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 the Quarterly Period Ended September 30, 2005
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 001-13769
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 ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
At October 20, 2005, there were 46,559,737 shares of the Corporation’s $1.00 par value common stock issued and outstanding.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
2
Chittenden Corporation
Consolidated Balance Sheets
(Unaudited)
September 30, 2005 | December 31, 2004 | |||||||
(in thousands) | ||||||||
Assets: | ||||||||
Cash and cash equivalents | $ | 150,409 | $ | 136,468 | ||||
Securities available for sale | 1,348,521 | 1,446,221 | ||||||
FRB and FHLB stock | 19,352 | 19,243 | ||||||
Loans held for sale | 34,774 | 33,535 | ||||||
Loans: | ||||||||
Commercial & Industrial | 841,430 | 801,369 | ||||||
Municipal | 156,630 | 106,120 | ||||||
Multi-family | 192,563 | 182,541 | ||||||
Commercial real estate | 1,760,621 | 1,590,457 | ||||||
Construction | 173,909 | 174,283 | ||||||
Residential real estate | 724,873 | 688,017 | ||||||
Home equity credit lines | 316,733 | 294,656 | ||||||
Consumer | 259,865 | 239,750 | ||||||
Total Loans | 4,426,624 | 4,077,193 | ||||||
Less: Allowance for loan losses | (61,468 | ) | (59,031 | ) | ||||
Net loans | 4,365,156 | 4,018,162 | ||||||
Accrued interest receivable | 29,202 | 28,956 | ||||||
Other assets | 81,616 | 64,970 | ||||||
Premises and equipment, net | 70,509 | 74,271 | ||||||
Mortgage servicing rights | 12,970 | 11,826 | ||||||
Identified intangibles | 18,320 | 20,422 | ||||||
Goodwill | 216,136 | 216,136 | ||||||
Total assets | $ | 6,346,965 | $ | 6,070,210 | ||||
Liabilities: | ||||||||
Deposits: | ||||||||
Demand | $ | 988,096 | $ | 890,561 | ||||
Savings | 499,119 | 519,623 | ||||||
NOW | 891,058 | 890,701 | ||||||
CMAs/ Money market | 1,592,743 | 1,577,474 | ||||||
Certificates of deposit less than $100,000 | 814,435 | 735,577 | ||||||
Certificates of deposit $100,000 and over | 607,897 | 424,794 | ||||||
Total deposits | 5,393,348 | 5,038,730 | ||||||
Securities sold under agreements to repurchase | 64,114 | 76,716 | ||||||
Borrowings | 179,552 | 279,755 | ||||||
Accrued expenses and other liabilities | 63,428 | 54,752 | ||||||
Total liabilities | 5,700,442 | 5,449,953 | ||||||
Stockholders’ Equity: | ||||||||
Preferred stock - $100 par value authorized – 1,000,000 shares; issued and outstanding - none | — | — | ||||||
Common stock - $1 par value; authorized – 120,000,000 shares; issued – 50,219,825 in 2005 and 50,203,529 in 2004 | 50,220 | 50,204 | ||||||
Surplus | 250,009 | 249,036 | ||||||
Retained earnings | 421,180 | 384,679 | ||||||
Treasury stock, at cost – 3,663,088 shares in 2005 and 3,861,710 shares in 2004 | (65,684 | ) | (69,246 | ) | ||||
Other comprehensive income | (14,595 | ) | 672 | |||||
Directors deferred compensation to be settled in stock | 5,400 | 4,930 | ||||||
Unearned portion of employee restricted stock | (7 | ) | (18 | ) | ||||
Total stockholders’ equity | 646,523 | 620,257 | ||||||
Total liabilities and stockholders’ equity | $ | 6,346,965 | $ | 6,070,210 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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Chittenden Corporation
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||
(in thousands, except per share amounts) | ||||||||||||||
Interest income: | ||||||||||||||
Loans | $ | 68,588 | $ | 53,090 | $ | 189,525 | $ | 152,805 | ||||||
Investments | 14,033 | 14,879 | 43,923 | 45,303 | ||||||||||
Total interest income | 82,621 | 67,969 | 233,448 | 198,108 | ||||||||||
Interest expense: | ||||||||||||||
Deposits | 17,561 | 9,411 | 43,022 | 26,139 | ||||||||||
Borrowings | 2,845 | 1,889 | 9,146 | 5,664 | ||||||||||
Total interest expense | 20,406 | 11,300 | 52,168 | 31,803 | ||||||||||
Net interest income | 62,215 | 56,669 | 181,280 | 166,305 | ||||||||||
Provision for loan losses | 1,325 | 1,025 | 3,800 | 2,553 | ||||||||||
Net interest income after provision for loan losses | 60,890 | 55,644 | 177,480 | 163,752 | ||||||||||
Noninterest income: | ||||||||||||||
Investment management and trust | 4,996 | 5,528 | 14,970 | 16,300 | ||||||||||
Service charges on deposits | 4,053 | 4,241 | 12,187 | 13,707 | ||||||||||
Mortgage servicing | 658 | (162 | ) | 1,222 | 419 | |||||||||
Gains on sales of loans, net | 2,586 | 2,261 | 6,720 | 7,057 | ||||||||||
Gains on sales of securities | 7 | 186 | 6 | 2,228 | ||||||||||
Loss on prepayments of borrowings | — | — | — | (1,194 | ) | |||||||||
Credit card, net | 1,237 | 1,146 | 3,343 | 3,076 | ||||||||||
Insurance commissions, net | 1,341 | 1,389 | 5,231 | 5,742 | ||||||||||
Other | 2,900 | 3,252 | 8,834 | 9,147 | ||||||||||
Total noninterest income | 17,778 | 17,841 | 52,513 | 56,482 | ||||||||||
Noninterest expense: | ||||||||||||||
Salaries | 22,245 | 20,652 | 65,719 | 63,317 | ||||||||||
Employee benefits | 5,784 | 5,027 | 16,501 | 16,677 | ||||||||||
Net occupancy | 5,844 | 5,481 | 18,194 | 17,259 | ||||||||||
Data processing | 921 | 994 | 2,506 | 5,271 | ||||||||||
Amortization of intangibles | 665 | 776 | 2,103 | 2,303 | ||||||||||
Conversion and restructuring charges | — | 505 | — | 1,975 | ||||||||||
Other | 9,201 | 9,376 | 28,457 | 26,574 | ||||||||||
Total noninterest expense | 44,660 | 42,811 | 133,480 | 133,376 | ||||||||||
Income before income taxes | 34,008 | 30,674 | 96,513 | 86,858 | ||||||||||
Income tax expense | 12,321 | 11,196 | 34,938 | 31,759 | ||||||||||
Net income | $ | 21,687 | $ | 19,478 | $ | 61,575 | $ | 55,099 | ||||||
Basic earnings per share | $ | 0.47 | $ | 0.42 | $ | 1.33 | $ | 1.20 | ||||||
Diluted earnings per share | 0.46 | 0.42 | 1.31 | $ | 1.18 | |||||||||
Dividends per share | 0.18 | 0.18 | 0.54 | 0.52 |
The accompanying notes are an integral part of these consolidated financial statements.
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Chittenden Corporation
Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended September 30, | ||||||||
2005 | 2004 | |||||||
(in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 61,575 | $ | 55,099 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 3,800 | 2,553 | ||||||
Depreciation | 6,147 | 5,948 | ||||||
Amortization of intangible assets | 2,103 | 2,302 | ||||||
Amortization of premiums, fees, and discounts, net | 9,095 | 13,423 | ||||||
Recovery of provision for impairment of MSR asset | (289 | ) | (2,113 | ) | ||||
Investment securities (gains) losses | (6 | ) | (2,228 | ) | ||||
Deferred income taxes | (3,943 | ) | (1,483 | ) | ||||
Loans originated for sale | (280,580 | ) | (375,741 | ) | ||||
Proceeds from sales of loans | 281,951 | 368,630 | ||||||
Gains on sales of loans, net | (6,720 | ) | (7,057 | ) | ||||
Changes in assets and liabilities, net of effect from purchase of acquired companies: | ||||||||
Accrued interest receivable | (246 | ) | 2,517 | |||||
Other assets | (4,181 | ) | 13,313 | |||||
Accrued expenses and other liabilities | 14,365 | 5,972 | ||||||
Net cash provided by operating activities | 83,071 | 81,135 | ||||||
Cash flows from investing activities: | ||||||||
Cash paid, net of cash acquired in acquisition | — | (1,120 | ) | |||||
Proceeds from sales of Federal Home Loan Bank stock | — | 8,513 | ||||||
Purchase of Federal Reserve Bank stock | (109 | ) | (7,003 | ) | ||||
Proceeds from sales of securities available for sale | 29,354 | 211,900 | ||||||
Proceeds from principal payments on securities available for sale | 222,166 | 218,910 | ||||||
Purchases of securities available for sale | (183,268 | ) | (318,560 | ) | ||||
Loans originated, net of principal repayments | (355,351 | ) | (263,651 | ) | ||||
Purchases of premises and equipment | (2,385 | ) | (13,136 | ) | ||||
Net cash provided by (used in) investing activities | (289,593 | ) | (164,147 | ) | ||||
Cash flows from financing activities: | ||||||||
Net increase in deposits | 354,618 | 122,586 | ||||||
Net decrease in securities sold under agreements to repurchase | (12,602 | ) | (7,924 | ) | ||||
Net decrease in borrowings | (100,203 | ) | (26,004 | ) | ||||
Proceeds from issuance of treasury and common stock | 3,724 | 8,166 | ||||||
Dividends on common stock | (25,074 | ) | (23,560 | ) | ||||
Net cash provided by financing activities | 220,463 | 73,264 | ||||||
Net (increase) decrease in cash and cash equivalents | 13,941 | (9,748 | ) | |||||
Cash and cash equivalents at beginning of period | 136,468 | 174,939 | ||||||
Cash and cash equivalents at end of period | $ | 150,409 | $ | 165,191 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 53,335 | $ | 32,427 | ||||
Income taxes | 39,096 | 19,582 | ||||||
Non-cash investing and financing activities: | ||||||||
Loans transferred to other real estate owned | 114 | 1,001 | ||||||
Issuance of treasury and common stock | 2,928 | 7,562 | ||||||
Assets acquired and liabilities assumed through acquisitions: | ||||||||
Fair value of assets acquired | $ | — | $ | 854 | ||||
Fair vale of liabilities assumed | — | — | ||||||
Equity issued | — | — | ||||||
Cash paid | — | 1,120 | ||||||
Goodwill | $ | — | $ | 266 |
The accompanying notes are an integral part of these consolidated financial statements.
5
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 2004 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. There were no new accounting policies or changes to existing policies adopted in the third quarter of 2005, which had a significant effect on the results of operations or statement of financial condition.
NOTE 2 - ACQUIRED INTANGIBLE ASSETS
As of September 30, 2005 | |||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||
(in thousands) | |||||||||
Amortized intangible assets | |||||||||
Core deposit intangibles | $ | 28,541 | $ | 14,368 | $ | 14,173 | |||
Customer list intangibles | 3,498 | 891 | 2,607 | ||||||
Acquired trust relationships | 4,000 | 2,460 | 1,540 | ||||||
Total | $ | 36,039 | $ | 17,719 | $ | 18,320 | |||
(in thousands) | |||
Aggregate Amortization Expense: | |||
For three months ended September 30, 2005 | $ | 665 | |
For nine months ended September 30, 2005 | 2,103 | ||
Estimated Amortization Expense: | |||
For year ended 12/31/06 | $ | 2,659 | |
For year ended 12/31/07 | 2,659 | ||
For year ended 12/31/08 | 2,659 | ||
For year ended 12/31/09 | 2,659 | ||
For year ended 12/31/10 | 2,542 |
NOTE 3 – GOODWILL
The changes in the carrying amount of goodwill for the nine months ended September 30, 2005 are as follows:
(in thousands) | Commercial Banking Segment | Other Segment | Total | ||||||
Balance as of December 31, 2004 | $ | 211,084 | $ | 5,052 | $ | 216,136 | |||
Goodwill acquired during year | — | — | — | ||||||
Impairment losses | — | — | — | ||||||
Balance as of September 30, 2005 | $ | 211,084 | $ | 5,052 | $ | 216,136 | |||
NOTE 4 – CAPITAL TRUST SECURITIES
On May 21, 2002, Chittenden Capital Trust I, (the “Trust”) issued $125 million of 8% trust preferred securities (“Trust Preferred Securities”) to the public and invested the proceeds from this offering in an
6
equivalent amount of junior subordinated debentures issued by “the Company”. These debentures are the sole asset of the Trust. 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 Trust Preferred 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. The Company has fully and unconditionally guaranteed the Trust Preferred Securities issued by the Trust.
Concurrent with the issuance of these Trust Preferred Securities, Chittenden entered into interest rate swap agreements with two counterparties, in which the Company 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.
NOTE 5 – COMPREHENSIVE INCOME
The Company’s comprehensive income for the three months and nine months ended September 30, 2005 and 2004 is presented below (amounts in thousands):
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net Income | $ | 21,687 | $ | 19,478 | $ | 61,575 | $ | 55,099 | ||||||||
Unrealized holding gains (losses) on securities available for sale, net of tax | (9,613 | ) | 10,042 | (15,263 | ) | (7,413 | ) | |||||||||
Reclassification adjustments for gains (losses) arising during the period, net of tax | (4 | ) | (893 | ) | (4 | ) | (2,805 | ) | ||||||||
Total Comprehensive Income | $ | 12,070 | $ | 28,627 | $ | 46,308 | $ | 44,881 | ||||||||
NOTE 6 – 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, | |||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||
(in thousands except per share information) | ||||||||||||
Net income | $ | 21,687 | $ | 19,478 | $ | 61,575 | $ | 55,099 | ||||
Weighted average common shares outstanding | 46,519 | 46,188 | 46,440 | 46,043 | ||||||||
Dilutive effect of common stock equivalents | 590 | 675 | 529 | 604 | ||||||||
Weighted average common and common equivalent shares outstanding | 47,109 | 46,863 | 46,969 | 46,647 | ||||||||
Basic earnings per share | $ | 0.47 | $ | 0.42 | $ | 1.33 | $ | 1.20 | ||||
Diluted earnings per share | 0.46 | 0.42 | 1.31 | 1.18 |
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 anti-dilutive:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||
Anti-dilutive options | 445,725 | 449,414 | 466,031 | 759,720 | ||||||||
Weighted average exercise price | $ | 29.90 | $ | 29.90 | $ | 29.78 | $ | 28.61 |
NOTE 7 – STOCK PLANS
The Company has two 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 for the period ended December 31,
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2004. 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.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||
(in thousands except per share information) | ||||||||||||
Net Income: | ||||||||||||
As reported | $ | 21,687 | $ | 19,478 | $ | 61,575 | $ | 55,099 | ||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | 3 | 1,166 | 1,349 | 2,439 | ||||||||
Pro forma | $ | 21,684 | $ | 18,312 | $ | 60,226 | $ | 52,660 | ||||
Earnings Per Share: | ||||||||||||
Basic: | ||||||||||||
As reported | $ | 0.47 | $ | 0.42 | 1.33 | $ | 1.20 | |||||
Pro forma | 0.47 | 0.40 | 1.30 | 1.14 | ||||||||
Diluted: | ||||||||||||
As reported | 0.46 | 0.42 | 1.31 | $ | 1.18 | |||||||
Pro forma | 0.46 | 0.39 | 1.28 | 1.13 |
The resulting pro forma compensation cost may not be representative of the cost to be expected in future periods and is primarily affected by the number of stock options granted in a particular period. Stock options granted by quarter in 2005 and 2004 were as follows:
2005 | 2004 | |||
First Quarter | — | 290,000 | ||
Second Quarter | 484,050 | 106,251 | ||
Third Quarter | 1,000 | 374,975 | ||
Fourth Quarter | N/A | — |
NOTE 8 – EMPLOYEE BENEFITS
Pension Plan
The Company sponsors a qualified defined benefit pension plan that covers substantially all of its employees. The Chittenden Pension Account Plan covers substantially all employees who meet minimum age and service requirements and provides benefits based on years of service and compensation earned during those years of service.
On May 18, 2005, the Board of Directors approved changes to the Company’s retirement program. As a result, on December 31, 2005, benefits accrued under the defined benefit Pension Account Plan will be frozen based on participants’ current service and pay levels. Effective January 1, 2006, the Company’s annual contribution to the Incentive Savings and Profit Sharing Plan (401 (k) Plan) will be enhanced for all eligible employees. The change in the defined benefit plan resulted in the recognition of a curtailment gain of $1.5 million in the second quarter.
8
The components of new periodic pension expense, which is included in employee benefits expense in the consolidated statements of income are presented below. The amounts shown exclude the $1.531 million curtailment gain recognized in the second quarter of 2005.
Nine Months Ended September 30, (in thousands) | ||||||||
2005 | 2004 | |||||||
Service cost | $ | 2,981 | $ | 2,570 | ||||
Interest cost | 3,120 | 2,772 | ||||||
Expected return on plan assets | (3,593 | ) | (3,337 | ) | ||||
Net amortization: | ||||||||
Prior service cost | (379 | ) | (442 | ) | ||||
Net actuarial loss | 776 | 351 | ||||||
Transition cost | — | (117 | ) | |||||
Total amortization | 397 | (208 | ) | |||||
Net periodic pension expense | $ | 2,905 | $ | 1,797 | ||||
As previously disclosed in its financial statements for the year ended December 31, 2004, due to a prior contribution made in excess of the minimum required amounts, the Company does not anticipate a required contribution during 2005. The Company has made voluntary contributions totaling $7.5 million to the Pension Account Plan during 2005.
NOTE 9 – 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 five 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, business services, investment management and trust, brokerage services, and mortgage banking.
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 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 for the fiscal year ended December 31, 2004. The consolidation adjustments reflect certain eliminations of inter-segment revenue, cash and parent company investments in subsidiaries.
9
For the Three Months Ended September 30, 2005 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 63,963 | $ | (1,748 | ) | $ | — | $ | 62,215 | |||||
Noninterest income | 16,412 | 1,366 | — | 17,778 | ||||||||||
Provision for loan losses | 1,325 | — | — | 1,325 | ||||||||||
Noninterest expense | 42,876 | 1,784 | — | 44,660 | ||||||||||
Net income (loss) before income tax | 36,174 | (2,166 | ) | — | 34,008 | |||||||||
Income tax expense/(benefit) | 13,103 | (782 | ) | — | 12,321 | |||||||||
Net income (loss) | $ | 23,071 | $ | (1,384 | ) | $ | $ | 21,687 | ||||||
End of Period Assets | $ | 6,408,632 | $ | 816,939 | $ | (878,606 | ) | $ | 6,346,965 | |||||
For the Three Months Ended September 30, 2004 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 57,789 | $ | (1,120 | ) | $ | — | $ | 56,669 | |||||
Noninterest income | 16,340 | 1,501 | — | 17,841 | ||||||||||
Provision for loan losses | 1,025 | — | — | 1,025 | ||||||||||
Noninterest expense | 41,499 | 1,312 | — | 42,811 | ||||||||||
Net income (loss) before income tax | 31,605 | (931 | ) | — | 30,674 | |||||||||
Income tax expense/(benefit) | 11,449 | (253 | ) | — | 11,196 | |||||||||
Net income (loss) | $ | 20,156 | $ | (678 | ) | $ | — | $ | 19,478 | |||||
End of Period Assets | $ | 6,076,619 | $ | 768,837 | $ | (827,636 | ) | $ | 6,017,820 | |||||
For the Nine Months Ended September 30, 2005 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 186,033 | $ | (4,753 | ) | $ | — | $ | 181,280 | |||||
Noninterest income | 47,207 | 5,306 | — | 52,513 | ||||||||||
Provision for loan losses | 3,800 | — | — | 3,800 | ||||||||||
Noninterest expense | 128,268 | 5,212 | — | 133,480 | ||||||||||
Net income (loss) before income tax | 101,172 | (4,659 | ) | — | 96,513 | |||||||||
Income tax expense/(benefit) | 36,572 | (1,634 | ) | — | 34,938 | |||||||||
Net income (loss) | $ | 64,600 | $ | (3,025 | ) | $ | — | $ | 61,575 | |||||
End of Period Assets | $ | 6,408,632 | $ | 816,939 | $ | (878,606 | ) | $ | 6,346,965 | |||||
For the Nine Months Ended September 30, 2004 (in thousands) | Commercial Banking | Other (2) | Consolidation Adjustments | Consolidated | ||||||||||
Net interest income (1) | $ | 169,335 | $ | (3,030 | ) | $ | — | $ | 166,305 | |||||
Noninterest income | 51,765 | 4,717 | — | 56,482 | ||||||||||
Provision for loan losses | 2,553 | — | — | 2,553 | ||||||||||
Noninterest expense | 129,942 | 3,434 | — | 133,376 | ||||||||||
Net income (loss) before income tax | 88,605 | (1,747 | ) | — | 86,858 | |||||||||
Income tax expense/(benefit) | 32,270 | (511 | ) | — | 31,759 | |||||||||
Net income (loss) | $ | 56,335 | $ | (1,236 | ) | $ | — | $ | 55,099 | |||||
End of Period Assets | $ | 6,076,619 | $ | 768,837 | $ | (827,636 | ) | $ | 6,017,820 |
(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 insurance related products and services, as well as other operations associated with the parent holding company. |
10
NOTE 10 – STOCKHOLDERS’ EQUITY
On October 19, 2005, the Company declared a dividend of $0.18 per share or approximately $8.4 million, to be paid on November 11, 2005 to shareholders of record on October 28, 2005. On October 20, 2005, the Company announced that the Board of Directors has authorized the repurchase of up to 1,000,000 shares of the Corporation’s common stock (approximately 2% of the Company’s outstanding Common Stock) in negotiated transactions or open market purchases. Chittenden, depending on market conditions, may repurchase its common stock without further Board authorization.
NOTE 11 – 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, 2005 (in thousands):
Loans and Other Commitments | |||
Commitments to originate loans | $ | 159,325 | |
Unused home equity lines of credit | 350,297 | ||
Other unused lines of credit | 42,690 | ||
Unadvanced portions of commercial real estate and construction loans | 233,707 | ||
Equity investment commitments to limited partnerships | 5,332 | ||
Standby Letters of Credit | |||
Notional amount fully collateralized by cash | 64,119 | ||
Notional amount of other standby letters of credit | 36,844 | ||
Liability associated with letters of credit recorded on balance sheet | 742 |
11
NOTE 12–RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123R (“SFAS 123R”)(revised December 2004), Share-Based Payment, which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123, however non-employee directors are included in the scope of SFAS 123R. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. SFAS 123R allows the use of valuation models other than those prescribed in SFAS 123, specifically the Binomial Lattice method. Therefore, the pro forma costs of stock option expense estimated in Note 7 using the Black-Scholes method may not be representative of the costs recognized by the Company upon adoption of SFAS 123R. On April 14, 2005, the Securities and Exchange Commission delayed the effective date for SFAS 123R, which allows companies to implement the statement at the beginning of their first fiscal year beginning after June 15, 2005, which would be January 1, 2006 for the Company. The Company is in the process of analyzing FAS 123R and expects to implement this new statement in the first quarter of 2006.
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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 noninterest income and expense related activities, changes in the methods or rates used by governments to assess taxes against the Company including income that is exempted from taxation or expenses that are not deductible for tax purposes, 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, 2004. 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 for the period ended December 31, 2004.
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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.
Mortgage Servicing Rights (MSRs). Servicing assets are recognized as separate assets when rights are acquired through purchase or the sale of financial assets on a servicing-retained basis. Capitalized servicing rights 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 servicing rights by predominant characteristics, such as interest rates and original loan terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment speeds can adversely impact the fair value of these 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. 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 nonaccrual status could have an adverse impact on interest income recognized in future periods.
Income Taxes. The Company estimates 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, 2005, there were no valuation allowances set aside against any deferred tax assets.
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Conversion and Restructuring Charges. The Company recognizes restructuring charges in accordance with Statement of Financial Accounting Standard No. 146 Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”) and SEC Staff Accounting Bulletin No. 100 Restructuring and Impairment Charges (“SAB 100”), which contain specific guidance regarding the types of, and circumstances under which, certain expenses can be accrued. In general, SFAS 146 and SAB 100 require that the Company have a detailed plan in place, which has been communicated to substantially all the employees affected in the staff reduction, branch closures/sales, or computer conversions. Significant management judgment is required in estimating the amount of expense that is appropriate to recognize in relation to these plans.
Management Overview
Chittenden’s financial results for the third quarter of 2005 reflected an 11% increase in net income and a 10% increase in earnings per share compared to the third quarter of 2004. The increase in earnings per share and net income was due to higher net interest income and effective management of expenses. The Company has continued to experience excellent credit quality, with very low net charge-offs and lower levels of non-performing assets. Total loans increased 11% from September 30, 2004. Strong growth was noted on a year over year basis in several categories with commercial and commercial real estate loans up 13% and home equity loans up 10%. The Company’s deposits also experienced solid organic growth of 6% from September 30, 2004.
On October 19, 2005 the Board of Directors authorized the repurchase of up to 1,000,000 shares of the Corporation’s common stock (approximately 2% of the Company’s outstanding common stock) in negotiated transactions or open market purchases.
Results of Operations
Chittenden Corporation posted third quarter 2005 net income of $0.46 per diluted share, compared to $0.42 per diluted share posted in the third quarter of last year. Net income for the third quarter of 2005 was $21.7 million compared to $19.5 million recorded in the same quarter a year ago. Return on average equity (ROE) was 13.39% for the quarter ended September 30, 2005 compared with 13.11% for the same period in 2004. Return on average assets (ROA) was 1.38% for the third quarter of 2005, up from the 1.31% for the third quarter of last year. Net interest income on a tax equivalent basis for the three months ended September 30, 2005 was $62.8 million, up from $57.0 million for the same period a year ago. The increase of 10.2% in net interest income was due primarily to continued growth in average earning assets and a higher net interest margin. The yield on earning assets was 4.35%, up 15 basis points from the third quarter of 2004. The increase in the yield on earning assets resulted from higher yields on loans and continued improvement in the Company’s earning asset mix, which was partially offset by higher funding costs.
On a year to date basis, Chittenden posted net income of $1.31 per diluted share, compared to $1.18 per diluted share posted for the same period of last year. Net income for the first nine months of 2005 was $61.6 million, compared to $55.1 million recorded for the first nine months of 2004. Return on average equity was 13.04% through September 30, 2005 compared with 12.54% for the same period in 2004. Return on average assets was 1.34% for the nine-month period ended September 30, 2005, up from 1.26% for the same period in 2004. Net interest income on a tax equivalent basis for the nine months ended September 30, 2005 was $182.7 million, an increase of 9.2% from the $167.2 million for the same period a year ago. The yield on earning assets was 4.31%, an increase of 12 basis points, compared to 4.19% a year ago.
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The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the three and nine months ended September 30, 2005 and 2004:
For the Three Months Ended September 30, 2005 | For the Three Months Ended September 30, 2004 | For the Nine Months Ended September 30, 2005 | For the Nine Months Ended September 30, 2004 | ||||||||||||||||||||||||||||||||||||
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: | |||||||||||||||||||||||||||||||||||||||
$ | 834,727 | $ | 14,460 | 6.87 | % | $ | 753,618 | $ | 10,237 | 5.40 | % | Commercial & Industrial | $ | 818,953 | $ | 39,533 | 6.45 | % | $ | 705,931 | $ | 28,371 | 5.37 | % | |||||||||||||||
146,877 | 1,622 | 4.42 | % | 102,206 | 799 | 3.13 | % | Municipal | 117,175 | 3,356 | 3.82 | % | 93,975 | 2,162 | 3.07 | % | |||||||||||||||||||||||
1,739,088 | 27,847 | 6.35 | % | 1,527,187 | 21,080 | 5.49 | % | Commercial Real Estate | 1,681,183 | 76,840 | 6.11 | % | 1,491,623 | 60,460 | 5.41 | % | |||||||||||||||||||||||
146,735 | 2,429 | 6.48 | % | 135,682 | 1,844 | 5.41 | % | Construction | 148,337 | 7,047 | 6.26 | % | 136,280 | 5,180 | 5.08 | % | |||||||||||||||||||||||
1,249,334 | 19,119 | 6.09 | % | 1,181,885 | 15,859 | 5.36 | % | Residential Real Estate (4) | 1,227,900 | 53,498 | 5.80 | % | 1,170,668 | 46,109 | 5.25 | % | |||||||||||||||||||||||
261,000 | 3,739 | 5.68 | % | 250,197 | 3,636 | 5.78 | % | Consumer | 250,493 | 10,641 | 5.68 | % | 249,591 | 11,449 | 6.13 | % | |||||||||||||||||||||||
4,377,761 | 69,216 | 6.27 | % | 3,950,775 | 53,455 | 5.39 | % | Total loans | 4,244,041 | 190,915 | 6.00 | % | 3,848,068 | 153,731 | 5.33 | % | |||||||||||||||||||||||
Investments: | |||||||||||||||||||||||||||||||||||||||
1,340,640 | 13,858 | 4.13 | % | 1,439,643 | 14,807 | 4.11 | % | Taxable | 1,398,707 | 43,710 | 4.17 | % | 1,472,216 | 45,145 | 4.09 | % | |||||||||||||||||||||||
1,008 | 15 | 6.04 | % | 1,295 | 20 | 6.27 | % | Tax-Favored Securities | 1,197 | 56 | 6.23 | % | 1,295 | 61 | 6.31 | % | |||||||||||||||||||||||
250 | 2 | 2.46 | % | 150 | 0 | 1.09 | % | Interest-Bearing Deposits | 198 | 3 | 2.18 | % | 150 | 1 | 1.20 | % | |||||||||||||||||||||||
18,840 | 164 | 3.46 | % | 22,887 | 50 | 0.86 | % | Federal Funds Sold | 6,792 | 173 | 3.40 | % | 11,642 | 106 | 1.22 | % | |||||||||||||||||||||||
5,738,499 | 83,255 | 5.76 | % | 5,414,750 | 68,332 | 5.03 | % | Total Interest-Earning Assets | 5,650,935 | 234,857 | 5.55 | % | 5,333,371 | 199,044 | 4.98 | % | |||||||||||||||||||||||
571,811 | 573,866 | Noninterest-Earning Assets | 560,766 | 563,315 | |||||||||||||||||||||||||||||||||||
(61,444) | (58,344 | ) | Allowance for Loan Losses | (60,450 | ) | (58,061 | ) | ||||||||||||||||||||||||||||||||
$6,248,866 | $ | 5,930,272 | Total Assets | $ | 6,151,251 | $ | 5,838,625 | ||||||||||||||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||||||||
Interest-Bearing Liabilities: | |||||||||||||||||||||||||||||||||||||||
502,122 | 597 | 0.47 | % | 538,913 | 411 | 0.30 | % | Savings | 509,436 | 1,567 | 0.41 | % | 527,918 | 1,223 | 0.31 | % | |||||||||||||||||||||||
890,033 | 1,237 | 0.55 | % | 892,358 | 628 | 0.28 | % | NOW | 876,608 | 2,927 | 0.45 | % | 884,226 | 1,771 | 0.27 | % | |||||||||||||||||||||||
1,518,362 | 6,005 | 1.57 | % | 1,570,431 | 3,019 | 0.76 | % | CMAs/Money Market | 1,519,236 | 14,474 | 1.27 | % | 1,530,564 | 8,070 | 0.70 | % | |||||||||||||||||||||||
814,942 | 5,118 | 2.49 | % | 765,759 | 3,637 | 1.89 | % | Certificates of deposit under $100,000 | 782,401 | 13,177 | 2.25 | % | 775,005 | 10,918 | 1.88 | % | |||||||||||||||||||||||
599,388 | 4,604 | 3.05 | % | 353,403 | 1,716 | 1.93 | % | Certificates of deposit $100,000and over | 526,632 | 10,877 | 2.76 | % | 311,979 | 4,157 | 1.78 | % | |||||||||||||||||||||||
4,324,847 | 17,561 | 1.61 | % | 4,120,864 | 9,411 | 0.91 | % | Total Interest-Bearing Deposits | 4,214,313 | 43,022 | 1.36 | % | 4,029,692 | 26,139 | 0.87 | % | |||||||||||||||||||||||
66,187 | 275 | 1.65 | % | 74,585 | 150 | 0.80 | % | Repurchase agreements | 94,774 | 1,202 | 1.70 | % | 73,264 | 465 | 0.85 | % | |||||||||||||||||||||||
206,070 | 2,570 | 4.95 | % | 192,738 | 1,739 | 3.59 | % | Borrowings | 246,970 | 7,944 | 4.30 | % | 225,738 | 5,199 | 3.08 | % | |||||||||||||||||||||||
4,597,104 | 20,406 | 4,388,187 | 11,300 | 1.02 | % | Total Interest-Bearing Liabilities | 4,556,057 | 52,168 | 1.53 | % | 4,328,694 | 31,803 | 0.98 | % | |||||||||||||||||||||||||
NonInterest-Bearing Liabilities: | |||||||||||||||||||||||||||||||||||||||
945,559 | 897,127 | Demand Deposits | 905,381 | 868,889 | |||||||||||||||||||||||||||||||||||
63,400 | 53,821 | Other Liabilities | 58,694 | 53,893 | |||||||||||||||||||||||||||||||||||
5,606,063 | 5,339,135 | Total Liabilities | 5,520,132 | 5,251,476 | |||||||||||||||||||||||||||||||||||
642,803 | 591,137 | Stockholders’ Equity | 631,119 | 587,149 | |||||||||||||||||||||||||||||||||||
$6,248,866 | $ | 5,930,272 | Total Liabilities and Stockholders’ Equity | $ | 6,151,251 | $ | 5,838,625 | ||||||||||||||||||||||||||||||||
$ | 62,849 | $ | 57,032 | Net Interest Income | $ | 182,689 | $ | 167,241 | |||||||||||||||||||||||||||||||
4.00 | % | 4.01 | % | Interest Rate Spread (2) | 4.02 | % | 4.00 | % | |||||||||||||||||||||||||||||||
4.35 | % | 4.20 | % | Net Yield on Earning Assets (3) | 4.31 | % | 4.19 | % |
(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. |
(4) | Residential real estate includes 1-4 family, multi-family and home equity loans. |
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The following tables attribute changes in the Company’s net interest income (on a fully taxable equivalent basis) to changes in either average balances or average rates for the three and nine months ended September 30, 2005. 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.
QTD 2005 Compared with QTD 2004 | ||||||||||||
Increase (Decrease) in Net Interest Income Due to: | Total Increase (Decrease) | |||||||||||
Average Rate | Average Balance | |||||||||||
(in thousands) | ||||||||||||
Interest income: | ||||||||||||
Loans: | ||||||||||||
Commercial & Industrial | $ | 2,818 | $ | 1,405 | $ | 4,223 | ||||||
Municipal | 332 | 491 | 823 | |||||||||
Commercial real estate | 3,320 | 3,447 | 6,767 | |||||||||
Construction | 400 | 185 | 585 | |||||||||
Residential real estate | 2,233 | 1,027 | 3,260 | |||||||||
Consumer | (62 | ) | 165 | 103 | ||||||||
Total loans | 9,041 | 6,720 | 15,761 | |||||||||
Investments: | ||||||||||||
Taxable | 75 | (1,024 | ) | (949 | ) | |||||||
Tax-favored | (1 | ) | (4 | ) | (5 | ) | ||||||
Interest-bearing deposits | 0 | 2 | 2 | |||||||||
Federal funds sold | 150 | (36 | ) | 114 | ||||||||
Total interest income | 9,265 | 5,658 | 14,923 | |||||||||
Interest expense: | ||||||||||||
Savings | (230 | ) | 44 | (186 | ) | |||||||
NOWs | (613 | ) | 4 | (609 | ) | |||||||
CMAs/ Money Market | (3,192 | ) | 206 | (2,986 | ) | |||||||
Certificates of deposit under $100,000 | (1,172 | ) | (309 | ) | (1,481 | ) | ||||||
Certificates of deposit $100,000 and over | (999 | ) | (1,889 | ) | (2,888 | ) | ||||||
Repurchase agreements | (160 | ) | 35 | (125 | ) | |||||||
Borrowings | (665 | ) | (166 | ) | (831 | ) | ||||||
Total interest expense | (7,031 | ) | (2,075 | ) | 9,106 | |||||||
Change in net interest income | $ | 2,234 | $ | 3,583 | $ | 5,817 | ||||||
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YTD 2005 Compared with YTD 2004 | ||||||||||||
Increase (Decrease) in Net Interest Income Due to: | Total Increase (Decrease) | |||||||||||
Average Rate | Average Balance | |||||||||||
(in thousands) | ||||||||||||
Interest income: | ||||||||||||
Loans: | ||||||||||||
Commercial & Industrial | $ | 5,753 | $ | 5,409 | $ | 11,162 | ||||||
Municipal | 529 | 665 | 1,194 | |||||||||
Commercial real estate | 7,881 | 8,499 | 16,380 | |||||||||
Construction | 1,316 | 551 | 1,867 | |||||||||
Residential real estate | 4,901 | 2,488 | 7,389 | |||||||||
Consumer | (838 | ) | 30 | (808 | ) | |||||||
Total loans | 19,542 | 17,642 | 37,184 | |||||||||
Investments: | ||||||||||||
Taxable | 865 | (2,300 | ) | (1,435 | ) | |||||||
Tax-favored | (1 | ) | (4 | ) | (5 | ) | ||||||
Interest bearing deposits | 1 | 1 | 2 | |||||||||
Federal funds sold | 191 | (124 | ) | 67 | ||||||||
Total interest income | 20,598 | 15,215 | 35,813 | |||||||||
Interest expense: | ||||||||||||
Savings | (396 | ) | 52 | (344 | ) | |||||||
NOWs | (1,171 | ) | 15 | (1,156 | ) | |||||||
CMAs/ Money Market | (6,459 | ) | 55 | (6,404 | ) | |||||||
Certificates of deposit under $100,000 | (2,086 | ) | (173 | ) | (2,259 | ) | ||||||
Certificates of deposit $100,000 and over | (2,230 | ) | (4,490 | ) | (6,720 | ) | ||||||
Repurchase agreements | (463 | ) | (274 | ) | (737 | ) | ||||||
Borrowings | (2,059 | ) | (686 | ) | (2,745 | ) | ||||||
Total interest expense | (14,864 | ) | (5,501 | ) | (20,365 | ) | ||||||
Change in net interest income | $ | 5,734 | $ | 9,714 | $ | 15,448 | ||||||
Noninterest Income and Noninterest Expense
Noninterest income for the third quarter 2005 was $17.8 million, essentially flat with the same period a year ago. Investment management and trust income declined $532,000 from the same period in 2004 primarily due to lower annuity sales at Chittenden Securities, Inc. Mortgage servicing income increased from the third quarter of 2004 due to higher impairment recoveries of $131,000 and lower amortization of $620,000. The increase in gains on sales of loans of $325,000 from the third quarter of 2004 related to an increase in sales volume from $104 million to $125 million. The decline of $188,000 in service charges on deposits reflects the continued expansion of the Company’s relationship accounts that minimize service charges and lower overdraft fee income from customers. The decline in other noninterest income primarily relates to the sale of a branch in 2004, which generated a gain of $757,000.
Noninterest income for the first nine months of 2005 was $52.5 million, a decline of $4.0 million from the same period in 2004. Mortgage servicing income increased $803,000 from the same period in 2004 due to lower amortization of $2.7 million (for further discussion on mortgage servicing see page 21). Gains on sales of securities, net of losses of prepayment of borrowings, declined $1.0 million from the same period in 2004. Investment management and trust income declined $1.3 million from the same period in 2004. The decrease in this type of fee income was due to lower annuity sales at Chittenden Securities, Inc. The decline of $1.5 million in service charges on deposits primarily reflects the Company’s expansion of its relationship accounts that minimize service charges and lower overdraft fee income from customers.
Noninterest expense was $44.7 million for the third quarter of 2005, an increase of $1.3 million on a linked quarter basis and $1.8 million from the same period a year ago. The increase from the second quarter was attributable to a one-time benefit resulting from the recognition in the second quarter of 2005 of $1.5 million in deferred credits relating to previous pension plan changes made in the mid-1990s. The increase from the third
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quarter of 2004 is primarily a result of higher salary, employee benefit and net occupancy expenses, which was offset by lower conversion and restructuring charges. Salary expense increased primarily due to higher incentive accruals of $1.4 million. Benefits expense increased as a result of higher medical and dental, and pension expenses. The increase in occupancy expenses was due to higher utility and property expenses as well as opening a new branch in Westborough, MA.
For the first nine months of 2005, noninterest expenses were $133.5 million essentially flat from 2004. Lower data processing expense and conversion and restructuring charges, were partially offset by increases in salary and other noninterest expense. Salary expense increased due to higher incentive accruals of $4.4 million. In employee benefits, higher medical and dental expenses were offset by lower pension costs year over year because of the one time curtailment gain recognized in the second quarter of 2005. Data processing expenses declined due to efficiencies gained from the conversion of the Company’s core data processing platform in mid-2004. Increases in other noninterest expense were related to higher legal, education & training, and state examination expenses.
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. The Company’s effective income tax rate for 2005 was 36.2% for both the third quarter and year to date, compared with 36.5% and 36.6% for the respective periods in 2004. The lower effective income tax rates were primarily attributable to higher tax credits from qualified low-income housing projects.
Financial Position
Total assets increased approximately $144 million from June 30, 2005 to $6.3 billion at September 30, 2005. The increase in total loans was driven by increases in commercial, commercial real estate, municipal and construction loans. The Company’s commercial and commercial real estate loan portfolios have continued to achieve steady growth throughout 2005 and are not specifically concentrated in any one market. The increase in municipal loans reflects a seasonal trend, as June 30th is historically the low point with respect to borrowing needs of municipalities, coinciding with their fiscal year-ends. The construction portfolio increased $49 million, primarily in loans to our commercial customers in the Vermont, Massachusetts and New Hampshire markets. The decline in the Company’s securities portfolio fair value resulted from higher market interest rates.
Total deposits increased $249 million from June 30, 2005. The increase was primarily a result of by the Company’s commercial and municipal customers and resulted in higher levels of demand, CMA/money market, and jumbo CDs. Customer repurchase agreements and borrowings at September 30, 2005 declined by 31% from June 30, 2005. The decrease was due to higher levels of deposits, which were utilized to repay short-term borrowings and fund loan growth.
Credit Quality
Net charge-off activity totaled $662,000 for the third quarter of 2005 compared to $396,000 for the same period in 2004. The allowance for loan losses was $61.5 million at September 30, 2005, an increase of $2.4 million from December 31, 2004. Nonperforming assets include nonaccrual loans and foreclosed real estate (Other Real Estate Owned). As of September 30, 2005, nonperforming assets (NPAs) were $18.3 million, down from the second quarter of 2005 as well as the prior year-end. As a percentage of total loans, NPAs were 41 basis points, which was down from the prior quarter and from the prior year-end.
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A summary of credit quality follows:
9/30/05 | 6/30/05 | 12/31/04 | 9/30/04 | |||||||||||||
(in thousands) | ||||||||||||||||
Loans on nonaccrual | $ | 18,299 | $ | 23,145 | $ | 19,915 | $ | 20,578 | ||||||||
Other real estate owned (OREO) | — | 5 | 109 | 987 | ||||||||||||
Total nonperforming assets (NPAs) | $ | 18,299 | $ | 23,150 | $ | 20,024 | $ | 21,565 | ||||||||
Loans past due 90 days or more | $ | 2,720 | $ | 1,981 | $ | 2,604 | $ | 3,140 | ||||||||
Allowance for loan losses | 61,468 | 60,805 | 59,031 | 58,598 | ||||||||||||
NPAs as % of loans plus OREO | 0.41 | % | 0.54 | % | 0.49 | % | 0.54 | % | ||||||||
Allowance as % of loans | 1.39 | % | 1.43 | % | 1.45 | % | 1.47 | % | ||||||||
Allowance as % of loans (excluding Municipal) | 1.44 | % | 1.46 | % | 1.49 | % | 1.51 | % | ||||||||
Allowance as % of nonperforming loans | 335.92 | % | 262.71 | % | 296.41 | % | 284.76 | % |
Provisions for and activity in the allowance for loan losses are summarized as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in thousands) | ||||||||||||||||
Beginning balance | $ | 60,805 | $ | 57,969 | $ | 59,031 | $ | 57,464 | ||||||||
Provision for loan losses | 1,325 | 1,025 | 3,800 | 2,553 | ||||||||||||
Loans charged off | (1,668 | ) | (1,654 | ) | (4,135 | ) | (4,338 | ) | ||||||||
Loan recoveries | 1,006 | 1,258 | 2,772 | 2,919 | ||||||||||||
Ending balance | $ | 61,468 | $ | 58,598 | $ | 61,468 | $ | 58,598 | ||||||||
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 and 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 Losses” in the Company’s annual report on Form 10-K for the year ended December 31, 2004.
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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, 2005:
Purchased | Originated | Total | ||||||||||
(in thousands) | ||||||||||||
Balance at December 31, 2004 | $ | 410 | $ | 11,416 | $ | 11,826 | ||||||
Additions | — | 4,110 | 4,110 | |||||||||
Amortization | (150 | ) | (3,105 | ) | (3,255 | ) | ||||||
Recovery of impairment | 68 | 221 | 289 | |||||||||
Balance at September 30, 2005 | $ | 328 | $ | 12,642 | $ | 12,970 | ||||||
The Company originated $471 million and sold $320 million in residential real estate loans during the first nine months of 2005, which was down from $516 million and $365 million in 2004, respectively. Volatility in interest rates can significantly impact the mortgage organization and sales volumes, the amortization of mortgage servicing assets and the related impairment recoveries based on the fair value of those assets as measured based on current interest rates. During 2005, mortgage interest rates have moved steadily but gradually upward, leading to slower prepayment speeds and as a result lower amortization and steadier impairment recoveries. In the previous year, rates moved up and down more dramatically which led to higher prepayment speeds and amortization expenses and higher impairment recoveries when rates rose and prepayments speeds slowed. During the first nine months of 2005, the MSR amortization was $3.3 million as compared to $6.0 million in 2004. The Company recorded an impairment recovery of $289,000 during 2005 as compared to $2.1 million for the same period a year ago. The remaining impairment reserve for particular stratas in the MSR’s at September 30, 2005 was $753,000. The Company services approximately $2.1 billion in mortgages for others and has net capitalized mortgage-servicing rights of $12.9 million. As a result, the MSR asset as a percentage of loans serviced was approximately 62 basis points as of September 30, 2005.
Capital
Stockholders’ equity totaled $646.5 million at September 30, 2005, compared to $620.3 million at December 31, 2004. “Tier One” capital, consisting of common equity and the Trust Preferred Securities, measured 10.72% of risk-weighted assets at September 30, 2005. Total capital, including the “Tier Two” allowance for loan losses, was 11.89% of risk-weighted assets and the leverage capital ratio was 9.08%. These ratios placed Chittenden in the “well-capitalized” category according to regulatory standards.
The Trust, which issued the Company’s Trust Preferred Securities, is no longer consolidated into the Company’s financial statements upon the adoption of FIN 46R in the first quarter of 2004. However, the Company continues to reflect the amounts payable to the Trust’s preferred shareholders as debt in its financial statements. On March 1, 2005, the Federal Reserve Board issued a final rule that would retain trust preferred securities in Tier One capital of bank holding companies, but with stricter quantitative limits and clearer standards. Under the proposal, after a five-year transition period, which would end on March 31, 2009, the aggregate amount of trust preferred securities would be limited to 25% of Tier One capital elements, net of goodwill.
The Company has evaluated the potential impact of such a change on its Tier One capital ratio and has concluded that the regulatory capital treatment of the Trust Preferred Securities in the Company’s total capital ratio would be unchanged.
Liquidity
The Company’s liquidity and rate sensitivity are monitored by the Company’s 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
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assets to cash at a reasonable price. For the quarter ended September 30, 2005, the Company’s ratio of average loans to average deposits was approximately 83.1%. At September 30, 2005, the Company maintained cash balances and short-term investments of $150.4 million, compared with $136.5 million at December 31, 2004. The Company has securities available for sale of $1.348 billion at September 30, 2005 with expected cash flow of $44 million remaining in 2005 and $222 million in 2006 from maturities and expected principal payments on mortgage-backed securities. Repurchase agreements and borrowings at September 30, 2005 were $243.7 million compared to $356.5 million on December 31, 2004.
The Company has available borrowing capacity under certain programs including the Federal Home Loan Bank, Treasury Tax & Loan, repo lines with investment banks, and advised Fed Funds lines totaling more than $787 million. 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 advances | $ | 52,489 | $ | 64 | $ | 133 | $ | 141 | $ | 52,151 | |||||
Trust preferred securities | 125,000 | — | — | — | 125,000 | ||||||||||
Data processing contract | 4,283 | 1,142 | 2,570 | 571 | — | ||||||||||
Equity investment commitments to limited partnerships | 5,332 | 784 | 3,436 | 636 | 476 | ||||||||||
Operating leases. | 25,939 | 4,953 | 11,350 | 1,714 | 7,922 | ||||||||||
Total | $ | 213,043 | $ | 6,943 | $ | 17,489 | $ | 3,062 | $ | 185,549 | |||||
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.
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Financial instruments whose contractual amounts represent off-balance sheet risk at September 30, 2005 (in thousands):
Loans and Other Commitments | |||
Commitments to originate loans | $ | 159,325 | |
Unused home equity lines of credit | 350,297 | ||
Other unused lines of credit | 42,690 | ||
Unadvanced portions of commercial real estate and construction loans | 233,707 | ||
Equity investment commitments to limited partnerships | 5,332 | ||
Standby Letters of Credit | |||
Notional amount fully collateralized by cash | 64,119 | ||
Notional amount of other standby letters of credit | 36,844 | ||
Liability associated with letters of credit recorded on balance sheet | 742 |
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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 annual report on Form 10-K for the year ended December 31, 2004. The Company has completed the analysis for September 30, 2005 and believes that there has not been a material change from December 31, 2004 in its interest-rate exposure.
Item 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2005, 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 were effective at the reasonable assurance level to ensure 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, 2005 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 control 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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ITEM 6. EXHIBITS
(a) | EXHIBITS | |
3.i | Amended and Restated By-Laws of the Company (Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003). | |
3.ii.1 | Amended and Restated Articles of Incorporation of the Company (Incorporated herein by reference to the Proxy Statement for the 1999 Annual Meeting of the Stockholders). | |
3.ii.2 | Articles of Amendment of the Amended and Restated Articles of Incorporation of the Company (Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005). | |
*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. | |
* 99.1 | Chittenden Corporation Form of Performance Share Award Agreement. |
* | Filed herewith |
** | Furnished herewith |
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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 21, 2005 | /S/ PAUL A. PERRAULT | |||
Date | Paul A. Perrault, | |||
Chairman, President and | ||||
Chief Executive Officer | ||||
October 21, 2005 | /S/ KIRK W. WALTERS | |||
Date | Kirk W. Walters | |||
Executive Vice President, | ||||
Treasurer, and Chief Financial Officer |
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