Pittsburgh, Pennsylvania
(investment management company)
52
<PAGE>
ESSEX BANCORP, INC.
Corporate Information
Executive Offices
Interstate Corporate Center
Building #9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Subsidiaries of Essex Bancorp, Inc.
Essex Savings Bank, F.S.B.
Interstate Corporate Center
Building #9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Essex Home Mortgage Servicing Corporation
2420 Virginia Beach Boulevard, Suite 109
Virginia Beach, Virginia 23454
Telephone (757) 631-4240
Essex Savings Bank, F.S.B.
Retail Banking Offices
Virginia
520 South Main Street
Emporia, Virginia 23847
1401 Gaskins Road
Richmond, Virginia 23233
2825 Godwin Boulevard
Suffolk, Virginia 23434
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
Essex First Mortgage, a Division of Essex Savings Bank, F.S.B.
Mortgage Loan Production Offices
Virginia
1401 Gaskins Road
Richmond, Virginia 23233
2430 Southland Drive, 3rd Floor
Chester, Virginia 23831
Interstate Corporate Center
Building #9, Suite 100
Norfolk, Virginia 23502
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
Opening Spring 2000
Essex Savings Bank, F.S.B.
9695 Sliding Hill Road
Ashland, Virginia 23005
53
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
As Updated December 31, 1999
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>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 6902
<INT-BEARING-DEPOSITS> 9820
<FED-FUNDS-SOLD> 2229
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 19
<INVESTMENTS-CARRYING> 3230
<INVESTMENTS-MARKET> 3192
<LOANS> 240583
<ALLOWANCE> 1697
<TOTAL-ASSETS> 277739
<DEPOSITS> 212209
<SHORT-TERM> 7692
<LIABILITIES-OTHER> 2743
<LONG-TERM> 37100
0
15008
<COMMON> 11
<OTHER-SE> 2976
<TOTAL-LIABILITIES-AND-EQUITY> 277739
<INTEREST-LOAN> 16645
<INTEREST-INVEST> 305
<INTEREST-OTHER> 508
<INTEREST-TOTAL> 17458
<INTEREST-DEPOSIT> 9558
<INTEREST-EXPENSE> 11184
<INTEREST-INCOME-NET> 6274
<LOAN-LOSSES> 149
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 8685
<INCOME-PRETAX> 771
<INCOME-PRE-EXTRAORDINARY> 2160
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2160
<EPS-BASIC> 0.19
<EPS-DILUTED> 0.07
<YIELD-ACTUAL> 2.71
<LOANS-NON> 884
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1405
<ALLOWANCE-OPEN> 1845
<CHARGE-OFFS> 321
<RECOVERIES> 24
<ALLOWANCE-CLOSE> 1697
<ALLOWANCE-DOMESTIC> 1697
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
