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 June 30, 2007
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. x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of a “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check One):
Large Accelerated Filer x Accelerated Filer ¨ Non-Accelerated Filer ¨
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 July 19, 2007, there were 46,523,713 shares of Chittenden 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)
June 30, 2007 | December 31, 2006 | |||||||
(in thousands) | ||||||||
Assets: | ||||||||
Cash and cash equivalents | $ | 361,240 | $ | 199,358 | ||||
Securities available for sale | 918,214 | 1,137,352 | ||||||
FRB and FHLB stock | 9,136 | 13,403 | ||||||
Loans held for sale | 23,495 | 17,354 | ||||||
Loans: | ||||||||
Commercial & Industrial (C&I) | 944,752 | 853,839 | ||||||
Municipal | 115,972 | 141,522 | ||||||
Multi-family | 254,068 | 216,049 | ||||||
Commercial real estate | 2,103,461 | 1,942,685 | ||||||
Construction | 239,493 | 232,000 | ||||||
Residential real estate | 849,557 | 751,450 | ||||||
Home equity credit lines | 344,210 | 322,124 | ||||||
Consumer | 258,168 | 237,541 | ||||||
Total Loans | 5,109,681 | 4,697,210 | ||||||
Less: Allowance for loan losses | (67,400 | ) | (62,160 | ) | ||||
Net loans | 5,042,281 | 4,635,050 | ||||||
Accrued interest receivable | 32,377 | 33,123 | ||||||
Other assets | 97,831 | 83,938 | ||||||
Premises and equipment, net | 74,151 | 67,036 | ||||||
Mortgage servicing rights | 16,128 | 14,155 | ||||||
Identified intangibles | 20,986 | 14,996 | ||||||
Goodwill | 282,448 | 216,038 | ||||||
Total assets | $ | 6,878,287 | $ | 6,431,803 | ||||
Liabilities: | ||||||||
Deposits: | ||||||||
Demand | $ | 997,538 | $ | 966,758 | ||||
Savings | 501,248 | 468,294 | ||||||
NOW | 913,155 | 861,435 | ||||||
CMAs/ Money market | 1,547,971 | 1,655,349 | ||||||
Certificates of deposit less than $100,000 | 971,505 | 848,814 | ||||||
Certificates of deposit $100,000 and over | 743,720 | 678,243 | ||||||
Total deposits | 5,675,137 | 5,478,893 | ||||||
Securities sold under agreements to repurchase | 114,798 | 73,611 | ||||||
Other borrowings | 290,067 | 136,409 | ||||||
Accrued expenses and other liabilities | 75,007 | 71,804 | ||||||
Total liabilities | 6,155,009 | 5,760,717 | ||||||
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 and outstanding – 52,424,744 in 2007 and 50,234,661 in 2006 | 52,425 | 50,235 | ||||||
Surplus | 342,392 | 276,034 | ||||||
Retained earnings | 478,499 | 468,331 | ||||||
Treasury stock, at cost – 5,538,517 shares in 2007 and 4,874,536 shares in 2006 | (139,535 | ) | (105,666 | ) | ||||
Accumulated other comprehensive income | (14,369 | ) | (24,008 | ) | ||||
Directors’ deferred compensation to be settled in stock | 6,164 | 6,160 | ||||||
Unearned portion of employee restricted stock | (2,298 | ) | — | |||||
Total stockholders’ equity | 723,278 | 671,086 | ||||||
Total liabilities and stockholders’ equity | $ | 6,878,287 | $ | 6,431,803 | ||||
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 June 30, | For the Six Months Ended June 30, | |||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||
(in thousands, except per share amounts) | ||||||||||||||
Interest income: | ||||||||||||||
Loans | $ | 87,780 | $ | 78,547 | $ | 170,589 | $ | 151,812 | ||||||
Investments | 13,637 | 14,120 | 26,152 | 28,814 | ||||||||||
Total interest income | 101,417 | 92,667 | 196,741 | 180,626 | ||||||||||
Interest expense: | ||||||||||||||
Deposits | 33,536 | 25,715 | 64,887 | 48,780 | ||||||||||
Borrowings | 5,927 | 4,900 | 11,119 | 8,798 | ||||||||||
Total interest expense | 39,463 | 30,615 | 76,006 | 57,578 | ||||||||||
Net interest income | 61,954 | 62,052 | 120,735 | 123,048 | ||||||||||
Provision for credit losses | 1,500 | 1,750 | 3,000 | 3,283 | ||||||||||
Net interest income after provision for credit losses | 60,454 | 60,302 | 117,735 | 119,765 | ||||||||||
Noninterest income: | ||||||||||||||
Investment management and trust | 6,183 | 5,322 | 11,850 | 10,475 | ||||||||||
Service charges on deposits | 4,420 | 4,358 | 8,564 | 8,287 | ||||||||||
Mortgage servicing | 910 | 657 | 1,702 | 1,320 | ||||||||||
Gains on sales of loans, net | 1,535 | 1,903 | 2,707 | 3,273 | ||||||||||
Losses on sales of securities | (14,137 | ) | — | (14,137 | ) | — | ||||||||
Credit card, net | 1,292 | 1,269 | 2,417 | 2,461 | ||||||||||
Insurance commissions, net | 1,393 | 1,429 | 3,549 | 3,475 | ||||||||||
Other | 3,176 | 3,590 | 6,203 | 6,824 | ||||||||||
Total noninterest income | 4,772 | 18,528 | 22,855 | 36,115 | ||||||||||
Noninterest expense: | ||||||||||||||
Salaries | 23,811 | 23,789 | 47,243 | 46,706 | ||||||||||
Employee benefits | 5,518 | 5,598 | 11,385 | 11,350 | ||||||||||
Net occupancy | 6,207 | 5,780 | 12,334 | 11,930 | ||||||||||
Data processing | 1,163 | 982 | 2,206 | 1,953 | ||||||||||
Amortization of intangibles | 726 | 664 | 1,391 | 1,329 | ||||||||||
Merger costs | 4,130 | — | 4,130 | — | ||||||||||
Other | 10,996 | 10,823 | 21,149 | 20,768 | ||||||||||
Total noninterest expense | 52,551 | 47,636 | 99,838 | 94,036 | ||||||||||
Income before income taxes | 12,675 | 31,194 | 40,752 | 61,844 | ||||||||||
Income tax expense | 3,636 | 10,185 | 11,688 | 20,637 | ||||||||||
Net income | $ | 9,039 | $ | 21,009 | $ | 29,064 | $ | 41,207 | ||||||
Basic earnings per share | $ | 0.20 | $ | 0.45 | $ | 0.64 | $ | 0.88 | ||||||
Diluted earnings per share | 0.20 | 0.45 | 0.64 | 0.87 | ||||||||||
Dividends per share | 0.22 | 0.20 | 0.42 | 0.38 |
The accompanying notes are an integral part of these consolidated financial statements.
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Chittenden Corporation
Consolidated Statements of CashFlows
(Unaudited)
For the Six Months Ended June 30, | ||||||||
2007 | 2006 | |||||||
(in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 29,064 | $ | 41,207 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for credit losses | 3,000 | 3,283 | ||||||
Depreciation | 3,713 | 3,856 | ||||||
Amortization of intangible assets | 1,391 | 1,329 | ||||||
Amortization of premiums, fees, and discounts, net | 3,164 | 3,458 | ||||||
Share-based payment compensation | 1,529 | 2,044 | ||||||
Recovery of MSR impairment | (469 | ) | (214 | ) | ||||
Investment securities losses | 14,137 | — | ||||||
Prepaid (deferred) income taxes | 3,097 | (2,288 | ) | |||||
Loans originated for sale | (163,472 | ) | (144,525 | ) | ||||
Proceeds from sales of loans | 158,640 | 146,463 | ||||||
Gains on sales of loans, net | (2,707 | ) | (3,273 | ) | ||||
Changes in assets and liabilities: | ||||||||
Accrued interest receivable | 2,694 | 1,483 | ||||||
Other assets | (10,862 | ) | (1,349 | ) | ||||
Accrued expenses and other liabilities | (4,334 | ) | 4,270 | |||||
Net cash provided by operating activities | 38,585 | 55,744 | ||||||
Cash flows from investing activities: | ||||||||
Cash paid, net of cash acquired in acquisition of Merrill Merchants Bancshares, Inc. | (28,712 | ) | — | |||||
Purchase of FHLB stock | 6,580 | 784 | ||||||
Proceeds from sales of securities available for sale | 578,689 | — | ||||||
Proceeds from principal payments on securities available for sale | 300,388 | 121,473 | ||||||
Purchases of securities available for sale | (594,898 | ) | (47,014 | ) | ||||
Loans originated, net of principal repayments | (57,509 | ) | (92,995 | ) | ||||
Purchases of premises and equipment | (6,111 | ) | (3,628 | ) | ||||
Net cash provided by (used in) investing activities | 198,427 | (21,380 | ) | |||||
Cash flows from financing activities: | ||||||||
Net decrease in deposits | (151,663 | ) | (196,765 | ) | ||||
Net increase in repurchase agreements | 41,187 | 114,489 | ||||||
Net increase (decrease) in other borrowings | (34,109 | ) | 82,458 | |||||
Issuance of subordinated debt | 125,000 | — | ||||||
Common stock transactions – net | 2,983 | 2,458 | ||||||
Dividends on common stock | (18,897 | ) | (17,797 | ) | ||||
Repurchase of common stock | (39,631 | ) | (27,347 | ) | ||||
Net cash used in financing activities | (75,130 | ) | (42,504 | ) | ||||
Net increase (decrease) in cash and cash equivalents | 161,882 | (8,140 | ) | |||||
Cash and cash equivalents at beginning of period | 199,358 | 180,707 | ||||||
Cash and cash equivalents at end of period | $ | 361,240 | $ | 172,567 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 77,069 | $ | 57,800 | ||||
Income taxes | 25,022 | 28,619 | ||||||
Non-cash investing and financing activities: | ||||||||
Loans transferred to other real estate owned | 227 | 193 | ||||||
Issuance of treasury and restricted stock | 1,102 | 1,966 | ||||||
Assets acquired and liabilities assumed through acquisitions: | ||||||||
Fair value of assets acquired, including core deposit intangibles | 464,558 | — | ||||||
Fair value of liabilities assumed | 419,670 | — | ||||||
Equity issued in common stock | 66,913 | — | ||||||
Cash paid | 44,384 | — | ||||||
Goodwill acquired | 66,410 | — |
The accompanying notes are an integral part of these consolidated financial statements.
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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 significant accounting policies of Chittenden Corporation (the “Company”) are described in Note 1 of the Notes to Consolidated Financial Statements included in its 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows the same accounting policies and considers each interim period as an integral part of an annual period. Certain amounts presented for the period have been reclassified to conform with the presentation used in the current period.
Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order to be recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 31, 2006 (See Note 7 for additional information).
NOTE 2 – ACQUISITIONS AND SALES
On May 31, 2007, Chittenden acquired Merrill Merchants Bancshares, Inc., headquartered in Bangor, Maine, and its subsidiary Merrill Merchants Bank for $111.3 million in cash and stock. Shareholders of the former Merrill Merchants Bancshares, Inc. who elected cash received all of their consideration in cash at the rate of $31.00 per share for each share of Merrill Merchants common stock. Shareholders who elected to receive Chittenden common stock received all of their consideration in the form of Chittenden common stock at the rate of 1.02 shares of Chittenden common stock for each share of Merrill Merchants common stock. The transaction has been accounted for as a purchase and, accordingly, the operations of Merrill Merchants 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 | $ | 15,672 | ||
FRB & FHLB Stock | 2,313 | |||
Securities available for sale | 65,596 | |||
Net loans | 357,080 | |||
Prepaid expenses and other assets | 11,800 | |||
Premises and equipment | 4,717 | |||
Identified Intangibles | 7,380 | |||
Goodwill | 66,410 | |||
Deposits | (347,907 | ) | ||
Borrowings | (62,767 | ) | ||
Accrued expenses and other liabilities | (8,996 | ) | ||
Total acquisition cost | $ | 111,298 | ||
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Following is supplemental information reflecting selected pro forma results as if this acquisition had been consummated as of the beginning of the earliest period presented, January 1, 2006 (in thousands, except EPS):
For the three months ended June 30, | For the six months ended June 30, | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
Total revenue | $ | 70,588 | $ | 85,984 | $ | 153,137 | $ | 169,558 | ||||
Income before income taxes | 18,178 | 28,995 | 48,374 | 61,189 | ||||||||
Net income | $ | 12,786 | $ | 19,300 | $ | 34,137 | $ | 40,347 | ||||
Diluted earnings per share (EPS) | $ | 0.28 | $ | 0.39 | $ | 0.75 | $ | 0.82 |
Total revenue includes net interest income and noninterest income.
NOTE 3 – ACQUIRED INTANGIBLE ASSETS
As of June 30, 2007 | |||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||
Amortized intangible assets (in thousands) | |||||||||
Core deposit intangibles | $ | 35,921 | $ | 17,934 | $ | 17,987 | |||
Customer list intangibles | 3,498 | 1,551 | 1,947 | ||||||
Acquired trust relationships | 4,000 | 2,948 | 1,052 | ||||||
Total | $ | 43,419 | $ | 22,433 | $ | 20,986 | |||
Aggregate Amortization Expense: | |||
For the three months ended June 30, 2007 | $ | 726 | |
For the six months ended June 30, 2007 | 1,391 | ||
Estimated Amortization Expense: | |||
For year ended 12/31/08 | $ | 3,397 | |
For year ended 12/31/09 | 3,397 | ||
For year ended 12/31/10 | 3,280 | ||
For year ended 12/31/11 | 3,117 | ||
For year ended 12/31/12 | 1,921 |
NOTE 4 – GOODWILL
The changes in the carrying amount of goodwill for the six months ended June 30, 2007 are as follows:
Commercial Banking Segment | Other Segment | Total | |||||||
Balance as of December 31, 2006 | $ | 210,986 | $ | 5,052 | $ | 216,038 | |||
Goodwill acquired during year | 66,410 | — | 66,410 | ||||||
Impairment losses | — | — | — | ||||||
Balance as of June 30, 2007 | $ | 277,396 | $ | 5,052 | $ | 282,448 | |||
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NOTE 5 – CREDIT QUALITY
The allowance for credit losses consists of two components: 1) the allowance for loan losses which is presented as a contra to total gross loans, and 2) the reserve for unfunded commitments included in other liabilities. 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. For a full discussion on the Company’s allowance for credit loss policies, see “Allowance for Credit Losses” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
Provisions for and activity in the allowance for credit losses are summarized as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Beginning allowance for loan losses: | $ | 62,768 | $ | 61,464 | $ | 62,160 | $ | 60,822 | ||||||||
Provision for loan losses | 1,500 | 1,750 | 3,000 | 3,283 | ||||||||||||
Allowance acquired from acquisition of Merrill Merchants | 4,054 | — | 4,054 | — | ||||||||||||
Loans charged off | (1,663 | ) | (1,872 | ) | (3,280 | ) | (3,625 | ) | ||||||||
Loan recoveries | 741 | 728 | 1,466 | 1,590 | ||||||||||||
Ending allowance for loan losses: | $ | 67,400 | $ | 62,070 | $ | 67,400 | $ | 62,070 | ||||||||
Components of allowance for credit losses: | ||||||||||||||||
Allowance for loan losses | $ | 67,400 | $ | 62,070 | $ | 67,400 | $ | 62,070 | ||||||||
Reserve for unfunded commitments | 1,226 | 1,200 | 1,226 | 1,200 | ||||||||||||
$ | 68,626 | $ | 63,270 | $ | 68,626 | $ | 63,270 | |||||||||
NOTE 6 – INVESTMENT SECURITIES
In the second quarter of 2007 Chittenden announced that it was taking steps to reposition its balance sheet through a strategy which involved the sale of approximately $572 million or 52% of the investment securities held in the available-for-sale investment portfolio in accordance with Statement of Financial Accounting Standards No.115 Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”). As a result of this strategy, Chittenden recorded a pretax loss on the sales of these securities of approximately $14.1 million. The available-for-sale investment securities, consisting primarily of lower yielding fixed rate agencies, mortgage backed securities and corporate notes, were replaced with shorter duration higher yielding securities. The Company executed the repositioning to reconfigure and shorten the cash flows of the investment portfolio to reflect the addition of Merrill Merchants, and to be consistent with its forecasts for future loan and deposit growth. As a result of the repositioning, the Company had securities available for sale of $918 million at June 30, 2007, down $219 million from December 31, 2006. The portfolio has expected cash flows of $87 million remaining in 2007 and $283 million in 2008 from maturities and expected principal payments on mortgage-backed securities.
NOTE 7 – 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 equivalent amount of junior subordinated debentures issued by the Company (the “Junior Subordinated Notes”). These Junior Subordinated Notes 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.
8
Concurrent with the issuance of the Trust Preferred Securities, the Company entered into interest rate swap agreements with two counterparties, pursuant to which the Company received 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. Transaction costs associated with the issuance were amortized on an effective yield basis over five years to the call date. In August 2006, the Company terminated the interest rate swap agreements with both counterparties. On July 1, 2007, the Company redeemed the remaining outstanding ($125 million aggregate principal amount) 8.00% Junior Subordinated Notes due 2032. The redemption of the Junior Subordinated Notes caused the trustee of the Trust to redeem the outstanding ($125 million liquidation amount) Trust Preferred Securities.
NOTE 8 – SUBORDINATED DEBT SECURITIES
On February 14, 2007, the Company issued $125 million in subordinated notes due February 2017. The subordinated debt has a coupon of 5.80% for the first five years and converts to a variable rate in year six that is tied to the three month LIBOR plus 68.5 basis points. The Company utilized the proceeds from the issuance of the subordinated debt, which was net of the $1.4 million of issuance costs, to redeem the Company’s Trust Preferred Securities, which were called on July 1, 2007. The issuance costs will be amortized over the next seven years. Beginning February 14, 2012, the Company may choose to redeem some or all of the notes. The subordinated debt securities ratings are Moody’s A3, DBRS BBBH, Fitch BBB+, and S&P BBB. The subordinated notes are included in the Company’s total capital ratio, including Tier two, for regulatory standards.
NOTE 9 – INCOME TAXES
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company adopted the provisions of FIN 48 and there has been no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48. However, certain amounts have been reclassified in the statement of financial position in order to comply with the requirements of the statement.
As of January 1, 2007, the Company provided a liability for $2,948,000 of unrecognized tax benefits related to various federal and state income tax matters. Of this amount, the amount that would impact the Company’s effective tax rate, if recognized, is $901,000. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets, and the federal tax benefit of state income tax items. The Company has provided an additional $144,000 to the reserve for unrecognized tax benefits through the quarter ended June 30, 2007. In addition, the Company paid $221,000 to the state of New Hampshire related to the 2002 year. Therefore, the reserve has decreased by $77,000 through June 30, 2007. The Company is currently undergoing a state tax audit for the 2003 year with the state of New Hampshire. The Company expects to settle this audit over the next year but does not believe the tax liability, if any, will be material. The Company does not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.
The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2003 through 2006. The Company and its subsidiaries state income tax returns are open to audit under the statute of limitations for the years ending December 31, 2002 through 2006.
As of January 1, 2007, the Company has accrued $356,000 of interest related to uncertain tax positions. As of June 30, 2007, the total amount of accrued interest was $407,000. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.
9
NOTE 10 – ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income is the total of net income and all other non-owner changes in equity. The following table summarizes reclassification detail for other comprehensive income for each of the three and six month periods ended June 30, 2007 and 2006 (amounts in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(In Thousands) | (In Thousands) | |||||||||||||||
Net Income | $ | 9,039 | $ | 21,009 | $ | 29,064 | $ | 41,207 | ||||||||
Unrealized gains (losses) on securities available for sale, net of tax | (2,227 | ) | (5,707 | ) | 529 | (11,960 | ) | |||||||||
Reclassification adjustments for losses arising during the period, net of tax | 9,124 | — | 9,115 | — | ||||||||||||
Foreign currency translation adjustments | (4 | ) | (1 | ) | (5 | ) | 4 | |||||||||
Total accumulated other comprehensive income | $ | 15,932 | $ | 15,301 | $ | 38,703 | $ | 29,251 | ||||||||
NOTE 11 – EARNINGS PER SHARE
The following table summarizes the calculation of basic and diluted earnings per share:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
(in thousands except per share information) | ||||||||||||
Net income | $ | 9,039 | $ | 21,009 | $ | 29,064 | $ | 41,207 | ||||
Weighted average common shares outstanding | 45,187 | 46,423 | 45,146 | 46,613 | ||||||||
Dilutive effect of common stock equivalents | 559 | 480 | 601 | 538 | ||||||||
Weighted average common and common equivalent shares outstanding | 45,746 | 46,903 | 45,747 | 47,151 | ||||||||
Basic earnings per share | $ | 0.20 | $ | 0.45 | $ | 0.64 | $ | 0.88 | ||||
Diluted earnings per share | 0.20 | 0.45 | 0.64 | 0.87 |
The following table summarizes anti-dilutive stock options which were not included in the computation of common stock equivalents:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
Anti-dilutive options | 521,742 | 923,865 | 501,436 | 923,865 | ||||||||
Weighted average exercise price | $ | 31.40 | $ | 29.50 | $ | 31.46 | $ | 29.50 |
NOTE 12 – STOCK PLANS
Stock options are the primary type of share-based payment utilized by the Company. Stock options are awards which allow an employee to purchase shares of the Company’s stock at a fixed price. In accordance with
10
the Company’s Stock Incentive Plan, stock options are granted at an exercise price equal to the Company’s stock price at the date of grant. For the 2007 grants the Company’s Board of Directors changed the option life from ten years to seven years.
The following tables summarize stock option activity during the first six months of 2007:
Options | Weighted-Average Exercise Price Per Share | |||||
Outstanding at December 31, 2006 | 3,536,986 | $ | 24.28 | |||
Options granted | 459,200 | 31.19 | ||||
Options exercised | (126,354 | ) | 22.68 | |||
Options forfeited | — | — | ||||
Options expired | — | — | ||||
Outstanding at June 30, 2007 | 3,869,832 | $ | 25.15 | |||
Exercisable at June 30, 2007 | 3,640,736 | $ | 24.77 |
Range of Exercise Prices | Options Outstanding | Options Exercisable | ||||||||
Options Outstanding | Weighted Avg. Contractual Life | Weighted Average Exercise Price | Options Exercisable | Weighted Average Exercise Price | ||||||
$ 14.62 - $ 20.70 | 704,104 | 3.75 | $ 19.51 | 704,104 | $ 19.51 | |||||
$ 20.86 - $ 22.89 | 695,983 | 4.45 | $ 22.08 | 695,983 | $ 22.08 | |||||
$ 22.93 - $ 24.50 | 655,961 | 6.80 | $ 23.95 | 655,961 | $ 23.95 | |||||
$ 24.60 - $ 29.11 | 982,442 | 7.01 | $ 27.51 | 982,442 | $ 27.51 | |||||
$ 29.20 - $ 31.20 | 787,606 | 6.79 | $ 30.47 | 558,510 | $ 30.17 | |||||
$ 32.74 - $ 36.02 | 43,736 | 1.35 | $ 34.38 | 43,736 | $ 34.38 | |||||
$ 14.62 - $ 36.02 | 3,869,832 | 5.81 | $ 25.15 | 3,640,736 | $ 24.77 | |||||
The Company estimates the fair value of stock option grants using the Black-Scholes valuation model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed by the Company based on historical volatility of the Company’s stock. The Company uses historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on the Company stock. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are consistent with SFAS 123R. Estimates of fair value are not intended to predict the actual future value ultimately realized by employees who receive share-based awards, and subsequent events are not indicative of the reasonableness of original estimates of fair value made by the Company under SFAS 123R.
The following table presents the key input assumptions for the Black-Scholes valuation model:
Six Months Ended June 30, | ||||||||
2007 | 2006 | |||||||
Expected term (years) | 4.46 | 4.79 | ||||||
Volatility | 22.45 | 24.67 | ||||||
Risk-free interest rate | 4.47 | % | 4.71 | % | ||||
Dividend yield | 2.57 | % | 2.47 | % | ||||
Fair value per share | $ | 6.09 | $ | 6.55 |
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The total intrinsic value (market value on date of exercise less grant price) of options exercised during the three months ended June 30, 2007 and 2006, was $301,000 and $376,000, respectively. The total cash received from employees as a result of employee stock option exercises for the quarters ended June 30, 2007 and 2006 was approximately $682,000 and $1.3 million, respectively. The tax benefit realized as a result of the stock option exercises was $98,000 in the second quarter of 2007 compared with $108,000 for the same period in 2006.
As of June 30, 2007, there was $1.3 million of unearned compensation cost related to non-vested stock options granted in 2007 under the plan. The Company expects to recognize the expense over the next two quarters. The total compensation cost related to options during the quarters ended June 30, 2007 and June 30, 2006 was $728,000 and $801,000, respectively. These amounts are included in salary expense in the accompanying consolidated Statements of Income.
NOTE 13 – PENSION PLAN
The Company sponsors a qualified defined benefit pension plan (“Pension Account Plan”). On December 31, 2005, benefits accrued under the Pension Account Plan were frozen based on participants’ current service and pay levels. Effective January 1, 2006, the Company’s annual contribution to its Incentive Savings and Profit Sharing Plan was enhanced for all eligible employees.
The components of net periodic pension expense, which is included in employee benefits expense in the consolidated statements of income, are presented below.
Six Months Ended June 30, | ||||||||
2007 | 2006 | |||||||
(in thousands) | ||||||||
Service cost | $ | — | $ | 498 | ||||
Interest cost | 1,939 | 1,922 | ||||||
Expected return on plan assets | (2,672 | ) | (2,600 | ) | ||||
Net amortization: | ||||||||
Prior service cost | — | — | ||||||
Net actuarial loss | 63 | 64 | ||||||
Transition cost | — | — | ||||||
Total amortization | 63 | 64 | ||||||
Net periodic pension income | $ | (670 | ) | $ | (116 | ) | ||
As previously disclosed in the Company’s financial statements for the year ended December 31, 2006, due to prior contributions made in excess of the minimum required amounts, the Company does not anticipate a required contribution during 2007. The Company made voluntary contributions totaling $1.5 million to the Pension Account Plan during 2006.
NOTE 14 – 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, Chittenden Trust Company, The Bank of Western Massachusetts, Flagship Bank and Trust Co., Ocean Bank, Maine Bank and Trust Co. and Merrill Merchants (the “Banks”), which provide similar products and services, and 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 deposits, business services, investment management and trust, and mortgage banking.
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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 consolidation adjustments reflect certain eliminations of inter-segment revenue, cash and parent company investments in subsidiaries
For the Three Months Ended June 30, 2007 | Commercial Banking | Other | Consolidation Adjustments | Consolidated | ||||||||||
(in thousands) | ||||||||||||||
Net interest income (1) | $ | 65,296 | $ | (3,342 | ) | $ | — | $ | 61,954 | |||||
Noninterest income | 3,215 | 1,557 | — | 4,772 | ||||||||||
Provision for credit losses | 1,500 | — | — | 1,500 | ||||||||||
Noninterest expense | 51,749 | 802 | — | 52,551 | ||||||||||
Net income (loss) before income tax | 15,262 | (2,587 | ) | — | 12,675 | |||||||||
Income tax expense/(benefit) | 4,790 | (1,154 | ) | — | 3,636 | |||||||||
Net income (loss) | $ | 10,472 | $ | (1,433 | ) | $ | — | $ | 9,039 | |||||
End of Period Assets | $ | 7,086,789 | $ | 1,047,180 | $ | (1,255,682 | ) | $ | 6,878,287 | |||||
For the Three Months Ended June 30, 2006 | Commercial Banking | Other | Consolidation Adjustments | Consolidated | ||||||||||
(in thousands) | ||||||||||||||
Net interest income (1) | $ | 64,267 | $ | (2,215 | ) | $ | — | $ | 62,052 | |||||
Noninterest income | 17,049 | 1,479 | — | 18,528 | ||||||||||
Provision for loan losses | 1,750 | — | — | 1,750 | ||||||||||
Noninterest expense | 45,692 | 1,944 | — | 47,636 | ||||||||||
Net income (loss) before income tax | 33,874 | (2,680 | ) | — | 31,194 | |||||||||
Income tax expense/(benefit) | 11,249 | (1,064 | ) | — | 10,185 | |||||||||
Net income (loss) | $ | 22,625 | $ | (1,616 | ) | $ | — | $ | 21,009 | |||||
End of Period Assets | $ | 6,632,815 | $ | 864,404 | $ | (1,036,604 | ) | $ | 6,460,615 | |||||
For the Six Months Ended June 30, 2007 | Commercial Banking | Other | Consolidation Adjustments | Consolidated | ||||||||||
(in thousands) | ||||||||||||||
Net interest income (1) | $ | 126,746 | $ | (6,011 | ) | $ | — | $ | 120,735 | |||||
Noninterest income | 19,066 | 3,789 | — | 22,855 | ||||||||||
Provision for credit losses | 3,000 | — | — | 3,000 | ||||||||||
Noninterest expense | 97,848 | 1,990 | — | 99,838 | ||||||||||
Net income (loss) before income tax | 44,964 | (4,212 | ) | — | 40,752 | |||||||||
Income tax expense/(benefit) | 13,711 | (2,023 | ) | — | 11,688 | |||||||||
Net income (loss) | $ | 31,253 | $ | (2,189 | ) | $ | — | $ | 29,064 | |||||
End of Period Assets | $ | 7,086,789 | $ | 1,047,180 | $ | (1,255,682 | ) | $ | 6,878,287 | |||||
For the Six Months Ended June 30, 2006 | Commercial Banking | Other | Consolidation Adjustments | Consolidated | ||||||||||
(in thousands) | ||||||||||||||
Net interest income (1) | $ | 127,303 | $ | (4,255 | ) | $ | — | $ | 123,048 | |||||
Noninterest income | 32,553 | 3,562 | — | 36,115 | ||||||||||
Provision for loan losses | 3,283 | — | — | 3,283 | ||||||||||
Noninterest expense | 90,906 | 3,130 | — | 94,036 | ||||||||||
Net income (loss) before income tax | 65,667 | (3,823 | ) | — | 61,844 | |||||||||
Income tax expense/(benefit) | 22,088 | (1,451 | ) | — | 20,637 | |||||||||
Net income (loss) | $ | 43,579 | $ | (2,372 | ) | $ | — | $ | 41,207 | |||||
End of Period Assets | $ | 6,632,815 | $ | 864,404 | $ | (1,036,604 | ) | $ | 6,460,615 |
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(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. |
NOTE 15 – STOCKHOLDERS’ EQUITY
On July 19, 2007 the Company’s Board of Directors declared the quarterly dividend of $0.22 cents per share, which will be paid on August 10, 2007 to shareholders of record on July 27, 2007. In the second quarter of 2007, the Company repurchased 534,600 shares of common stock at an average price per share of $29.56 under the Company’s share repurchase plans. The repurchase of the common stock may be done in negotiated transactions or open market purchases for two years from the date the repurchase plan was adopted. The Company issued approximately 2.2 million shares of common stock with a value of $66.6 million as part of the consideration in the Merrill Merchants transaction
NOTE 16 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet customers’ financing needs 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 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 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, plant and equipment, and real estate.
Commitments to originate loans, unused lines of credit, and unadvanced portions of commercial real estate and 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.
Other commitments refer to the Company’s equity investments in limited partnerships for CRA related low income housing projects.
Financial instruments whose contractual amounts represent off-balance sheet risk at June 30, 2007 (in thousands):
Loan Commitments | |||
Commitments to originate loans | $ | 181,928 | |
Unused home equity lines of credit | 445,007 | ||
Unused portions of business credit card lines | 46,418 | ||
Unadvanced portions of C&I loans | 537,087 | ||
Unadvanced portions of commercial real estate and construction loans | 226,863 |
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Standby Letters of Credit | |||
Notional amount collateralized by cash | $ | 48,132 | |
Notional amount of other standby letters of credit | 50,123 | ||
Liability associated with letters of credit recorded on balance sheet | 996 | ||
Other Commitments | |||
Equity investment commitments | $ | 10,350 |
NOTE 17 – SUBSEQUENT EVENTS
On July 1, 2007, the Company redeemed the outstanding Junior Subordinated Notes. The redemption of the Junior Subordinated Notes caused the property trustee of the Trust to redeem the outstanding Trust Preferred Securities. The Trust Preferred Securities were redeemed at a redemption price equal to the $25 liquidation amount for each of the Trust Preferred Securities plus accumulated but unpaid distributions to the redemption date. The Company utilized the proceeds from the February 14, 2007 issuance of subordinated debt, which was net of the $1.4 million of issuance costs, to redeem the Company’s Trust Preferred Securities. As a result of the redemption of the Trust Preferred Securities, the Company’s Tier 1 and leverage regulatory capital ratios will decline from the levels reported at June 30, 2006 and December 31, 2006 since the subordinated debt only counts as Tier 2 capital.
NOTE 18 – PENDING MERGERS AND ACQUISITIONS
On June 27, 2007, the Company announced that it had signed a definitive merger agreement to be acquired by People’s United Financial, Inc. (“People’s United”), in a stock and cash transaction valued at approximately $1.9 billion. The transaction, which is expected to close in the first quarter of 2008, remains subject to approvals by regulators and the Company’s shareholders. At closing, Chittenden shareholders will have the right, subject to proration, to elect to receive cash or People’s United common stock, in either case having a value equal to $20.35 plus the product of .8775 times the average closing price of People’s United shares for the five day period prior to the closing. As a result, the actual per share value on consummation of the acquisition will depend on the share price of People’s United at that time.
On June 4, 2007, the Company announced that it had signed a definitive merger agreement to acquire Community Bank & Trust Company (“Community”), for approximately $124.1 million in cash and stock as of announcement date. The acquisition is expected to close in the fourth quarter of 2007; however completion of the acquisition remains subject to the approval of the shareholders of Community, as well as various regulatory agencies. Under the rems of the merger agreement, shareholders of Community can elect to receive $33.37 per share in cash, with total cash consideration of approximately $33.4 million (assuming all stock options are cashed out at closing), or 1.1293 shares of Chittenden common stock for each share of Community stock they own, with total stock consideration of approximately 3.1 million shares of Chittenden commons stock. As a result of the transaction, Community will merge into Ocean Bank.
NOTE 19 – RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159 (“SFAS 159”),The Fair Value Option for Financial Assets and Financial Liabilities, which gives entities the option to measure eligible financial assets, and financial liabilities at fair value on an instrument by instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability. Subsequent changes in fair value must be recorded in earnings. This statement is effective as of the beginning of a company’s first fiscal year after November 15, 2007. The Company is in the process of analyzing the impact of SFAS 159.
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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, among others: changes in general, national or regional economic conditions; changes in loan default and charge-off rates; reductions in deposit levels necessitating increased borrowings to fund loans and investments; changes in interest rates; changes in levels of income and expense in 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; competition and its effect on pricing, spending, third-party relationships and revenues; failure of the parties to satisfy the closing conditions for the Chittenden/Community merger or the People’s United/Chittenden merger in a timely manner or at all; failure to obtain governmental approvals of either merger, or imposition of adverse regulatory conditions in connection with such approvals; failure of the Community shareholders to approve the Chittenden/Community merger or the Company’s shareholders to approve the People’s United/Chittenden merger; costs or difficulties related to the integration of the businesses following the completion of each merger; disruptions to the Company’s business as a result of the announcement and pendency of the People’s United/Chittenden merger; and other risk factors identified from time to time in the Company’s periodic filings with the Securities and Exchange Commission, including under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and in Item 1A of this report.
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 or non-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 Annual Report on Form 10-K for the year ended December 31, 2006. 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 Credit Losses (ACL). The allowance for credit losses consists of two components: (1) the allowance for loan losses and (2) the reserve for unfunded commitments. The allowance for loan losses is established through a charge against current earnings to the provision for credit 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 U.S. 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
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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 reserve for unfunded commitments is based on management’s estimate of the amount required to reflect the probable inherent losses on outstanding letters of credit, merchant processing activity and unused loan credit commitments. Adequacy of the reserve is determined using a consistent, systematic methodology, similar to the one that analyzes the allowance for loan losses. Management must also estimate the likelihood that these commitments would be funded and become loans. This is done by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the current utilization rates on lines available at the balance sheet date could change in the future. The Company’s methodology with respect to the assessment of the adequacy of the allowance for credit losses is more fully discussed in its Annual Report on Form 10-K for the year ended December 31, 2006.
Income Taxes.On January 1, 2007, the Company adopted Financial Accounting Interpretation Number 48 (“FIN 48”) to account for uncertain tax positions. FIN 48 prescribes a recognition threshold of more-likely –than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.
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 June 30, 2007, there were no valuation allowances set aside against any deferred tax assets.
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 unpaid 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.
Management Overview
For the quarter ended June 30, 2007, the Company earned $9.0 million, or $0.20 per diluted share. Excluding the non-recurring loss on the repositioning of the securities portfolio and the costs related to the merger of Merrill Merchants Bancshares Inc., the Company’s second quarter core earnings per share (non-GAAP) were $0.47 per diluted share or $21.6 million, compared to $21.0 million or $0.45 per diluted share for the same period a year ago. For the first six months of 2006, GAAP earnings were $29.1 million or $0.64 per diluted share. Core earnings (non-GAAP) for the first six months of 2007 were $41.6 million or $0.91 per diluted share, compared to $41.2 million or $0.87 per diluted share for the same period of a year ago. A reconciliation table of GAAP to non-GAAP financial measures for the estimated impact on the Company’s earnings per share is included below. Non-GAAP measures typically adjust GAAP performance measures to exclude the effects of significant gains, losses or expenses unusual in nature and not expected to recur. The Company’s management uses non-GAAP measures for
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operational and investment decisions and believes that these measures are among several useful measures for understanding its operating results, including in relation to its performance for prior periods, and financial condition. However, these measures should not be construed as a substitute for GAAP measures. Non-GAAP measures should be read and used in conjunction with the Company’s reported GAAP operating results and financial information. The following table reconciles the GAAP to non-GAAP measures referenced above.
For the three months ended 6/30/07 | For the six months ended 6/30/07 | |||||
Net income (GAAP) | $ | 9,039 | $ | 29,064 | ||
Losses on sales of securities (after tax) | 9,676 | 9,676 | ||||
Non recurring charge for Merrill Merchants (after tax) | 2,859 | 2,859 | ||||
Core net income (non-GAAP) | $ | 21,574 | $ | 41,599 | ||
Fully diluted earnings per share (GAAP) | $ | 0.20 | $ | 0.64 | ||
Fully diluted core earnings per share (non-GAAP) | $ | 0.47 | $ | 0.91 |
On June 27, 2007, the Company announced that it had signed a definitive merger agreement to be acquired by People’s United Financial, Inc. (“People’s United”), in a stock and cash transaction valued at approximately $1.9 billion. The transaction, which is expected to close in the first quarter of 2008, remains subject to approvals by regulators and the Company’s shareholders. At closing, Chittenden shareholders will have the right, subject to proration, to elect to receive cash or People’s United common stock, in either case having a value equal to $20.35 plus the product of .8775 times the average closing price of People’s United shares for the five day period prior to the closing. As a result, the actual per share value on consummation of the acquisition will depend on the share price of People’s United at that time.
On June 4, 2007, the Company announced that it had signed a definitive merger agreement to acquire Community Bank & Trust Company (“Community”), for approximately $124.1 million in cash and stock as of announcement date. The acquisition is expected to close in the fourth quarter of 2007; however completion of the acquisition remains subject to the approval of the shareholders of Community, as well as various regulatory agencies. Under the rems of the merger agreement, shareholders of Community can elect to receive $33.37 per share in cash, with total cash consideration of approximately $33.4 million (assuming all stock options are cashed out at closing), or 1.1293 shares of Chittenden common stock for each share of Community stock they own, with total stock consideration of approximately 3.1 million shares of Chittenden commons stock. As a result of the transaction, Community will merge into Ocean Bank.
On May 31, 2007, the Company announced that it had completed its acquisition of Merrill Merchants Bancshares, Inc., a $457 million commercial bank headquartered in Bangor, Maine for $44 million in cash and approximately 2.2 million shares of the Company’s common stock. This transaction has been accounted for as a purchase and, accordingly, Merrill Merchants’ operations are reflected in the Company’s consolidated financial statements from the date of acquisition. Merrill Merchants presently operates 11 banking offices in Kennebec, Penobscot, and Somerset counties in Maine.
Results of Operations
Net interest income on a tax equivalent basis for the three months ended June 30, 2007 was $63.2 million, which was up $3.3 million or 5.6% from the first quarter of 2007 and $408,000 from the same period a year ago. Merrill Merchants contributed $1.5 million in net interest income during the second quarter. The net yield on earning assets was 4.14% for the second quarter of 2007, an increase of 8 basis points on a linked quarter basis and down 8 basis points from the second quarter of 2006. The increases in both net interest income and the net interest margin from the first quarter of 2007 resulted primarily from the acquisition of Merrill Merchants, and the second quarter investment securities portfolio repositioning. The decline in the net interest margin from the second quarter of 2006 primarily related to the 2007 issuance of the subordinated debt securities, higher funding costs and termination of the TPS interest rate swaps in the third quarter of 2006.
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Net interest income on a tax equivalent basis for the six months ended June 30, 2007 was $123.1 million compared with $124.5 million for the same period a year ago. The net interest margin was 4.10%, a decrease of 11 basis points, compared to 4.21% for the same period a year ago. The decline from a year ago was driven by an increase in funding costs, which was partially offset by an increase in the yield on interest earning assets and a higher average balance sheet.
For the second quarter of 2007 GAAP return on average equity (ROE) was 5.35%. Core ROE (non-GAAP) for the quarter ended June 30, 2007 was 12.75% flat with the same period in 2006. GAAP return on average assets (ROA) was 0.55% for the second quarter of 2007. Core ROA (non-GAAP) was 1.30% flat with the second quarter of last year. The six month GAAP ROE was 8.73% through June 30, 2007. The Company’s year to date Core ROE (non-GAAP) was 12.47%, compared with 12.48% for the same period in 2006. GAAP ROA was 0.90% for the six-month period ended June 30, 2007. Core ROA (non-GAAP) of 1.28% was effectively flat with the same period in 2006. The following table reconciles the GAAP to non-GAAP measures.
For the three months ended | For the six months ended | |||||||||||||||
6/30/07 | 6/30/06 | 6/30/07 | 6/30/06 | |||||||||||||
Net income (GAAP) | $ | 9,039 | $ | 21,009 | $ | 29,064 | $ | 41,207 | ||||||||
Losses on sales of securities (after tax) | 9,676 | — | 9,676 | — | ||||||||||||
Non recurring charge for Merrill Merchants (after tax) | 2,859 | — | 2,859 | — | ||||||||||||
Core net income (non-GAAP) | $ | 21,574 | $ | 21,009 | $ | 41,599 | $ | 41,207 | ||||||||
Average Equity (GAAP) | $ | 677,370 | $ | 661,020 | $ | 671,212 | $ | 666,008 | ||||||||
Non recurring charge for Merrill Merchants (after tax) | 1,361 | — | 1,361 | — | ||||||||||||
Core Average Equity (non-GAAP) | $ | 678,731 | $ | 661,020 | $ | 672,573 | $ | 666,008 | ||||||||
Average Assets (GAAP) | 6,637,111 | 6,462,457 | 6,532,150 | 6,446,587 | ||||||||||||
Return on Average Equity | 5.35 | % | 12.75 | % | 8.73 | % | 12.48 | % | ||||||||
Core Return on Average Equity (non-GAAP) | 12.75 | % | 12.75 | % | 12.47 | % | 12.48 | % | ||||||||
Return on Average Assets | 0.55 | % | 1.30 | % | 0.90 | % | 1.29 | % | ||||||||
Core Return on Average Assets (non-GAAP) | 1.30 | % | 1.30 | % | 1.28 | % | 1.29 | % |
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The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the three months and six months ended June 30, 2007 and 2006:
For the Three Months Ended June 30, 2007 | For the Three Months Ended June 30, 2006 | Description | For the Six Months Ended June 30, 2007 | For the Six Months Ended June 30, 2006 | ||||||||||||||||||||||||||||||||||||
Average Balance | Interest Income/ Expense (1) | Average Yield/ Rate (1) | Average Balance | Interest Income/ Expense (1) | Average Yield/ Rate (1) | 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: | ||||||||||||||||||||||||||||||||||||||||
$ | 902,204 | $ | 18,253 | 8.11 | % | $ | 852,140 | $ | 16,604 | 7.82 | % | C&I | $ | 880,840 | $ | 35,121 | 8.04 | % | $ | 835,763 | $ | 31,432 | 7.58 | % | ||||||||||||||||
152,404 | 2,228 | 5.85 | 167,621 | 2,034 | 4.85 | Municipal | 150,292 | 4,401 | 5.86 | 167,373 | 4,012 | 4.79 | ||||||||||||||||||||||||||||
255,054 | 4,527 | 7.02 | 198,799 | 3,475 | 6.91 | Multifamily | 237,124 | 8,375 | 7.02 | 197,544 | 6,779 | 6.83 | ||||||||||||||||||||||||||||
2,010,441 | 36,003 | 7.18 | 1,847,041 | 31,682 | 6.88 | Commercial real estate | 1,979,645 | 70,048 | 7.14 | 1,829,732 | 61,713 | 6.80 | ||||||||||||||||||||||||||||
224,423 | 4,230 | 7.46 | 220,701 | 4,061 | 7.28 | Construction | 228,067 | 8,600 | 7.50 | 213,326 | 7,668 | 7.15 | ||||||||||||||||||||||||||||
805,079 | 12,946 | 6.43 | 756,450 | 11,636 | 6.15 | Residential | 785,641 | 25,328 | 6.51 | 752,950 | 22,652 | 6.02 | ||||||||||||||||||||||||||||
328,717 | 6,544 | 7.98 | 318,705 | 6,135 | 7.72 | Home equity | 324,723 | 12,937 | 8.03 | 315,891 | 11,814 | 7.54 | ||||||||||||||||||||||||||||
241,421 | 3,904 | 6.49 | 253,296 | 3,664 | 5.79 | Consumer | 237,575 | 7,466 | 6.34 | 253,680 | 7,218 | 5.72 | ||||||||||||||||||||||||||||
4,919,743 | 88,635 | 7.21 | 4,614,753 | 79,291 | 6.88 | Total loans | 4,823,907 | 172,276 | 7.18 | 4,566,259 | 153,288 | 6.75 | ||||||||||||||||||||||||||||
Investments: | ||||||||||||||||||||||||||||||||||||||||
961,203 | 10,861 | 4.52 | 1,332,946 | 14,113 | 4.24 | Taxable | 1,041,323 | 22,534 | 4.33 | 1,361,749 | 28,730 | 4.22 | ||||||||||||||||||||||||||||
95,751 | 1,452 | 6.08 | 498 | 8 | 6.52 | Tax-favored securities | 82,476 | 2,433 | 5.95 | 499 | 16 | 6.52 | ||||||||||||||||||||||||||||
3,080 | 39 | 5.10 | 280 | 2 | 3.08 | Interest-bearing deposits in banks | 2,035 | 50 | 4.98 | 280 | 4 | 3.02 | ||||||||||||||||||||||||||||
127,611 | 1,683 | 5.29 | 16 | — | 5.12 | Federal funds sold | 68,676 | 1,801 | 5.29 | 3,295 | 69 | 4.23 | ||||||||||||||||||||||||||||
6,107,388 | 102,670 | 6.73 | 5,948,493 | 93,414 | 6.29 | Total interest-earning assets | 6,018,417 | 199,094 | 6.65 | 5,932,082 | 182,107 | 6.17 | ||||||||||||||||||||||||||||
594,412 | 575,990 | Noninterest-earning assets | 577,505 | 576,363 | ||||||||||||||||||||||||||||||||||||
(64,689 | ) | (62,026 | ) | Allowance for loan losses | (63,772 | ) | (61,858 | ) | ||||||||||||||||||||||||||||||||
$6,637,111 | $ | 6,462,457 | Total assets | $ | 6,532,150 | $ | 6,446,587 | |||||||||||||||||||||||||||||||||
Liabilities and stockholders’ Equity | ||||||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||
475,400 | 1,072 | 0.90 | 480,161 | 768 | 0.64 | Savings | 469,847 | 2,077 | 0.89 | % | 485,563 | 1,480 | 0.61 | |||||||||||||||||||||||||||
857,561 | 2,055 | 0.96 | 881,753 | 1,566 | 0.71 | NOW | 841,799 | 3,907 | 0.94 | 875,765 | 2,997 | 0.69 | ||||||||||||||||||||||||||||
1,590,711 | 12,509 | 3.15 | 1,564,648 | 9,773 | 2.51 | CMAs/money market | 1,598,637 | 24,739 | 3.12 | 1,603,093 | 19,026 | 2.39 | ||||||||||||||||||||||||||||
914,064 | 9,117 | 4.00 | 861,429 | 6,939 | 3.23 | Certificates of deposit under $100,000 | 888,822 | 17,264 | 3.92 | 846,869 | 12,957 | 3.09 | ||||||||||||||||||||||||||||
745,627 | 8,782 | 4.72 | 661,091 | 6,669 | 4.05 | Certificates of deposit $100,000 and over | 723,125 | 16,900 | 4.71 | 641,491 | 12,320 | 3.87 | ||||||||||||||||||||||||||||
4,583,363 | 33,535 | 2.93 | 4,449,082 | 25,715 | 2.32 | Total interest-bearing deposits | 4,522,230 | 64,887 | 2.89 | 4,452,781 | 48,780 | 2.21 | ||||||||||||||||||||||||||||
96,062 | 854 | 3.56 | 96,846 | 886 | 3.67 | Repurchase agreements | 92,269 | 1,658 | 3.62 | 80,801 | 1,251 | 3.12 | ||||||||||||||||||||||||||||
286,967 | 5,074 | 7.09 | 270,675 | 4,014 | 5.95 | Other borrowings | 263,886 | 9,461 | 7.23 | 263,695 | 7,547 | 5.77 | ||||||||||||||||||||||||||||
4,966,392 | 39,463 | 3.19 | 4,816,603 | 30,615 | 2.55 | Total interest-bearing liabilities | 4,878,385 | 76,006 | 3.14 | 4,797,277 | 57,578 | 2.42 | ||||||||||||||||||||||||||||
Noninterest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||
926,161 | 923,285 | Demand deposits | 914,720 | 922,234 | ||||||||||||||||||||||||||||||||||||
67,188 | 61,549 | Other liabilities | 67,833 | 61,068 | ||||||||||||||||||||||||||||||||||||
5,959,741 | 5,801,437 | Total liabilities | 5,860,938 | 5,780,579 | ||||||||||||||||||||||||||||||||||||
677,370 | 661,020 | Stockholders’ equity | 671,212 | 666,008 | ||||||||||||||||||||||||||||||||||||
$ | 6,637,111 | $ | 6,462,457 | Total liabilities and stockholders’ equity | $ | 6,532,150 | $ | 6,446,587 | ||||||||||||||||||||||||||||||||
$ | 63,207 | $ | 62,799 | Net interest income | $ | 123,088 | $ | 124,529 | ||||||||||||||||||||||||||||||||
3.54 | % | 3.74 | % | Interest rate spread (2) | 3.51 | % | 3.75 | % | ||||||||||||||||||||||||||||||||
4.14 | % | 4.22 | % | Net yield on earning assets (3) | 4.10 | % | 4.21 | % |
(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. |
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 six months ended June 30, 2007. Changes due to both interest rate and volume have been allocated in proportion to the relationship of the absolute dollar amounts of the change in each.
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QTD 2007 Compared with QTD 2006 | Description | YTD 2007 Compared with YTD 2006 | ||||||||||||||||||||||
Increase (Decrease) in Net Interest Income Due to: | Total Increase (Decrease) | Increase (Decrease) in Net Interest Income Due to: | Total Increase | |||||||||||||||||||||
Average Rate | Average Balance | Average Rate | Average Balance | |||||||||||||||||||||
(in thousands) | (in thousands) | |||||||||||||||||||||||
Interest income: | ||||||||||||||||||||||||
Loans: | ||||||||||||||||||||||||
$ | 635 | $ | 1,014 | $ | 1,649 | C&I | $ | 1,892 | $ | 1,797 | $ | 3,689 | ||||||||||||
416 | (222 | ) | 194 | Municipal | 889 | (500 | ) | 389 | ||||||||||||||||
57 | 995 | 1,052 | Multifamily | 198 | 1,398 | 1,596 | ||||||||||||||||||
1,395 | 2,926 | 4,321 | Commercial real estate | 3,030 | 5,305 | 8,335 | ||||||||||||||||||
99 | 70 | 169 | Construction | 376 | 556 | 932 | ||||||||||||||||||
529 | 781 | 1,310 | Residential real estate | 1,621 | 1,055 | 2,676 | ||||||||||||||||||
210 | 199 | 409 | Home equity | 771 | 352 | 1,123 | ||||||||||||||||||
432 | (192 | ) | 240 | Consumer | 754 | (506 | ) | 248 | ||||||||||||||||
3,773 | 5,571 | 9,344 | Total loans | 9,531 | 9,457 | 18,988 | ||||||||||||||||||
Investments: | ||||||||||||||||||||||||
948 | (4,200 | ) | (3,252 | ) | Taxable | 738 | (6,934 | ) | (6,196 | ) | ||||||||||||||
— | 1,444 | 1,444 | Tax-favored | (1 | ) | 2,418 | 2,417 | |||||||||||||||||
1 | 36 | 37 | Interest-bearing deposits | 3 | 43 | 46 | ||||||||||||||||||
— | 1,683 | 1,683 | Federal funds sold | 17 | 1,715 | 1,732 | ||||||||||||||||||
4,722 | 4,534 | 9,256 | Total interest income | 10,288 | 6,699 | 16,987 | ||||||||||||||||||
Interest expense: | ||||||||||||||||||||||||
(315 | ) | 11 | (304 | ) | Savings | (667 | ) | 70 | (597 | ) | ||||||||||||||
(547 | ) | 58 | (489 | ) | NOWs | (1,068 | ) | 158 | (910 | ) | ||||||||||||||
(2,531 | ) | (205 | ) | (2,736 | ) | CMAs/ Money Market | (5,782 | ) | 69 | (5,713 | ) | |||||||||||||
(1,653 | ) | (525 | ) | (2,178 | ) | Certificates of deposit under $100,000 | (3,492 | ) | (815 | ) | (4,307 | ) | ||||||||||||
(1,117 | ) | (996 | ) | (2,113 | ) | Certificates of deposit $100,000 and over | (2,672 | ) | (1,908 | ) | (4,580 | ) | ||||||||||||
25 | 7 | 32 | Repurchase agreements | (200 | ) | (207 | ) | (407 | ) | |||||||||||||||
(772 | ) | (288 | ) | (1,060 | ) | Other borrowings | (1,907 | ) | (7 | ) | (1,914 | ) | ||||||||||||
(6,910 | ) | (1,938 | ) | (8,848 | ) | Total interest expense | (15,788 | ) | (2,640 | ) | (18,428 | ) | ||||||||||||
$ | (2,188 | ) | $ | 2,596 | $ | 408 | Change in net interest income | $ | (5,500 | ) | $ | 4,059 | $ | (1,441 | ) | |||||||||
Noninterest Income
Noninterest income was $4.8 million for the second quarter of 2007. Investment management and trust fees increased $516,000 from the first quarter of 2007 and $861,000 from the second quarter of 2006. This increase was primarily driven by higher annuity income at Chittenden Securities, LLC, as well as increased sales of retirement plan services. Merrill Merchants contributed $388,000 to noninterest income for the second quarter of 2007. As previously noted, Chittenden realized $14.1 million of losses on sales of investments for the second quarter of 2007 related to its repositioning of its securities portfolio. Further discussion on this repositioning is located in the “Liquidity” section below.
Gains on sales of loans declined $566,000 for the first six months of 2007. The Company originated $211 million and sold $157 million in residential real estate loans during the first six months of 2007, which was up from $204 million and $145 million, respectively, during the same period in 2006. Volatility in interest rates can significantly impact mortgage origination and sales volumes, amortization of mortgage servicing assets and related impairment recoveries based on the fair value of those assets as measured based on current interest rates. During 2007, mortgage interest rates have moved steadily but gradually upward, leading to slower prepayment speeds and as a result lower amortization and higher impairment recoveries. During the first six months of 2007, the MSR amortization was $1.4 million as compared to $1.6 million for the same period in 2006. The Company recorded an impairment recovery of $469,000 during 2007 as compared to $214,000 for the same period a year ago. The remaining impairment reserve for particular stratas in the MSR’s at June 30, 2007 was $138,000. The Company services approximately $2.2 billion in mortgages for others and has net capitalized mortgage-servicing rights of $16.1 million. As a result, the MSR asset as a percentage of loans serviced was approximately 72 basis points as of June 30, 2007.
Noninterest Expense
Noninterest expense was $52.6 million for the second quarter of 2007, compared with $47.3 million for the first quarter of 2007. In the second quarter of 2007, the Company recognized $4.1 million of non-recurring charges related to the acquisition of Merrill Merchants. Excluding the acquisition charge ($4.1 million) and noninterest expenses ($854,000) related to Merrill Merchants, noninterest expenses for the second quarter of 2007 would have been $47.4 million, an increase of only $100,000 on a linked quarter basis.
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For the first six months of 2007 noninterest expense was $99.8 million, an increase of $5.8 million from the same period in 2006. Merrill Merchants represented $5.2 million of the increase, which resulted from higher net occupancy and other noninterest expenses. Excluding Merrill Merchants, net occupancy increased $279,000 primarily due to higher landscaping, utilities and maintenance contracts. Other noninterest expense increased from the same period in 2006 due to higher legal 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 effective income tax rate was 28.7% for the second quarter compared with 32.7% for the respective period in 2006. The lower effective income tax rate was primarily attributable to higher low income housing credits and charitable contributions as well as a first quarter 2007 change in the tax accounting method for a customer list intangible related to a prior acquisition.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company adopted the provisions of FIN 48 and there has been no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48. However, certain amounts have been reclassified in the statement of financial position in order to comply with the requirements of the statement.
As of January 1, 2007, the Company has provided a liability for $2,948,000 of unrecognized tax benefits related to various federal and state income tax matters. Of this liability, the amount that would impact the Company’s effective tax rate, if recognized, is $901,000. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets, and the federal tax benefit of state income tax items. The Company has provided an additional $144,000 to the reserve through the quarter ended June 30, 2007. In addition, the Company paid $221,000 to the state of New Hampshire related to the 2002 year. Therefore, the reserve has decreased by $77,000 through June 30, 2007. The Company is currently undergoing a state tax audit for the 2003 year with the state of New Hampshire. The Company expects to settle this audit over the next year but does not believe the tax liability, if any, will be material. The Company does not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.
The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2003 through 2006. The Company and its subsidiaries state income tax returns are open to audit under the statute of limitations for the years ending December 31, 2002 through 2006. As of January 1, 2007, the Company has accrued $356,000 of interest related to uncertain tax positions. As of June 30, 2007, the total amount of accrued interest was $407,000. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.
Financial Position
Total loans at June 30, 2007 increased $412 million from December 31, 2006 and $535 million from the same period a year ago. The increases were attributable to continued growth across the various commercial loan categories as well as the inclusion of Merrill Merchants, which contributed $360 million. The Company’s securities portfolio declined by 19% from $1.1 billion at December 31, 2006 to $918 billion at June 30, 2007. This decline was partially offset by an increase in cash and cash equivalents of $162 million and $65 million related to Merrill Merchants. These variances primarily resulted from the Company’s repositioning of its securities portfolio in the second quarter of 2007 as well as loan growth in excess of the Company’s deposit growth. (Further discussion on the repositioning is located in the “Liquidity” section below.) The commercial real estate portfolio including Merrill Merchants experienced
22
growth of 6.4% on a linked quarter basis and 11.6% from the same period of a year ago. The growth in the commercial real estate portfolio was throughout the franchise and was not specifically concentrated in any one industry. In addition, over 64% of the commercial real estate portfolio is owner occupied. The emphasis on the construction portfolio relates to the financing of projects for commercial customers, as well as individual consumer loans. Accordingly, this portfolio is comprised of approximately 28% in loans to residential developers, 27% in individual consumer construction loans, 23% in loans to commercial customers for owner occupied properties and 22% to commercial customers for investor properties.
Total deposits at June 30, 2007 increased $196 million from December 31, 2006 and $358 million from June 30, 2006. The increase in both periods is a result of the Merrill Merchants acquisition, which contributed $360 million at June 30, 2007. The variance from year-end included the normal seasonal declines in municipal deposits of approximately $83 million. Approximately 43% of the Company’s deposit base is comprised of demand, savings and NOW accounts, which had an overall weighted average cost of 56 basis points in the second quarter of 2007. In addition, approximately 27% of the Company’s deposits are held in CMA/Money Market accounts with an average weighted cost for the second quarter of 2007 of 315 basis points. The overall cost of the Company’s deposits in the second quarter of 2007 was 244 basis points (including noninterest bearing deposits) and the Company’s all in cost of funds was 269 basis points.
Repurchase agreements and other borrowings at June 30, 2007 were $405 million, which includes $62 million for Merrill Merchants, compared with $210 million at December 31, 2006 and $424 million at June 30, 2006. The increase from the prior year end was primarily due to the issuance of $125 million of subordinated debt securities on February 14, 2007 and Merrill Merchants. The decline of $19 million from June 30, 2006 was due to a decline in fed funds of $152 million, which was offset by the issuance of $125 million of subordinated debt securities.
Credit Quality
The provision for credit losses was $1.5 million for the second quarter of 2007, down $250,000 from the second quarter of 2006. Consistent low net charge-offs and solid asset quality supported the lower provision. As of June 30, 2007, nonperforming assets (“NPAs”) were $29.5 million, up $4.8 million from the same period in 2006. The increase in NPAs related to a number of small commercial loans, the largest of which was $1.5 million and the addition of $1.4 million related to Merrill Merchants. In addition, loans with payments less than 30 days past due represent 56% of the total loans in non-performing loans. As a percentage of total loans, NPAs were 58 basis points, which was up 4 basis points from the second quarter of 2006. Net charge-off activity totaled $922,000 for the second quarter of 2007, which was down $222,000 from the second quarter of 2006.
A summary of the Company’s credit quality follows:
6/30/07 | 3/31/07 | 12/31/06 | 6/30/06 | |||||||||||||
(in thousands) | ||||||||||||||||
Nonaccrual loans | $ | 29,113 | $ | 23,282 | $ | 20,094 | $ | 24,323 | ||||||||
Other real estate owned (OREO) | 426 | 30 | 264 | 404 | ||||||||||||
Total NPAs | $ | 29,539 | $ | 23,312 | $ | 20,358 | $ | 24,727 | ||||||||
Loans past due 90 days or more and still accruing interest | $ | 4,141 | $ | 3,930 | $ | 3,352 | $ | 2,283 | ||||||||
NPAs as % of loans plus OREO | 0.58 | % | 0.49 | % | 0.43 | % | 0.54 | % | ||||||||
ACL as % of loans | 1.34 | % | 1.34 | % | 1.35 | % | 1.38 | % | ||||||||
ACL as % of loans (excluding municipal loans) | 1.37 | % | 1.39 | % | 1.39 | % | 1.41 | % | ||||||||
ACL as % of nonaccrual loans | 235.72 | % | 274.75 | % | 315.32 | % | 260.13 | % |
23
Provisions for and activity in the allowance for credit losses are summarized as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Beginning allowance for loan losses: | $ | 62,768 | $ | 61,464 | $ | 62,160 | $ | 60,822 | ||||||||
Provision for loan losses | 1,500 | 1,750 | 3,000 | 3,283 | ||||||||||||
Allowance acquired from acquisition of Merrill Merchants | 4,054 | — | 4,054 | — | ||||||||||||
Loans charged off | (1,663 | ) | (1,872 | ) | (3,280 | ) | (3,625 | ) | ||||||||
Loan recoveries | 741 | 728 | 1,466 | 1,590 | ||||||||||||
Ending allowance for loan losses: | $ | 67,400 | $ | 62,070 | $ | 67,400 | $ | 62,070 | ||||||||
Components of allowance for credit losses: | ||||||||||||||||
Allowance for loan losses | $ | 67,400 | $ | 62,070 | $ | 67,400 | $ | 62,070 | ||||||||
Reserve for unfunded commitments | 1,226 | 1,200 | 1,226 | 1,200 | ||||||||||||
$ | 68,626 | $ | 63,270 | $ | 68,626 | $ | 63,270 | |||||||||
The allowance for credit losses consists of two components: 1) the allowance for loan losses which is presented as a contra to total gross loans, and 2) the reserve for unfunded commitments included in other liabilities. 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.
For a full discussion on the Company’s allowance for credit loss policies, see “Allowance for Credit Losses” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
Capital
Stockholders’ equity totaled $723 million at June 30, 2007, compared to $671 million at December 31, 2006. Net income of $29 million for the first six months of 2007 and an after tax increase of $9.6 million in the fair market value of the Company’s securities portfolio increased stockholders’ equity, which was offset by common stock dividend payments of $19 million and the Company’s repurchase of $39.6 million in common stock. In the second quarter of 2007, the Company repurchased 534,600 shares of common stock at an average price of $29.46 per share. These repurchases were completed under the Company’s share repurchase plans. The Company may repurchase up to 1,000,000 shares of its common stock in negotiated transactions or open market purchases for two years from the date that the repurchase plan was adopted. Tier one capital, consisting of common equity and the Trust Preferred Securities, measured 10.26% of risk-weighted assets at June 30, 2007. Total capital, including the Tier two allowance for credit losses, Trust Preferred Securities, and the subordinated debt, was 13.83% of risk-weighted assets and the leverage capital ratio was 8.73%. These ratios placed the Company in the “well-capitalized” category according to regulatory standards. As a result of the redemption of the Trust Preferred Securities, the regulatory capital ratios will decline from the levels at June 30, 2007.
In June 2004, the central bank governors of the member countries of the Basel Committee approved a revised capital adequacy framework generally known as the “Basel II Framework.” The Basel II Framework is a three-pillar capital adequacy approach versus the flat 8% of risk-weighted assets (as defined) currently used. The Basel II Framework also permits qualifying bank institutions to use more advanced approaches for measuring operational risk and credit risk. In order to address competitive equity issues for community and regional banking organizations that could arise under the bifurcated regulatory capital framework following the implementation of the Basel II Framework, the United States bank regulatory agencies issued an advance notice of proposed rulemaking in October 2005, known as Basel IA, which would make some aspects of the Basel II Framework applicable in modified form to smaller banks. After receiving extensive comment, the agencies proposed a notice of proposed rulemaking in December 2006. It remains uncertain whether the rules will be adopted and, even if adopted, how closely the final Basel IA rules will resemble the rules described in the notice of proposed rulemaking and the effective date of such rules.
Liquidity
The Company’s liquidity is 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
24
all times with available cash or by conversion of other assets to cash at a reasonable price. For the quarter ended June 30, 2007, the Company’s ratio of average loans to average deposits was approximately 89.3%. At June 30, 2007, the Company maintained cash balances and short-term investments of $361 million, compared with $199 million at December 31, 2006.
In the second quarter of 2007 Chittenden announced that it was taking steps to reposition its balance sheet through a strategy which involved the sale of approximately $572 million or 52% of the investment securities held in the available-for-sale investment portfolio in accordance with Statement of Financial Accounting Standards No.115 Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”). As a result of this strategy, Chittenden recorded a pretax loss on the sales of these securities of approximately $14.1 million. The available-for-sale investment securities, consisting primarily of lower yielding fixed rate agencies, mortgage backed securities and corporate notes, were replaced with shorter duration higher yielding securities. The Company executed the repositioning to reconfigure and shorten the cash flows of the investment portfolio to reflect the addition of Merrill Merchants, and to be consistent with its forecasts for future loan and deposit growth. As a result of the repositioning, the Company had securities available for sale of $918 million at June 30, 2007, down $219 million from December 31, 2006. The portfolio has expected cash flows of $87 million remaining in 2007 and $283 million in 2008 from maturities and expected principal payments on mortgage-backed securities.
Repurchase agreements and other borrowings at June 30, 2007 were $405 million compared to $210 million on December 31, 2006. The increase primarily resulted from the issuance of $125 million of subordinated debt securities in February 2007 as well as the addition of Merrill Merchants, which contributed $62 million. The Company utilized the proceeds from the issuance of the subordinated debt securities to redeem its Trust Preferred Securities on July 1, 2007. The Company has available borrowing capacity under certain programs including the FHLB, U.S. Treasury, repurchase agreement lines, and advised Fed Funds lines totaling more than $1.4 billion. The Company also has an effective shelf registration statement under which an additional $100 million in debt securities, common stock, preferred stock, or warrants may be offered from time to time.
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 | $ | 19,878 | $ | 4,348 | $ | 9,375 | $ | 2,987 | $ | 3,168 | |||||
Trust preferred securities | 125,000 | 125,000 | — | — | — | ||||||||||
Subordinated debt securities | 125,000 | — | — | — | 125,000 | ||||||||||
Data processing contract | 3,593 | 1,797 | 1,796 | — | — | ||||||||||
Equity investment commitments | 10,350 | 5,395 | 4,955 | — | — | ||||||||||
Operating leases | 30,044 | 5,618 | 8,307 | 5,676 | 10,443 | ||||||||||
Total | $ | 313,865 | $ | 142,158 | $ | 24,433 | $ | 8,663 | $ | 138,611 | |||||
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet customers’ financing needs 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 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
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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 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, plant and equipment, and real estate.
Commitments to originate loans, unused lines of credit, and unadvanced portions of commercial real estate and 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. Other commitments refer to the Company’s equity investments in limited partnerships for CRA related low income housing projects.
Financial instruments whose contractual amounts represent off-balance sheet risk at June 30, 2007 (in thousands):
Loan Commitments | |||
Commitments to originate loans | $ | 181,928 | |
Unused home equity lines of credit | 445,007 | ||
Unused portions of business credit card lines | 46,418 | ||
Unadvanced portions of C&I loans | 537,087 | ||
Unadvanced portions of commercial real estate and construction loans | 226,863 | ||
Standby Letters of Credit | |||
Notional amount collateralized by cash | $ | 48,132 | |
Notional amount of other standby letters of credit | 50,123 | ||
Liability associated with letters of credit recorded on balance sheet | 996 | ||
Other Commitments | |||
Equity investment commitments to limited partnerships | $ | 10,350 |
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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 “Qualitative and Quantitative Disclosures about Market Risk” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The Company has completed the analysis for June 30, 2007 and it remains consistent with the prior year-end.
Item 4. | Controls and Procedures |
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of June 30, 2007, 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. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2007 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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PART II - OTHER INFORMATION
Item 1. | Legal Proceedings |
None
Item 1A. | Risk Factors |
There have been no material changes to the risk factors previously disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, except for the following risks associated with the Company’s pending merger with People’s United:
• | The merger is subject to a number of contingencies, including approval by the Company’s stockholders, the receipt of required regulatory approvals and other customary closing conditions, each of which must either be satisfied or waived prior to the closing. |
• | The Company’s stock price may fluctuate prior to the completion of the merger due to (1) market assessments regarding the expected timing of the merger and risks related to completion of the merger, and (2) the trading price of People’s United common stock, as the value of the merger consideration to be received by the Company’s stockholders at the closing is based, in part, on the average closing price of People’s United common stock during the five trading days before completion of the merger. |
• | If the merger is not completed, the Company’s stock price will be subject to decline to the extent that the current trading price reflects a market assumption that the merger will be completed. |
• | The Company could lose important personnel as a result of the departure of employees who decide to pursue other opportunities in light of the proposed merger. |
• | The Company has and will continue to incur significant expenses related to the merger prior to its closing, which must be paid even if the merger is not completed. |
• | Depending upon the circumstances, the Company may be obligated to pay People’s United a termination fee of $65 million under the terms of the merger agreement with People’s United. |
• | The merger agreement with People’s United also imposes restrictions on the Company’s ability to conduct its business prior to the completion of the merger, which could potentially leave the Company unable to respond effectively to competitive pressures, industry developments and future opportunities or may otherwise harm its financial condition or results of operations. |
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
(c) The following table sets forth information with respect to any purchase made by or on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during the indicated periods.
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that may yet be Purchased under the Plans or Programs (1)(2) | |||||
April 1 - 30, 2007 | 249,500 | $ | 29.51 | 249,500 | 1,172,500 | ||||
May 1- 31, 2007 | 250,500 | 29.75 | 250,500 | 922,000 | |||||
June 1- 30, 2007 | 34,600 | 28.50 | 34,600 | 887,400 | |||||
Total | 534,600 | $ | 29.56 | 534,600 | 887,400 |
(1) On July 19, 2006, the Board of Directors authorized the repurchase of 1,000,000 shares of the Company’s common stock. The repurchase of the common stock may be done in negotiated transactions or open market purchases for two years from the date the repurchase plan was adopted.
(2) On April 18, 2007, the Board of Directors authorized the repurchase of 1,000,000 shares of the Company’s common stock. The repurchase of the common stock may be done in negotiated transactions or open market purchases for two years from the date the repurchase plan was adopted.
Item 3. | Defaults Upon Senior Securities |
None
Item 4. | Submission of Matters to a Vote of Security Holders |
Annual Meeting, April 18, 2007
Proposal 1:
Election of two directors, each to serve for a term of three years.
DIRECTOR | FOR | AUTHORITY WITHHELD | ||
Pall D. Spera | 40,463,807 | 405,263 | ||
Owen Wells | 40,565,984 | 303,086 |
Proposal 2:
To ratify the appointment of PricewaterhouseCoopers LLP as independent auditors for 2007.
FOR: 40,738,377
AGAINST: 40,490
ABSTAIN: 90,204
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ITEM 6. | EXHIBITS |
(a) EXHIBITS
2.1 | Agreement and Plan of Merger, dated June 26, 2007, by and between Chittenden Corporation and People’s United Financial, Inc. (Incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 27, 2007) | |
3.i.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.i.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). | |
3.ii.1 | Bylaws of the Company, as amended and restated as of October 18, 2006, (Incorporated herein by reference to Exhibit 3(ii) of the Company’s Current Report on Form 8-K filed on October 24, 2006). | |
* 10.1 | First Amendment to Chittenden Corporation Stock Incentive Plan, as Amended and Restated, adopted on April 18, 2007. | |
* 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. |
* | Filed herewith |
** | Furnished herewith |
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SIGNATURES
Pursuant to the requirements 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 | ||
July 26, 2007 | /s/ PAUL A. PERRAULT | |
Date | Paul A. Perrault, | |
Chairman, President and | ||
Chief Executive Officer | ||
July 26, 2007 | /s/ KIRK W. WALTERS | |
Date | Kirk W. Walters | |
Executive Vice President, | ||
Treasurer, and Chief Financial Officer |
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