SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For Nine Months Ended September 30, 2003 |
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to |
Commission File Number 0-7974
CHITTENDEN CORPORATION
(Exact Name of Registrant as Specified in its Charter)
VERMONT | 03-0228404 | |
(State of Incorporation) | (IRS Employer Identification No.) |
TWO BURLINGTON SQUARE | ||
BURLINGTON, VERMONT | 05401 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrant’s Telephone Number: (802) 658-4000
NOT APPLICABLE
Former Name, Former Address and Formal Fiscal Year
If Changed Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES x NO ¨
At October 24th, 2003, there were 36,545,666 shares of the Corporation’s $1.00 par value common stock issued and outstanding.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
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C h i t t e n d e n C o r p o r a t i o n
C o n s o l i d a t e d B a l a n c e S h e e t s
( U n a u d i t e d )
September 30, 2003 | December 31, 2002 | |||||||
(in thousands) | ||||||||
Assets | ||||||||
Cash and cash equivalents | $ | 209,697 | $ | 192,142 | ||||
Securities available for sale | 1,653,111 | 1,497,111 | ||||||
FHLB stock | 24,352 | 17,030 | ||||||
Loans held for sale | 95,777 | 94,874 | ||||||
Loans: | ||||||||
Commercial | 633,221 | 568,224 | ||||||
Municipal | 106,512 | 77,820 | ||||||
Real Estate: | ||||||||
Residential | 1,155,832 | 861,706 | ||||||
Commercial | 1,375,027 | 1,103,897 | ||||||
Construction | 143,515 | 85,512 | ||||||
Total Real Estate | 2,674,374 | 2,051,115 | ||||||
Consumer | 267,615 | 276,704 | ||||||
Total Loans | 3,681,722 | 2,973,863 | ||||||
Less: Allowance for loan losses | (59,171 | ) | (48,197 | ) | ||||
Net loans | 3,622,551 | 2,925,666 | ||||||
Accrued interest receivable | 29,277 | 27,992 | ||||||
Other real estate owned | 52 | 158 | ||||||
Other assets | 61,451 | 35,269 | ||||||
Premises and equipment, net | 75,624 | 57,074 | ||||||
Mortgage servicing rights | 10,615 | 8,491 | ||||||
Identified intangibles | 23,488 | 9,480 | ||||||
Goodwill | 216,431 | 55,257 | ||||||
Total assets | $ | 6,022,426 | $ | 4,920,544 | ||||
Liabilities: | ||||||||
Deposits: | ||||||||
Demand | $ | 880,354 | $ | 684,077 | ||||
Savings | 523,497 | 400,616 | ||||||
NOW | 912,563 | 578,272 | ||||||
Money market deposits | 1,617,176 | 1,540,267 | ||||||
Certificates of deposit less than $100,000 | 822,634 | 691,467 | ||||||
Certificates of deposit $100,000 and over | 262,137 | 231,393 | ||||||
Total deposits | 5,018,361 | 4,126,092 | ||||||
Borrowings | 240,367 | 173,654 | ||||||
Company obligated, mandatorily redeemable securities of subsidiary trust | 125,000 | 125,000 | ||||||
Accrued expenses and other liabilities | 64,427 | 77,006 | ||||||
Total liabilities | 5,448,155 | 4,501,752 | ||||||
Stockholders’ Equity: | ||||||||
Preferred stock - $100 par value authorized – 1,000,000 shares; issued and outstanding - none | — | — | ||||||
Common stock - $1 par value; authorized – 60,000,000 shares; issued – 40,134,477 in 2003 and 35,748,653 in 2002 | 40,134 | 35,749 | ||||||
Surplus | 256,215 | 145,191 | ||||||
Retained earnings | 329,035 | 294,943 | ||||||
Treasury stock, at cost – 3,611,537 shares in 2003 and 3,809,183 shares in 2002 | (80,951 | ) | (85,382 | ) | ||||
Accumulated other comprehensive income | 25,610 | 24,289 | ||||||
Directors deferred compensation to be settled in stock | 4,266 | 4,052 | ||||||
Unearned portion of employee restricted stock | (38 | ) | (50 | ) | ||||
Total stockholders’ equity | 574,271 | 418,792 | ||||||
Total liabilities and stockholders’ equity | $ | 6,022,426 | $ | 4,920,544 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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C h i t t e n d e n C o r p o r a t i o n
C o n s o l i d a t e d S t a t e m e n t s o f I n c o m e
( U n a u d i t e d )
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
(in thousands, except per share amounts) | ||||||||||||||||
Interest income: | ||||||||||||||||
Loans | $ | 49,434 | $ | 48,734 | $ | 149,558 | $ | 146,717 | ||||||||
Investment securities: | ||||||||||||||||
Taxable | 17,648 | 17,954 | 54,375 | 46,065 | ||||||||||||
Tax-favored | 61 | 96 | 148 | 304 | ||||||||||||
Short-term investments | 88 | 83 | 223 | 125 | ||||||||||||
Total interest income | 67,231 | 66,867 | 204,304 | 193,211 | ||||||||||||
Interest expense: | ||||||||||||||||
Deposits: | ||||||||||||||||
Savings | 432 | 1,089 | 1,690 | 3,321 | ||||||||||||
NOW | 713 | 530 | 2,517 | 1,542 | ||||||||||||
Money market | 2,830 | 5,968 | 10,615 | 18,838 | ||||||||||||
Certificates of deposit under $100,000 | 4,491 | 5,406 | 14,118 | 17,470 | ||||||||||||
Certificates of deposit $100,000 and over | 1,139 | 1,479 | 3,725 | 4,648 | ||||||||||||
Borrowings | 2,965 | 2,734 | 9,930 | 4,881 | ||||||||||||
Total interest expense | 12,570 | 17,206 | 42,595 | 50,700 | ||||||||||||
Net interest income | 54,661 | 49,661 | 161,709 | 142,511 | ||||||||||||
Provision for loan losses | 2,050 | 2,315 | 6,150 | 6,081 | ||||||||||||
Net interest income after provision for loan losses | 52,611 | 47,346 | 155,559 | 136,430 | ||||||||||||
Noninterest income: | ||||||||||||||||
Investment management income | 3,983 | 3,865 | 11,634 | 11,750 | ||||||||||||
Service charges on deposit accounts | 4,583 | 4,067 | 13,711 | 11,919 | ||||||||||||
Mortgage servicing income | 1,275 | (882 | ) | (311 | ) | 432 | ||||||||||
Gains on sales of loans, net | 6,959 | 2,086 | 17,494 | 6,702 | ||||||||||||
Credit card income, net | 1,149 | 1,026 | 3,022 | 2,715 | ||||||||||||
Gains on sales of securities | 3,305 | 6 | 14,349 | 328 | ||||||||||||
Loss on prepayments of borrowings | (2,154 | ) | — | (2,154 | ) | — | ||||||||||
Insurance commissions, net | 2,041 | 1,185 | 5,185 | 3,005 | ||||||||||||
Retail investment services | 1,287 | 620 | 3,497 | 1,870 | ||||||||||||
Other | 2,570 | 1,803 | 7,611 | 6,778 | ||||||||||||
Total noninterest income | 24,998 | 13,776 | 74,038 | 45,499 | ||||||||||||
Noninterest expense: | ||||||||||||||||
Salaries | 23,233 | 18,450 | 67,183 | 54,092 | ||||||||||||
Employee benefits | 5,419 | 3,678 | 15,421 | 11,319 | ||||||||||||
Net occupancy expense | 5,977 | 4,766 | 17,654 | 14,546 | ||||||||||||
Other real estate owned, net | (20 | ) | (115 | ) | (139 | ) | (276 | ) | ||||||||
Amortization of intangibles | 755 | 348 | 1,993 | 931 | ||||||||||||
Data processing | 2,319 | 2,830 | 6,980 | 8,550 | ||||||||||||
Information technology conversion | — | — | 6,800 | — | ||||||||||||
Other | 9,175 | 7,089 | 27,403 | 22,527 | ||||||||||||
Total noninterest expense | 46,858 | 37,046 | 143,295 | 111,689 | ||||||||||||
Income before income taxes | 30,751 | 24,076 | 86,302 | 70,240 | ||||||||||||
Income tax expense | 10,887 | 8,364 | 31,221 | 24,391 | ||||||||||||
Net income | $ | 19,864 | $ | 15,712 | $ | 55,081 | $ | 45,849 | ||||||||
Basic earnings per share | $ | 0.54 | $ | 0.49 | $ | 1.55 | $ | 1.43 | ||||||||
Diluted earnings per share | 0.54 | 0.48 | 1.54 | 1.41 | ||||||||||||
Dividends per share | 0.20 | 0.20 | 0.60 | 0.59 |
The accompanying notes are an integral part of these consolidated financial statements.
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C h i t t e n d e n C o r p o r a t i o n
C o n s o l i d a t e d S t a t e m e n t s o f C a s h F l o w s
( U n a u d i t e d )
For the Nine Months Ended September 30, | ||||||||
2003 | 2002 | |||||||
(in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 55,081 | $ | 45,849 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 6,150 | 6,081 | ||||||
Depreciation | 6,544 | 5,591 | ||||||
Amortization of intangible assets | 1,993 | 931 | ||||||
Amortization of premiums, fees, and discounts, net | 9,010 | 2,888 | ||||||
Provision for on (recovery) impairment of MSR asset | (3,898 | ) | 1,200 | |||||
Investment securities (gains) | (14,349 | ) | (328 | ) | ||||
Deferred income taxes | (14,024 | ) | (776 | ) | ||||
Loans originated for sale | (1,142,958 | ) | (470,437 | ) | ||||
Proceeds from sales of loans | 1,172,400 | 465,292 | ||||||
Gains on sales of loans, net | (17,494 | ) | (6,702 | ) | ||||
Changes in assets and liabilities, net of effect from purchase of acquired companies: | ||||||||
Accrued interest receivable | 5,235 | (3,767 | ) | |||||
Other assets | 1,545 | 1,465 | ||||||
Accrued expenses and other liabilities | (1,371 | ) | (3,337 | ) | ||||
Net cash provided by operating activities | 63,864 | 43,950 | ||||||
Cash flows from investing activities: | ||||||||
Cash paid, net of cash acquired in acquisitions | (90,468 | ) | (41,481 | ) | ||||
Proceeds from sales (purchases) of Federal Home Loan Bank stock | 946 | (148 | ) | |||||
Proceeds from sales of securities available for sale | 583,600 | 430,656 | ||||||
Proceeds from maturing securities and principal payments on securities available for sale | 503,568 | 237,094 | ||||||
Purchases of securities available for sale | (846,200 | ) | (1,190,416 | ) | ||||
Loans originated, net of principal repayments | (96,868 | ) | 27,897 | |||||
Purchases of premises and equipment | (11,770 | ) | (3,455 | ) | ||||
Net cash provided by (used in) investing activities | 42,808 | (539,853 | ) | |||||
Cash flows from financing activities: | ||||||||
Net increase in deposits | 109,375 | 265,894 | ||||||
Net increase (decrease) in borrowings | (180,389 | ) | 127,105 | |||||
Issuance of trust preferred securities | — | 120,577 | ||||||
Proceeds from issuance of treasury and common stock | 2,888 | 3,383 | ||||||
Dividends on common stock | (20,991 | ) | (18,991 | ) | ||||
Repurchase of common stock | — | (9,904 | ) | |||||
Net cash provided by (used in) financing activities | (89,117 | ) | 488,064 | |||||
Net increase (decrease) in cash and cash equivalents | 17,555 | (7,839 | ) | |||||
Cash and cash equivalents at beginning of period | 192,142 | 308,023 | ||||||
Cash and cash equivalents at end of period | $ | 209,697 | $ | 300,184 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 41,318 | $ | 51,245 | ||||
Income taxes | 48,065 | 18,851 | ||||||
Non-cash investing and financing activities: | ||||||||
Loans transferred to other real estate owned | 267 | 945 | ||||||
Issuance of treasury and restricted stock | 4,165 | 183 | ||||||
Assets acquired and liabilities assumed through acquisitions: | ||||||||
Fair value of assets acquired | $ | 1,122,089 | $ | 267,310 | ||||
Fair value of liabilities assumed | 1,044,334 | 242,968 | ||||||
Equity issued | 115,931 | — | ||||||
Cash paid | 122,998 | 53,250 | ||||||
Goodwill | $ | 161,174 | $ | 28,908 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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C h i t t e n d e n C o r p o r a t i o n
N o t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s
NOTE 1 - ACCOUNTING POLICIES
The financial information included herein is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results for interim periods are not necessarily indicative of the results of operations for the full year or any other interim period.
The Company’s significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in its 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows the same basic accounting policies and considers each interim period as an integral part of an annual period.
NOTE 2 – RECENTLY ADOPTED ACCOUNTING POLICIES
In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. Statement No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In addition, the Statement requires an issuer to classify certain instruments with specific characteristics described in it as liabilities. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of Statement No. 150 did not have a significant impact on either of the Company’s financial position or results of operations.
In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Statement No. 149 amends Statement 133 for decisions made (1) as part of the Derivatives Implementation Group process that effectively required amendments to Statement 133, (2) in connection with other Board projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative discussed in paragraph 6(b) of Statement 133, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and amends certain other existing pronouncements. This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of Statement No. 149 did not have a significant impact on either of the Company’s financial position or results of operations.
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46,Consolidation of Variable Interest Entities, (or VIEs) which addresses consolidation by business enterprises of variable interest entities. FIN 46 expands upon and strengthens existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Under previous guidance, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. The Interpretation requires a variable interest entity to be consolidated by a company if that company is the “primary beneficiary” of that entity. The primary beneficiary is subject to a majority of the risk of loss from the VIE’s activities, or is entitled to receive a majority of the VIE’s residual returns, or both. The consolidation requirements of the Interpretation applied immediately to VIEs created after January 31, 2003. On October 9, 2003, the FASB issued FSP (FASB Staff Position) FIN 46-6, “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities.” This deferred the effective date for VIEs created after January 31, 2003 to an entity’s first reporting period ending after December 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the VIE was established. Management does not expect that the adoption of FIN 46 will have a significant impact on the Company’s financial position or results of operations.
In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure. This statement amends FASB No. 123, Accounting for Stock-Based Compensation. The purpose of this statement is to provide alternative methods of transition for companies that voluntarily change to the fair value based method of
6
accounting for stock-based employee compensation. The disclosure requirements of FASB 123 are also amended to include disclosure in quarterly financial statements of compensation expense calculated in accordance with FASB No. 123 and these amended disclosure requirements are presented in note 9.
In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others, which clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies, relating to a guarantors accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon the issuance of a guarantee, the guarantor recognize a liability for the fair value of the obligation it assumes under that guarantee. Financial and performance standby letters of credit are included in the scope of FIN 45, while commercial letters of credit are not. The Interpretation’s provisions for initial recognition and measurement are required to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. FIN 45 also contains additional disclosure requirements that require disclosure of the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. Significant guarantees that have been entered into are disclosed in Note 12.
NOTE 3 – ACQUISITIONS AND SALES
On February 28, 2003, Chittenden acquired Granite State Bankshares, Inc., headquartered in Keene, New Hampshire, and its subsidiary, Granite Bank for $239 million in cash and stock. The transaction has been accounted for as a purchase and, accordingly, the operations of Granite Bank are included in Chittenden’s consolidated financial statements from the date of acquisition.
The purchase price has been allocated to assets acquired and liabilities assumed based on estimates of fair value at the date of acquisition. The excess of purchase price over the fair value of net tangible and intangible assets acquired has been recorded as goodwill. The fair value of these assets and liabilities is summarized as follows (in thousands):
Cash and cash equivalents | $ | 32,530 | ||
FHLB Stock | 8,271 | |||
Securities available for sale | 395,443 | |||
Net loans | 626,238 | |||
Prepaid expenses and other assets | 26,907 | |||
Premises and equipment | 13,387 | |||
Identified intangibles | 19,313 | |||
Goodwill | 161,174 | |||
Deposits | (782,894 | ) | ||
Borrowings | (247,102 | ) | ||
Accrued expenses and other liabilities | (14,338 | ) | ||
Total acquisition cost | $ | 238,929 | ||
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On February 28, 2002, Chittenden acquired Ocean National Corporation, headquartered in Kennebunk, Maine, and its subsidiary, Ocean National Bank for $53.25 million in cash. The transaction has been accounted for as a purchase and, accordingly, the operations of Ocean National Bank (ONB) are included in Chittenden’s consolidated financial statements from the date of acquisition.
The purchase price has been allocated to assets acquired and liabilities assumed based on estimates of fair value at the date of acquisition. The excess of purchase price over the fair value of net tangible and intangible assets acquired has been recorded as goodwill. The fair value of these assets and liabilities is summarized as follows (in thousands):
Cash and cash equivalents | $ | 11,769 | ||
FHLB stock | 1,256 | |||
Securities available for sale | 41,498 | |||
Net loans | 207,443 | |||
Prepaid expenses and other assets | (5,341 | ) | ||
Premises and equipment | 3,934 | |||
Core deposit intangibles | 6,751 | |||
Goodwill | 28,908 | |||
Deposits | (235,851 | ) | ||
Accrued expenses and other liabilities | (7,117 | ) | ||
Total acquisition cost | $ | 53,250 | ||
Following is supplemental information reflecting selected pro forma results as if these acquisitions had been consummated as of the beginning of the earliest period presented, January 1, 2002 (in thousands, except EPS):
For the three months ended September 30, | For the nine months ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
Total revenue | $ | 79,408 | $ | 75,631 | $ | 242,479 | $ | 227,092 | ||||
Income before income taxes | 30,500 | 28,703 | 87,768 | 85,347 | ||||||||
Net income | 19,709 | 18,406 | 55,497 | 54,771 | ||||||||
Diluted earnings per share (EPS) | $ | 0.54 | $ | 0.50 | $ | 1.51 | $ | 1.48 |
Total revenue includes net interest income and noninterest income.
NOTE 4 – ACQUIRED INTANGIBLE ASSETS
As of September 30, 2003 | |||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||
Amortized intangible assets | |||||||||
Core deposit intangibles | $ | 28,541 | 9,710 | $ | 18,831 | ||||
Customer list intangible | 2,733 | 175 | 2,558 | ||||||
Acquired trust relationships | 4,000 | 1,901 | 2,099 | ||||||
Total | $ | 35,274 | $ | 11,786 | $ | 23,488 | |||
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Aggregate Amortization Expense: | |||
For three months ended September 30, 2003 | $ | 755 | |
For nine months ended September 30, 2003 | 1,993 | ||
Estimated Amortization Expense: | |||
For year ended 12/31/04 | $ | 3,347 | |
For year ended 12/31/05 | 3,019 | ||
For year ended 12/31/06 | 2,910 | ||
For year ended 12/31/07 | 2,910 | ||
For year ended 12/31/08 | 2,910 |
NOTE 5 – GOODWILL
The changes in the carrying amount of goodwill for the nine months ended September 30, 2003 are as follows:
Commercial Banking Segment | Other Segment | Total | |||||||
Balance as of December 31, 2002 | $ | 50,205 | $ | 5,052 | $ | 55,257 | |||
Goodwill acquired during year | 161,174 | — | 161,174 | ||||||
Impairment losses | — | — | — | ||||||
Balance as of September 30, 2003 | $ | 211,379 | $ | 5,052 | $ | 216,431 | |||
NOTE 6 – CAPITAL TRUST SECURITIES
On May 21, 2002, a wholly-owned subsidiary of the Chittenden Corporation (Chittenden), Chittenden Capital Trust I, issued $125 million of 8% trust preferred securities (“Securities”) to the public and invested the proceeds from this offering in an equivalent amount of junior subordinated debentures issued by Chittenden. These debentures are the sole asset of the trust subsidiary. The proceeds from the offering, which was net of $4.4 million of issuance costs, were primarily used to fund the cash consideration paid in the Granite Bank transaction. The Securities pay interest quarterly, are mandatorily redeemable on July 1, 2032 and may be redeemed by the Trust at par any time on or after July 1, 2007. Chittenden has fully and unconditionally guaranteed the Securities issued by the Chittenden Capital Trust I.
Concurrent with the issuance of these securities, Chittenden entered into interest rate swap agreements with two counterparties, in which Chittenden will receive 8% fixed on the notional amount of $125 million, while paying the counterparties a variable rate based on the three month LIBOR (London Interbank Offered Rate), plus approximately 122 basis points.
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NOTE 7 – COMPREHENSIVE INCOME
The Company’s comprehensive income for the three and nine months ended September 30, 2003 and 2002 is presented below (amounts in thousands):
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Net Income | $ | 19,864 | $ | 15,712 | $ | 55,081 | $ | 45,849 | ||||||||
Unrealized gains/losses on investment securities: | ||||||||||||||||
Unrealized holding gains (losses) on securities available for sale, net of tax | (8,617 | ) | 14,802 | 6,364 | 22,994 | |||||||||||
Reclassification adjustments for (gains) losses arising during period, net of tax | (2,148 | ) | (4 | ) | (9,327 | ) | (213 | ) | ||||||||
Accrued minimum pension liability, net of tax | 3,829 | 0 | 4,284 | 0 | ||||||||||||
Total Comprehensive Income | $ | 12,928 | $ | 30,510 | $ | 56,402 | $ | 68,630 | ||||||||
NOTE 8 – EARNINGS PER SHARE
The following table summarizes the calculation of basic and diluted earnings per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
(in thousands except per share information) | ||||||||||||
Net income | $ | 19,864 | $ | 15,712 | $ | 55,081 | $ | 45,849 | ||||
Weighted average common shares outstanding | 36,509 | 32,133 | 35,504 | 32,162 | ||||||||
Dilutive effect of common stock equivalents | 347 | 404 | 301 | 422 | ||||||||
Weighted average common and common equivalent shares | 36,856 | 32,537 | 35,805 | 32,584 | ||||||||
Basic earnings per share | $ | 0.54 | $ | 0.49 | $ | 1.55 | $ | 1.43 | ||||
Diluted earnings per share | 0.54 | 0.48 | 1.54 | 1.41 |
The following table summarizes options that could potentially dilute earnings per share in the future which were not included in the computation of the common stock equivalents because to do so would have been antidilutive:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
Anti-dilutive options | 650,451 | 274,451 | 1,198,076 | 274,451 | ||||||||
Weighted average exercise price | $ | 31.03 | $ | 33.76 | $ | 29.86 | $ | 33.76 |
NOTE 9 – STOCK PLANS
The Company has three stock option plans, which are described more fully in Note 10 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock option-related compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock options granted in the respective periods.
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Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
Net Income: | ||||||||||||
As reported | $ | 19,864 | $ | 15,712 | $ | 55,081 | $ | 45,849 | ||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | 1,381 | 129 | 2,574 | 2,171 | ||||||||
Pro forma | $ | 18,483 | $ | 15,583 | $ | 52,507 | $ | 43,678 | ||||
Earnings Per Share: | ||||||||||||
Basic: | ||||||||||||
As reported | $ | 0.54 | $ | 0.49 | $ | 1.55 | $ | 1.43 | ||||
Pro forma | 0.51 | 0.48 | 1.48 | 1.36 | ||||||||
Diluted: | ||||||||||||
As reported | $ | 0.54 | $ | 0.48 | $ | 1.54 | $ | 1.41 | ||||
Pro forma | 0.50 | 0.48 | 1.47 | 1.34 |
The SFAS 123 method of accounting has not been applied to options granted prior to January 1, 1995. The resulting pro forma compensation cost may not be representative of that to be expected in future periods and is primarily affected by the number of stock options granted in a particular period.
NOTE 10 – BUSINESS SEGMENTS
The Company has identified Commercial Banking as its reportable operating business segment based on the fact that the results of operations are viewed as a single strategic unit by the chief operating decision-maker. The Commercial Banking segment is comprised of the six Commercial Banking subsidiaries and Chittenden Connecticut Corporation, which provide similar products and services, have similar distribution methods, types of customers and regulatory responsibilities. Commercial Banking derives its revenue from a wide range of banking services, including lending activities, acceptance of demand, savings and time deposits, merchant credit card services, trust and investment management, data processing, brokerage services, mortgage banking, and loan servicing for investor portfolios.
Immaterial operating segments of the Company’s operations, which do not have similar characteristics to the commercial banking operations and do not meet the quantitative thresholds requiring disclosure, are included in the Other category in the disclosure of business segments below. Revenue derived from these segments includes insurance commissions from insurance related products and services, as well as other operations associated with the parent holding company.
The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies included in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K. The consolidation adjustments reflect certain eliminations of inter-segment revenue, cash and parent company investments in subsidiaries.
11
For the Three Months Ended September 30, 2003 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 55,275 | $ | (614 | ) | $ | — | $ | 54,661 | |||||
Noninterest income | 22,947 | 2,091 | (40 | ) | 24,998 | |||||||||
Provision for loan losses | 2,050 | — | — | 2,050 | ||||||||||
Noninterest expense | 45,241 | 1,657 | (40 | ) | 46,858 | |||||||||
Net income (loss) before income tax | 30,931 | (180 | ) | — | 30,751 | |||||||||
Income tax expense/(benefit) | 10,929 | (42 | ) | — | 10,887 | |||||||||
Net income (loss) | $ | 20,002 | $ | (138 | ) | $ | — | $ | 19,864 | |||||
End of Period Assets | $ | 6,022,229 | $ | 856,959 | $ | (856,762 | ) | $ | 6,022,426 | |||||
For the Three Months Ended September 30, 2002 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 50,251 | $ | (590 | ) | $ | — | $ | 49,661 | |||||
Noninterest income | 12,617 | 1,186 | (27 | ) | 13,776 | |||||||||
Provision for loan losses | 2,315 | — | — | 2,315 | ||||||||||
Noninterest expense | 36,032 | 1,041 | (27 | ) | 37,046 | |||||||||
Net income (loss) before income tax | 24,521 | (445 | ) | — | 24,076 | |||||||||
Income tax expense/(benefit) | 8,549 | (185 | ) | — | 8,364 | |||||||||
Net income (loss) | $ | 15,972 | $ | (260 | ) | $ | — | $ | 15,712 | |||||
End of Period Assets | $ | 4,944,651 | $ | 660,792 | $ | (639,660 | ) | $ | 4,965,783 | |||||
For the Nine Months Ended September 30, 2003 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 163,181 | $ | (1,472 | ) | $ | — | $ | 161,709 | |||||
Noninterest income | 68,836 | 5,350 | (148 | ) | 74,038 | |||||||||
Provision for loan losses | 6,150 | — | — | 6,150 | ||||||||||
Noninterest expense | 138,907 | 4,536 | (148 | ) | 143,295 | |||||||||
Net income (loss) before income tax | 86,960 | (658 | ) | — | 86,302 | |||||||||
Income tax expense/(benefit) | 31,417 | (196 | ) | — | 31,221 | |||||||||
Net income (loss) | $ | 55,543 | $ | (462 | ) | $ | — | $ | 55,081 | |||||
End of Period Assets | $ | 6,022,229 | $ | 856,959 | $ | (856,762 | ) | $ | 6,022,426 | |||||
For the Nine Months Ended September 30, 2002 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 143,420 | $ | (909 | ) | $ | — | $ | 142,511 | |||||
Noninterest income | 42,492 | 3,094 | (87 | ) | 45,499 | |||||||||
Provision for loan losses | 6,081 | — | — | 6,081 | ||||||||||
Noninterest expense | 108,850 | 2,926 | (87 | ) | 111,689 | |||||||||
Net income (loss) before income tax | 70,981 | (741 | ) | — | 70,240 | |||||||||
Income tax expense/(benefit) | 24,636 | (245 | ) | — | 24,391 | |||||||||
Net income (loss) | $ | 46,345 | $ | (496 | ) | $ | — | $ | 45,849 | |||||
End of Period Assets | $ | 4,944,651 | $ | 660,792 | $ | (639,660 | ) | $ | 4,965,783 |
(1) | The Commercial Banking segment derives a majority of its revenue from interest. In addition, management primarily relies on net interest income, not the gross revenue and expense amounts, in managing the segment. Therefore, only the net amount has been disclosed. |
(2) | Revenue derived from these non-reportable segments includes insurance commissions from various insurance related products and services, as well as other operations associated with the parent holding company. |
12
NOTE 11 – STOCKHOLDERS’ EQUITY
On October 15, 2003, the Company declared dividends of $0.20 per share or approximately $7.3 million, to be paid on November 14, 2003 to shareholders of record on October 31, 2003.
NOTE 12 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet the financing needs of their customers and to reduce their own exposure to fluctuations in interest rates, the Banks are parties to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks’ exposure to credit loss in the event of nonperformance by the other party to the financial instrument, for loan commitments and standby letters of credit, is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. The Banks evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Commitments to originate loans, unused lines of credit, and unadvanced portions of construction loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
Financial instruments whose contractual amounts represent off-balance sheet risk at September 30, 2003 (in thousands):
Loans and Other Committments | |||
Commitments to originate loans | $ | 248,282 | |
Unused home equity lines of credit | 282,927 | ||
Other unused lines of credit | 41,877 | ||
Unadvanced portions of construction loans | 207,710 | ||
Equity investment commitments to limited partnerships | 6,804 | ||
Standby Letters of Credit | |||
Notional amount of standby letters of credit fully collateralized by cash | 52,972 | ||
Notional amount of other standby letters of credit | 44,108 | ||
Liability associated with letters of credit recorded on balance sheet | 429 |
13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report contains statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these statements by forward-looking words such as “may,” “could,” “should,” “would,” “intend,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue” or similar words. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of complying with these safe harbor provisions. You should read statements that contain these words carefully because they discuss the Company’s future expectations, contain projections of the Company’s future results of operations or financial condition, or state other “forward-looking” information.
There may be events in the future that the Company is not able to predict accurately or control and that may cause actual results to differ materially from the expectations described in forward-looking statements. Readers are cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those discussed in this report. These differences may be the result of various factors, including changes in general, national or regional economic conditions, changes in loan default and charge-off rates, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in interest rates, changes in levels of income and expense in noninterest income and expense related activities and other risk factors identified from time to time in the Company’s periodic filings with the Securities and Exchange Commission.
The factors referred to above include many, but not all, of the factors that could impact the Company’s ability to achieve the results described in any forward-looking statements. You should not place undue reliance on forward-looking statements. You should be aware that the occurrence of the events described above and elsewhere in this report could harm the Company’s business, prospects, operating results or financial condition. The Company does not undertake any obligation to update any forward-looking statements as a result of future events or developments.
Application of Critical Accounting Policies
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company’s Form 10-K for the year-ended December 31, 2002. The Company considers the following accounting policies and related estimates to be the most critical in their potential effect on its financial position or results of operations:
Allowance for Loan Losses. The allowance for loan losses is established through a charge against current earnings to the provision for loan losses. The allowance for loan losses is based on management’s estimate of the amount required to reflect the probable inherent losses in the loan portfolio, based on circumstances and conditions known at each reporting date in accordance with Generally Accepted Accounting Principles (“GAAP”). There are three components of the allowance for loan losses: 1) specific reserves for loans considered to be impaired or for other loans for which management considers a specific reserve to be necessary; 2) allocated reserves based upon management’s formula-based process for assessing the adequacy of the allowance for loan losses; and 3) a non-specific environmentally-driven allowance considered necessary by management based on its assessment of other qualitative factors. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy using a consistent, systematic methodology which assesses such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. Adverse changes in management’s assessment of these factors could lead to additional provisions for loan losses. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed in its Form 10-K.
14
Goodwill Impairment. The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangibles, effective January 1, 2002. The statement addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and requires periodic impairment evaluations of goodwill. Impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exist. In the event that the Company were to determine that its goodwill were impaired, the recognition of an impairment charge could have an adverse impact on its results of operations in the period that the impairment occurred or on its financial position.
Income Taxes. The Company must estimate income tax expense in each of the jurisdictions in which it operates for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of September 30, 2003, there were no valuation allowances set aside against any deferred tax assets.
Mortgage Servicing Rights (MSR or MSRs). Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and original loan terms (primarily 15 and 30 years.) Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. In periods of falling market interest rates, accelerated loan prepayment speeds can adversely impact the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets were to increase in the future, the Company can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. When the book value of an individual stratum exceeds its fair value, an impairment reserve must be recognized. Future changes in management’s assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact the Company’s financial condition and results of operations either positively or adversely.
Interest Income Recognition. Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income, therefore an increase in loans on nonaccural status could have an adverse impact on interest income recognized in future periods.
15
Results of Operations
Chittenden Corporation posted third quarter 2003 net income of $0.54 per diluted share, compared to $0.48 per diluted share posted in the third quarter of last year. Net income for the third quarter of 2003 was $19.9 million, compared to $15.7 million recorded in the same quarter a year ago and $18.6 million for the second quarter of 2003. For the first nine months of 2003, diluted earnings per share were $1.54, compared to $1.41 per share recorded for the same time period in 2002. Year to date net income for 2003 was $55.1 million compared to $45.8 million for the same period a year ago.
Return on average equity (ROE) was 14.19% for the quarter ended September 30, 2003 compared with 15.36% for the same period in 2002. Return on average assets (ROA) was 1.32% for the third quarter of 2003 unchanged from the third quarter of last year. The decline in ROE from a year ago is attributed to the Granite Bank acquisition.
The net interest margin for the third quarter of 2003 was 3.98% compared to the net interest margin of 4.14% for the second quarter of 2003. In addition to scheduled amortization for purchase accounting adjustments for loans, deposits, and borrowings which reduced net interest income, the Company recognized accelerated amortization of $1.7 million in the third quarter, due to heavy prepayments on Granite Bank’s residential mortgages. Excluding the impact of the accelerated amortization, the operating net interest margin for the third quarter, was 4.11%. Although operating net interest margin as defined by Chittenden is not a GAAP measure, Chittenden’s management believes that this information helps investors understand the effect of acquisition activity in reported results.
Reported quarter-to-date tax equivalent net interest income as of September 30, 2003 was approximately $54.7 million. Excluding the accelerated amortization of $1.7 million the net interest income would have been $56.4 million. Therefore, the accelerated amortization reduced the net interest margin by 13 basis points in the third quarter of 2003.
16
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the three months and nine months ended September 30, 2003 and 2002:
For the Three Months Ended September 30, | For the Three Months Ended September 30, 2002 | For the Nine Months Ended September 30, 2003 | For the Nine Months Ended September 30, 2002 | |||||||||||||||||||||||||||||||||||||
Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1) | Description | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1) | ||||||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||||||||||||||||
Interest-Earning Assets: | ||||||||||||||||||||||||||||||||||||||||
Loans: | ||||||||||||||||||||||||||||||||||||||||
$ | 659,503 | $ | 9,023 | 5.43 | % | $ | 565,917 | $ | 8,523 | 5.98 | % | Commercial | $ | 622,770 | $ | 25,921 | 5.56 | % | $ | 566,147 | $ | 25,801 | 6.09 | % | ||||||||||||||||
100,712 | 759 | 3.01 | % | 98,325 | 906 | 3.69 | % | Municipal | 84,350 | 2,147 | 3.39 | % | 89,563 | 2,856 | 4.25 | % | ||||||||||||||||||||||||
Real Estate: | ||||||||||||||||||||||||||||||||||||||||
1,246,866 | 14,965 | 4.79 | % | 945,779 | 15,332 | 6.47 | % | Residential | 1,211,982 | 48,807 | 5.37 | % | 937,326 | 46,941 | 6.68 | % | ||||||||||||||||||||||||
1,343,864 | 18,542 | 5.47 | % | 1,051,040 | 17,004 | 6.42 | % | Commercial | 1,278,785 | 54,240 | 5.67 | % | 1,013,289 | 49,083 | 6.48 | % | ||||||||||||||||||||||||
120,487 | 1,613 | 5.31 | % | 77,417 | 1,562 | 8.01 | % | Construction | 106,181 | 4,546 | 5.72 | % | 83,371 | 4,925 | 7.90 | % | ||||||||||||||||||||||||
2,711,217 | 35,120 | 5.15 | % | 2,074,236 | 33,898 | 6.50 | % | Total Real Estate | 2,596,948 | 107,593 | 5.53 | % | 2,033,986 | 100,949 | 6.63 | % | ||||||||||||||||||||||||
280,316 | 4,835 | 6.84 | % | 299,155 | 5,728 | 7.60 | % | Consumer | 276,246 | 14,701 | 7.11 | % | 315,584 | 18,125 | 7.68 | % | ||||||||||||||||||||||||
3,751,748 | 49,737 | 5.27 | % | 3,037,633 | 49,055 | 6.42 | % | Total loans | 3,580,314 | 150,362 | 5.61 | % | 3,005,280 | 147,731 | 6.57 | % | ||||||||||||||||||||||||
Investments: | ||||||||||||||||||||||||||||||||||||||||
1,691,276 | 17,648 | 4.17 | % | 1,371,196 | 17,954 | 5.24 | % | Taxable | 1,660,540 | 54,375 | 4.37 | % | 1,146,872 | 46,065 | 5.36 | % | ||||||||||||||||||||||||
17,353 | 86 | 1.96 | % | 16,582 | 136 | 3.25 | % | Tax-Favored | 12,357 | 210 | 2.27 | % | 17,112 | 434 | 3.39 | % | ||||||||||||||||||||||||
150 | 1 | 2.64 | % | 225 | 2 | 3.02 | % | Interest-Bearing Deposits | 192 | 3 | 2.04 | % | 225 | 6 | 3.27 | % | ||||||||||||||||||||||||
36,302 | 88 | 0.96 | % | 18,179 | 81 | 1.77 | % | Federal Funds Sold | 36,569 | 221 | 0.81 | % | 9,286 | 119 | 1.72 | % | ||||||||||||||||||||||||
5,496,829 | 67,560 | 4.89 | % | 4,443,815 | 67,228 | 6.02 | % | Total Interest-Earning Assets | 5,289,972 | 205,171 | 5.18 | % | 4,178,775 | 194,355 | 6.21 | % | ||||||||||||||||||||||||
535,877 | 333,050 | Noninterest-Earning Assets | 492,363 | 315,442 | ||||||||||||||||||||||||||||||||||||
(58,154 | ) | (49,228 | ) | Allowance for Loan Losses | (55,515 | ) | (48,538 | ) | ||||||||||||||||||||||||||||||||
$ | 5,974,552 | $ | 4,727,637 | Total Assets | $ | 5,726,820 | $ | 4,445,679 | ||||||||||||||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||||||||||||
Interest-Bearing Liabilities: | ||||||||||||||||||||||||||||||||||||||||
526,894 | 432 | 0.33 | % | 396,322 | 1,089 | 1.09 | % | Savings | 515,046 | 1,690 | 0.44 | % | 383,378 | 3,321 | 1.16 | % | ||||||||||||||||||||||||
2,466,136 | 3,543 | 0.57 | % | 2,002,458 | 6,498 | 1.29 | % | NOW and money market accounts | 2,328,190 | 13,132 | 0.75 | % | 1,949,125 | 20,380 | 1.40 | % | ||||||||||||||||||||||||
835,307 | 4,491 | 2.13 | % | 688,467 | 5,406 | 3.12 | % | Certificates of deposit under $100,000 | 818,354 | 14,118 | 2.31 | % | 670,957 | 17,470 | 3.48 | % | ||||||||||||||||||||||||
250,501 | 1,139 | 1.80 | % | 226,240 | 1,479 | 2.59 | % | Certificates of deposit $100,000and over | 251,862 | 3,725 | 1.98 | % | 219,646 | 4,648 | 2.83 | % | ||||||||||||||||||||||||
4,078,838 | 9,605 | 0.93 | % | 3,313,487 | 14,472 | 1.73 | % | Total Interest-Bearing Deposits | 3,913,452 | 32,665 | 1.12 | % | 3,223,106 | 45,819 | 1.90 | % | ||||||||||||||||||||||||
284,621 | 2,019 | 2.81 | % | 170,896 | 1,570 | 3.65 | % | Borrowings | 328,464 | 6,990 | 2.85 | % | 98,749 | 3,196 | 4.33 | % | ||||||||||||||||||||||||
125,000 | 946 | 3.00 | % | 128,890 | 1,164 | 3.58 | % | Company obligated mandatorily redeemable securities | 125,000 | 2,940 | 3.14 | % | 61,808 | 1,685 | 3.64 | % | ||||||||||||||||||||||||
4,488,459 | 12,570 | 1.11 | % | 3,613,273 | 17,206 | 1.89 | % | Total Interest-Bearing Liabilities | 4,366,916 | 42,595 | 1.30 | % | 3,383,663 | 50,700 | 2.00 | % | ||||||||||||||||||||||||
NonInterest-Bearing Liabilities: | ||||||||||||||||||||||||||||||||||||||||
862,228 | 637,675 | Demand Deposits | 760,806 | 611,605 | ||||||||||||||||||||||||||||||||||||
68,298 | 70,906 | Other Liabilities | 72,445 | 61,982 | ||||||||||||||||||||||||||||||||||||
5,418,985 | 4,321,854 | Total Liabilities | 5,200,167 | 4,057,250 | ||||||||||||||||||||||||||||||||||||
555,567 | 405,783 | Stockholders’ Equity | 526,653 | 388,429 | ||||||||||||||||||||||||||||||||||||
$ | 5,974,552 | $ | 4,727,637 | Total Liabilities and Stockholders’ Equity | $ | 5,726,820 | $ | 4,445,679 | ||||||||||||||||||||||||||||||||
$ | 54,990 | $ | 50,022 | Net Interest Income | $ | 162,576 | $ | 143,655 | ||||||||||||||||||||||||||||||||
3.78 | % | 4.13 | % | Interest Rate Spread (2) | 3.88 | % | 4.21 | % | ||||||||||||||||||||||||||||||||
3.98 | % | 4.49 | % | Net Yield on Earning Assets (3) | 4.10 | % | 4.59 | % |
(1) | On a fully taxable equivalent basis, calculated using a Federal income tax rate of 35%. Loan income includes fees. |
(2) | Interest rate spread is the average rate earned on total interest-earning assets less the average rate paid on interest-bearing liabilities. |
(3) | Net yield on earning assets is net interest income divided by total interest-earning assets. |
17
The significant declines noted in the yields on earning assets and the costs of interest-bearing liabilities relate to the numerous reductions in federal funds rates by the Federal Reserve during 2002 and 2003 and the resulting declines in market interest rates.
The following table attributes changes in the Company’s net interest income (on a fully taxable equivalent basis) to changes in either average balances or average rates. Changes due to both interest rate and volume have been allocated to change due to balance and change due to rate in proportion to the relationship of the absolute dollar amounts of the change in each.
Nine Months Ended September 30, 2003 | ||||||||||||
Increase (Decrease) Due to Change in: | Total | |||||||||||
Average Rate | Average Balance | |||||||||||
(in thousands) | ||||||||||||
Interest income: | ||||||||||||
Loans | (21,486 | ) | 24,117 | 2,631 | ||||||||
Investments: | ||||||||||||
Taxable | (8,614 | ) | 16,924 | 8,310 | ||||||||
Tax-favored | (143 | ) | (81 | ) | (224 | ) | ||||||
Interest-bearing deposits in banks | (2 | ) | (1 | ) | (3 | ) | ||||||
Federal funds sold | (64 | ) | 166 | 102 | ||||||||
Total interest income | (30,309 | ) | 41,125 | 10,816 | ||||||||
Interest expense: | ||||||||||||
Savings deposits | 2,063 | (432 | ) | 1,631 | ||||||||
NOW and money market deposits | 9,385 | �� | (2,138 | ) | 7,247 | |||||||
Certificates of deposit under $100,000 and other time deposits | 5,895 | (2,543 | ) | 3,352 | ||||||||
Certificates of deposit $100,000 and over | 1,399 | (476 | ) | 923 | ||||||||
Borrowings | 1,326 | (6,375 | ) | (5,049 | ) | |||||||
Total interest expense | 20,068 | (11,964 | ) | 8,104 | ||||||||
Change in net interest income | $ | (10,241 | ) | $ | 29,161 | $ | 18,920 | |||||
Noninterest Income and Noninterest Expense
Noninterest income was $25.0 million for the third quarter of 2003, compared to $13.8 million for the same period a year ago. Gains on sales of loans were $4.9 million higher in 2003 due to significantly higher volumes of loans sold. Mortgage servicing income was $2.2 million higher in 2003 due to several factors. Prepayment speeds used to calculate the fair value of the servicing portfolio slowed from June 30, 2003, resulting in an impairment recovery of $3.3 million in the third quarter. The impairment recovery was sufficient to offset amortization of the mortgage servicing rights (MSRs) portfolio of $3.5 million in the third quarter caused by heavy prepayments during the quarter. Between the impairment recovery and the amortization, the net impact on mortgage servicing income was an approximate $200,000 reduction. This compares to a reduction of approximately $2.2 million in the third quarter of 2002, which consisted of amortization of MSRs of $1.2 million and an impairment provision of $1.0 million. Securities gains of $3.3 million were realized due to sales of agency and mortgage-backed securities. The agency securities were sold to fund the redemption of borrowings, thereby reducing borrowings and the investment portfolio. Gains on the sales of these securities of approximately $2.2 million offset losses on the redemption of the borrowings of approximately $2.1 million. In addition, gains of approximately $1.0 million were recognized on the sale of mortgage-backed securities that had elevated extension risk in rising market interest rate environments. Insurance commissions were $856,000 higher in 2003 due to higher performance-based commissions of $256,000 and the Granite Bank acquisition. Finally, retail investments increased $667,000 due to increased sales of annuities as well as the Granite Bank acquisition.
On a year-to-date basis noninterest income increased $28.5 million to $74.0 million at September 30, 2003. The Granite Bank acquisition accounted for $11.4 million of the increase. Increases excluding the acquisition were recorded in gains on sales of loans, and gains on sales of securities. The increased gains on sales of loans resulted from the increased market activity described above.
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Noninterest expenses increased $9.8 million from the third quarter of 2002 to $46.9 million for the third quarter of 2003. Salaries and benefits increased $6.5 million, of which Granite Bank represented approximately $4.0 million of the increase. Of the remaining $2.5 million increase, $1.9 million is due to higher commission expenses primarily associated with higher loan originations and $690,000 in higher employee benefits expenses. Net occupancy increased $1.2 million from the same period a year ago, substantially all of which is associated with the acquisition of Granite Bank. Other noninterest expenses increased approximately $2.0 million from the third quarter of 2002 of which $1.5 million is attributed to the Granite Bank acquisition.
Year-to-date noninterest expenses were $143.3 million up $31.6 million from a year ago. Approximately half of the increase is attributed to the Granite Bank acquisition. The remaining $15.6 million is due to $8.0 million in salaries and benefits, $6.8 million in non-recurring charges related to the Company’s decision to convert its core data processing system, and $3.1 million of other noninterest expenses. Contributing factors to the increase in salaries and benefits were nine full months in 2003 for Ocean National Bank compared to seven months in 2002, which comprised $1.5 million of the variance; a $3.0 million increase in mortgage commissions; a $900,000 increase in pension costs; $800,000 increase in medical/dental expenses; and approximately $1.8 million increase of salary expense throughout the remaining subsidiary banks.
Income Taxes
The Company and its subsidiaries are taxed on their income at the Federal level and by various states in which they do business. The State of Vermont levies franchise taxes on banks based upon average deposit levels in lieu of taxing income. Franchise taxes are included in income tax expense in the consolidated statements of income.
Income tax expense for the third quarter of 2003 was $10.9 million, up from $8.4 million the same period a year ago. Effective income tax rates for 2003 were 35.4% for the third quarter and 36.2% year to date compared to 34.7% for both respective periods in 2002. The higher effective rates in 2003 are due primarily to the higher proportion of the Company’s taxable income being generated in New Hampshire. The lower effective tax rate in the third quarter versus year-to-date was due to the recognition of the settlement of tax assessments by the Massachusetts Department of Revenue relating to the taxation of Real Estate Investment Trusts. This settlement benefited the current quarter’s provision by approximately $250,000.
Financial Position
The Company invests the majority of its assets in loans and securities. Chittenden Corporation’s total assets at September 30, 2003 were $6.0 billion, up $1.1 billion from the prior year-end, as a result of the Granite acquisition. Total loans increased $85 million from June 30, 2003, due to increases in municipal, commercial real estate and construction loans. The increase in municipal loans reflects a seasonal trend, as the second quarter is historically the low point for municipal borrowings, coinciding with the borrowers’ fiscal year-ends. Commercial real estate loans increased $50 million from June 30th with growth throughout Chittenden’s markets. The Company’s residential real estate portfolio declined $43 million due to continued heavy prepayments emanating from the decline in long term interest rates which hit their recent lows in the second quarter of 2003. This decline was substantially offset by growth in construction loans due to the financing of several projects within Chittenden’s commercial customer base, continuing a trend that has been seen for the last several quarters.
Credit Quality
Net charge-off activity totaled $470,000 for the third quarter of 2003 compared to $3.1 million for the same period in 2002. The allowance for loan losses was $59.2 million at September 30, 2003, up from $48.2 million a year ago, and from the prior year-end. The acquisition of Granite Bank led to $7.9 million of the increase from the prior balances. Nonperforming assets include nonaccrual loans and foreclosed real estate (Other Real Estate Owned). As of September 30, 2003, nonperforming assets (NPAs) were $18.0 million unchanged from June 30,
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2003 and as a percentage of total loans decreased to 48 basis points compared with 49 basis points. Loans 90 days past due and still accruing increased $1.1 million from the prior quarter to $3.0 million at September 30, 2003. The September 30, 2003 level was consistent with those of the prior year-end and the third quarter of 2002, both of which were prior to the Granite Bank acquisition.
A summary of credit quality follows:
9/30/03 | 6/30/03 | 12/31/02 | 9/30/02 | |||||||||||||
(in thousands) | ||||||||||||||||
Loans on nonaccrual | $ | 17,749 | $ | 17,725 | $ | 14,576 | $ | 16,184 | ||||||||
Troubled debt restructurings | 210 | 215 | 225 | 231 | ||||||||||||
Other real estate owned (OREO) | 52 | 30 | 158 | — | ||||||||||||
Total nonperforming assets (NPAs) | $ | 18,011 | $ | 17,970 | $ | 14,959 | $ | 16,415 | ||||||||
Loans past due 90 days or more and still accruing interest | $ | 3,021 | $ | 1,921 | $ | 2,953 | $ | 3,213 | ||||||||
Allowance for loan losses | 59,171 | 57,591 | 48,197 | 48,187 | ||||||||||||
NPAs as % of loans plus OREO | 0.48 | % | 0.49 | % | 0.49 | % | 0.54 | % | ||||||||
Allowance as % of loans | 1.57 | % | 1.56 | % | 1.57 | % | 1.57 | % | ||||||||
Allowance as % of nonperforming loans | 329.48 | % | 321.01 | % | 325.64 | % | 293.56 | % |
Provisions for and activity in the allowance for loan losses are summarized as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||||
(in thousands) | ||||||||||||||||||
Beginning balance | $ | 57,591 | $ | 48,994 | $ | 48,197 | $ | 45,268 | ||||||||||
Provision for loan losses | 2,050 | 2,315 | 6,150 | 6,081 | ||||||||||||||
Allowance acquired through acquisitions | — | — | 7,937 | 2,972 | ||||||||||||||
Loans charged off | (1,239 | ) | (3,849 | ) | (5,863 | ) | (8,574 | ) | ||||||||||
Loan recoveries | 769 | 727 | 2,750 | 2,440 | ||||||||||||||
Ending balance | $ | 59,171 | $ | 48,187 | $ | 59,171 | $ | 48,187 | ||||||||||
The allowance for loan losses is based on management’s estimate of the amount required to reflect the potential inherent losses in the loan portfolio, based on circumstances and conditions known or anticipated at each reporting date. There are inherent uncertainties with respect to the collectibility of the Banks’ loans. Because of these inherent uncertainties, it is reasonably possible that actual losses experienced in the near term may differ from the amounts reflected in this report.
Adequacy of the allowance is determined using a consistent, systematic methodology which analyzes the size and risk of the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for loan losses, management also takes into consideration other factors such as changes in the mix and volume of the loan portfolio, historic loss experience, the amount of the delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio which have similar attributes. The Company’s historical loss experience, industry trends, and the impact of the local and regional economy on the Company’s borrowers, were considered by management in determining the adequacy of the allowance for loan losses. For a full discussion on the Company’s allowance for loan loss policies see “Allowance for Loan Loss” in the Company’s 2002 annual report on Form 10-K.
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Mortgage Servicing Rights
The following table summarizes activity for mortgage servicing rights purchased and originated for the nine months ended September 30, 2003:
Purchased | Originated | Total | ||||||||||
(in thousands) | ||||||||||||
Balance at December 31, 2002 | $ | 982 | $ | 7,509 | $ | 8,491 | ||||||
MSRs obtained in Granite Bank acquisition | — | 1,480 | 1,480 | |||||||||
Additions | — | 5,244 | 5,244 | |||||||||
Amortization | (975 | ) | (7,523 | ) | (8,498 | ) | ||||||
Recovery of (provision for) impairment | 603 | 3,295 | 3,898 | |||||||||
Balance at September 30, 2003 | $ | 610 | $ | 10,005 | $ | 10,615 | ||||||
At September 30, 2003, a $4.6 million impairment valuation allowance was necessary to recognize the excess of the mortgage-servicing rights’ book value over their current fair value. A precipitous drop in market mortgage interest rates and the resultant acceleration of prepayment speeds late in 2002 necessitated this valuation allowance. Market interest rates continued to fall until early in June 2003, and prepayments, while still high, slowed somewhat in the third quarter of 2003, leading to the impairment recovery recognized above.
Capital
The Company periodically repurchases its own stock under a share repurchase program originally authorized by the Board of Directors on January 19, 2000. Subsequent authorizations have increased the number of shares authorized to be repurchased under the program to six million shares. As of September 30, 2003, the Company had repurchased 4.2 million shares at a total cost of $93 million under this program. Based on the resolution passed by the Corporation’s Board of Directors, the Company has until December 31, 2003 to purchase the remaining 1.8 million shares authorized.
Stockholders’ equity totaled $574.3 million at September 30, 2003, compared to $418.8 million at December 31, 2002. The current level reflects the issuance of $116 million in common stock as consideration in the Granite Bank transaction. “Tier One” capital, consisting of common equity and certain types of preferred stock, including the Trust Preferred issuance, measured 9.72% of risk-weighted assets at September 30, 2003. Total capital, including the “Tier Two” allowance for loan losses, was 10.97% of risk-weighted assets and the leverage capital ratio was 7.49%. These ratios placed Chittenden in the “well-capitalized” category according to regulatory standards.
The trust subsidiary which issued the Company’s trust preferred securities will no longer be consolidated into the Company’s financial statements upon the adoption of FIN 46 in the fourth quarter of 2003. However, the Company will continue to reflect the amounts payable to the trust’s preferred shareholders as debt in its financial statements. At some future point, this accounting change may result in the exclusion of the Trust Preferred securities (TPS) from Tier 1 capital, however, the Federal Reserve Board (FRB) has indicated that it will continue to qualify as such until further notice and that it may be grandfathered for some period of time in the event that they were to conclude that it should no longer qualify. The Company has evaluated the potential impact of such a change on its Tier 1 capital ratio and has concluded that it would remain well capitalized in the event the FRB were to change the regulatory capital treatment of these securities. The regulatory capital treatment of the TPS in the Company’s total capital ratio would be unchanged.
Liquidity
The Company’s liquidity and rate sensitivity are monitored by the asset and liability committee, based upon policies approved by the Board of Directors. The measure of an institution’s liquidity is its ability to meet its cash commitments at all times with available cash or by conversion of other assets to cash at a reasonable price. The Company’s commercial banking operations generate significant amounts of low cost
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funds through their deposit gathering operations. For the quarter ended September 30, 2003, the Company’s ratio of average loans to average deposits was approximately 75.9%. At September 30, 2003, the Company maintained cash balances and short-term investments of approximately $209.7 million, compared with $212.7 million at June 30, 2003. Borrowings at September 30, 2003 were $240.4 million compared to $399.0 million on June 30, 2003. Of the $159 million decline, $111 million was a result of the early redemption of FHLB borrowings and customer repurchase agreements, while the remaining $48 million decline was related to short term borrowings.
The Company has available borrowing capacity under certain programs including Federal Home Loan Bank borrowings, Treasury Tax & Loan borrowings, repo lines with investment banks, and advised Fed Funds lines totaling more than $1.0 billion. The Company also has an effective shelf registration statement under which an additional $225 million in debt securities, common stock, preferred stock, or warrants may be offered from time to time.
Aggregate Contractual Obligations
Payments due by period | |||||||||||||||
(in thousands) | |||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||
FHLB borrowings | $ | 154,931 | — | — | $ | 32,463 | $ | 122,468 | |||||||
Trust preferred securities | 125,000 | — | — | — | 125,000 | ||||||||||
Data processing contract | 18,129 | 12,849 | 2,136 | 2,096 | 1,048 | ||||||||||
Equity investments commitments to limited partnerships | 9,399 | 3,077 | 6,322 | ||||||||||||
Operating leases | 23,817 | 4,719 | 11,975 | 2,633 | 4,490 | ||||||||||
Total | $ | 331,276 | $ | 20,645 | $ | 20,433 | $ | 37,192 | $ | 253,006 | |||||
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Item 3. Qualitative and Quantitative Disclosures About Market Risk
To measure the sensitivity of its income to changes in interest rates, the Company uses a variety of methods, including simulation, valuation techniques and gap analyses. Interest-rate risk is the sensitivity of income to variations in interest rates over both short-term and long-term horizons. The primary goal of interest-rate management is to control this risk within limits approved by the Board of Directors. These limits and guidelines reflect the Company’s tolerance for interest-rate risk. The Company attempts to control interest-rate risk by identifying exposures, quantifying them and taking appropriate actions. For a full discussion of interest-rate risk see “Liquidity and Rate Sensitivity” in the Company’s 2002 annual report on Form 10-K. There has not been a material change in the Company’s interest-rate exposure or its anticipated market risk during the current period.
Item 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2003, the end of the quarter covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal controls over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
31.1 | Certification of Chairman, President and Chief Executive Officer, Paul A. Perrault pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | Certification of Executive Vice President and Chief Financial Officer, Kirk W. Walters pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | Certification of Chairman, President, and Chief Executive Officer, Paul A. Perrault, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | Certification of Executive Vice President and Chief Financial Officer, Kirk W. Walters, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(b) REPORTS ON FORM 8-K
The Company’s second quarter 2003 press release announcing earnings and quarterly dividends, as well as a copy of the quarterly comparative financial statements was file on Form 8-K on July 18, 2003.
The Company’s investor presentation distributed at various analyst meetings was furnished on Form 8-K on September 2, 2003.
The Company’s investor presentation made at the RBC Capital Markets conference on September 18, 2003 was furnished on Form 8-K on September 17, 2003.
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CHITTENDEN CORPORATION
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CHITTENDEN CORPORATION | ||
Registrant | ||
October 27, 2003 | /s/ PAUL A. PERRAULT | |
Date | Paul A. Perrault, | |
Chairman, President and | ||
Chief Executive Officer | ||
October 27, 2003 | /s/ KIRK W. WALTERS | |
Date | Kirk W. Walters | |
Executive Vice President, | ||
Treasurer, and Chief Financial Officer |
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