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Letter to the Stockholders
LSB Corporation (the “Company”) reported net income of $4,680,000 or $1.05 diluted earnings per share for the year ended December 31, 2004 compared to net income of $4,136,000 or $0.94 diluted earnings per share for the year ended December 31, 2003. The Company and its wholly owned subsidiary, Lawrence Savings Bank, (the “Bank”) focus and commitment in 2004 has been to customers, the local community, financial performance, lawsuit recovery, capital adequacy and shareholders’ value.
Customers
On June 10, 2004 the Bank hosted a ribbon cutting ceremony to celebrate the opening of their new branch in Salem, New Hampshire at 401 Main Street in the Route 97 Shops plaza. The new full-service Salem branch features drive-up banking open at 7:30 a.m. for early morning commuters; a drive up ATM and night deposit box for convenient after-hours access. This new branch location helps to better-serve our retail and business customers in this area and attract new customers to the Bank. During the year, there were several new products introduced to deposit customers such as a new service to reduce charges by vendors for overdraft fees to their checking accounts and to provide customers with a choice of various free checking accounts depending on their needs.
Community
The Company conducts its business in the Merrimack Valley in Massachusetts and southern New Hampshire. The Company helps meet the needs of the community through various means. The Officers meet these needs through participation in various organizations located in or around the community. Almost all Officers have had direct or indirect participation for many years with community organizations. Some of these organizations provide direct care to individuals such as Family Service, Inc., Lawrence General Hospital, YWCA, Salvation Army and Samaritans. Other organizations provide a higher level of service to the community such as the Chamber of Commerce, Exchange Club, Kiwanis and Rotary. There are industry organizations that our Officers actively participate beside these community organizations such as the Deposit Insurance Fund (DIF), Savings Bank Employee Retirement Associations (SBERA) and MassBankers. All these organizations serviced by our Officers keep us in touch with the needs of our customers and the community.
Financial Performance
Meeting the needs of customer and the community can be a challenging job while maintaining financial performance. The focus has been to originate commercial real estate, construction and commercial loans while increasing our core deposits. The net-interest margin has improved slightly to 2.91% in 2004 from 2.90% in 2003 and down from 3.20% in 2002. Loan growth and purchases of investment securities, when profitable to do so, has increased net interest income in 2004 to approximately $13,811,000 up from $12,357,000 in 2003 and $13,573,000 in 2002.
Non-interest income (excluding the lawsuit payments in 2004 and 2003) decreased by $55,000 to $1,553,000 in 2004 from $1,608,000 in 2003 as a result of a decrease in gains on mortgage loan sales of $399,000 due to a lower level of loan sales in 2004. Partially offsetting this decrease were increases in loan fees of $164,000 and deposit account fees increasing by $176,000 in 2004 from 2003.
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Non-interest expenses increased by $926,000 to $10,664,000 for the year 2004 compared to $9,738,000 in 2003. This increase was mainly attributable to salaries and benefits increasing to $6,507,000 from $5,923,000 for the year ended December 31, 2004 from 2003, respectively. Occupancy and equipment expense increased to $872,000 in 2004 from $752,000 in 2003, due to an increase in rent and depreciation expenses associated with the new branch. Professional fees declined slightly to $623,000 in 2004 from $643,000 in 2003 attributable to a reduction in legal expenses. Data processing expenses increased by $151,000 to $878,000 in 2004, from $727,000 in 2003, due to installation of new communication lines for the Bank’s Wide Area Network (“WAN”). Marketing expenses increased to $273,000 in 2004 from $95,000 in 2003, due to increased advertising for the new Salem, New Hampshire branch and promotions for new product lines.
Lawsuit Recoveries
On June 15, 2004, the Company reported the receipt of $2.5 million on a U.S. Bankruptcy Judge’s Order on the Trustee’s Motion for authorization to make an interim distribution in a case in which the Company’s wholly owned subsidiary, Lawrence Savings Bank (the “Bank”), is the only secured creditor. The after tax impact is approximately $1,565,000, which represents approximately $0.35 per diluted earnings per share.
On October 21, 2003 the Massachusetts Appeals Court rendered a favorable opinion on a lawsuit in which the Bank was the plaintiff. The Company received payment in the amount of $1,996,000 on October 30, 2003. The after tax impact is approximately $1,251,000, which represents approximately $0.29 per diluted earnings per share.
Capital Adequacy
Total Assets increased by $52,369,000 or 11.2% during 2004 while maintaining adequate capital. The Company is considered to be “well capitalized” as defined by the Federal Reserve Bank and the Federal Deposit Insurance Corporation for all periods presented. The Corporation’s leverage ratio was 11.25% and 12.11% at December 31, 2004 and December 31, 2003, respectively.
Stockholders’ Value
The Company’s stock price closed at $18.52 and $17.31 at December 31, 2004 and 2003, respectively. The increase of $1.21 represents approximately a 7.0% increase at December 31, 2004 compared to December 31, 2003. Shareholders received an increase in the dividend paid during the year to $0.52 per share or an 8.3% increase in 2004 compared to $0.48 per share in 2003 with a dividend payout ratio of approximately 47.7% and 50.0%, respectively. During 2005, our Board of Directors, management and staff will continue to work to further improve the earnings of the Company and stockholder value.
Paul A. Miller
President and Chief Executive Officer
LSB CORPORATION
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FINANCIAL HIGHLIGHTS
December 31, | |||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||
(Dollars in Thousands, Except Per Share Data) | |||||||||||||||||||||
Balance Sheet Data : | |||||||||||||||||||||
Total assets | $ | 518,477 | $ | 466,108 | $ | 439,134 | $ | 438,267 | $ | 413,090 | |||||||||||
Loans, gross | 232,810 | 211,503 | 243,127 | 236,397 | 222,045 | ||||||||||||||||
Allowance for loan losses | 4,140 | 4,220 | 4,167 | 4,070 | 3,685 | ||||||||||||||||
Other real estate owned | — | 2 | 12 | 22 | 32 | ||||||||||||||||
Federal funds sold | 209 | 889 | 9,633 | 5,705 | 15,427 | ||||||||||||||||
U.S. Treasury, Federal agency and Corporate obligations | 259,831 | 226,338 | 155,132 | 160,337 | 125,542 | ||||||||||||||||
Municipal obligations | 1,576 | 1,624 | 4,021 | 2,062 | 60 | ||||||||||||||||
Other securities | 1,896 | 4,916 | 7,256 | 11,369 | 25,231 | ||||||||||||||||
Deposits | 299,106 | 272,540 | 279,465 | 268,450 | 270,548 | ||||||||||||||||
Borrowed funds | 157,263 | 133,352 | 101,591 | 111,099 | 86,161 | ||||||||||||||||
Equity | 57,838 | 55,002 | 54,059 | 54,092 | 52,313 |
Year Ended December 31, | 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||
Operating Data: | ||||||||||||||||||||
Interest income | $ | 22,331 | $ | 21,334 | $ | 25,138 | $ | 28,792 | $ | 29,037 | ||||||||||
Interest expense | 8,520 | 8,977 | 11,565 | 15,611 | 16,358 | |||||||||||||||
Net interest income | 13,811 | 12,357 | 13,573 | 13,181 | 12,679 | |||||||||||||||
Provision for loan (recoveries) losses | (300 | ) | — | — | 175 | 250 | ||||||||||||||
Non-interest income | 1,553 | 1,608 | 1,493 | 1,426 | 1,124 | |||||||||||||||
Lawsuit judgment collected | 2,280 | 1,996 | — | — | — | |||||||||||||||
Non-interest expense | 10,664 | 9,738 | 10,155 | 9,122 | 8,376 | |||||||||||||||
Income before income taxes | 7,280 | 6,223 | 4,911 | 5,310 | 5,177 | |||||||||||||||
Income tax expense | 2,600 | 2,087 | 1,811 | 1,953 | 854 | |||||||||||||||
Net income | $ | 4,680 | $ | 4,136 | $ | 3,100 | $ | 3,357 | $ | 4,323 | ||||||||||
Basic earnings per share | $ | 1.09 | $ | 0.98 | $ | 0.71 | $ | 0.77 | $ | 0.99 | ||||||||||
Diluted earnings per share | $ | 1.05 | $ | 0.94 | $ | 0.69 | $ | 0.74 | $ | 0.97 | ||||||||||
At or for the year ended December 31, | 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||
Other Data: | ||||||||||||||||||||
Interest rate spread | 2.64 | % | 2.57 | % | 2.78 | % | 2.64 | % | 2.66 | % | ||||||||||
Net interest margin on average earning assets | 2.91 | 2.90 | 3.20 | 3.21 | 3.22 | |||||||||||||||
Return on average assets (net income / average assets) | 0.96 | 0.94 | 0.71 | 0.79 | 1.05 | |||||||||||||||
Return on average equity (net income / average stockholders’ equity) | 8.33 | 7.76 | 5.72 | 6.35 | 8.72 | |||||||||||||||
Dividend payout ratio (dividends declared per share divided by basic earnings per share) | 47.71 | 48.98 | 61.97 | 51.95 | 26.26 | |||||||||||||||
Average stockholders’ equity to average assets ratio | 11.53 | 12.16 | 12.34 | 12.39 | 12.06 | |||||||||||||||
Cash dividends declared and paid per common share | $ | 0.52 | $ | 0.48 | $ | 0.44 | $ | 0.40 | $ | 0.26 | ||||||||||
Book value per share at year end | 13.33 | 12.99 | 12.71 | 12.35 | 11.99 | |||||||||||||||
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BUSINESS
Summary
LSB Corporation (the “Corporation” or the “Company”) is a one bank-holding company principally conducting business through Lawrence Savings Bank (the “Bank”). The Corporation became the holding company for the Bank on July 1, 2001 pursuant to a plan of reorganization in which each share of Bank common stock then outstanding (and accompanying preferred stock purchase rights) was converted into and exchanged for one share of the Corporation’s common stock (and accompanying preferred stock purchase rights). The Corporation’s common stock is currently traded on the Nasdaq Stock Market under the symbol “LSBX”. Prices of the common stock are reported in TheWall Street Journal as “LSB Corp”.
The Bank was established as a Massachusetts savings bank in 1868; the Bank converted from mutual to stock form on May 9, 1986.
The Corporation is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (“FRB”), and Massachusetts Division of Banks. The Bank is subject to supervision and regulation of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks.
The Bank has four wholly-owned subsidiaries at December 31, 2004. Shawsheen Security Corporation and Shawsheen Security Corporation II engage exclusively in buying, selling, dealing in and holding securities for their own accounts. Pemberton Corporation and Spruce Wood Realty Trust, respectively, hold foreclosed real estate and real estate used in the ordinary course of the Bank’s business.
The Bank offers various financial products to the general public. These products include loans for residential real estate, commercial real estate, construction, consumer and commercial businesses. The Bank offers various deposit accounts including savings, checking, money market, certificates of deposit and individual retirement accounts. The Bank invests a portion of its funds in federal funds and investment securities.
The principal source of funds for the Corporation is dividends from its Bank subsidiary. The principal sources of funds for the Bank’s lending and investment activities are deposits, loan payments and prepayments, investment securities payments and maturities, advances from the Federal Home Loan Bank, Federal funds purchased and securities sold under agreements to repurchase.
Market Area
The Bank’s primary market area is the Merrimack Valley in Massachusetts and southern New Hampshire. The Bank has six banking offices in the communities of Andover, Lawrence, Methuen (2), North Andover, Massachusetts and Salem, New Hampshire.
Lending Activities
The Bank’s loan portfolio consists of commercial real estate, commercial business, construction, residential mortgage, home equity and consumer loans. The Bank is aggressive in seeking loans from creditworthy customers; competition on both pricing and underwriting terms has been strong in the Bank’s market area. Gross loans at December 31, 2004 were $232.8 million up from $211.5 million at December 31, 2003, but down from $243.1 million in 2002.
Commercial real estate. The Bank originates loans secured by real estate other than 1-4 family residential properties. These loans are generally secured by various types of commercial real estate including income properties, commercial facilities (including retail, manufacturing, office and office condominiums) and small businesses. The interest rates on these loans are fixed or variable. The interest rates are based on a margin over similar terms from FHLB advances or another index (such as the Prime Rate as published inThe Wall Street Journal) for a similar term. The margin is determined by the Bank based on the creditworthiness of the borrower, relationship profitability and competitive factors.
Commercial business . The Bank originates loans secured by business assets which are not real estate. The Bank has “Preferred Lender” status from the U.S. Small Business Administration (“SBA”), which the SBA guarantees repayment of some portion of the loan amount. The interest rates on these loans may be fixed or variable. The rates are primarily based on a margin over the Prime Rate as published inThe Wall Street Journal or the Base Rate determined by the Bank. The margin is determined based on the creditworthiness of the borrower, security offered and competitive factors.
Construction. These are generally short-term loans for land development, construction of residential homes built on speculation, construction of homes for homeowners with permanent financing, and construction of commercial facilities (including retail, manufacturing and office space). These loans are generally priced to yield The Wall Street Journal Prime Rate plus a margin. Construction loans may involve additional risk due to uncertainty of estimated cost of completion of a project, or ultimate sale of the property to an end buyer. The Bank attempts to reduce these risks by lending to contractors with pre-arranged buyers or permanent financing commitments upon completion, or to businesses that are expanding and will occupy the completed project.
Residential mortgages. The Bank originates fixed and adjustable rate residential mortgage loans which are underwritten to be eligible for sale in the secondary market. These loans are secured primarily by owner occupied 1-4 family primary residential properties. Adjustable rate mortgage loans are generally held by the Bank in the loan portfolio as a means to manage interest rate risk. Fixed rate mortgages are generally sold into the secondary market unless management believes they represent a good long-term asset based on various factors such as loan-to-value ratios, interest rates and management’s expectations of a loan’s duration.
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Secondary mortgage market. The Bank is an approved seller and servicer for the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Massachusetts Housing Financing Agency (“MHFA”). Sales of mortgage loans may be made at a premium or discount resulting in gains or losses on the transaction. Based on the structure of the sale, loans sold to the secondary market may provide the Bank with service fee income over the life of the loan.
Home equity. The Bank makes second mortgage and home equity loans. Home equity loans can be accessed by the borrower through a deposit account established with the Bank. These loans carry interest rates that are either fixed or variable based on the Prime Rate published inThe Wall Street Journal plus or minus a margin above or below this rate depending on the particular product selected by the borrower.
Consumer. The Bank offers a variety of consumer loan products including overdraft lines of credit, collateral loans, and secured and unsecured personal loans. These loans are generally fixed rate in nature. The Bank adjusts interest rates on these products from time to time based on competitive factors in the marketplace.
Deposit Activity and Other Sources of Funds
Deposits and borrowings are the primary source of funds for funding loans and purchasing investment securities. The mix of deposits and borrowings is dependent on many factors, such as loan demand, competition, the economy, interest rates, and capital resources. Deposits are obtained from the general public through the Bank’s branch offices by additions to various deposit accounts, including checking, savings, money market, certificates of deposit and individual retirement accounts. The interest rates on these accounts generally are competitive with other local financial institutions. The Bank’s core deposit products (savings, checking and money market accounts) allow customers more flexibility and access and generally earn lower interest rates than other types of accounts due to the Bank’s operating costs to service these accounts. Certificates of deposit provide customers with higher interest rates, but less flexibility and access to deposits. Increasing and decreasing interest rates offered on certificates of deposit allows the Bank to adjust its sources of funds while providing a competitive interest rate. In addition to deposit accounts, other sources of funds include advances from the Federal Home Loan Bank of Boston (“FHLB”), Federal funds purchased and securities sold under agreements to repurchase.
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). The Bank is required to own stock of the FHLB which is carried on the Bank’s balance sheet at par. On April 19, 2004, the FHLB implemented a new capital structure and stock investment requirements for members to comply with the Gramm-Leach-Bliley Act of 1999. There are two components of the minimum stock investment requirements. 1) The Membership Stock Investment Requirement is equal to 0.35% of Class B Stock for Qualifying Collateral as determined by the FHLB from the most recently available FDIC Call Report from the Bank. 2) The Activity Based Stock Investment Requirement is equal to 4.50% of the Bank’s outstanding advances with the FHLB. The Bank receives an amount equal to the par value of the FHLB stock when excess stock is redeemed.
Competition
The Bank competes with local, regional and national financial service providers in its lending and deposit activities. The Bank competes in the local market against other local and branch offices of regional financial institutions such as banks, thrifts and credit unions. In addition, local and national non-bank businesses such as mortgage companies, securities brokerage firms, insurance companies and mutual funds offer services competitive with those of the Bank. Bank mergers and recent legislation permitting interstate and cross-industry expansion may increase competition in the Bank’s market area. The Bank competes on the basis of interest rates, deposit and loan terms, fees, office location, product and service arrays, customer convenience and technological advantages. Competition in the Bank’s deposit taking and lending activities is affected by movements in interest rates, local and national market developments, economic trends and the Bank’s ability to adjust to change.
Supervision and regulation
The Corporation is subject to regulation and supervision by the Federal Reserve Board (“FRB”) pursuant to the Bank Holding Company Act of 1956, as amended, and files with the FRB an annual report and such additional reports as the FRB may require. The Corporation is also subject to the jurisdiction of the Massachusetts Division of Banks. As a bank holding company, the Corporation’s activities are limited to the business of banking and activities closely related or incidental to banking. The Corporation may not directly or indirectly acquire the ownership or control of more than five percent of any class of voting shares or substantially all of the assets of any company that is not engaged in activities closely related to banking and also generally must provide notice to or obtain approval of the FRB in connection with any such acquisition. The Bank is an FDIC insured state-chartered savings bank subject to the regulations and supervisory authority of, and periodic examinations by, both the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks. These examinations test the Bank’s safety and soundness and compliance with various statutory and regulatory requirements. The Corporation and the Bank are both subject to federal and state taxation authorities. The Bank is subject to certain reserve and reporting requirements as a non-member bank of the Federal Reserve System. Federal and state bank regulatory agencies have authority to issue cease and desist orders, assess civil money penalties, remove officers and directors, issue capital directives and impose prompt corrective action restrictions or requirements to address safety and soundness and compliance issues of the Bank. In addition, the Bank must obtain prior regulatory approvals to undertake certain banking transactions and initiatives, including establishment, relocation or termination of a banking office, and merger or acquisition transactions with other banks or non-banking entities. The supervision and regulation of the Bank are intended primarily for the protection of depositors and non-business borrowers.
The results of examinations provide regulators with a means of measuring and assessing each institution and taking prompt corrective actions to address any safety and soundness or compliance issues.
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USA Patriot Act. On October 26, 2001, President George W. Bush signed into law the “Uniting and Strengthening America by providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001” (or “USA Patriot Act”). Title III of the USA Patriot Act, known as “The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001” (the “Act”) is intended to make it more difficult for terrorists to launder money in the United States. In addition, the Act also makes it easier for law enforcement and regulatory officials to share information and identify illegal money laundering activity.
Section 326 of the Act requires the Secretary of the Treasury to promulgate regulations effective no later than October 25, 2002 that would substantially increase the identification and verification requirements for customers of financial institutions. The regulations may require, at a minimum, financial institutions to develop procedures for verifying the identity of a person opening an account, maintaining records of such information, and, consulting lists of suspected terrorists “to determine whether a person seeking to open an account appears on any such list.”
In addition, under Section 311 of the Act the Secretary of the Treasury may require, by regulation or by order, that financial institutions take certain “special measures” for all institutions, accounts or transactions that the Secretary deems to be a “primary money laundering concern.” Most significant among these are requirements (known as “know your customer” requirement) to maintain records and report information which identify the participants in a transaction involving a primary money laundering concern, and to maintain information relative to the beneficiaries of such a transaction.
Section 352 of the Act amends the Bank Secrecy Act to require all financial institutions to establish anti-money laundering programs. These must include, at a minimum: “(A) the development of internal policies, procedures, and controls; (B) the designation of a compliance officer; (C) an ongoing employee training program; and (D) an independent audit function to test programs.” The Secretary of the Treasury may prescribe minimum standards for such programs effective April 24, 2002.
Under Section 314 of the USA Patriot Act, the Secretary of the Treasury must promulgate regulations by February 23, 2002 to encourage cooperation among financial institutions, their regulators, and law enforcement officials. The purpose is to help provide financial institutions with information regarding suspected terrorist or money laundering activity. The regulations may require each financial institution to designate one or more individuals to receive such information and may establish procedures for the protection of such information.
Sarbanes-Oxley Act of 2002. On July 31, 2002, President George W. Bush signed into law the “Sarbanes — Oxley Act of 2002” (or the “Sarbanes-Oxley Act”). The Sarbanes-Oxley Act establishes a comprehensive framework for modernizing and reforming the oversight of public company financial accounting and disclosure practices. Principal components of the Sarbanes-Oxley Act include:
• | The creation of a public company accounting oversight board, with which all accounting firms performing audits for public companies are required to register, and which is empowered to set auditing, quality control and independence standards, to inspect registered firms, and to conduct investigations and to take disciplinary actions, subject to SEC oversight. | |||
• | The strengthening of auditor independence from corporate management by limiting the type and scope of services that auditors can offer their public company audit clients, requiring periodic rotation of public company audit partners, requiring direct auditor reports to company audit committees, and prohibiting public companies from exerting improper influence over their outside auditors. | |||
• | The imposition of new corporate governance requirements including among other things, independence and financial expertise requirements for audit committee membership and empowerment of public company audit committees to appoint, compensate and oversee their company’s outside auditors. | |||
• | Requirements that the Chief Executive Officer and the Chief Financial Officer certify financial statements included in public company filings with the SEC and disgorge bonuses and stock-based compensation for periods for which the company is forced to restate its financial results, a prohibition of insider stock trades during “black-out” periods when a company’s employee benefits plans are precluded from trading, and a prohibition of public company loans or extensions of credit to directors and officers. | |||
• | Requirements that public companies disclose whether they have a code of ethics for their senior financial officers and if not, why not, and that management periodically assess and report on the adequacy of the company’s internal controls. | |||
• | The imposition of new and accelerated public company disclosure requirements, requirements to report off balance sheet transactions and of accelerated reporting of insider transactions in company stock |
The SEC has issued final and proposed regulations implementing many of the Sarbanes-Oxley Act provisions. Management anticipate that the Company will incur additional expenses during 2005 in complying with the provisions of the Sarbanes-Oxley Act of 2002 and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operation or financial condition. On March 2, 2005, the SEC announced an extension of compliance dates for non-accelerated filers regarding internal controls over financial reporting requirements (Section 404 of the Sarbanes-Oxley Act of 2002). The Company is considered a non-accelerated filer with the SEC and must begin to comply with Section 404 requirements for its fiscal year ending on or after July 15, 2006.
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Securities and Exchange Commission Filings on Company’s Web Site. Under the Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current reports must be filed with the Securities and Exchange Commission (“SEC”). The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Report of Unscheduled Material Events), Form 3, 4 & 5 (Statements of Ownership), Form S-3 and 8-A (Registration Statements, and Form DEF 14A (Proxy Statement). The Company may file additional forms. The SEC maintains an Internet site,www.sec.gov in which all forms filed electronically may be accessed. The Company’s website:www.lawrencesavings.com has a new section for SEC filings available free of charge and provides a link underwww.lawrencesavings.com/stockholder-info.asp.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements and Factors Which May Affect Future Results
This Annual Report contains forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended) that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, projected or anticipated benefits, or events related to other future developments involving the Company or the industry in which it operates. Also, when verbs in the present tense such as “believes,” “expects,” “anticipates,” “continues,” “attempts” or similar expressions are used, forward-looking statements are being made. Stockholders should note that many factors, some of which are discussed elsewhere in this document and in the documents which we incorporate by reference, could affect the future financial results of the Company and could cause results to differ materially from those expressed in or incorporated by reference in this document. Those factors include fluctuations in interest rates, disruptions in credit markets, inflation, changes in the regulatory environment, government regulations and changes in regional and local economic conditions and changes in the competitive environment in the geographic and business areas in which the Company conducts its operations. As a result of such risks and uncertainties, the Company’s actual results may differ materially from such forward-looking statements. The Company does not undertake, and specifically disclaims any obligation to publicly release revisions to any such forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Executive Level Overview
The Company’s financial results are dependent on the following areas of the income statement: net interest income, provision for loan losses, non-interest income, non-interest expense and provision for income taxes. Net interest income is the primary earnings of the Company and the main focus of management. Net interest income is the difference between interest earned on loans and investment securities and interest paid on deposits and borrowings. Deposits and borrowings have short durations and the cost of these funds do not rise and fall in tandem with earnings on loans and investment securities. There are many risks involved in managing net interest income including, but not limited to underwriting standards, interest rate and duration risk. These risks have a direct impact on the level of net- interest income. The Company manages these risks through credit review by an outside firm and regular meetings of its Asset and Liability Management Committee (“ALCO”). The credit review process reviews loans for underwriting and grading of loan quality while ALCO reviews liquidity, interest rate risk and capital resources. Loan quality has a direct impact on the amount of provisions for loan losses the Company reports.
Non-interest income has a direct impact on earnings of the Company. Maintenance of customers’ accounts for loans and deposits generate fee income depending on the product selected. The Company generates gains on sales of mortgage loans and receives fee income from servicing loans sold. Non-interest income is primarily impacted by the volume of customer’s transactions which could change in response to interest rates, pricing and competition.
Non-interest expenses include various expenses of the Company which are controlled by a budget process. In 2004 and 2003, management determined that net-interest income would experience some compression due to lower interest rates and implemented various expense reduction programs to help offset the reduction in net interest income.
Provisions for income taxes are directly related to earnings or implemented tax strategies of the Company. Changes in the statutory tax rates and the earnings of the Company, the Bank and its subsidiaries would affect the amount of income taxes reported.
There are areas in the Consolidated Financial Statements where significant estimates or assumptions are used. Management monitors the application of the Company’s Critical Accounting Policies in relation to the nature and impact of these estimates and assumptions on earnings. The Critical Accounting Policies are discussed below.
Critical Accounting Policies
Critical accounting policies are defined as those policies that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management believes that the Company’s critical accounting policies upon which the Consolidated Financial Statements depend and which involve the most complex or subjective decisions or assessments are as follows:
Allowance for Loan Losses: The allowance balance reflects management’s assessment of losses and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan-by-loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company’s regular review of individual loans, and economic conditions are primary factors in establishing the allowance. The allowance for loan losses reflects all information available at the end of the year. The allowance is increased by provisions for loan losses, which are a charge to the income statement, and by recoveries on loans previously charged-off. The allowance is reduced by
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loans charged-off and by negative (credit) provisions to the allowance. For a further discussion of the Company’s methodology of assessing the adequacy of the allowance for loan losses, see Management’s Discussion and Analysis of Financial Condition and Results of Operation and see Note 1 to the Consolidated Financial Statements for more details on establishing the allowance for loan losses.
Income Taxes: Operating losses in the early 1990’s resulted in available tax loss carry-forwards. A deferred tax valuation allowance is required to reduce the potential deferred tax asset when it is more likely than not that all or some portion of the potential deferred tax asset will not be realized due to the lack of sufficient taxable income in the carry-forward period. Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax valuation allowances are established and based on management’s judgment as to whether it is more likely than not that all or some portion of the future tax benefits of prior operating losses will be realized. It should be noted, however, that factors beyond management’s control, such as the general state of the economy and real estate values, can affect future levels of taxable income and that no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences. For a further discussion on income taxes, see Management’s Discussion and Analysis of Financial Condition and Results of Operation and see Note 1 & 8 to the Consolidated Financial Statements.
Mortgage Servicing Rights: When loans are sold with servicing rights retained, the Company allocates the carrying amount of the loan between the underlying asset sold and the rights retained, based on their relative fair values. The fair value is estimated using market prices when available or using a valuation model that calculates the present value of future servicing fee income using discount rates and prepayment assumptions that management believes represent current market conditions. The following risk characteristics are considered for determining fair value; loan type, interest rate, loan term and remaining maturities. The resulting mortgage servicing rights are amortized over the period of estimated net servicing income using a method which approximates the interest method. Actual prepayment experience is reviewed periodically. When actual prepayments exceed estimated prepayments, the balance of the mortgage servicing rights is adjusted accordingly through the establishment of a valuation allowance. Periodically, the mortgage servicing rights are assessed for impairment based on the fair value of such rights and any impairment is recognized by a charge to the valuation allowance. For further details on mortgage servicing rights see Notes 1 & 4 to the Consolidated Financial Statement.
Financial Condition
Overview
Total assets amounted to $518.5 million at December 31, 2004 up from $466.1 million at December 31, 2003. The increase in asset size is due to an increase of $31.7 million in investment securities and $21.3 million in loans. The cash used for the investment security purchases and loan growth came from $26.6 million in deposit growth and an increase in borrowed funds totaling $23.9 million from December 31, 2003.
Interest Earning Assets
The Company manages its earning assets by utilizing available capital resources in a manner consistent with the Company’s credit, investment and leverage policies. Loans, U.S. Treasury and Government Agency obligations, mortgage-backed securities, other investment securities, and short-term investments comprise the Company’s earning assets. Total earning assets averaged $474.1 million in 2004, an increase of $48.4 million or 11.4% from 2003.
One of the Company’s primary objectives continues to be the origination of loans that are soundly underwritten and collateralized. The Company’s average loan portfolios decreased in 2004. The change in these portfolios caused the average balance of the loan portfolio to decrease by $1.5 million in 2004 to $217.7 million.
The Company increases the investment portfolio through funds obtained from the FHLB, repurchase agreements and other borrowings when it is profitable to do so. The average balance of investment securities, including U.S. Treasury and Government Agency securities, mortgage-backed securities, other bonds and equity securities, and short-term investments amounted to $256.4 million in 2004 as compared to $206.5 million in 2003. These securities represent 52.6% of the Company’s average assets at December 31, 2004 versus 47.1% of average assets at December 31, 2003.
Investment Securities
The investment portfolio totaled $263.3 million and $232.9 million, respectively, at December 31, 2004 and 2003, reflecting an increase of $30.4 million or 13.1% in 2004. The largest increase of $24.5 million was in asset-backed securities. Also experiencing increases were U.S. Government Agency obligations and U.S. Treasury obligations increasing $22.7 million and $50 thousand, respectively. Partially offsetting these increases were decreases of $10.6 million, $6.1 million and $48 thousand in mortgage-backed securities, corporate obligations and municipal obligations, respectively, as these securities matured. For more information on investment securities, see Financial Highlights and Note 2 of the Consolidated Financial Statements.
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Loans
Total loans at December 31, 2004 and 2003 amounted to $232.8 million and $211.5 million, respectively, reflecting an increase of $21.3 million or 10.1% in 2004. Residential loans increased $3.0 million or 5.3% during 2004. Also increasing were commercial loans and commercial real estate loans by $1.6 million and $19.1 million, respectively. The increase in the portfolios was due to increased borrowers’ demand for these types of loans and the completion of the construction projects transferred to the commercial real estate portfolio. Construction loans decreased $829 thousand or 5.2% due to the completion of some projects which have been transferred into the commercial real estate portfolio partially offset by new loan originations. Home equity loans decreased $1.4 million or 13.4% as a result of customers paying off Home equity loans when they refinance existing residential first mortgage loans. For more information on loans, see Interest Rate Sensitivity and Note 4 to the Consolidated Financial Statements.
The components of the loan portfolio at December 31, follow:
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||||||||||||||||||||||
Balance | Percent | Balance | Percent | Balance | Percent | Balance | Percent | Balance | Percent | |||||||||||||||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||||||||||||||||||
Residential real estate loans: | ||||||||||||||||||||||||||||||||||||||||
Fixed rate | $ | 33,061 | 14.2 | % | $ | 33,059 | 15.7 | % | $ | 31,583 | 13.0 | % | $ | 40,861 | 17.3 | % | $ | 44,350 | 20.0 | % | ||||||||||||||||||||
Adjustable rate | 26,996 | 11.6 | 23,958 | 11.3 | 28,557 | 11.7 | 37,744 | 16.0 | 33,576 | 15.1 | ||||||||||||||||||||||||||||||
60,057 | 25.8 | 57,017 | 27.0 | 60,140 | 24.7 | 78,605 | 33.3 | 77,926 | 35.1 | |||||||||||||||||||||||||||||||
Home equity loans: | ||||||||||||||||||||||||||||||||||||||||
Fixed rate | 3,535 | 1.5 | 5,882 | 2.7 | 7,915 | 3.3 | 10,155 | 4.3 | 12,367 | 5.6 | ||||||||||||||||||||||||||||||
Adjustable rate | 5,334 | 2.3 | 4,354 | 2.1 | 3,575 | 1.5 | 3,238 | 1.4 | 3,630 | 1.6 | ||||||||||||||||||||||||||||||
8,869 | 3.8 | 10,236 | 4.8 | 11,490 | 4.8 | 13,393 | 5.7 | 15,997 | 7.2 | |||||||||||||||||||||||||||||||
Commercial real estate loans: | ||||||||||||||||||||||||||||||||||||||||
Fixed rate | 18,629 | 8.0 | 16,508 | 7.8 | 16,651 | 6.8 | 16,447 | 7.0 | 10,247 | 4.6 | ||||||||||||||||||||||||||||||
Adjustable rate | 112,976 | 48.5 | 95,995 | 45.3 | 96,094 | 39.4 | 83,663 | 35.3 | 76,882 | 34.6 | ||||||||||||||||||||||||||||||
131,605 | 56.5 | 112,503 | 53.1 | 112,745 | 46.2 | 100,110 | 42.3 | 87,129 | 39.2 | |||||||||||||||||||||||||||||||
Construction loans | 15,211 | 6.5 | 16,040 | 7.6 | 23,502 | 9.7 | 20,593 | 8.7 | 17,148 | 7.7 | ||||||||||||||||||||||||||||||
Loans held for sale | — | — | 338 | 0.2 | 2,579 | 1.1 | 4,156 | 1.8 | — | — | ||||||||||||||||||||||||||||||
Commercial loans | 16,369 | 7.1 | 14,805 | 7.0 | 32,017 | 13.2 | 18,549 | 7.8 | 22,602 | 10.2 | ||||||||||||||||||||||||||||||
Consumer loans | 699 | 0.3 | 564 | 0.3 | 654 | 0.3 | 991 | 0.4 | 1,243 | 0.6 | ||||||||||||||||||||||||||||||
Total loans | 232,810 | 100.0 | % | 211,503 | 100.0 | % | 243,127 | 100.0 | % | 236,397 | 100.0 | % | 222,045 | 100.0 | % | |||||||||||||||||||||||||
Allowance for loan losses | 4,140 | 4,220 | 4,167 | 4,070 | 3,685 | |||||||||||||||||||||||||||||||||||
Loans, net | $ | 228,670 | $ | 207,283 | $ | 238,960 | $ | 232,327 | $ | 218,360 | ||||||||||||||||||||||||||||||
Allowance for Loan Losses
The allowance for loan losses is maintained through the provision for loan losses which is a charge to operations. The allowance balance reflects management’s assessment of losses and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan-by-loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company’s regular review of individual loans, and economic conditions are primary factors in establishing the allowance. The allowance for loan losses reflects all information available at the end of each year. The Company considers the current year end 2004 level of the allowance for loan losses to be appropriate. The allowance as a percentage of total loans was 1.8% at December 31, 2004 and 2.0% at December 31, 2003. See Note 1 to the financial statements for the accounting policy related to the allowance for loan losses.
“Impaired loans” are commercial, commercial real estate and individually significant residential mortgage loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are not the same as “non-accrual loans,” although the two categories overlap. Non-accrual loans include impaired loans and are those on which the accrual of interest is discontinued when principal or interest has become contractually past due 90 days. The Company may choose to place a loan on non-accrual status due to payment delinquency or the uncertainty of collectibility, while not classifying the loan as impaired, if (i) it is probable that the Company will collect all amounts due in accordance with the contractual terms of the loan or (ii) the loan is not a commercial, commercial real estate or an individually significant residential mortgage loan. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment is determined by the difference between the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or, as a practical expedient in the case of collateral dependent loans, the difference between the fair value of the collateral and the recorded amount of the loan. When foreclosure is probable, impairment is based on the fair value of the collateral.
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The Company maintained a low level of risk assets and had minimal delinquencies during the year 2004. As a result, there was no charge to the provision for loan losses in the year 2004 or 2003. During 2004, the Bank recognized $253 thousand of the interim distribution from a prior year legal judgment as a recovery to the allowance for loan losses on amounts previously charged off. In conjunction with this, the Bank also recorded a credit (negative) provision for loan losses of $300 thousand. The Company had net recoveries of $220 thousand in 2004 and $53 thousand in 2003.
The following table summarizes changes in the allowance for loan losses for the years ended December 31:
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Balance at beginning of year | $ | 4,220 | $ | 4,167 | $ | 4,070 | $ | 3,685 | $ | 3,381 | ||||||||||
Charge-offs by loan type: | ||||||||||||||||||||
Residential mortgage | (25 | ) | — | — | — | — | ||||||||||||||
Commercial | — | — | — | (3 | ) | — | ||||||||||||||
Commercial real estate | — | — | — | — | (27 | ) | ||||||||||||||
Consumer | (20 | ) | — | (1 | ) | — | (1 | ) | ||||||||||||
Total charge-offs | (45 | ) | — | (1 | ) | (3 | ) | (28 | ) | |||||||||||
Recoveries by loan type: | ||||||||||||||||||||
Residential mortgage | — | 31 | — | 2 | 6 | |||||||||||||||
Commercial | — | — | — | — | 5 | |||||||||||||||
Commercial real estate | 254 | 16 | 89 | 201 | 62 | |||||||||||||||
Consumer | 11 | 6 | 9 | 10 | 9 | |||||||||||||||
Total recoveries | 265 | 53 | 98 | 213 | 82 | |||||||||||||||
Net recoveries | 220 | 53 | 97 | 210 | 54 | |||||||||||||||
Provision (credit) for loan losses | (300 | ) | — | — | 175 | 250 | ||||||||||||||
Ending balance | $ | 4,140 | $ | 4,220 | $ | 4,167 | $ | 4,070 | $ | 3,685 | ||||||||||
Ratio of net recoveries to average loans outstanding during the period | 0.10 | % | 0.02 | % | 0.04 | % | 0.09 | % | 0.03 | % | ||||||||||
The following table sets forth the breakdown of the allowance for loan losses by loan category for the years ended December 31. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||||||||||||||||||||||
Percent | Percent | Percent | Percent | Percent | ||||||||||||||||||||||||||||||||||||
of loans | of loans | of loans | of loans | of loans | ||||||||||||||||||||||||||||||||||||
in each | in each | in each | in each | in each | ||||||||||||||||||||||||||||||||||||
category | category | category | category | category | ||||||||||||||||||||||||||||||||||||
to Total | to Total | to Total | to Total | to Total | ||||||||||||||||||||||||||||||||||||
(Dollars in Thousands) | Amount | Loans | Amount | Loans | Amount | Loans | Amount | Loans | Amount | Loans | ||||||||||||||||||||||||||||||
Construction, commercial and commercial real estate | $ | 3,408 | 70.1 | % | $ | 3,175 | 67.7 | % | $ | 3,525 | 69.1 | % | $ | 3,251 | 58.8 | % | $ | 2,711 | 57.1 | % | ||||||||||||||||||||
Residential mortgage and home equity | 273 | 29.6 | 270 | 32.0 | 314 | 30.6 | 397 | 40.8 | 436 | 42.3 | ||||||||||||||||||||||||||||||
Consumer | 30 | 0.3 | 26 | 0.3 | 29 | 0.3 | 41 | 0.4 | 49 | 0.6 | ||||||||||||||||||||||||||||||
Unallocated | 429 | N/A | 749 | N/A | 299 | N/A | 381 | N/A | 489 | N/A | ||||||||||||||||||||||||||||||
$ | 4,140 | 100.0 | % | $ | 4,220 | 100.0 | % | $ | 4,167 | 100.0 | % | $ | 4,070 | 100.0 | % | $ | 3,685 | 100.0 | % | |||||||||||||||||||||
In determining the adequacy of the allowance for loan losses, the Company aggregates estimated credit loss on individual loans, pools of loans and other pools of risk having geographic, industry or other common exposures where inherent losses are identified or anticipated.
All loans classified as “Substandard” or “Doubtful” are evaluated for collectibility and an allocation is made based on an assessment of the net realizable value of any collateral.
The Company categorizes each commercial loan into different pools of risk. Each risk level allocation factor has been determined based upon the Company’s review of common practices within the industry, its estimate of expected loss for loans with similar credit characteristics based upon historical experience and migration analysis, the losses experienced by the Company in the most recent 36 months, together with the Company’s assessment of economic conditions and other relevant factors that may have an impact on or may affect repayment of loans in these pools.
Residential mortgages, home equity loans, equity lines of credit, second mortgages and all other small consumer loans are considered in the aggregate and an allocation factor is assessed based upon the Company’s most recent 24-month historical loss experience together with an assessment of future economic trends, conditions and other relevant factors that may have an impact on repayment of the loans in these pools.
On a quarterly basis, the Company evaluates all allocation factors for appropriateness, considering (i) significant changes in the nature and volume of the loan portfolio, (ii) the Company’s assessment of local and national economic business conditions, and (iii) any other relevant factor that it considers may have an impact on loan portfolio risk.
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Based upon these evaluations, changes to the reserve provision may be made to maintain the overall level of the reserve at a level that the Company deems appropriate and adequate to cover the estimated credit losses inherent in the Company’s loan portfolio including unfunded binding commitments to lend.
Potential Problem Loans
The Company has a loan review and grading system. During the loan review process, deteriorating conditions of certain loans come to management’s attention in which erosion of the borrower’s ability to comply with the original terms of the loan agreement could potentially result in the classification of the loan as a risk asset. This may result from deteriorating conditions such as cash flows, collateral values or creditworthiness of the borrower. There were no potential problem loans identified at December 31, 2004. At December 31, 2003, there were $2.5 million identified as potential problem loans.
Risk Assets
Risk assets consist of non-performing loans, OREO, and restructured loans. The following paragraphs define each of these categories. The components of risk assets at December 31, for the years indicated are as follows:
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Risk assets: | ||||||||||||||||||||
Non-performing loans: | ||||||||||||||||||||
Residential real estate | $ | — | $ | — | $ | 1 | $ | 10 | $ | 10 | ||||||||||
Commercial real estate | — | — | — | 730 | — | |||||||||||||||
Commercial business | — | — | — | 211 | — | |||||||||||||||
Total non-performing loans | — | — | 1 | 951 | 10 | |||||||||||||||
Other real estate owned: | ||||||||||||||||||||
Land | 34 | 47 | 57 | 67 | 77 | |||||||||||||||
OREO valuation allowance | (34 | ) | (45 | ) | (45 | ) | (45 | ) | (45 | ) | ||||||||||
Total other real estate owned | — | 2 | 12 | 22 | 32 | |||||||||||||||
Total risk assets | $ | — | $ | 2 | $ | 13 | $ | 973 | $ | 42 | ||||||||||
Risk assets as a percent of total loans and OREO | 0.0 | % | 0.0 | % | 0.0 | % | 0.4 | % | 0.0 | % | ||||||||||
Risk assets as a percent of total assets | 0.0 | % | 0.0 | % | 0.0 | % | 0.2 | % | 0.0 | % | ||||||||||
Non-performing loans consist of both (i) loans 90 days or more past due, and (ii) loans placed on a non-accrual status because full collection of the principal balance is in doubt. Non-performing loans at December 31, 2004 and 2003 were zero.
The Company actively monitors risk assets. The Company attempts to work with delinquent borrowers in order to bring loans current. If the borrower is not able to bring the loan current, the Company commences collection efforts. Valuation of property at foreclosure, and periodically thereafter, is based upon appraisals and management’s best estimates of fair value less selling costs. The Company’s policy is to sell such property as quickly as possible at fair value.
Interest Bearing Liabilities
The Company’s earning assets are primarily funded with deposits, securities sold under agreements to repurchase, FHLB advances and stockholders’ equity. The Company manages its interest bearing liabilities to maintain a stable source of funds while providing competitively priced deposit accounts. Interest bearing deposits include regular savings accounts, NOW and Super NOW accounts, money market accounts, and certificates of deposit.
In 2004 total average interest bearing liabilities were $411.5 million which was a $43.6 million or 11.9% increase from $367.9 million in 2003. Average total interest bearing deposits of $273.0 million comprised 66.3% of interest bearing liabilities in 2004 while in 2003 such deposits totaling $265.6 million comprised 72.2% of interest bearing liabilities.
Changing interest rates can affect the mix and level of various deposit categories. The lower average interest rate paid on certificates of deposit and money market accounts had an impact on the overall interest rate paid on deposits and caused a decrease of 21 basis points in 2004 and 65 basis points in 2003. The average balance of money market investment accounts increased by $11.2 million to $80.7 million in 2004, and by $10.5 million to $69.5 million in 2003.The average balance of NOW and Super NOW accounts increased by $1.4 million to $37.6 million in 2004 and by $2.6 million to $36.2 million in 2003. The average balance of certificates of deposit decreased by $6.1 million to $109.0 million in 2004 and decreased by $8.6 million to $115.1 million in 2003.
Average borrowed funds in 2004, 2003 and 2002 were $138.6 million, $102.3 million and $107.0 million, respectively, including advances from the FHLB and other borrowed funds. The increase of $36.3 million in 2004 resulted from the utilization of available credit in a low interest rate environment.
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Deposits
Total deposits increased $26.6 million or 9.7% during 2004 to $299.1 million at December 31, 2004 from $272.5 million at December 31, 2003. Certificates of deposit had the largest increase of $15.5 million or 20.8%. Also increasing were money market investment accounts, NOW accounts and retirement accounts by $6.7 million, $2.0 million and $1.4 million, respectively, in 2004. Demand deposits and savings accounts increased slightly by $687 thousand and $345 thousand, respectively, during 2004. For more information, see Note 6 to the Consolidated Financial Statements.
Borrowed Funds
Total borrowed funds increased $23.9 million or 17.9% during 2004 to $157.3 million from $133.4 million at December 31, 2004 and 2003, respectively. FHLB advances totaled $105.1 million in 2004 versus $78.9 million in 2003, an increase of $26.2 million due to utilization of available credit in a low interest rate environment.
Other borrowed funds are comprised of FHLB short-term advances which totaled $49.0 million and $52.0, respectively, at December 31, 2004 and 2003, and sales of securities subject to agreements to repurchase which totaled $3.2 million and $2.5 million, respectively, in 2004 and 2003. See Note 7 to the Consolidated Financial Statements for further information.
Results of Operations
Overview
The Company’s net earnings amounted to $4.7 million or $1.05 diluted earnings per share, $4.1 million or $0.94 diluted earnings per share and $3.1 million or $0.69 diluted earnings per share for the years ended December 31, 2004, 2003 and 2002, respectively. The Company’s earnings increased during 2004 by $544 thousand due primarily to the receipt of a $2.5 million payment on a U.S. Bankruptcy Judge’s order to make an interim distribution in a case in which the Company’s wholly-owned subsidiary, Lawrence Savings Bank, is a secured creditor. The Bank recognized $253 thousand of the interim distribution payment as a recovery to the allowance for loan losses on amounts previously charged off and the remainder of this payment received was recorded in non-interest income. The after-tax impact was approximately $1.6 million, which represents approximately $0.35 per diluted earnings per share. Net interest-income increased by $1.5 million to $13.8 million in 2004. These increases to earnings were offset by increases in non-interest expenses by $0.9 million, see discussion below. Net income increased by $1.0 million in 2003 from 2002 due to a $2.0 million lawsuit judgment collected which was recorded in non-interest income. The after-tax impact of this payment was approximately $1.3 million and represented approximately $0.29 per diluted earnings per share.
The Company’s net interest income, which is the difference between interest earned on assets and interest paid on liabilities, totaled $13.8 million in 2004, $12.4 million in 2003 and $13.6 million in 2002. The increase in 2004 versus 2003 can be attributed to the purchases of investment securities funded from Federal Home Loan Bank advances and deposit growth. Net interest-income was positively impacted by higher yields on investment securities and lower cost of borrowed funds. These increases to net interest-income were negatively impacted by lower yields on loans. The Company’s net interest margin was 2.91% in 2004 versus 2.90% and 3.20% in 2003 and 2002, respectively. The increase in 2004 resulted primarily from lower average rates paid on interest bearing liabilities. The decrease in 2003 resulted primarily from lower average rates earned on interest earning assets.
The Bank recorded a credit provision for loan losses of $300 thousand in 2004 and no provision for loan losses in 2003 due to the low level of risk assets and minimal delinquent loans. The credit provision in 2004 was recognized in conjunction with a $253 thousand interim distribution from a prior year legal judgment which was recorded as a recovery to the allowance for loan losses on amounts previously charged off.
Non-interest income amounted to $3.8 million, $3.6 million and $1.5 million in 2004, 2003 and 2002, respectively.Excluding the lawsuit judgment collected noted above, the decrease during 2004 was the result of a decrease in gains on loan sales of $399 thousand due to a lower level of loan sales in 2004. Partially offsetting this decrease were increases in loan fees of $164 thousand and deposit account fees of $176 thousand. The increase during 2003 excluding the payment from the lawsuit totaled $115 thousand attributable mainly to income on loan fees of $20 thousand from a loss of $145 thousand in 2002. Deposit fees also increased $48 thousand during 2003.
Non-interest expense totaled $10.7 million in 2004, $9.7 million in 2003 and $10.2 million in 2002. The increase in 2004 is mainly attributed to an increase in salaries and employee benefits expenses of $584 thousand. Marketing expenses and occupancy and equipment expenses increased by $178 thousand and $120 thousand, respectively, due to increased advertising, promotions and rent and depreciation expenses associated with the opening of the new Salem, New Hampshire branch. Data processing expenses increased by $151 thousand due to the installation of new communication lines for the Bank’s Wide Area Network. Professional fees decreased slightly in 2004 due to a reduction in legal expenses. The decline in non-interest expense in 2003 is primarily attributable to a reduction in professional fees of $163 thousand resulting from lower legal fees, and a reduction in salaries and employee benefits of $83 thousand resulting from salary reduction initiatives and a lower headcount in 2003.
The Company recognized income tax expense of $2.6 million in 2004, $2.1 million in 2003 and $1.8 million in 2002. The rise in the provision for taxes during 2004 resulted from increases in pre-tax income by $1.1 million to $7.3 million. The higher provision for taxes in 2003 as compared with 2002 resulted from an increase in income before income taxes to $6.2 million for the year ended 2003 versus $4.9 million in 2002.
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Average Balances, Net Interest Income and Average Interest Rates
The table below presents the Company’s average balance sheet, net interest income and average interest rates for the years ended December 31. Average real estate, commercial business, and consumer loans include non-performing loans.
2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||||||||||||||
Average | Interest | Average | Interest | Average | Interest | |||||||||||||||||||||||||||||||
(Dollars in Thousands) | Balance | Interest | Rate | Balance | Interest | Rate | Balance | Interest | Rate | |||||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||||||
Loans: | ||||||||||||||||||||||||||||||||||||
Residential real estate | $ | 69,252 | $ | 3,629 | 5.24 | % | $ | 68,150 | $ | 4,027 | 5.91 | % | $ | 87,122 | $ | 5,848 | 6.71 | % | ||||||||||||||||||
Commercial real estate | 133,832 | 8,855 | 6.62 | 126,950 | 9,005 | 7.09 | 126,083 | 9,759 | 7.74 | |||||||||||||||||||||||||||
Commercial business | 13,989 | 832 | 5.95 | 23,511 | 1,282 | 5.45 | 20,918 | 1,256 | 6.00 | |||||||||||||||||||||||||||
Consumer | 630 | 43 | 6.83 | 543 | 42 | 7.73 | 905 | 69 | 7.62 | |||||||||||||||||||||||||||
Total loans | 217,703 | 13,359 | 6.14 | 219,154 | 14,356 | 6.55 | 235,028 | 16,932 | 7.20 | |||||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||||||||||
U.S. Treasury and Government Agency obligations | 182,658 | 6,311 | 3.46 | 122,238 | 3,964 | 3.24 | 105,438 | 4,763 | 4.52 | |||||||||||||||||||||||||||
Other bonds and equity securities | 30,653 | 1,155 | 3.77 | 39,698 | 1,580 | 3.98 | 57,228 | 2,275 | 3.98 | |||||||||||||||||||||||||||
Mortgage-backed securities | 40,775 | 1,476 | 3.62 | 37,746 | 1,362 | 3.61 | 18,715 | 1,040 | 5.56 | |||||||||||||||||||||||||||
Short-term investments | 2,324 | 30 | 1.29 | 6,843 | 72 | 1.05 | 8,351 | 128 | 1.53 | |||||||||||||||||||||||||||
Total investment securities | 256,410 | 8,972 | 3.50 | 206,525 | 6,978 | 3.38 | 189,732 | 8,206 | 4.33 | |||||||||||||||||||||||||||
Total interest earning assets | 474,113 | 22,331 | 4.71 | % | 425,679 | 21,334 | 5.01 | % | 424,760 | 25,138 | 5.92 | % | ||||||||||||||||||||||||
Allowance for loan losses | (4,204 | ) | (4,247 | ) | (4,131 | ) | ||||||||||||||||||||||||||||||
Cash and due from banks | 7,773 | 7,450 | 7,132 | |||||||||||||||||||||||||||||||||
Other real estate owned | — | 8 | 18 | |||||||||||||||||||||||||||||||||
Other assets | 9,588 | 9,604 | 11,841 | �� | ||||||||||||||||||||||||||||||||
Total assets | $ | 487,270 | $ | 438,494 | $ | 439,620 | ||||||||||||||||||||||||||||||
Liabilities and Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||||||||||||
Regular savings accounts | $ | 45,696 | $ | 159 | 0.35 | % | $ | 44,842 | $ | 196 | 0.44 | % | $ | 45,102 | $ | 389 | 0.86 | % | ||||||||||||||||||
NOW and Super NOW accounts | 37,560 | 42 | 0.11 | 36,175 | 44 | 0.12 | 33,596 | 86 | 0.26 | |||||||||||||||||||||||||||
Money market accounts | 80,681 | 980 | 1.21 | 69,498 | 900 | 1.30 | 59,011 | 1,097 | 1.86 | |||||||||||||||||||||||||||
Certificates of deposit | 109,044 | 2,519 | 2.31 | 115,121 | 3,036 | 2.64 | 123,673 | 4,232 | 3.42 | |||||||||||||||||||||||||||
Total interest bearing deposits | 272,981 | 3,700 | 1.36 | 265,636 | 4,176 | 1.57 | 261,382 | 5,804 | 2.22 | |||||||||||||||||||||||||||
Borrowed funds | 138,554 | 4,820 | 3.48 | 102,294 | 4,801 | 4.69 | 107,001 | 5,761 | 5.38 | |||||||||||||||||||||||||||
Total interest bearing liabilities | 411,535 | 8,520 | 2.07 | % | 367,930 | 8,977 | 2.44 | % | 368,383 | 11,565 | 3.14 | % | ||||||||||||||||||||||||
Non-interest bearing deposits | 15,884 | 13,727 | 13,515 | |||||||||||||||||||||||||||||||||
Other liabilities | 3,673 | 3,510 | 3,488 | |||||||||||||||||||||||||||||||||
Total liabilities | 431,092 | 385,167 | 385,386 | |||||||||||||||||||||||||||||||||
Stockholders’ equity | 56,178 | 53,327 | 54,234 | |||||||||||||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 487,270 | $ | 438,494 | $ | 439,620 | ||||||||||||||||||||||||||||||
Net interest rate spread | 2.64 | % | 2.57 | % | 2.78 | % | ||||||||||||||||||||||||||||||
Net interest income | $ | 13,811 | $ | 12,357 | $ | 13,573 | ||||||||||||||||||||||||||||||
Net interest margin on average earning assets | 2.91 | % | 2.90 | % | 3.20 | % | ||||||||||||||||||||||||||||||
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Rate-Volume Analysis
The effect on net interest income of changes in interest rates and in the amounts of interest earning assets and interest bearing liabilities is shown in the following table. Information is provided on changes for the years indicated and is attributable to (i) changes in volume (change in average balance multiplied by prior year rate), (ii) changes in interest rate (change in rate multiplied by prior year average balance) and (iii) the combined effects of changes in interest rates and volume (change in rate multiplied by change in average balance).
2004 vs. 2003 | 2003 vs. 2002 | |||||||||||||||||||||||||||||||
Total | Rate/ | Total | Rate/ | |||||||||||||||||||||||||||||
Change | Volume | Rate | Volume | Change | Volume | Rate | Volume | |||||||||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||||||||||
Interest Income : | ||||||||||||||||||||||||||||||||
Loans: | ||||||||||||||||||||||||||||||||
Residential real estate | $ | (398 | ) | $ | 65 | $ | (456 | ) | $ | (7 | ) | $ | (1,821 | ) | $ | (1,273 | ) | $ | (700 | ) | $ | 152 | ||||||||||
Commercial real estate | (150 | ) | 488 | (605 | ) | (33 | ) | (754 | ) | 67 | (815 | ) | (6 | ) | ||||||||||||||||||
Commercial business | (450 | ) | (519 | ) | 116 | (47 | ) | 26 | 156 | (115 | ) | (15 | ) | |||||||||||||||||||
Consumer | 1 | 7 | (5 | ) | (1 | ) | (27 | ) | (28 | ) | 1 | — | ||||||||||||||||||||
Total loans | (997 | ) | 41 | (950 | ) | (88 | ) | (2,576 | ) | (1,078 | ) | (1,629 | ) | 131 | ||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||||||
U.S. Treasury and Government Agency obligations | 2,347 | 1,959 | 259 | 129 | (799 | ) | 759 | (1,344 | ) | (214 | ) | |||||||||||||||||||||
Other bonds and equity securities | (425 | ) | (360 | ) | (84 | ) | 19 | (695 | ) | (697 | ) | 3 | (1 | ) | ||||||||||||||||||
Mortgage-backed securities | 114 | 109 | 4 | 1 | 322 | 1,058 | (365 | ) | (371 | ) | ||||||||||||||||||||||
Short-term investments | (42 | ) | (48 | ) | 16 | (10 | ) | (56 | ) | (23 | ) | (40 | ) | 7 | ||||||||||||||||||
Total investments | 1,994 | 1,660 | 195 | 139 | (1,228 | ) | 1,097 | (1,746 | ) | (579 | ) | |||||||||||||||||||||
Total interest income | 997 | 1,701 | (755 | ) | 51 | (3,804 | ) | 19 | (3,375 | ) | (448 | ) | ||||||||||||||||||||
Interest Expense : | ||||||||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||||||||
Regular savings accounts | (37 | ) | 4 | (40 | ) | (1 | ) | (193 | ) | (2 | ) | (192 | ) | 1 | ||||||||||||||||||
NOW and Super NOW accounts | (2 | ) | 2 | (4 | ) | — | (42 | ) | 7 | (45 | ) | (4 | ) | |||||||||||||||||||
Money market accounts | 80 | 145 | (56 | ) | (9 | ) | (197 | ) | 195 | (333 | ) | (59 | ) | |||||||||||||||||||
Certificates of deposit | (517 | ) | (160 | ) | (377 | ) | 20 | (1,196 | ) | (293 | ) | (970 | ) | 67 | ||||||||||||||||||
Total interest bearing deposits | (476 | ) | (9 | ) | (477 | ) | 10 | (1,628 | ) | (93 | ) | (1,540 | ) | 5 | ||||||||||||||||||
Borrowed funds | 19 | 1,702 | (1,242 | ) | (441 | ) | (960 | ) | (253 | ) | (739 | ) | 32 | |||||||||||||||||||
Total interest expense | (457 | ) | 1,693 | (1,719 | ) | (431 | ) | (2,588 | ) | (346 | ) | (2,279 | ) | 37 | ||||||||||||||||||
Net interest income | $ | 1,454 | $ | 8 | $ | 964 | $ | 482 | $ | (1,216 | ) | $ | 365 | $ | (1,096 | ) | $ | (485 | ) | |||||||||||||
Net Interest Income
Net interest income is the difference between the interest income earned on earning assets and the interest expense paid on interest bearing liabilities. Interest income and interest expense are affected by changes in earning assets and interest bearing liability balances in addition to changes in interest rates.
The Company’s net interest income was $13.8 million in 2004, $12.4 million in 2003 and $13.6 million in 2002. Interest income from earning assets was $22.3 million, $21.3 million and $25.1 million in 2004, 2003 and 2002, respectively. The rise in interest income during 2004 compared to 2003 was due primarily to increases in volume of investment securities and loans. Also contributing to the increase were higher interest rates earned on investment securities.
The reduction in interest income during 2003 compared to 2002 was due to a decrease in rates earned on investment securities and loans coupled with a decrease in loan volume.
Interest expense on interest bearing deposits was $3.7 million in 2004, compared to $4.2 million in 2003 and $5.8 million in 2002. Average deposit balances increased during 2004 from 2003 and 2002. The primary increase during 2004 was in money market investment accounts. NOW accounts and regular savings accounts increased slightly and were partially offset by decreases in certificates of deposit.
Interest expense continued to decline during 2004 attributable mainly to the reduction of all deposit rates, coupled with the decrease in volume of the certificates of deposit. The primary increase in 2003 was in money market investment accounts. NOW accounts also increased and were partially offset by decreases in certificates of deposit and regular savings accounts. Interest expense declined during 2003 attributable mainly to the reduction of all deposit rates. Average rates paid on certificates of deposit decreased to 2.31% during 2004 from 2.64% in 2003 resulting in a net decrease of $517 thousand in interest expense in 2004. Average rates paid on money market investment accounts declined to 1.21% in 2004 from 1.30% in 2003 reducing interest expense by $56 thousand offset by an increase to interest expense of $145 thousand due to increased volume. Average rates paid on certificates of deposit decreased to 2.64% during 2003 from 3.42 % in 2002 resulting in a net decrease of $1.2 million in interest expense during 2003. Average rates paid on money
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market accounts decreased to 1.30% in 2003 from 1.86% in 2002 which resulted in $197 thousand net decrease in interest expense. Interest expense on borrowed funds remained stable in 2004 and decreased to $4.8 million in 2003 and $5.8 million in 2002. The net decrease in interest expense on borrowed funds of $960 thousand in 2003 resulted from a reduction in rates paid coupled with a decline in the average balances outstanding. Interest expense on total interest bearing liabilities totaled $8.5 million, $9.0 million and $11.6 million during 2004, 2003 and 2002, respectively.
Over the past three years, the Company has been operating in a declining interest rate environment. The result of this environment has been lower yields in assets and a lower cost of funds. The average yield on earning assets in 2004 declined 30 basis points to 4.71% and in 2003 and 2002, respectively, was down 91 basis points and 108 basis points to 5.01% in 2003 and 5.92% in 2002. The average rate paid on interest bearing liabilities in 2004 was 2.07%, or a decrease of 37 basis points, in 2003 was 2.44% and in 2002 was 3.14%. The net interest rate spread in 2004 was 2.64%, a 7 basis point increase from 2003 in which the net interest rate spread was 2.57% down 21 basis points from 2.78% in 2002. In an environment of declining asset yields, management strives to control the cost of funds and maintain net-interest margin. The Company’s net-interest margin increased to 2.91% in 2004 from 2.90% and 3.20% in 2003 and 2002, respectively.
Provision for Loan Losses
The Company recognized a credit provision for loan losses in the amount of $300 thousand in 2004 due to the $253 thousand recovery to the allowance for loan losses and the continued low level of non-performing loans. The Company made no provision for loan losses in 2003 and 2002. The absence of a provision for loan losses in 2003 and 2002 was due to the overall asset quality of the Company and low level of delinquent loans.
Non-Interest Income
Non-interest income increased 6.0% and totaled $3.8 million versus $3.6 million and $1.5 million for the years ended 2004, 2003 and 2002, respectively. In 2004 and 2003, the increase is primarily due to the lawsuit judgment collected amounting to $2.3 million and $2.0 million in 2004 and 2003, respectively. Excluding the lawsuit, non-interest income decreased $55 thousand during 2004. Loan servicing fees increased to $184 thousand from $20 thousand in 2003 mainly attributable to the recovery of fair values on MSR. See Note 4 in the Consolidated Financial Statements on Mortgage Servicing Rights.
Deposit account fees increased to $889 thousand in 2004 from $713 thousand for the year 2003. Partially offsetting these increases were a reduction in gains on the sale of mortgage loans totaling $399 thousand, loss on sale of investment securities of $14 thousand and a decrease of $10 thousand in other income.
Excluding the lawsuit, non-interest income increased $115 thousand during 2003. Loan servicing fees increased to $20 thousand from a loss of $145 thousand in 2002 mainly attributable to $186 thousand in commercial loan prepayments and the recovery of fair values on MSR. Deposit account fees increased to $713 thousand in 2003 from $665 thousand for the year 2002. Partially offsetting these increases were a reduction in gains on the sale of mortgage loans totaling $62 thousand, loss on sale of investment securities of $14 thousand and a decrease of $22 thousand in other income.
Non-Interest Expense
Non-interest expense increased to $10.7 million in 2004, from $9.7 million in 2003 and $10.2 million in 2002. The increase in 2004 was attributable to salaries and benefits increasing by $584 thousand, occupancy and equipment increasing $120 thousand and marketing expenses increasing $178 thousand due to increased rent and depreciation expenses and advertising and promotion expenses related to the opening of the new Salem, New Hampshire branch. Data processing expenses increased $151 thousand due to the installation of new communication lines for the Bank’s Wide Area Network.
The decrease in 2003 was attributable to a reduction of $163 thousand in professional fees resulting from lower legal fees and a reduction of $83 thousand in salaries and employee benefits resulting from the salary reduction initiatives and a lower headcount.
Salaries and employee benefits expense totaled $6.5 million in 2004, $5.9 million in 2003 and $6.0 million in 2002. Full-time equivalent employees were 99 at December 31, 2004, and 2003 and 105 at December 31, 2002. In 2004, the increase was the result of normal merit raises, increases in medical & dental premiums and reestablishing salary reduction initiatives taken away in 2003. The decrease in 2003 relates to several salary reduction initiatives instituted during 2003 as a result of the net-interest margin declining during 2003. The Company continually evaluates staffing levels in order to control salaries and employee benefits while managing business volumes.
Occupancy and equipment expenses increased to $872 thousand in 2004, compared to $752 thousand in 2003 and $790 thousand in 2002 due to the opening of a new branch in Salem, NH in 2004. Data processing expenses increased to $878 thousand in 2004, compared to $727 thousand in 2003 and $749 thousand in 2002. This includes the Company’s service contract to provide on-line deposit accounting, loan accounting and item processing services. In which, the Bank installed new communication lines for its Wide Area Network (“WAN”). Insurance expenses totaled $157 thousand, $151 thousand and $153 thousand in 2004, 2003 and 2002, respectively, and other expenses increased to $1.6 million in 2004, as compared to $1.5 million in 2003 and $1.7 million in 2002.
Income Taxes
The Company reported income tax expense of $2.6 million in 2004, $2.1 million in 2003 and $1.8 million in 2002. The effective income tax rate for the year 2004 was 35.7% and for 2003 was 33.5% compared to 36.9% in 2002. The decrease in the effective income tax rate
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for 2004 and 2003 from 2002 is due to change in estimates for tax contingencies. See Note 8 to the Consolidated Financial Statements for further information regarding income taxes.
Liquidity
Managing liquidity involves planning to meet anticipated funding needs at a reasonable cost, as well as contingency plans to meet unanticipated funding needs or a loss of funding sources. The following factors are considered in managing liquidity; marketability of assets, the sources and stability of funding and the level of unfunded commitments. The Company’s primary source of funds is dividends from its Bank subsidiary. The Bank’s loans and investments are primarily funded by deposits, Federal Home Loan Bank advances, securities sold under agreements to repurchase and stockholders’ equity.
The investment portfolio is one of the primary sources of liquidity for the Bank. Maturities of securities provide a flow of funds which are available for cash needs such as loan originations and net deposit outflows. In addition, the investment portfolio consists of high quality, and, therefore, readily marketable, U.S. Treasury and Government Agency obligations. At December 31, 2004, the Bank’s investment securities and mortgage-backed securities available for sale totaled $63.0 million which is available to meet the Bank’s liquidity needs.
Loan maturities and amortization as well as deposit growth provide for a constant flow of funds. In addition, the Bank has two overnight lines of credit totaling $11.8 million to meet short-term liquidity needs. The Bank did not utilize these overnight lines at December 31, 2004 and had the full $11.8 million available.
The liquidity position of the Company is managed by the Asset/Liability Management Committee (“ALCO”). The duties of ALCO are to periodically review the Company’s level of liquidity under prescribed policies and procedures. It is the responsibility of ALCO to report to the Board of Directors on a regular basis the Company’s liquidity position as it relates to these policies and procedures. At December 31, 2004, the Company’s liquidity position was above policy guidelines. Management believes that the Bank has adequate liquidity to meet current and future liquidity demands.
Contractual Obligations And Commitments
The company enters into off-balance sheet contractual obligations and commitments in the normal course of business. The Company has contractual obligations such as payments on FHLB advances, operating lease obligations and customer repurchase agreements. The Company has commitments in the form of financial instruments that are for loan originations, lines of credit, letters of credit and to sell mortgage loans. These commitments have various expiration dates. The following table summarizes the expiration dates of these commitments at December 31, 2004.
Payments Due – By Period | ||||||||||||||||||||
Less than | One to | Four to | After | |||||||||||||||||
Contractual Obligations | Total | One Year | Three Years | Five Years | Five Years | |||||||||||||||
(In Thousands) | ||||||||||||||||||||
FHLB Advances | $ | 105,102 | $ | 32,000 | $ | 40,000 | $ | 224 | $ | 32,878 | ||||||||||
FHLB short-term borrowings | 49,000 | 49,000 | — | — | — | |||||||||||||||
Lease Obligations | 1,109 | 201 | 404 | 296 | 208 | |||||||||||||||
Data processing vendor | 6,134 | 927 | 1,947 | 2,126 | 1,134 | |||||||||||||||
Employee benefit contributions (1) | — | — | ||||||||||||||||||
Customer Repurchase Agreements | 3,161 | 3,161 | — | — | — | |||||||||||||||
Total Contractual Cash Obligations | $ | 164,506 | $ | 85,289 | $ | 42,351 | $ | 2,646 | $ | 34,220 | ||||||||||
1) | Employee benefit contributions include expected contributions to the Company’s defined pension benefit plan, post retirement plan and supplemental executive retirement plans. Expected contributions for the defined pension benefit plan have been included only through the plan year November 1, 2004 through October 31, 2005. Contributions beyond the plan year can not be quantified as contributions will be determined based upon the return on the investments in the plan. Expected contributions for the post retirement plan and the supplemental executive retirement plan can not be quantified as the level of retirees is unknown, interest rates and average salary amounts have not yet been determined. |
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Amount of Commitment Expiring – By Period | ||||||||||||||||||||
Less than | One to | Four to | After | |||||||||||||||||
Commitments | Total | One Year | Three Years | Five Years | Five Years | |||||||||||||||
(In Thousands) | ||||||||||||||||||||
Loan Originations | $ | 23,444 | $ | 23,444 | $ | — | $ | — | $ | — | ||||||||||
Lines of Credit | 45,315 | 14,395 | 11,491 | 11,601 | 7,828 | |||||||||||||||
Letters of Credit | 1,393 | 1,393 | — | — | — | |||||||||||||||
Sell mortgage Loans | 300 | 300 | — | — | — | |||||||||||||||
Total commitments | $ | 70,452 | $ | 39,532 | $ | 11,491 | $ | 11,601 | $ | 7,828 | ||||||||||
The Corporation has no off-balance sheet arrangements except those discussed in the commitment table in the Liquidity section and Note 12 of the Consolidated Financial Statements.
Capital Adequacy
The Company and the Bank are required to maintain a leverage capital ratio of 5% and risk-based capital ratios of at least 10% in order to be categorized as “well capitalized” in accordance with definitions in regulatory guidelines promulgated by the FDIC and FRB. At December 31, 2004 and 2003, the Company’s and the Bank’s leverage and risk-based capital ratios exceeded the required levels for the category of “well-capitalized” as defined by their respective regulatory agencies.
The Company and the Bank may not declare or pay cash dividends on their outstanding common stock if the effect thereof would cause its stockholders’ equity to be reduced below applicable capital requirements or if such declaration and payments would otherwise violate regulatory requirements. See note 9 to the Consolidated Financial Statements for further information regarding capital adequacy.
On July 25, 2002, the Board of Directors of the Company adopted a stock repurchase program (the “Repurchase Program”) authorizing the Company to repurchase up to five percent of its common stock outstanding as of June 30, 2002 for cash. As of December 31, 2004 the number of shares repurchased and included as Treasury Stock was 219,300, which had an average purchase price of $12.57. The Company did not purchase shares of Treasury Stock during 2004. The Company’s book value per share was $13.33 at December 31, 2004. The book value per share increased from $12.99 at December 31, 2003 due to net income of $4.7 million and exercise of stock options of $806 thousand. Offsetting these increases were the declaration of dividends $2.2 million, and a decrease in market value of investment securities available for sale (net of taxes) in the amount of $414 thousand.
Asset/Liability Management
Managing interest rate risk is fundamental to banking. The Company has continued to manage its liquidity, capital, and GAP position so as to control its exposure to interest rate risk. As of December 31, 2004, the Company had interest rate sensitive assets which repriced or matured within one year of $201.9 million and interest rate sensitive liabilities which repriced or matured within one year of $232.8 million. As of December 31, 2003, the Company had interest rate sensitive assets which matured or repriced within one year of $212.7 million and interest rate sensitive liabilities which repriced or matured within one year of $215.7 million.
Interest Rate Sensitivity
The Company actively manages its interest rate sensitivity position. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve a stable and rising flow of net interest income. The ALCO using policies approved by the Board of Directors, is responsible for managing the Bank’s rate sensitivity position.
The asset/liability management policy establishes guidelines for acceptable exposure to interest rate risk, liquidity, and capital. The objective of ALCO is to manage earning assets and liabilities to produce results which are consistent with the Company’s policy for net interest income, liquidity and capital and identify acceptable levels of growth, risk and profitability. ALCO establishes and monitors origination and pricing strategies consistent with ALCO policy. ALCO meets regularly to review the current economic environment, income simulation model and GAP analysis and implements appropriate changes in strategy that will manage the Company’s exposure to interest rate risk, liquidity and capital.
ALCO manages the Company’s interest rate risk using both income simulation and GAP analysis. Income simulation is used to quantify interest rate risk inherent in the Company’s consolidated balance sheet by showing the effect of a change in net interest income over a 24 month period. The income simulation model uses parallel interest rate shocks of up 200 basis points (bp) or down 100 basis points (bp) for earning assets and liabilities in the first year of the model. Interest rates are not shocked in the second year of the model. The composition of the Company’s consolidated balance sheet at December 31, 2004 remains relatively well matched over the 24 month horizon with a slight bias towards liability sensitivity in the first year. The simulation takes into account the dates for repricing, maturing, prepaying and call options assumptions of various financial categories which may vary under different interest rate scenarios. Prepayment speeds are estimates for the loans and are adjusted according to the degree of rate changes. Call options and prepayment speeds for investment securities are estimates using industry standards for pricing and prepayment assumptions. The assumptions of financial instrument categories are reviewed before each simulation by ALCO in light of current economic trends. As of December 31,
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2004, the income simulation model indicated some negative exposure of net interest income to rising interest rates to a degree that remains within tolerance levels established by the Company’s policy. The interest rate scenario used does not necessarily reflect ALCO’s view of the “most likely” change in interest rates over the model’s period. Furthermore, the model assumes a static consolidated balance sheet. These results do not reflect the anticipated future net interest income of the Company for the same periods.
The following table summarizes the net interest income for the 24 month period of the Company’s consolidated balance sheet for earning assets and liabilities for the years ended December 31;
Net Interest Income Simulation Model Results:
Interest Rate Shock | ||||||||||||
Down | Up | |||||||||||
2004 | Flat Rates | 100 bp | 200 bp | |||||||||
(Dollars in Thousands) | ||||||||||||
Year One | $ | 14,090 | $ | 14,380 | $ | 13,535 | ||||||
Year Two | 14,309 | 14,574 | 13,258 | |||||||||
Total net interest income for 2 year period | $ | 28,399 | $ | 28,954 | $ | 26,793 | ||||||
Interest Rate Shock | ||||||||||||
Down | Up | |||||||||||
2003 | Flat Rates | 100 bp | 200 bp | |||||||||
(Dollars in Thousands) | ||||||||||||
Year One | $ | 13,246 | $ | 13,538 | $ | 12,902 | ||||||
Year Two | 12,122 | 12,201 | 11,994 | |||||||||
Total net interest income for 2 year period | $ | 25,368 | $ | 25,739 | $ | 24,896 | ||||||
The income simulation model reflects negative exposure to net interest income in a rising interest rate environment from flat rates to up 200 bp, which would result from shorter liabilities due to short-term borrowings from FHLB. Margins would narrow as deposits and borrowings are faster to reprice to higher interest rates. The Company’s primary measure of interest rate risk is GAP analysis. GAP measurement attempts to analyze any mismatches in the timing of interest rate repricing between assets and liabilities. It identifies those balance sheet sensitivity areas which are vulnerable to unfavorable interest rate movements. As a tool of asset/liability management, the GAP position is compared with potential changes in interest rate levels in an attempt to measure the favorable and unfavorable effect such changes would have on net interest income. For example, when the GAP is positive, (i.e., assets reprice faster than liabilities) a rise in interest rates will increase net interest income; and, conversely, if the GAP is negative, a rise in interest rates will decrease net interest income. The accuracy of this measure is limited by unpredictable loan prepayments and the lags in the interest rate indices used for repricing variable rate loans or investment securities.
The Company’s one-year cumulative GAP to total assets decreased from less than 1% at December, 2003, to less than 6% at December, 2004. The following table shows the interest rate sensitivity gap position as of December 31, 2004. The table excludes non-performing loans and assumes that all deposits except savings and NOWs will be withdrawn within the legal time period for withdrawal. This withdrawal of deposit assumption is not likely to occur.
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Rate Sensitivity GAP Position | ||||||||||||||||||||||||
Position/Volume | ||||||||||||||||||||||||
Time interval from December 31, 2004 | 0-3 Mo. | 4-6 Mo. | 7-12 Mo. | 13-36 Mo. | 37-60 Mo. | +60 Mo. | ||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
Earning Assets: | ||||||||||||||||||||||||
Investment securities held to maturity | $ | 29,887 | $ | 10,462 | $ | 12,109 | $ | 105,793 | $ | 33,967 | $ | 8,046 | ||||||||||||
Investments securities available for sale | 17,274 | 11,329 | 2,637 | 17,852 | 7,723 | 6,056 | ||||||||||||||||||
Federal Home Loan Bank Stock and other earning assets | 8,934 | — | — | — | — | 168 | ||||||||||||||||||
Fixed rate mortgages loans | 2,529 | 2,057 | 3,840 | 11,640 | 7,406 | 9,123 | ||||||||||||||||||
Adjustable rate mortgages loans | 8,868 | 2,230 | 5,593 | 9,058 | 6,582 | — | ||||||||||||||||||
Consumer loans | 371 | 34 | 136 | 115 | 5 | 38 | ||||||||||||||||||
Fixed rate commercial real estate loans | 1,063 | 344 | 700 | 5,322 | 4,584 | 6,616 | ||||||||||||||||||
Adjustable rate commercial real estate loans | 29,077 | 7,435 | 14,759 | 47,068 | 14,637 | — | ||||||||||||||||||
Construction loans | 15,211 | — | — | — | — | — | ||||||||||||||||||
Fixed rate commercial business loans | 3,134 | 519 | 830 | 1,153 | 170 | — | ||||||||||||||||||
Adjustable rate commercial business loans | 10,563 | — | — | — | — | — | ||||||||||||||||||
Total earning assets | 126,911 | 34,410 | 40,604 | 198,001 | 75,074 | 30,047 | ||||||||||||||||||
Interest Bearing Liabilities: | ||||||||||||||||||||||||
Savings and escrow accounts | — | — | — | — | — | 45,179 | ||||||||||||||||||
NOW and Super Now accounts | — | — | — | — | — | 38,061 | ||||||||||||||||||
Money market accounts | 82,877 | — | — | — | — | — | ||||||||||||||||||
Certificates of deposit and retirement accounts | 20,714 | 20,851 | 24,028 | 44,589 | 8,516 | — | ||||||||||||||||||
FHLB advances and other borrowed funds | 78,191 | 6,030 | 62 | 40,266 | 298 | 32,416 | ||||||||||||||||||
Total interest bearing liabilities | 181,782 | 26,881 | 24,090 | 84,855 | 8,814 | 115,656 | ||||||||||||||||||
Interest Sensitivity Gap | $ | (54,871 | ) | $ | 7,529 | $ | 16,514 | $ | 113,146 | $ | 66,260 | $ | (85,609 | ) | ||||||||||
Cumulative GAP | $ | (54,871 | ) | $ | (47,342 | ) | $ | (30,828 | ) | $ | 82,318 | $ | 148,578 | $ | 62,969 | |||||||||
Cumulative GAP as a percent of total assets | (11 | )% | (9 | )% | (6 | )% | 16 | % | 29 | % | 12 | % | ||||||||||||
Recent Accounting Developments
The Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) Issue 03-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” In November 2003 and March 2004, the FASB’s EITF issued a consensus on EITF Issue 03-1. EITF 03-1 contains new guidance on other-than-temporary impairments of investment securities. The guidance dictates when impairment is deemed to exist, provides guidance on determining if impairment is other than temporary, and directs how to calculate impairment loss. Issue 03-1 also details expanded annual disclosure rules. In September 2004, the FASB’s EITF issued EITF Issue No. 03-1-1 “Effective Date of Paragraphs 10-20 of EITF Issue 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1 to be concurrent with the final issuance of EITF 03-1-a “Implementation Guidance for the Application of Paragraph 16 of EITF 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-1-a is currently being debated by the FASB in regards to final guidance and effective date with a comment period that ended October 29, 2004. EITF 03-1, as issued, was originally effective for periods beginning after June 15, 2004 and the disclosure requirements of this consensus remain in effect. The adoption of the original EITF 03-1 (excluding paragraphs 10-20) did not have a material impact on the Company’s financial position or results of operations.
Statement of Position 03-3 (“SOP 03-3”): “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” in December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 03-3. SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality be recognized at their fair value. The yield that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual, or valuation allowance. Valuation allowances can not be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans with evidence of deterioration of credit quality since origination. However, valuation allowances for non-impaired loans acquired in a business combination can be carried over. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Company does not believe the adoption of SOP 03-3 will have a material impact on the Company’s financial position or results of operations.
SFAS No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment” In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004). SFAS No. 123R replaces SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”. SFAS No. 123R will require that the compensation cost relating to share-based payment transactions be recognized in the Company’s financial statements, eliminating pro forma disclosure as an alternative. That cost will be measured based on the grant-date fair value of the equity or liability instruments issued. SFAS No. 123R is effective for public entities as of the first interim or annual period that begins after June 15, 2005. The impact of the Company adopting such accounting can be seen in Note 1, Stock-Based Compensation of the Notes to Consolidated Financial Statements. The Company does believe the adoption of SFAS 123R will have an impact to the Company and estimates the 2005 gross compensation expense related to share-based payment transactions to be recognized will be approximately $61 thousand for the six months of 2005 for which SFAS 123R will be effective. For years 2006 and beyond, a full year of compensation expense will be recognized.
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FIN No. 46 “Consolidation of Variable Interest Entities — an Interpretation of Accounting Research Bulletin No. 51” In January 2003, the FASB issued FIN No. 46. FIN 46 established accounting guidance for consolidation of variable interest entities (“VIE”) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The Company adopted FIN No. 46 as of February 1, 2003 for all arrangements entered into after January 31, 2003. The Company does not believe the adoption of FIN No. 46 will have a material impact on the Company’s financial position or results of operations.
Impact of Inflation and Changing Prices
The Company’s asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of the Company are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company’s ability to react to changes in interest rates and by such reaction reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services. As discussed previously, management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide net interest income fluctuations, including those resulting from inflation.
Various information shown elsewhere in this Annual Report will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions, the compositions of the loan and security portfolios and the data on the interest rate sensitivity of loans and deposits should be considered.
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Report of Management Responsibility
The management of LSB Corporation (the “Corporation” or the “Company”) is responsible for the preparation and integrity of the Consolidated Financial Statements and other financial information contained in this annual report. The Consolidated Financial Statements have been prepared in conformity with U.S. generally accepted accounting principles and prevailing practices of the banking industry and, accordingly, include amounts based on management’s best estimates and judgments.
Management has established and is responsible for maintaining internal accounting controls designed to provide reasonable assurance as to the integrity and reliability of the Consolidated Financial Statements, the protection of assets, and the prevention and detection of irregularities. The concept of reasonable assurance recognizes that the cost of a system of internal accounting controls should not exceed the benefits derived. The internal accounting control system is augmented by written policies and guidelines, careful selection and training of qualified personnel, a written program of internal audits, appropriate review by management, and a written code of professional conduct for directors and officers.
The Corporation’s Board of Directors has an Audit Committee composed solely of independent directors. The Committee meets periodically with management, the internal auditors and KPMG LLP (“KPMG”) to review the work of each and to inquire of each as to their assessment of the performance of the others in their work relating to the Company’s Consolidated Financial Statements. Both the independent registered public accounting firm and internal auditors have, at all times, the right of full access to the Audit Committee, without management present, to discuss any matter they believe should be brought to the attention of the Audit Committee.
Management recognizes that there are inherent limitations in the effectiveness of any internal control system. However, management believes that as of December 31, 2004 the Company’s internal accounting controls provide reasonable assurance as to the integrity and reliability of the Consolidated Financial Statements and related financial information.
The independent registered public accounting firm, KPMG, is appointed by the Audit Committee. KPMG’s audits include reviews and tests of the Company’s internal controls to the extent they believe necessary to determine and conduct the audit procedures that support their report. Members of that firm also have the right of full access to each member of management in conducting their audits. The report of KPMG appears on the next page.
![]() | ![]() | |
Paul A. Miller | John E. Sharland | |
President and | Senior Vice President and | |
Chief Executive Officer | Chief Financial Officer |
December 31, 2004
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
LSB Corporation:
We have audited the accompanying consolidated balance sheets of LSB Corporation (the “Company”) and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LSB Corporation and subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Boston, Massachusetts
March 28, 2005
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Consolidated Balance Sheets
December 31, | 2004 | 2003 | ||||||
(In Thousands) | ||||||||
Assets: | ||||||||
Cash and due from banks | $ | 7,193 | $ | 7,872 | ||||
Fed funds sold | 209 | 889 | ||||||
Total cash and cash equivalents | 7,402 | 8,761 | ||||||
Investment securities held to maturity market value of $198,716 in 2004 and $184,592 in 2003 (notes 2 and 7) | 200,264 | 184,286 | ||||||
Investment securities available for sale amortized cost of $63,706 in 2004 and $48,571 in 2003 (notes 2 and 7) | 63,039 | 48,592 | ||||||
Federal Home Loan Bank stock, at cost (note 3) | 7,887 | 6,593 | ||||||
Loans, net of allowance for loan losses of $4,140 in 2004 and $4,220 in 2003 (notes 4 and 7) | 228,670 | 207,283 | ||||||
Bank premises and equipment (note 5) | 3,486 | 2,875 | ||||||
Accrued interest receivable | 2,894 | 2,552 | ||||||
Deferred income tax asset (note 8) | 3,067 | 3,519 | ||||||
Other assets | 1,768 | 1,647 | ||||||
Total assets | $ | 518,477 | $ | 466,108 | ||||
Liabilities And Stockholders’ Equity: | ||||||||
Liabilities: | ||||||||
Interest bearing deposits (note 6) | $ | 284,309 | $ | 258,430 | ||||
Non-interest bearing deposits (note 6) | 14,797 | 14,110 | ||||||
Federal Home Loan Bank advances (note 7) | 105,102 | 78,866 | ||||||
Other borrowed funds (note 7) | 52,161 | 54,486 | ||||||
Advance payments by borrowers for taxes and insurance | 506 | 450 | ||||||
Other liabilities | 3,764 | 4,764 | ||||||
Total liabilities | 460,639 | 411,106 | ||||||
Commitments and contingencies (notes 5, 11 and 12): | ||||||||
Stockholders’ equity (notes 9 and 10): | ||||||||
Preferred stock, $.10 par value; 5,000,000 shares authorized, none issued | — | — | ||||||
Common stock, $.10 par value; 20,000,000 shares authorized; 4,556,742 and 4,454,262 shares issued in 2004 and 2003, respectively, 4,337,442 and 4,234,962 shares outstanding in 2004 and 2003, respectively | 456 | 445 | ||||||
Additional paid-in capital | 59,145 | 58,350 | ||||||
Retained earnings (Accumulated deficit) | 1,389 | (1,055 | ) | |||||
Treasury stock, at cost (219,300 shares in 2004 and 2003, respectively) | (2,758 | ) | (2,758 | ) | ||||
Accumulated other comprehensive (loss) income | (394 | ) | 20 | |||||
Total stockholders’ equity | 57,838 | 55,002 | ||||||
Total liabilities and stockholders’ equity | $ | 518,477 | $ | 466,108 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Operations
Year Ended December 31, | 2004 | 2003 | 2002 | |||||||||
(In Thousands, Except Share Data) | ||||||||||||
Interest and dividend income: | ||||||||||||
Loans | $ | 13,359 | $ | 14,356 | $ | 16,932 | ||||||
Investment securities held to maturity | 6,834 | 4,938 | 6,056 | |||||||||
Investment securities available for sale | 1,899 | 1,785 | 1,817 | |||||||||
Federal Home Loan Bank stock | 209 | 183 | 205 | |||||||||
Other interest income | 30 | 72 | 128 | |||||||||
Total interest and dividend income | 22,331 | 21,334 | 25,138 | |||||||||
Interest expense: | ||||||||||||
Deposits (note 6) | 3,700 | 4,176 | 5,804 | |||||||||
Borrowed funds | 4,229 | 4,583 | 5,458 | |||||||||
Securities sold under agreements to repurchase | 15 | 17 | 20 | |||||||||
Short-term and other borrowed funds | 576 | 201 | 283 | |||||||||
Total interest expense | 8,520 | 8,977 | 11,565 | |||||||||
Net interest income | 13,811 | 12,357 | 13,573 | |||||||||
Credit for loan recoveries (note 4) | (300 | ) | — | — | ||||||||
Net interest income after credit for loan recoveries | 14,111 | 12,357 | 13,573 | |||||||||
Non-interest income: | ||||||||||||
Deposit account fees | 889 | 713 | 665 | |||||||||
Loan servicing fees, net | 184 | 20 | (145 | ) | ||||||||
Gains on sales of mortgage loans, net | 68 | 467 | 529 | |||||||||
Loss on sale of investment securities | — | (14 | ) | — | ||||||||
Lawsuit judgment collected (note 11) | 2,280 | 1,996 | — | |||||||||
Other income | 412 | 422 | 444 | |||||||||
Total non-interest income | 3,833 | 3,604 | 1,493 | |||||||||
Non-interest expense: | ||||||||||||
Salaries and employee benefits | 6,507 | 5,923 | 6,006 | |||||||||
Occupancy and equipment expense | 872 | 752 | 790 | |||||||||
Data processing expense | 878 | 727 | 749 | |||||||||
Professional expense | 623 | 643 | 806 | |||||||||
Insurance expense | 157 | 151 | 153 | |||||||||
Other expense | 1,627 | 1,542 | 1,651 | |||||||||
Total non-interest expense | 10,664 | 9,738 | 10,155 | |||||||||
Income before income tax expense | 7,280 | 6,223 | 4,911 | |||||||||
Income tax expense (note 8) | 2,600 | 2,087 | 1,811 | |||||||||
Net income | $ | 4,680 | $ | 4,136 | $ | 3,100 | ||||||
Average shares outstanding | 4,302,729 | 4,215,944 | 4,348,085 | |||||||||
Common stock equivalents | 163,848 | 175,868 | 170,564 | |||||||||
Average diluted shares outstanding | 4,466,577 | 4,391,812 | 4,518,649 | |||||||||
Basic earnings per share | $ | 1.09 | $ | 0.98 | $ | 0.71 | ||||||
Diluted earnings per share | $ | 1.05 | $ | 0.94 | $ | 0.69 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Changes in
Accumulated | ||||||||||||||||||||||||
Additional | Retained Earnings | Other | Total | |||||||||||||||||||||
Common | Paid-in | (Accumulated | Treasury | Comprehensive | Stockholders’ | |||||||||||||||||||
Stock | Capital | Deficit) | Stock | Income (Loss) | Equity | |||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||
Balance at December 31, 2001 | $ | 438 | $ | 57,813 | $ | (4,348 | ) | $ | — | $ | 189 | $ | 54,092 | |||||||||||
Net income | — | — | 3,100 | — | — | 3,100 | ||||||||||||||||||
Other comprehensive income unrealized gain (loss) on securities available for sale (tax effect $253) | — | — | — | — | 490 | 490 | ||||||||||||||||||
Total comprehensive income | — | — | — | — | 3,590 | |||||||||||||||||||
Exercise of stock options and tax benefits | 1 | 32 | — | — | — | 33 | ||||||||||||||||||
Purchase of treasury stock | — | — | — | (1,736 | ) | — | (1,736 | ) | ||||||||||||||||
Dividends declared and paid ($0. 44 per share) | — | — | (1,920 | ) | — | — | (1,920 | ) | ||||||||||||||||
Balance at December 31, 2002 | 439 | 57,845 | (3,168 | ) | (1,736 | ) | 679 | 54,059 | ||||||||||||||||
Net income | — | — | 4,136 | — | — | 4,136 | ||||||||||||||||||
Other comprehensive income unrealized gain (loss) on securities available for sale (tax effect $338) | — | — | — | — | (659 | ) | (659 | ) | ||||||||||||||||
Total comprehensive income | 3,447 | |||||||||||||||||||||||
Exercise of stock options and tax benefits | 6 | 505 | — | — | — | 511 | ||||||||||||||||||
Purchase of treasury stock | — | — | — | (1,022 | ) | — | (1,022 | ) | ||||||||||||||||
Dividends declared and paid ($0.48 per share) | — | — | (2,023 | ) | — | — | (2,023 | ) | ||||||||||||||||
Balance at December 31, 2003 | 445 | 58,350 | (1,055 | ) | (2,758 | ) | 20 | 55,002 | ||||||||||||||||
Net income | — | — | 4,680 | — | — | 4,680 | ||||||||||||||||||
Other comprehensive income unrealized gain (loss) on securities available for sale (tax effect $274) | — | — | — | — | (414 | ) | (414 | ) | ||||||||||||||||
Total comprehensive income | 4,266 | |||||||||||||||||||||||
Exercise of stock options and tax benefits | 11 | 795 | — | — | — | 806 | ||||||||||||||||||
Dividends declared and paid ($0.52 per share) | — | — | (2,236 | ) | — | — | (2,236 | ) | ||||||||||||||||
Balance at December 31, 2004 | $ | 456 | $ | 59,145 | $ | 1,389 | $ | (2,758 | ) | $ | (394 | ) | $ | 57,838 | ||||||||||
Disclosure of reclassification amount: | 2004 | 2003 | 2002 | |||||||||
(In Thousands) | ||||||||||||
Gross unrealized (depreciation) appreciation arising during the period | $ | (688 | ) | $ | (1,011 | ) | $ | 743 | ||||
Tax effect | 274 | 343 | (253 | ) | ||||||||
Unrealized holding (depreciation) appreciation net of tax | (414 | ) | (668 | ) | 490 | |||||||
Less: reclassification adjustment for gains (losses) included in net income | — | (14 | ) | — | ||||||||
Tax effect | — | 5 | — | |||||||||
Unrealized (depreciation) appreciation on securities, net of reclassification | $ | (414 | ) | $ | (659 | ) | 490 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements
Year Ended December 31, | 2004 | 2003 | 2002 | |||||||||
(In Thousands) | ||||||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 4,680 | $ | 4,136 | $ | 3,100 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Credit for loan recoveries | (300 | ) | — | — | ||||||||
Gains on sales of mortgage loans | (68 | ) | (467 | ) | (529 | ) | ||||||
Loss on sale of investment securities available for sale | — | 14 | — | |||||||||
Net amortization of investment securities | 1,725 | 2,117 | 1,426 | |||||||||
Depreciation of premises and equipment and other assets | 430 | 398 | 454 | |||||||||
Loans originated for sale | (3,883 | ) | (21,139 | ) | (35,415 | ) | ||||||
Proceeds from sales of mortgage loans | 4,289 | 23,847 | 37,521 | |||||||||
(Increase) decrease in accrued interest receivable | (342 | ) | (93 | ) | 145 | |||||||
Deferred income tax expense | 726 | 516 | 1,798 | |||||||||
(Increase) decrease in other assets | (121 | ) | 204 | (299 | ) | |||||||
Increase (decrease) in advance payments by borrowers | 56 | (68 | ) | (55 | ) | |||||||
(Decrease) increase in other liabilities | (1,000 | ) | 1,263 | (552 | ) | |||||||
Net cash provided by operating activities | 6,192 | 10,728 | 7,594 | |||||||||
Cash flows from investing activities: | ||||||||||||
Proceeds from maturities of investment securities held to maturity | 23,500 | 171,500 | 337,318 | |||||||||
Proceeds from maturities of investment securities available for sale | 25,585 | 12,000 | 5,493 | |||||||||
Purchases of investment securities held to maturity | (60,422 | ) | (248,915 | ) | (351,927 | ) | ||||||
Purchases of investment securities available for sale | (45,195 | ) | (16,712 | ) | (31,194 | ) | ||||||
Purchase of mutual funds available for sale | — | (1,000 | ) | — | ||||||||
Purchases of mortgage-backed securities held to maturity | — | (38,118 | ) | (2,967 | ) | |||||||
Purchases of mortgage-backed securities available for sale | — | (14,775 | ) | — | ||||||||
Proceeds from sales of mortgage-backed securities available for sale | — | 5,684 | — | |||||||||
Principal payments of securities held to maturity | 19,526 | 43,209 | 38,283 | |||||||||
Principal payments of securities available for sale | 4,168 | 17,519 | 11,670 | |||||||||
Purchases of Federal Home Loan Bank stock | (1,294 | ) | (643 | ) | — | |||||||
(Increase) decrease in loans, net | (21,425 | ) | 29,436 | (8,210 | ) | |||||||
Proceeds from sales of Bank premises and equipment | 4 | — | — | |||||||||
Purchases of Bank premises and equipment | (1,045 | ) | (223 | ) | (337 | ) | ||||||
Net cash used in investing activities | (56,598 | ) | (41,038 | ) | (1,871 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Net increase (decrease) in deposits | 26,566 | (6,925 | ) | 11,015 | ||||||||
Additions to Federal Home Loan Bank advances | 58,346 | — | 11,000 | |||||||||
Payments on Federal Home Loan Bank advances | (32,110 | ) | (15,371 | ) | (19,755 | ) | ||||||
Net increase (decrease) in agreements to repurchase securities | 675 | (1,464 | ) | (270 | ) | |||||||
(Decrease) increase in other borrowed funds | (3,000 | ) | 48,596 | (483 | ) | |||||||
Dividends paid | (2,236 | ) | (2,023 | ) | (1,920 | ) | ||||||
Treasury stock purchased | — | (1,022 | ) | (1,736 | ) | |||||||
Proceeds from exercise of stock options | 806 | 511 | 33 | |||||||||
Net cash provided by (used in) financing activities | 49,047 | 22,302 | (2,116 | ) | ||||||||
Net (decrease) increase in cash and cash equivalents | (1,359 | ) | (8,008 | ) | 3,607 | |||||||
Cash and cash equivalents, beginning of year | 8,761 | 16,769 | 13,162 | |||||||||
Cash and cash equivalents, end of year | $ | 7,402 | $ | 8,761 | $ | 16,769 | ||||||
Cash paid during the year for: | ||||||||||||
Interest on deposits and borrowed funds | $ | 8,445 | $ | 9,039 | $ | 11,632 | ||||||
Income taxes | 2,871 | 538 | 271 | |||||||||
Cash received during the year for: | ||||||||||||
Income taxes | — | — | 133 | |||||||||
Supplemental Schedule of non-cash activities: | ||||||||||||
Change in valuation of investment securities available for sale | (688 | ) | (1,008 | ) | 743 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Notes To Consolidated
Financial Statements
(1)Summary of Significant Accounting Policies:
Basis of Presentation – LSB Corporation (the “Corporation” or the “Company”) is a Massachusetts corporation and the holding company of its wholly-owned subsidiary Lawrence Savings Bank (the “Bank”) a state-chartered Massachusetts savings bank. The Corporation was organized by the Bank on July 1, 2001 to be a bank holding company and to acquire all of the capital stock of the Bank. The Consolidated Financial Statements presented herein reflect the accounts of the Corporation and its predecessor, Lawrence Savings Bank. The Corporation is supervised by the Board of Governors of the Federal Reserve System (“FRB”), and it is also subject to the jurisdiction of the Massachusetts Division of Banks, while the Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks. The Bank’s deposits are insured by the Bank Insurance Fund of the FDIC up to $100,000 per account, as defined by the FDIC, and the Depositors Insurance Fund, Inc. (“DIF”) for customer deposit amounts in excess of $100,000. The Consolidated Financial Statements include the accounts of LSB Corporation and its wholly-owned consolidated subsidiary, Lawrence Savings Bank, and its wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security Corporation II, Pemberton Corporation, and Spruce Wood Realty Trust. All inter-company balances and transactions have been eliminated in consolidation. The Company has one reportable operating segment. Certain amounts in prior periods have been reclassified to conform to the current presentation.
The LSB Corporation’s Consolidated Financial Statements have been prepared in conformity with U.S. generally accepted accounting principles. Accordingly, management is required to make estimates and assumptions that affect amounts reported in the balance sheets and statements of operations. Actual results could differ significantly from those estimates and judgments. Material estimates that are particularly susceptible to change relate to the allowance for loan losses, income taxes and mortgage servicing rights.
Cash and Cash Equivalents – For the purpose of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and Federal Funds sold. Generally, Federal Funds are sold with overnight maturities.
Investment and Mortgage-backed Securities – Debt securities that the Company has the intent and ability to hold to maturity are classified as “held to maturity” and reported at amortized cost; debt, mortgage-backed and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading” and reported at fair value, with unrealized gains and losses included in earnings; and debt, mortgage-backed and equity securities not classified as either held to maturity or trading are classified as “available for sale” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, net of estimated income taxes.
Premiums and discounts on debt and mortgage-backed securities are amortized or accreted into income by use of the interest method. If a decline in fair value below the amortized cost basis of a debt or mortgage-backed security is judged to be other than temporary, the cost basis of the investment is written down to fair value and the amount of the write-down is included as a charge to earnings. Gains and losses on the sale of debt and mortgage-backed securities are recognized at the time of sale on a specific identification basis.
Equity Securities – Includes Northeast Retirement Services (“NRS”) stock. NRS stock is closely held and not publicly traded and is carried at cost. Dividend income is recorded when dividends are declared.
Interest on Loans – Interest on loans is accrued as earned. Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. It is management’s policy to discontinue the accrual of interest on a loan when there is a reasonable doubt as to its collectibility. Interest on loans 90 days or more contractually delinquent is generally excluded from interest income. When a loan is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on loans that have been 90 days or more past due only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are expected to be fully collectible as to both principal and interest.
Loan Fees – Loan origination fees, net of direct loan acquisitions costs, are deferred and recognized over the contractual life of the loan as an adjustment of the loan’s yield using a basis, which approximates the interest method. Amortization of loan fees is discontinued once a loan is designated as non-accrual status. When loans are sold or paid-off, the unamortized portion of net fees and costs is credited to income.
Mortgage Banking Activities – Loans held for sale are valued at the lower of their amortized cost or market value. The Bank, from time-to-time, enters into forward commitments to sell loans or mortgage-backed securities for the purpose of reducing interest rate risk associated with the origination of loans for sale. Gains or losses on sales of loans are recognized to the extent that the sale proceeds exceed or are less than the carrying amount of the loans. Gains and losses are determined using the specific identification method.
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When loans are sold with servicing rights retained, the Bank allocates the carrying amount of the loans between the underlying asset sold and the rights retained, based on their relative fair values. The resulting mortgage servicing rights are amortized over the period of estimated net servicing income using a method which approximates the interest method. Actual prepayment experience is reviewed periodically. When actual prepayments exceed estimated prepayments, the balance of the mortgage servicing rights is adjusted accordingly. Periodically, the mortgage servicing rights are assessed for impairment based on the fair value of such rights using market prices.
Transfers and Servicing of Assets and Extinguishments of Liabilities – The Company accounts and reports for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial components approach that focuses on control. This approach distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. After a transfer of financial assets, the Company recognizes all financial and servicing assets it controls and liabilities it has incurred and derecognizes financial assets it no longer controls and liabilities that have been extinguished. This financial components approach focuses on the assets and liabilities that exist after the transfer. Many of these assets and liabilities are components of financial assets that existed prior to the transfer. If a transfer does not meet the criteria for recognition as a sale, the Company accounts for the transfer as a secured borrowing with a pledge of collateral.
Allowance for Loan Losses – Losses on loans are provided for under the allowance method of accounting. The allowance is increased by provisions charged to operations on the basis of many factors including the risk characteristics of the portfolio, current economic conditions and trends in loan delinquencies and charge-offs. When management believes that the collection of a loan’s principal balance is unlikely, the principal amount is charged against the allowance. Recoveries on loans which have been previously charged off are credited to the allowance as received.
Management’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include a formula allowance, specific allowances for identified problem loans and an unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding loans, in each case based on the internal risk grade of such loans. Changes in risk grades affect the amount of the formula allowance. Loss factors are based on the Bank’s historical loss experience as well as regulatory guidelines.
Specific allowances are established in cases where management has identified significant conditions related to a credit such that management believes it probable that a loss has been incurred in excess of the amount determined by the application of the formula allowance.
The unallocated allowance recognizes the model and estimation risk associated with the formula allowance and specific allowances as well as management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits.
In addition, various regulatory agencies, including the FDIC and the Massachusetts Division of Banks, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance for loan losses based on judgments different from those of management.
Impaired loans are commercial, commercial real estate, and individually significant residential mortgage loans for which it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans, except those loans that are accounted for at fair value or at lower of cost or fair value, are accounted for at the present value of the expected future cash flows discounted at the loan’s effective interest rate.
Premises and Equipment – Premises and equipment are stated at cost less allowances for depreciation and amortization. Depreciation and amortization are computed principally on the straight-line method over the estimated useful lives of the assets or the terms of the leases, if shorter.
Other Real Estate Owned – Other real estate owned (OREO) is comprised of foreclosed properties where the Bank has formally received title or has possession of the collateral. Properties are carried at the lower of the investment in the related loan or the estimated fair value of the property or collateral less selling costs.
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Stock Options – The Corporation measures compensation cost for stock-based plans using the intrinsic value method. The intrinsic value method measures compensation cost, if any, as the fair market value of the Company’s stock at the grant date over the exercise price. All options granted have an exercise price equivalent to the fair market value at the date of grant and, accordingly, no compensation cost has been recorded. Beginning July 1, 2005, the Company will adopt Statement of Financial Standard (“SFAS”) No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment (See discussion which follows in recent accounting developments),” which will require the Company to record compensation measured at the date of grant based on the fair value of the awards and recognized over its service period. If the fair value based method of accounting for stock options had been used, the Company’s net income and earnings per share would have been reduced to the proforma amounts for the years ended December 31, and are presented in the table which follows:
2004 | 2003 | 2002 | ||||||||||
(In Thousands except per share data) | ||||||||||||
Net Income: | ||||||||||||
As Reported | $ | 4,680 | $ | 4,136 | $ | 3,100 | ||||||
Pro forma | 4,344 | 3,954 | 2,867 | |||||||||
Basic earnings per share: | ||||||||||||
As Reported | $ | 1.09 | $ | 0.98 | $ | 0.71 | ||||||
Pro forma | 1.01 | 0.94 | 0.66 | |||||||||
Diluted earnings per share: | ||||||||||||
As Reported | $ | 1.05 | $ | 0.94 | $ | 0.69 | ||||||
Pro forma | 0.97 | 0.90 | 0.63 |
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
2004 | 2003 | 2002 | ||||||||||
Expected volatility | 28.93 | % | — | — | ||||||||
Risk-free interest rate | 3.44 | % | — | — | ||||||||
Expected dividend yield | 3.08 | % | — | — | ||||||||
Expected life in years | 8 years | — | — | |||||||||
Pension Expense – The Bank is a participant in a multiple employer defined benefit pension plan. Pension expense is recognized on a net periodic pension cost method over the employee’s approximate service period. Pension costs are funded in the year of accrual using the aggregate cost method.
Income Taxes – Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax valuation allowances are established and based on management’s judgment as to whether it is more likely than not that all or some portion of the future tax benefits of prior operating losses will be realized.
Earnings Per Share – Basic EPS is calculated based on the weighted average number of common shares outstanding during each period. Stock options outstanding, accounted for under the treasury stock method, have a dilutive effect to the computation of diluted EPS.
Recent Accounting Developments
FASB Emerging Issues Task Force (“EITF”) Issue 03-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” In November 2003 and March 2004, the FASB’s EITF issued a consensus on EITF Issue 03-1. EITF 03-1 contains new guidance on other-than-temporary impairments of investment securities. The guidance dictates when impairment is deemed to exist, provides guidance on determining if impairment is other than temporary, and directs how to calculate impairment loss. Issue 03-1 also details expanded annual disclosure rules. In September 2004, the FASB’s EITF issued EITF Issue No. 03-1-1 “Effective Date of Paragraphs 10-20 of EITF Issue 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1 to be concurrent with the final issuance of EITF 03-1-a “Implementation Guidance for the Application of Paragraph 16 of EITF 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-1-a is currently being debated by the FASB in regards to final guidance and effective date with a comment period that ended October 29, 2004. EITF 03-1, as issued, was originally effective for periods beginning after June 15, 2004 and the disclosure requirements of this consensus remain in effect. The adoption of the original EITF 03-1 (excluding paragraphs 10-20) did not have a material impact on the Company’s financial position or results of operations.
Statement of Position 03-3 (“SOP 03-3”): “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” in December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 03-3. SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality be recognized at their fair value. The yield that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual, or valuation allowance. Valuation allowances can not be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans with evidence
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of deterioration of credit quality since origination. However, valuation allowances for non-impaired loans acquired in a business combination can be carried over. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Company does not believe the adoption of SOP 03-3 will have a material impact on the Company’s financial position or results of operations.
SFAS No. 123 (revised 2004) (“SFAS 123FR”), “Share-Based Payment” In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004). SFAS No. 123R replaces SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”. SFAS No. 123R will require that the compensation cost relating to share-based payment transactions be recognized in the Company’s financial statements, eliminating pro forma disclosure as an alternative. That cost will be measured based on the grant-date fair value of the equity or liability instruments issued. SFAS No. 123R is effective for public entities as of the first interim or annual period that begins after June 15, 2005. The impact of the Company adopting such accounting can be seen in accounting policies for stock options. The Company does believe the adoption of SFAS 123R will have a impact to the Company and estimate the 2005 gross compensation expense related to share-based payment transactions to be recognized will be approximately $61 thousand for the six months of 2005 for which SFAS 123R will be effective. For years 2006 and beyond, a full year of compensation expense will be recognized.
FIN No. 46 “Consolidation of Variable Interest Entities – an Interpretation of Accounting Research Bulletin No. 51” In January 2003, the FASB issued FIN No. 46. FIN 46 established accounting guidance for consolidation of variable interest entities (“VIE”) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIE’s were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The Company adopted FIN No. 46 as of February 1, 2003 for all arrangements entered into after January 31, 2003. The Company does not believe the adoption of FIN No. 46 will have a material impact on the Company’s financial position or results of operations.
(2) Investment Securities
The amortized cost and market value of investment securities at December 31, follows:
2004 | 2003 | |||||||||||||||||||||||||||||||
Amortized | Unrealized | Market | Amortized | Unrealized | Market | |||||||||||||||||||||||||||
Cost | Gain | Loss | Value | Cost | Gain | Loss | Value | |||||||||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||||||||||
Investment securities held to maturity: | ||||||||||||||||||||||||||||||||
Federal Agency obligations (1) | $ | 104,042 | $ | 70 | $ | (763 | ) | $ | 103,349 | $ | 94,798 | $ | 1,058 | $ | (367 | ) | $ | 95,489 | ||||||||||||||
Mortgage-backed securities | 31,193 | 140 | (531 | ) | 30,802 | 39,467 | 188 | (686 | ) | 38,969 | ||||||||||||||||||||||
Asset-backed securities | 50,829 | 51 | (406 | ) | 50,474 | 32,735 | 204 | (284 | ) | 32,655 | ||||||||||||||||||||||
Corporate obligations | 12,624 | 46 | (146 | ) | 12,524 | 15,662 | 323 | (133 | ) | 15,852 | ||||||||||||||||||||||
Municipal obligations | 1,576 | — | (9 | ) | 1,567 | 1,624 | 3 | — | 1,627 | |||||||||||||||||||||||
$ | 200,264 | $ | 307 | $ | (1,855 | ) | $ | 198,716 | $ | 184,286 | $ | 1,776 | $ | (1,470 | ) | $ | 184,592 | |||||||||||||||
Investment securities available for sale: | ||||||||||||||||||||||||||||||||
US Treasury obligations | $ | 5,133 | $ | — | $ | (288 | ) | $ | 4,845 | $ | 5,146 | $ | — | $ | (351 | ) | $ | 4,795 | ||||||||||||||
Federal Agency obligations (1) | 34,977 | 15 | (85 | ) | 34,907 | 21,015 | 464 | — | 21,479 | |||||||||||||||||||||||
Mortgage-backed securities | 4,590 | 15 | (23 | ) | 4,582 | 6,858 | 34 | (30 | ) | 6,862 | ||||||||||||||||||||||
Asset-backed securities | 14,619 | 1 | (168 | ) | 14,452 | 8,139 | 13 | (61 | ) | 8,091 | ||||||||||||||||||||||
Corporate obligations | 3,219 | — | (99 | ) | 3,120 | 6,245 | 81 | (98 | ) | 6,228 | ||||||||||||||||||||||
Mutual funds | 1,000 | — | (28 | ) | 972 | 1,000 | — | (31 | ) | 969 | ||||||||||||||||||||||
Equity securities | 168 | — | (7 | ) | 161 | 168 | — | — | 168 | |||||||||||||||||||||||
$ | 63,706 | $ | 31 | $ | (698 | ) | $ | 63,039 | $ | 48,571 | $ | 592 | $ | (571 | ) | $ | 48,592 | |||||||||||||||
(1) | Federal agency obligations include investment securities issued by Government Sponsored Enterprises (“GSE’s”) such as Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal Home Loan Bank (“FHLB”). These investment securities do not represent obligations of the U.S. government and are not backed by the full faith and credit of the United States Treasury. |
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(2) Investment Securities – (continued)
Proceeds from sales, realized gains and losses on investments available for sale for the years ended December 31, follow:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Proceeds from sales | $ | — | $ | 5,684 | $ | — | ||||||
Realized gains on sales | — | — | — | |||||||||
Realized losses on sales | — | 14 | — |
Other Than Temporarily Impaired Securities
The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004.
Less Than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | |||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||
US Treasury obligations | $ | — | $ | — | $ | 4,845 | $ | (288 | ) | $ | 4,845 | $ | (288 | ) | ||||||||||
Federal Agency obligations | 72,095 | (391 | ) | 41,043 | (457 | ) | 113,138 | (848 | ) | |||||||||||||||
Mortgage-backed securities | 322 | (4 | ) | 26,136 | (550 | ) | 26,458 | (554 | ) | |||||||||||||||
Asset-backed securities | 39,732 | (349 | ) | 21,669 | (225 | ) | 61,401 | (574 | ) | |||||||||||||||
Corporate obligations | 2,065 | (16 | ) | 8,802 | (229 | ) | 10,867 | (245 | ) | |||||||||||||||
Municipal obligations | 1,567 | (9 | ) | — | — | 1,567 | (9 | ) | ||||||||||||||||
Mutual funds | — | — | 972 | (28 | ) | 972 | (28 | ) | ||||||||||||||||
Equity securities | 161 | (7 | ) | — | — | 161 | (7 | ) | ||||||||||||||||
Total temporarily impaired securities | $ | 115,942 | $ | (776 | ) | $ | 103,467 | $ | (1,777 | ) | $ | 219,409 | $ | (2,553 | ) | |||||||||
U.S. Treasury and Federal Agency Obligations
The unrealized losses on the Company’s investments in U.S. Treasury obligations and direct obligations of U.S. government agencies were caused by interest rate increases. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004.
Mortgage-Backed Securities
The unrealized losses on the Company’s investment in federal agency mortgage-backed securities were caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold theses investments until a recovery of fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004.
Corporate and Municipal Obligations
The unrealized losses on the Company’s investments in corporate and municipal obligations were caused by interest rate increases. Because the company has the ability and intent to hold these investments until a recovery of fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004.
Equity Securities and Mutual Funds
The unrealized losses on equity securities and mutual funds are a result of specific conditions and circumstances that are unique to each company represented in the portfolio. When needed, management diligently monitors its holdings for impairment by reviewing the financial condition of the issuer, company specific events, industry developments, and general economic conditions. In evaluating the severity and duration of impairment, management also reviews corporate financial reports, press releases and other publicly available information. Based upon this evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired.
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The following table is a summary of the contractual maturities of investment securities held to maturity and available for sale at December 31, 2004. These amounts exclude mutual funds and equity securities, which have no contractual maturities. Mortgage-backed securities consist of FHLMC, FNMA, and GNMA certificates. Mortgage-backed and asset-backed securities are shown at their final contractual maturity date but are expected to have shorter average lives.
Held to maturity | Available for sale | |||||||||||||||||||||||
Weighted | Weighted | |||||||||||||||||||||||
Amortized | Market | Average | Amortized | Market | Average | |||||||||||||||||||
December 31, 2004 | Cost | Value | Yield | Cost | Value | Yield | ||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
US Treasury & Agencies obligations: | ||||||||||||||||||||||||
Within 1 year | $ | 14,997 | $ | 15,067 | 6.01 | % | $ | 5,000 | $ | 5,014 | 3.83 | % | ||||||||||||
1 to 2 years | 20,314 | 20,131 | 2.53 | — | — | — | ||||||||||||||||||
2 to 3 years | 43,220 | 42,940 | 3.10 | 9,992 | 9,967 | 2.84 | ||||||||||||||||||
3 to 5 years | 25,511 | 25,211 | 2.82 | 9,974 | 9,916 | 3.01 | ||||||||||||||||||
5 to 10 years | — | — | — | 15,144 | 14,855 | 3.23 | ||||||||||||||||||
104,042 | 103,349 | 3.34 | 40,110 | 39,752 | 3.15 | |||||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Within 1 year | 1,058 | 1,059 | 6.27 | 17 | 17 | 3.61 | ||||||||||||||||||
2 to 3 years | 192 | 199 | 7.05 | — | �� | — | ||||||||||||||||||
3 to 5 years | 2,590 | 2,598 | 4.04 | 687 | 691 | 3.81 | ||||||||||||||||||
5 to 10 years | 26,592 | 26,179 | 3.63 | 2,781 | 2,758 | 3.52 | ||||||||||||||||||
After 10 years | 761 | 767 | 3.50 | 1,105 | 1,116 | 3.44 | ||||||||||||||||||
31,193 | 30,802 | 3.77 | 4,590 | 4,582 | 3.55 | |||||||||||||||||||
Asset-backed securities: | ||||||||||||||||||||||||
2 to 3 years | 1,123 | 1,131 | 6.48 | — | — | — | ||||||||||||||||||
5 to 10 years | 3,086 | 3,075 | 3.57 | — | — | — | ||||||||||||||||||
After 10 years | 46,620 | 46,268 | 3.82 | 14,619 | 14,452 | 3.65 | ||||||||||||||||||
50,829 | 50,474 | 3.87 | 14,619 | 14,452 | 3.65 | |||||||||||||||||||
Corporate obligations: | ||||||||||||||||||||||||
Within 1 year | 4,011 | 4,019 | 2.97 | — | — | — | ||||||||||||||||||
1 to 2 years | 720 | 758 | 8.13 | — | — | — | ||||||||||||||||||
2 to 3 years | 2,080 | 2,065 | 3.15 | 1,000 | 994 | 1.96 | ||||||||||||||||||
3 to 5 years | 5,813 | 5,682 | 3.22 | 2,219 | 2,126 | 2.86 | ||||||||||||||||||
12,624 | 12,524 | 3.41 | 3,219 | 3,120 | 2.58 | |||||||||||||||||||
Municipal obligations: | ||||||||||||||||||||||||
Within 1 year | 1,576 | 1,567 | 2.89 | — | — | — | ||||||||||||||||||
$ | 200,264 | $ | 198,716 | 3.54 | % | $ | 62,538 | $ | 61,906 | 3.27 | % | |||||||||||||
Issuers may have the right to call or prepay obligations with or without call or prepayment penalties. This right may cause actual maturities and yields to differ from the contractual maturities summarized above. As of December 31, 2004, the Company had callable investment securities with an amortized cost of $12.1 million and a market value of $12.0 million in the held to maturity portfolio which are callable during 2005. The callable investment securities in the available for sale portfolio had an amortized cost and market value of $20.1 million which are also callable during 2005.
(3) Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). The Bank is required to own stock of the FHLB at par. On April 19, 2004, the FHLB implemented a new capital structure and stock investment requirements for members to comply with the Gramm-Leach-Bliley Act of 1999.
There are two components of the minimum stock investment requirements. 1) The Membership Stock Investment Requirement is equal to 0.35% of Class B Stock for Qualifying Collateral as determined by the FHLB from the most recently available FDIC Call Report from the Bank. 2) The Activity Based Stock Investment Requirement is equal to 4.50% of the Bank’s outstanding advances with the FHLB. The Bank receives an amount equal to the par value of the FHLB stock when excess stock is redeemed.
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(4) Loans
The components of the loan portfolio at December 31, follow:
2004 | 2003 | |||||||
(In Thousands) | ||||||||
Residential real estate | $ | 60,057 | $ | 57,017 | ||||
Loans held for sale | — | 338 | ||||||
Home equity | 8,869 | 10,236 | ||||||
Construction | 15,211 | 16,040 | ||||||
Commercial real estate | 131,605 | 112,503 | ||||||
Commercial business | 16,369 | 14,805 | ||||||
Consumer | 699 | 564 | ||||||
Total loans | 232,810 | 211,503 | ||||||
Allowance for loan losses | (4,140 | ) | (4,220 | ) | ||||
$ | 228,670 | $ | 207,283 | |||||
The amounts above include net deferred loan origination fees and costs totaling $105 thousand at December 31, 2004 and $81 thousand at December 31, 2003.
Mortgage loans serviced by the Company for others amounted to $45.8 million and $57.9 million at December 31, 2004 and 2003, respectively.
There were no non-performing or impaired loans at December 31, 2004 or at December 31, 2003.
In the ordinary course of business, the Bank makes loans to its Directors and Officers and their associates and affiliated companies (“related parties”) at substantially the same terms and conditions as those prevailing at the time of origination for comparable transactions with other borrowers.
An analysis of total related party loans for the year ended December 31, 2004 follows:
Balance at | Balance at | |||||
January 1, 2004 | Additions | Repayments | December 31, 2004 | |||
(In Thousands) | ||||||
$1,668 | $1,235 | $823 | $2,080 | |||
The activity in the allowance for loan losses for the years ended December 31, follows:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Balance at beginning of year | $ | 4,220 | $ | 4,167 | $ | 4,070 | ||||||
Total charge-offs | (45 | ) | — | (1 | ) | |||||||
Total recoveries | 265 | 53 | 98 | |||||||||
Net recoveries | 220 | 53 | 97 | |||||||||
Credit for loan recoveries | (300 | ) | — | — | ||||||||
Balance at end of year | $ | 4,140 | $ | 4,220 | $ | 4,167 | ||||||
The following table summarizes the balances of mortgage service fees at December 31:
2004 | 2003 | |||||||
(In Thousands) | ||||||||
Balance at beginning of year | $ | 488 | $ | 1,015 | ||||
Additions | 53 | 201 | ||||||
Amortization | (137 | ) | (728 | ) | ||||
Mortgage servicing rights | 404 | 488 | ||||||
Valuation allowance | (98 | ) | (96 | ) | ||||
Balance at end of year | $ | 306 | $ | 392 | ||||
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(4) Loans – (continued)
The following table summarizes activity in the mortgage service fees valuation allowance for the years ended December 31:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Balance at beginning of year | $ | 96 | $ | 377 | $ | 75 | ||||||
Provision (recoveries) charged to operations | 2 | (281 | ) | 302 | ||||||||
Balance at end of year | $ | 98 | $ | 96 | $ | 377 | ||||||
The following table summarizes activity in the loan servicing fees net for the years ended December 31:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Service fee income | $ | 158 | $ | 216 | $ | 269 | ||||||
Amortization of mortgage servicing rights | (137 | ) | (728 | ) | (269 | ) | ||||||
(Provision) recoveries for valuation allowance | (2 | ) | 281 | (302 | ) | |||||||
Mortgage servicing income (expense) | 19 | (231 | ) | (302 | ) | |||||||
Late charges and other loan fees | 165 | 251 | 157 | |||||||||
Loan servicing fees, net | $ | 184 | $ | 20 | $ | (145 | ) | |||||
(5) Bank Premises and Equipment
The components of premises and equipment at December 31, follow:
Estimated | ||||||||||||
Useful Lives | 2004 | 2003 | ||||||||||
(In Thousands) | ||||||||||||
Premises | 10 – 39 years | $ | 3,788 | $ | 3,657 | |||||||
Equipment | 3 – 5 years | 2,722 | 2,648 | |||||||||
Leasehold improvements | 3 – 10 years | (1) | 1,038 | 408 | ||||||||
7,548 | 6,713 | |||||||||||
Less accumulated depreciation and amortization | (4,062 | ) | (3,838 | ) | ||||||||
$ | 3,486 | $ | 2,875 | |||||||||
(1) | Leasehold improvements – Depreciated over term of lease or asset life, whichever is shorter. |
Depreciation and amortization expense for the years ended December 31, 2004, 2003, and 2002 amounted to $430,000, $398,000, and $454,000, respectively. Rent expense for leased premises for the years ended December 31, 2004, 2003 and 2002 amounted to $186,000, $152,000 and $152,000, respectively. The Company is obligated, under non-cancelable leases for premises and equipment, for minimum payments in future periods of $201,000 for each of the years 2005 and 2006, $203,000 in the year 2007, $159,000 in the year 2008 and $137,000 in the year 2009.
The Company enters into operating leases in which office space is rented to other business at its Corporate Headquarters. Rental income for the years ended December 31, 2004, 2003 and 2002 amounted to $181,000, $221,000 and $213,000, respectively. These businesses are obligated under non-cancelable leases for premises, for minimum payments in future periods of $160,000 in 2005, $123,000 in 2006, $18,000 in 2007, $17,000 in 2008 and $9,000 in 2009.
6) Deposits
The following table shows the components of deposits at December 31, 2004 and 2003 and the range of interest rates paid as of December 31, 2004.
Rates as of | ||||||||||||
December 31, | ||||||||||||
2004 | 2004 | 2003 | ||||||||||
(Dollars in Thousands) | ||||||||||||
Interest bearing accounts: | ||||||||||||
NOW and Super NOW accounts | 0.10-0.25 | % | $ | 38,061 | $ | 36,108 | ||||||
Savings accounts | 0.35 | % | 44,673 | 44,324 | ||||||||
Money market investment accounts | 0.25-1.45 | % | 82,877 | 76,148 | ||||||||
Certificates of deposit | 1.00-6.25 | % | 89,649 | 74,184 | ||||||||
Retirement accounts | 1.00-6.25 | % | 29,049 | 27,666 | ||||||||
Total interest bearing deposits | 284,309 | 258,430 | ||||||||||
Non-interest bearing demand deposit accounts | — | 14,797 | 14,110 | |||||||||
$ | 299,106 | $ | 272,540 | |||||||||
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6) Deposits – (continued)
The components of interest expense on deposits for the years ended December 31, follow:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Now and Super NOW accounts | $ | 40 | $ | 40 | $ | 81 | ||||||
Savings accounts | 161 | 200 | 394 | |||||||||
Money market investment accounts | 980 | 900 | 1,097 | |||||||||
Certificates of deposit | 1,656 | 2,088 | 3,109 | |||||||||
Retirement accounts | 863 | 948 | 1,123 | |||||||||
$ | 3,700 | $ | 4,176 | $ | 5,804 | |||||||
The amount and weighted average interest rate on certificates of deposit, including retirement accounts, by periods to maturity at December 31, 2004 are summarized as follows:
Equal to | Weighted | |||||||||||||||
Less | and greater | Average | ||||||||||||||
than | than | Interest | ||||||||||||||
$100,000 | $100,000 | Total | Rate | |||||||||||||
(Dollars in Thousands) | ||||||||||||||||
3 months or less | $ | 13,959 | $ | 6,753 | $ | 20,712 | 1.76 | % | ||||||||
From three to six months | 15,943 | 4,606 | 20,549 | 1.84 | ||||||||||||
From six to twelve months | 19,852 | 4,424 | 24,276 | 2.14 | ||||||||||||
From one to two years | 21,801 | 7,368 | 29,169 | 3.00 | ||||||||||||
From two to three years | 9,518 | 5,815 | 15,333 | 3.61 | ||||||||||||
Three years and thereafter | 6,079 | 2,580 | 8,659 | 3.45 | ||||||||||||
$ | 87,152 | $ | 31,546 | $ | 118,698 | 2.52 | % | |||||||||
There were no brokered deposits at December 31, 2004 or at December 31, 2003.
(7) Federal Home Loan Bank Advances and Other Borrowed Funds
The FHLB permits member institutions to borrow funds for various purposes. Outstanding advances at December 31, 2004 are collateralized by a blanket lien against residential mortgages and other qualifying collateral.
Advances outstanding at December 31, follow:
2004 | 2003 | |||||||||||||||
Weighted Average | Weighted Average | |||||||||||||||
Maturity | Amount | Interest Rate | Amount | Interest Rate | ||||||||||||
(Dollars in Thousands) | ||||||||||||||||
2004 | $ | — | — | % | $ | 20,000 | 4.73 | % | ||||||||
2005 | 32,000 | 2.97 | 6,000 | 5.91 | ||||||||||||
2006 | 10,000 | 3.34 | 5,000 | 4.69 | ||||||||||||
2007 | 30,000 | 3.40 | 15,000 | 4.53 | ||||||||||||
2009 | 224 | 6.42 | 240 | 6.42 | ||||||||||||
2010 | 20,000 | 6.03 | 20,000 | 6.03 | ||||||||||||
2011 | 10,000 | 4.93 | 10,000 | 4.93 | ||||||||||||
2021 | 2,542 | 6.23 | 2,626 | 6.23 | ||||||||||||
2024 | 336 | 1.07 | — | — | ||||||||||||
$ | 105,102 | 3.98 | % | $ | 78,866 | 5.19 | % | |||||||||
Issuers may have the right to call or prepay obligations with or without call or prepayment penalties. This right may cause actual maturities to differ from the contractual maturities summarized above. As of December 31, 2004 the Company had callable advances totaling $45.0 million and amortizing advances totaling $3.1 million.
The Company may enter into agreements to repurchase securities sold. These agreements are treated as secured borrowings and the obligations to repurchase securities sold are reflected as liabilities and the securities collateralized by the agreements remain as assets. Generally, the outstanding collateral consists of U.S. Treasury and Government Agency obligations and is held by third party custodians. Repurchase agreements totaled $3.2 million at December 31, 2004 at a rate of 0.75%. Repurchase agreements outstanding at December 31, 2003 totaled $2.5 million at a rate of 0.50%.
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The components of other borrowed funds at December 31, follows:
2004 | 2003 | |||||||
(Dollars In Thousands) | ||||||||
FHLB Short-term borrowings | $ | 49,000 | $ | 52,000 | ||||
Customer repurchase agreements | 3,161 | 2,486 | ||||||
$ | 52,161 | $ | 54,486 | |||||
Information relating to short-term borrowed funds for the years ended, follows:
2004 | 2003 | 2002 | ||||||||||||||||||||||
Repurchase | FHLB | Repurchase | FHLB | Repurchase | FHLB | |||||||||||||||||||
Agreements | Advances | Agreements | Advances | Agreements | Advances | |||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||
Outstanding at December 31 | $ | 3,161 | $ | 49,000 | $ | 2,486 | $ | 52,000 | $ | 3,950 | $ | — | ||||||||||||
Average balance outstanding during the year | 2,949 | 40,160 | 2,719 | 12,152 | 3,254 | 41 | ||||||||||||||||||
Maximum outstanding at any month end | 3,946 | 55,500 | 3,610 | 52,000 | 5,463 | — | ||||||||||||||||||
Weighted average rate at December 31 | 0.75 | % | 2.27 | % | 0.50 | % | 1.10 | % | 0.75 | % | — | % | ||||||||||||
Weighted average rate during the year | 0.50 | 1.43 | 0.62 | 0.91 | 0.58 | 2.11 |
(8) Income Taxes
An analysis of income tax expense for the years ended December 31, follows:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Current expense (benefit): | ||||||||||||
Federal | $ | 1,590 | $ | 1,095 | $ | (214 | ) | |||||
State | 284 | 476 | 227 | |||||||||
Total current expense | 1,874 | 1,571 | 13 | |||||||||
Deferred expense (benefit): | ||||||||||||
Federal | 574 | 541 | 1,791 | |||||||||
State | 167 | (24 | ) | (11 | ) | |||||||
Change in valuation reserve | (15 | ) | (1 | ) | 18 | |||||||
Total deferred expense | 726 | 516 | 1,798 | |||||||||
Total income tax expense | $ | 2,600 | $ | 2,087 | $ | 1,811 | ||||||
A reconciliation of the difference between the expected federal income tax expense computed by applying the federal statutory rate of 34% to the amount of actual income tax expense for the years ended December 31, follows:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Expected federal income tax expense | $ | 2,475 | $ | 2,116 | $ | 1,670 | ||||||
Items affecting expected tax: | ||||||||||||
State income tax, net of federal benefit | 298 | 298 | 143 | |||||||||
Change in estimate for tax contingencies | (98 | ) | (300 | ) | — | |||||||
Other | (60 | ) | (26 | ) | (20 | ) | ||||||
Change in valuation reserve | (15 | ) | (1 | ) | 18 | |||||||
Total income tax expense | $ | 2,600 | $ | 2,087 | $ | 1,811 | ||||||
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(8) Income Taxes – (continued)
The tax effects of temporary differences (the difference between financial statement carrying amounts of existing assets and liabilities and their respective tax basis that give rise to deferred tax assets and liabilities) for the years ended December 31, follow:
2004 | 2003 | |||||||
(In Thousands) | ||||||||
Deferred tax assets: | ||||||||
Allowance for loan losses | $ | 1,576 | $ | 2,464 | ||||
Capital loss carryforward | 40 | 55 | ||||||
Unrealized loss on investment securities available for sale | 273 | — | ||||||
Pension costs | 388 | 386 | ||||||
Deferred compensation | 534 | 486 | ||||||
Loan origination fees | 10 | 10 | ||||||
Depreciation | 329 | 318 | ||||||
Other | 238 | 193 | ||||||
Gross deferred tax asset | 3,388 | 3,912 | ||||||
Valuation reserve | (40 | ) | (55 | ) | ||||
Deferred tax asset | 3,348 | 3,857 | ||||||
Deferred tax liabilities: | ||||||||
Unrealized gains on investment securities available for sale | — | (1 | ) | |||||
Other | (281 | ) | (337 | ) | ||||
Gross deferred tax liability | (281 | ) | (338 | ) | ||||
Net deferred income tax asset | $ | 3,067 | $ | 3,519 | ||||
Capital losses on the sale of securities resulted in capital loss carryforwards. A deferred tax valuation allowance on capital loss carryforwards is required to reduce the potential deferred tax asset when it is more likely than not that all or some portion of the potential deferred tax asset will not be realized due to the lack of sufficient capital gains in the carryforward period. At December 31, 2004, the Company has $118 thousand of capital loss carryforwards available that expire between 2004 and 2007.
At December 31, 2004, the Bank would need to generate approximately $9.0 million of future net taxable income to realize the net deferred income tax asset. Management believes that it is more likely than not that the net deferred income tax asset at December 31, 2004 will be realized based upon recent operating results.
It should be noted, however, that factors beyond Management’s control, such as the general state of the economy and real estate values, can affect future levels of taxable income and that no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences.
The unrecaptured base year tax reserves as of October 31, 1998 will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt tax reserves continue to be subject to a provision of the current law that requires recapture in the case of certain excess distribution to shareholders. The tax effect of pre-1988 bad debt tax reserves subject to recapture in the case of certain excess distributions is approximately $1.1 million.
(9) Stockholders’ Equity
The Company and the Bank are regulated by federal and state regulatory agencies. Failure by the Company or the Bank to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal or state regulators that, if undertaken, could have a direct material effect on the Company’s Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (Leverage ratio). There are two categories of capital under the guidelines. Tier 1 capital as it applies to the Company and the Bank, includes stockholders’ equity exclusive of the net unrealized gains/losses on investment securities available for sale and the deferred tax asset is disallowed. Tier 2 capital includes the allowance for loan losses, subject to guideline limitations.
At December 31, 2004 and 2003, the Company and the Bank not only exceeded each of the minimum capital requirements but also met the definition of “well capitalized” as defined by the FRB and the FDIC under the regulatory framework for prompt corrective action. To be categorized as “well capitalized” the Company or the Bank must maintain Tier 1 Total, and Leverage ratios as set forth in the table below. There are no conditions or events that management believes have changed the Company’s or the Bank’s classification as “well capitalized.”
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(9) Stockholders’ Equity – (continued)
The Company’s and the Bank’s actual capital ratios and amounts at December 31, 2004 and 2003, follow:
Risk-Based Ratios | ||||||||||||||||||||||||
Tier 1 Capital | Total Capital | Leverage Capital | ||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
Capital Ratios: | ||||||||||||||||||||||||
Adequately capitalized | 4.00 | % | 4.00 | % | 8.00 | % | 8.00 | % | 4.00 | % | 4.00 | % | ||||||||||||
Well capitalized | 6.00 | % | 6.00 | % | 10.00 | % | 10.00 | % | 5.00 | % | 5.00 | % | ||||||||||||
LSB Corporation | 18.38 | % | 19.25 | % | 19.63 | % | 20.50 | % | 11.25 | % | 12.11 | % | ||||||||||||
Lawrence Savings Bank | 17.49 | % | 19.00 | % | 18.74 | % | 20.25 | % | 10.64 | % | 11.94 | % | ||||||||||||
Capital Amounts: | ||||||||||||||||||||||||
Adequately capitalized | ||||||||||||||||||||||||
LSB Corporation | $ | 12,474 | $ | 11,421 | $ | 24,949 | $ | 22,842 | $ | 20,383 | $ | 18,163 | ||||||||||||
Lawrence Savings Bank | 12,355 | 11,392 | 24,711 | 22,784 | 20,300 | 18,125 | ||||||||||||||||||
Well capitalized | ||||||||||||||||||||||||
LSB Corporation | 18,712 | 17,132 | 31,186 | 28,553 | 25,478 | 22,703 | ||||||||||||||||||
Lawrence Savings Bank | 18,533 | 17,088 | 30,889 | 28,480 | 25,374 | 22,656 | ||||||||||||||||||
Actual Amounts: | ||||||||||||||||||||||||
LSB Corporation | 57,310 | 54,969 | 61,211 | 58,546 | 57,310 | 54,969 | ||||||||||||||||||
Lawrence Savings Bank | 54,019 | 54,100 | 57,884 | 57,668 | 54,019 | 54,100 | ||||||||||||||||||
Stockholders’ Rights Plan
In 1996, the Board of Directors adopted a stockholder rights plan declaring a dividend of one preferred stock purchase right for each share of outstanding common stock. The rights will remain attached to the common stock and are not exercisable except under limited circumstances relating to (i) acquisition of beneficial ownership of more than 10% of the outstanding shares of common stock, or (ii) a tender offer or exchange offer that would result in a person or group beneficially owning more than 10% of the outstanding shares of common stock. The rights are not exercisable until those aforementioned circumstances occur. The rights expire in 2006. Until a right is exercised, the holder has no rights to vote or to receive dividends. The rights are not taxable to stockholders until exercisable.
(10) Employee Benefits
The Company provides pension benefits for its employees through membership in the Savings Bank Employees’ Retirement Association (the “Plan”). The Plan is a multiple-employer, non-contributory, defined benefit plan. Bank employees become eligible after attaining age 21 and completing one year of service. Additionally, benefits become fully vested after three years of eligible service. The Company’s annual contribution to the Plan is based upon standards established by the Employee Retirement Income Security Act. The contribution is based on an actuarial method intended to provide not only for benefits attributable to service to date, but also for those expected to be earned in the future. The Company does not expect to contribute to the Plan for the year ending October 31, 2005.
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(10) Employee Benefits – (continued)
The following table sets forth the Plan’s funded status and amounts recognized in the Company’s Consolidated Financial Statements through the Plan’s latest valuation dates which were October 31, 2004 and 2003.
2004 | 2003 | |||||||
(In Thousands) | ||||||||
Change in benefit obligation: | ||||||||
Benefit obligation at beginning of year | $ | 6,760 | $ | 6,042 | ||||
Service cost | 415 | 355 | ||||||
Interest cost | 423 | 408 | ||||||
Actuarial loss | 134 | 332 | ||||||
Benefits paid | (276 | ) | (377 | ) | ||||
Benefit obligation at end of year | $ | 7,456 | $ | 6,760 | ||||
Change in plan assets: | ||||||||
Fair value of plan assets at beginning of year | $ | 6,060 | $ | 5,308 | ||||
Actual return on plan assets | 638 | 789 | ||||||
Employer contribution | 356 | 340 | ||||||
Benefits paid | (276 | ) | (377 | ) | ||||
Fair value of plan assets at end of year | $ | 6,778 | $ | 6,060 | ||||
Funded status | $ | (678 | ) | $ | (700 | ) | ||
Unrecognized net actuarial gain | (187 | ) | (168 | ) | ||||
Unrecognized transition asset | (24 | ) | (28 | ) | ||||
Accrued benefit cost included in other liabilities | $ | (889 | ) | $ | (896 | ) | ||
Accumulated benefit obligation | $ | 5,224 | $ | 4,424 | ||||
The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 5.75% and 4.50% for 2004 and 6.25% and 4.50% for 2003.
The Plan assets are an integral part of the Company’s defined benefit plan and the asset mix between debt and equity securities plays an important factor in the determination of the funded status and net periodic pension cost based on Plan assumptions, interest rates and the overall economic climate. SBERA offers a common and collective trust as the underlying investment structure for pension plans participating in the Association. The target allocation mix for the common and collective trust portfolio calls for an equity-based investment deployment range from 55% to 75% of total portfolio assets. The remainder of the portfolio is allocated to fixed income. The approximate investment allocation of the portfolio is shown in the table below. The Trustees of SBERA, through the Association’s Investment Committee, select investment managers for the common and collective trust portfolio. A professional investment advisory firm is retained by the Investment Committee to provide allocation analysis, performance measurement and to assist with manager searches. The overall investment objective is to diversify equity investments across a spectrum of investment types (e.g., small cap, large cap, international, etc.) and styles (e.g., growth, value, etc.). The following table shows the allocation of assets between debt and equity for the Plan as of October 31:
2004 | 2003 | |||||||
Debt securities | 34 | % | 45 | % | ||||
Equity securities | 66 | % | 55 | % | ||||
Total Plan assets | 100 | % | 100 | % | ||||
The Plan’s assets are distributed to Plan participants in the form of benefits. The Plan paid $276 thousand and $377 thousand for the Plan years ended October 31, 2004 and 2003, respectively. The Company anticipates that the Plan is expected to pay benefits of $1.5 million, $101 thousand, $81 thousand, $172 thousand and $144 thousand during the Plan year ended October 31, 2005, 2006, 2007, 2008 and 2009, respectively. The aggregate benefits expected to be paid in the five-year period from 2010-2014 are $3.2 million. These expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at October 31, 2004 and include estimated future employee services.
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(10) Employee Benefits – (continued)
Net pension cost components for the years ended October 31, follow:
2004 | 2003 | 2002 | ||||||||||
(In Thousands) | ||||||||||||
Service cost | $ | 415 | $ | 355 | $ | 319 | ||||||
Interest cost | 423 | 408 | 377 | |||||||||
Expected return on plan assets | (485 | ) | (425 | ) | (456 | ) | ||||||
Amortization of net gains | — | — | (81 | ) | ||||||||
Net amortization and deferrals | (4 | ) | (4 | ) | (4 | ) | ||||||
Net periodic pension cost | $ | 349 | $ | 334 | $ | 155 | ||||||
Assumptions used to develop the net periodic pension cost were:
2004 | 2003 | 2002 | ||||||||||
Discount rate | 6.25 | % | 6.75 | % | 7.00 | % | ||||||
Rate of increase in compensation levels | 4.50 | 4.50 | 4.50 | |||||||||
Expected long-term rate of return on assets | 8.00 | 8.00 | 8.00 |
In general, the Company has selected the assumptions with respect to the expected long-term rate of return based on prevailing yields on high quality debt securities increased by a premium of 3% to 5% for equity securities.
The Company provides an employee savings plan (the “Savings Plan”) through the Savings Banks Employees’ Retirement Association. The Savings Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. Employees are eligible to participate in the Savings Plan immediately upon employment with the Company provided they have attained 21 years of age. Company employees become eligible for matching contributions after completing one year of service with 1,000 hours or more. On an annual basis, the Company determines whether or not to contribute to the Savings Plan. The Company contributed $105 thousand and $55 thousand on behalf of the employees who were in the Savings Plan in 2004 and 2003, respectively.
The Board offers options on its common stock to Directors, Management and Officers to purchase unissued common stock of the Company at a price equal to the fair market value of the Company’s common stock on the date of grant. All options expire ten years from the date of grant. Under the 1986 and 1997 Stock Option Plans, the Company may grant options to Directors, Officers or employees for up to 859,100 shares of common stock of which 340,750 shares have been granted and exercised. As of December 31, 2004, 511,350 options were outstanding with 6,000 available for future use. The vesting schedule provides for 50% of options granted to vest after the first year and an additional 25% to vest each year thereafter. Options are fully vested three years after the grant date.
The summary of the status of the Stock Option Plan as of December 31, and changes during the years ended follow:
2004 | 2003 | 2002 | ||||||||||||||||||||||
Weighted | Weighted | Weighted | ||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||
Number of | Exercise | Number of | Exercise | Number of | Exercise | |||||||||||||||||||
Options | Price | Options | Price | Options | Price | |||||||||||||||||||
Outstanding at beginning of year | 505,730 | $ | 8.86 | 586,330 | $ | 8.69 | 601,030 | $ | 8.63 | |||||||||||||||
Granted | 114,100 | 16.77 | — | — | — | — | ||||||||||||||||||
Exercised | (102,480 | ) | 6.70 | (71,600 | ) | 6.83 | (14,700 | ) | 6.32 | |||||||||||||||
Canceled | (6,000 | ) | 16.77 | (9,000 | ) | 13.90 | — | — | ||||||||||||||||
Outstanding at end of year | 511,350 | 10.97 | 505,730 | 8.86 | 586,330 | 8.69 | ||||||||||||||||||
Options exercisable end of year | 405,250 | 9.45 | 466,730 | 8.44 | 503,830 | 7.84 | ||||||||||||||||||
Weighted average fair value of options granted during the year | $ | 4.64 | $ | — | $ | — | ||||||||||||||||||
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(10) Employee Benefits – (continued)
The following table summarizes information about the Stock Option Plans based on a range of exercise prices as of December 31, 2004.
Options Outstanding | Options Exercisable | |||||||||||||||||||
Weighted | Weighted | Weighted | ||||||||||||||||||
Average | Average | Average | ||||||||||||||||||
Number of | Exercise | Remaining | Number of | Exercise | ||||||||||||||||
Range of Exercise Price | Options | Price | Life | Options | Price | |||||||||||||||
$2.00 to $5.00 | 11,250 | $ | 3.94 | 0.5 years | 11,250 | $ | 3.94 | |||||||||||||
$5.01 to $8.00 | 149,500 | 6.06 | 1.5 | 149,500 | 6.06 | |||||||||||||||
$8.01 to $11.00 | 108,000 | 9.13 | 4.6 | 108,000 | 9.13 | |||||||||||||||
$11.01 to $14.00 | 136,500 | 13.87 | 6.6 | 136,500 | 13.87 | |||||||||||||||
$14.01 to $17.00 | 106,100 | 16.77 | 9.1 | — | — | |||||||||||||||
Outstanding at end of year | 511,350 | $ | 10.97 | 4.8 | 405,250 | $ | 9.45 | |||||||||||||
In addition to the Company’s defined benefit pension plan, the Company sponsors a defined benefit post-retirement plan that provides limited post-retirement medical benefits to certain full-time employees who retire before age 65 and life insurance benefits to full-time employees who retire after age 62 and after completing 10 years of service. The plan is non-contributory. The Company’s policy is to fund the cost of postretirement benefits in amounts determined at the discretion of management. The amounts of accrued postretirement benefit cost reported on the Company’s consolidated balance sheet were $338 thousand as of December 31, 2004 and 2003, respectively.
The Company has two supplemental executive retirement plans with one of its key officers. At December 31, 2004 and 2003 the accrued liability was $1.3 million and $1.2 million, respectively. Expense associated with the plans was $118 thousand for the years ended December 31, 2004 and 2003, respectively and $143 thousand for the year ended December 31, 2002.
(11) Contingencies
The Bank is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of such litigation will have a material adverse effect on the financial condition and operating results of the Company.
In one litigation matter, the Bank was awarded a $4.2 million judgment against the debtor in 1997. On February 13, 2002, the debtor filed a petition in bankruptcy under Chapter 7 of the Bankruptcy Code. Post-judgment interest calculated from the date of judgment to the date of the bankruptcy filing is approximately $1.9 million.
On June 15, 2004, the Company reported the receipt of $2.5 million on a U.S. Bankruptcy Judge’s Order on the Trustee’s Motion for authorization to make an interim distribution in this case in which the Company’s wholly owned subsidiary, Lawrence Savings Bank (the “Bank”), is the only secured creditor. The $2.5 million distribution was recorded as income by the Bank on June 15, 2004. The Bank has agreed to return any of the interim distribution as would be necessary to pay additional taxes imposed on the bankruptcy estate in the event reserves set aside for expenses and taxes are insufficient.
The Bankruptcy Trustee has sold various assets during 2004 and 2005, and is currently holding approximately $1.8 million in cash (net of various expenses). The completion of the final tax returns for the Bankruptcy Estate (which may create a recovery on taxes previously paid) and the distribution date of the remaining assets held by the Bankruptcy Trustee to the Bank are not known at this time. Accordingly, no recognition of the remaining assets currently held by the Bankruptcy Trustee has been recorded in the Consolidated Financial Statements.
It is management’s opinion that collection of any remaining amounts owed to the Bank beyond the amount of the interim distribution and assets currently held by the Bankruptcy Trustee are substantially uncertain and are not susceptible to meaningful estimation at this time.
(12) Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk. These instruments, in the form of commitments to extend credit and financial and standby letters of credit, are offered in the normal course of business to meet the financing needs of customers. The company is exposed to varying degrees of credit and interest rate risk in excess of amounts recognized in the consolidated financial statements as a result of such transactions. Commitments to extend credit are agreements to lend to a customer as long as there is compliance with conditions established in the agreement. These extensions of credit are based upon traditional underwriting standards and generally have a fixed expiration date of less than five years.
Letters of credit are documents issued by the Company on behalf of its customers in favor of third parties, who can present requests for drafts from the Company within specified terms and conditions. Letters of credit are secured by cash deposits. Standby letters of credit are conditional commitments issued by the Company to guarantee payment to a third party. Outstanding letters of credit generally expire within one year. The credit risk involved with these instruments is similar to the risk of
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(12) Financial Instruments with Off-Balance Sheet Risk – (continued)
extending loans and, accordingly, the underwriting standards are also similar. It is expected that most letters of credit will not require cash disbursements.
The components of financial instruments with off-balance sheet risk at December 31, follow:
Fixed | Variable | |||||||||||
2004 | Rate | Rate | Total | |||||||||
(In Thousands) | ||||||||||||
Financial instruments with contract amounts represent credit risk: | ||||||||||||
Unused commitments to extend credit: | ||||||||||||
Residential mortgages | $ | 793 | $ | 478 | $ | 1,271 | ||||||
Home equity lines of credit | 596 | 8,661 | 9,257 | |||||||||
Personal lines of credit | 154 | — | 154 | |||||||||
Commercial real estate mortgage | — | 19,168 | 19,168 | |||||||||
Construction | — | 21,040 | 21,040 | |||||||||
Commercial loans | 2 | 17,867 | 17,869 | |||||||||
Total unused commitments | $ | 1,545 | $ | 67,214 | $ | 68,759 | ||||||
Letters of credit and standby letters of credit | $ | — | $ | 1,393 | $ | 1,393 | ||||||
Forward commitments to sell mortgage loans | $ | 300 | $ | — | $ | 300 | ||||||
Fixed | Variable | |||||||||||
2003 | Rate | Rate | Total | |||||||||
(In Thousands) | ||||||||||||
Financial instruments with contract amounts represent credit risk: | ||||||||||||
Unused commitments to extend credit: | ||||||||||||
Residential mortgages | $ | 1,327 | $ | 377 | $ | 1,704 | ||||||
Home equity lines of credit | 1,615 | 7,737 | 9,352 | |||||||||
Personal lines of credit | 165 | — | 165 | |||||||||
Commercial real estate mortgage | 6 | 6,502 | 6,508 | |||||||||
Construction | — | 17,160 | 17,160 | |||||||||
Commercial loans | 10 | 18,416 | 18,426 | |||||||||
Total unused commitments | $ | 3,123 | $ | 50,192 | $ | 53,315 | ||||||
Letters of credit and standby letters of credit | $ | — | $ | 851 | $ | 851 | ||||||
Forward commitments to sell mortgage loans | $ | 340 | $ | — | $ | 340 | ||||||
Forward commitments to sell mortgage loans are contracts which the Company enters into for the purpose of reducing the interest rate risk associated with originating loans held for sale. Risk may arise from the possible inability of the Company to originate loans to fulfill the contracts.
(13) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Due From Banks, Short-Term Investments, Stock in Federal Home Loan Bank of Boston, Accrued Interest Receivable and Accrued Interest Payable.
The carrying amount of each of these assets and liabilities is a reasonable estimate of fair value.
Investment Securities
For investment securities, fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans
Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by classified and non-classified categories.
The fair value of non-classified loans is calculated by discounting scheduled cash flows through the expected maturity using current rates at which similar loans would be made to borrowers with similar credit ratings. For non-classified residential mortgage loans, maturity estimates are based on secondary market sources.
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13) Fair Value of Financial Instruments – (continued)
Fair value for significant classified loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
Deposits and Mortgagors’ Escrow Accounts
The fair value of demand deposits, NOW accounts, money market deposit accounts, savings accounts, and mortgage escrow accounts of borrowers is the amount payable on demand at the balance sheet date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Borrowed Funds
The fair value of borrowed funds is determined as the cost of extinguishing the debt inclusive of any and all prepayment penalties. The prepayment penalties are determined by the Federal Home Loan Bank of Boston.
The estimated fair values of the Bank’s financial instruments at December 31, follow:
2004 | 2003 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Value | Value | Value | Value | |||||||||||||
(In Thousands) | ||||||||||||||||
Financial assets: | ||||||||||||||||
Cash and due from banks | $ | 7,193 | $ | 7,193 | $ | 7,872 | $ | 7,872 | ||||||||
Short-term investments | 209 | 209 | 889 | 889 | ||||||||||||
Investment securities | 263,303 | 261,755 | 232,878 | 233,184 | ||||||||||||
Federal Home Loan Bank stock | 7,887 | 7,887 | 6,593 | 6,593 | ||||||||||||
Accrued interest receivable | 2,894 | 2,894 | 2,552 | 2,552 | ||||||||||||
Loans, net | 228,670 | 228,516 | 207,283 | 210,457 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Deposits | $ | 299,106 | $ | 298,588 | $ | 272,540 | $ | 273,248 | ||||||||
Borrowed funds | 157,263 | 160,061 | 133,352 | 139,039 | ||||||||||||
Mortgagors’ escrow accounts | 506 | 506 | 450 | 450 | ||||||||||||
Accrued interest payable | 444 | 444 | 369 | 369 |
Fair Value of Off-Balance-Sheet Financial Instruments
Off-balance sheet financial instruments generally have interest rates which reflect current market rates. Management has determined that the difference between the carrying and fair value of these instruments is not material.
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and market conditions could significantly affect these estimates.
Fair value estimates are based on existing on and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets that are not considered financial assets include other real estate acquired, banking premises and equipment, and core deposit and other intangibles. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
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(14) Condensed Parent Company Financial Statements
Balance Sheets | 2004 | 2003 | ||||||
(In Thousands) | ||||||||
Assets: | ||||||||
Cash deposits in subsidiaries | $ | 424 | $ | 159 | ||||
Investment securities held to maturity at amortized cost | 2,996 | 500 | ||||||
Investment in subsidiary, at equity | 54,478 | 54,133 | ||||||
Other assets | 12 | 217 | ||||||
Total assets | $ | 57,910 | $ | 55,009 | ||||
Liabilities and Stockholders’ Equity: | ||||||||
Liabilities: | ||||||||
Accrued income taxes | $ | 10 | $ | (17 | ) | |||
Accrued expenses | 62 | 24 | ||||||
Total liabilities | 72 | 7 | ||||||
Total stockholders’ equity | 57,838 | 55,002 | ||||||
Total liabilities and stockholders’ equity | $ | 57,910 | $ | 55,009 | ||||
Statements of Operations | 2004 | 2003 | 2002 | |||||||||
(In Thousands) | ||||||||||||
Dividends from bank subsidiary | $ | 4,200 | $ | 500 | $ | 4,500 | ||||||
Interest income from investment securities held to maturity | 21 | 18 | 47 | |||||||||
Total operating income | 4,221 | 518 | 4,547 | |||||||||
Non-interest expenses | 243 | 180 | 235 | |||||||||
Income before income taxes and undistributed earnings | 3,978 | 338 | 4,312 | |||||||||
Income tax benefit | (63 | ) | (51 | ) | (50 | ) | ||||||
Income before undistributed earnings of subsidiary | 4,041 | 389 | 4,362 | |||||||||
Equity in undistributed earnings of subsidiary | 639 | 3,747 | (1,262 | ) | ||||||||
Net income | $ | 4,680 | $ | 4,136 | $ | 3,100 | ||||||
The Parent Company’s statements of changes in stockholders’ equity are identical to the consolidated statements of changes in stockholders’ equity and therefore are not presented here.
Cash flows | 2004 | 2003 | ||||||
(In Thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 4,680 | $ | 4,136 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Decrease in deferred income tax asset | 216 | |||||||
Net distributed earnings of subsidiaries | (759 | ) | (3,747 | ) | ||||
Increase in other assets | (11 | ) | (156 | ) | ||||
Increase in liabilities | 65 | 3 | ||||||
Accretion of discounts on investment securities | (21 | ) | (18 | ) | ||||
Net cash provided by operating activities | 4,170 | 218 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of investment securities held to maturity | (13,975 | ) | (20,833 | ) | ||||
Proceeds from maturities of investment securities held to maturity | 11,500 | 22,350 | ||||||
Net cash (used in) provided by investing activities | (2,475 | ) | 1,517 | |||||
Cash flows from financing activities: | ||||||||
Proceeds from exercise of stock options | 806 | 511 | ||||||
Treasury stock purchased | — | (1,022 | ) | |||||
Dividends paid | (2,236 | ) | (2,023 | ) | ||||
Net cash used in financing activities | (1,430 | ) | (2,534 | ) | ||||
Net (decrease) increase in cash and cash equivalents | 265 | (799 | ) | |||||
Cash and cash equivalents, beginning of year | 159 | 958 | ||||||
Cash and cash equivalents, end of year | $ | 424 | $ | 159 | ||||
Supplemental cash flow information: | ||||||||
Cash paid during the year for: | ||||||||
Income taxes | $ | – | $ | 5 | ||||
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(15) Quarterly Results of Operations (Unaudited)
2004 | ||||||||||||||||
March | June | September | December | |||||||||||||
31 | 30 | 30 | 31 | |||||||||||||
(In Thousands, Except Per Share Data) | ||||||||||||||||
Interest and dividend income | $ | 5,442 | $ | 5,461 | $ | 5,488 | $ | 5,940 | ||||||||
Interest expense | 2,019 | 2,095 | 2,096 | 2,310 | ||||||||||||
Net interest income | 3,423 | 3,366 | 3,392 | 3,630 | ||||||||||||
Provision (credit) for loan losses | — | (300 | ) | — | — | |||||||||||
Net interest income after provision (credit) for loan losses | 3,423 | 3,666 | 3,392 | 3,630 | ||||||||||||
Non-interest income | 322 | 505 | 348 | 378 | ||||||||||||
Lawsuit judgment collected | — | 2,275 | — | 5 | ||||||||||||
Non-interest expense | 2,488 | 2,771 | 2,706 | 2,699 | ||||||||||||
Income before income tax | 1,257 | 3,675 | 1,034 | 1,314 | ||||||||||||
Income tax expense | 471 | 1,318 | 337 | 474 | ||||||||||||
Net income | $ | 786 | $ | 2,357 | $ | 697 | $ | 840 | ||||||||
Basic earnings per share | $ | 0.18 | $ | 0.55 | $ | 0.16 | $ | 0.19 | ||||||||
Diluted earnings per share | $ | 0.18 | $ | 0.53 | $ | 0.16 | $ | 0.19 | ||||||||
2003 | ||||||||||||||||
March | June | September | December | |||||||||||||
31 | 30 | 30 | 31 | |||||||||||||
(In Thousands, Except Per Share Data) | ||||||||||||||||
Interest and dividend income | $ | 5,662 | $ | 5,314 | $ | 4,977 | $ | 5,381 | ||||||||
Interest expense | 2,399 | 2,316 | 2,165 | 2,097 | ||||||||||||
Net interest income | 3,263 | 2,998 | 2,812 | 3,284 | ||||||||||||
Provision for loan losses | — | — | — | — | ||||||||||||
�� | ||||||||||||||||
Net interest income after provision for loan losses | 3,263 | 2,998 | 2,812 | 3,284 | ||||||||||||
Non-interest income | 280 | 383 | 658 | 287 | ||||||||||||
Lawsuit judgment collected | — | — | — | 1,996 | ||||||||||||
Non-interest expense | 2,672 | 2,372 | 2,417 | 2,277 | ||||||||||||
Income before income tax | 871 | 1,009 | 1,053 | 3,290 | ||||||||||||
Income tax expense | 321 | 374 | 399 | 993 | ||||||||||||
Net income | $ | 550 | $ | 635 | $ | 654 | $ | 2,297 | ||||||||
Basic earnings per share | $ | 0.13 | $ | 0.15 | $ | 0.16 | $ | 0.54 | ||||||||
Diluted earnings per share | $ | 0.13 | $ | 0.15 | $ | 0.15 | $ | 0.52 | ||||||||
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Stockholders’ Information | ||||
The following table sets forth for the fiscal periods indicated certain information with respect to the sales prices of the Company’s common stock.
Price | ||||||||
Fiscal Year | High | Low | ||||||
2004 | ||||||||
First Quarter | $ | 18.25 | $ | 16.68 | ||||
Second Quarter | 17.75 | 15.00 | ||||||
Third Quarter | 20.81 | 16.00 | ||||||
Fourth Quarter | 20.50 | 18.27 | ||||||
2003 | ||||||||
First Quarter | $ | 13.00 | $ | 12.01 | ||||
Second Quarter | 17.40 | 12.60 | ||||||
Third Quarter | 17.52 | 15.31 | ||||||
Fourth Quarter | 17.99 | 16.00 | ||||||
2002 | ||||||||
First Quarter | $ | 13.20 | $ | 12.00 | ||||
Second Quarter | 14.02 | 12.26 | ||||||
Third Quarter | 14.00 | 12.00 | ||||||
Fourth Quarter | 13.51 | 11.00 |
The Company declared and paid a cash dividend of $0.52 per share ($0.13 in each quarter) during 2004. The Company expects to pay dividends during 2005.
On December 31, 2004 there were approximately 966 holders of common stock. This number does not reflect the number of persons or entities who hold their stock in nominee or “street” name through various brokerage firms.
The Annual Meeting of the stockholders of LSB Corporation will be held at 10:00 a.m. on Tuesday, May 3, 2005 at the Andover Country Club, Canterbury Street, Andover, Massachusetts.
Corporate Headquarters
30 Massachusetts Avenue
North Andover, MA 01845-3460
Mailing Address
North Andover, MA 01845-3460
Investor Relations
Telephone (978) 725-7556
Fax (978) 725-7593
A copy of the Company’s Form 10-K as filed with the Securities and Exchange Commission pursuant to the Securities and Exchange Act of 1934, is available without charge upon written request to Investor Relations.
Transfer Agent
P.O. Box 43010
Providence, RI 02940-3010
Independent Registered Public Accounting Firm
99 High Street
Boston, MA 02110
Legal Counsel
112 South Street, 2nd Floor
Boston, MA 02111-2847
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Table of Contents
Directors Of LSB Corporation and Lawrence Savings Bank | ||||
Eugene A. Beliveau, D.D.S.
Dentist
Kathleen Boshar Reynolds
Prudential/Howe and Doherty
Malcolm W. Brawn
Executive Vice President & Secretary
The Andover Companies
Thomas J. Burke
Chairman of the Board
Lawrence Savings Bank
Register of Deeds
Attorney
Byron R. Cleveland, Jr.
President
J. H. Horne & Co.
Richard Hart Harrington, CPA
Chairman
Gordon, Harrington & Osborn, P.C.
Robert F. Hatem
Business Consultant (retired)
Marsha A. McDonough
Education Consultant
Paul A. Miller
President and
Chief Executive Officer
Lawrence Savings Bank and
LSB Corporation
Officers of LSB Corporation | ||||
Paul A. Miller
President and
Chief Executive Officer
John E. Sharland
Senior Vice President, Treasurer and
Chief Financial Officer
Barbara A. Biondo
Secretary
Richard J. D’Ambrosio
Assistant Treasurer
Timothy L. Felter
Assistant Treasurer and
Investment Officer
Jeffrey W. Leeds
Assistant Treasurer
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Table of Contents
Officers of Lawrence Savings Bank | ||||
Paul A. Miller
President and
Chief Executive Officer
Barbara A. Biondo
Secretary
Robyn K. LeBuff
Vice President and
Marketing Officer
Brenda Miskinis
Assistant Vice President and
Marketing Officer
Lending Division
Executive Vice President and
Chief Lending Officer
Maureen McCarthy
Vice President and
Compliance/CRA Officer
Commercial Banking
Jacob Kojalo
Senior Vice President and
Senior Lending Officer
Robert J. DeLuca
Vice President
Steven K. Ventre
Vice President
Scott P. McDuffee
Commercial Credit Officer
Commercial Real Estate Lending
Richard L. Archambault
Vice President
Frederick P. Maloof
Vice President
Paul M. Vallace
Vice President
Credit Policy and Administration
Lee. D. Dickey
Senior Vice President
John P. Malynn
Vice President and
Collections Manager
Linda A. Bailey
Assistant Vice President and
Credit Administration Officer
Personal Lending
John P. Teoli
Vice President
Susan M. Cain
Assistant Vice President and
Senior Mortgage Underwriter
Linda Chamberland
Residential Mortgage Officer
Finance Division
Senior Vice President, Treasurer and
Chief Financial Officer
Linda M. Chase Borrelli
Vice President and Controller
Linda D. Dulski
Assistant Vice President and
Accounting Operations Supervisor
Personal Banking Division
Timothy L. Felter
Executive Vice President and
Investment Officer
Gayle M. Fili
Vice President and Branch
Administration/Security Officer
Susan M. Dancause
Assistant Vice President,
Retirement Services Officer and
Internet Branch Manager
Linda Buell
Assistant Vice President and
Branch Manager
Veronica Calixto
Branch Manager
Cheryl Fisher
Branch Manager
Carrie Higginbottom
Branch Manager
Johanny Rodriguez
Branch Manager
Amy Marcello
Branch Manager
Support Service Division
Senior Vice President
Carmela A. Cutuli
Vice President and
Loan Servicing Manager
Cheryl A. Vining
Vice President and
Deposit Servicing Manager
Stanley R. Ward, Jr.
Assistant Vice President
Laura LaVoie
Assistant Vice President
Senior Computer Network Engineer
Table of Contents
Corporate Headquarters of
LSB Corporation
30 Massachusetts Avenue
North Andover, MA 01845-3460
(978) 725-7500
Banking Offices of
Lawrence Savings Bank
Main Office:
North Andover, MA 01845-3460
(978) 725-7500
Fax: (978) 725-7607
Branch Offices:
Andover, MA 01810
(978) 725-7590
300 Essex Street
Lawrence, MA 01840
(978) 725-7530
20 Jackson Street
Methuen, MA 01844
(978) 725-7545
148 Lowell Street
Methuen, MA 01844
(978) 725-7570
401- 403 Main Street, Suite 105
Salem, NH 03079
(603) 870-9570
Lawrence Savings Bank
24 Hour Information
Phone: (978) 725-7700
www.LawrenceSavings.com
Member
FDIC
Member
DIF
This Annual Report is printed on recycled paper: LSBCM-AR-05